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When companies talk about cost management, their focus typically is on slashing their current expenses. But in today’s digital era, cost management has taken on a new hue: It provides a strategic lever to generate savings that can be invested in driving growth.
Christopher Ittner, who chairs the accounting department at Wharton, and recently co-authored a paper titled, “Cost Management in the Digital Era,” with Omar Aguilar, the global strategic cost transformation leader of Deloitte Consulting. Ittner says: “Using cost management as a strategic lever, as opposed to a defensive response, opens up new opportunities.”
In a conversation with Knowledge@Wharton, Ittner discusses how companies can leverage digital technologies for cost management in a proactive way.
An edited transcript of the conversation follows.
Knowledge@Wharton: You write in your paper that cost management has become a competitive necessity. Why have companies changed their approach to cost management from being a defensive measure to something that is much more proactive?
Christopher Ittner: Traditionally, the only time we heard about cost management was when a company was in trouble. They laid off workers, closed manufacturing plants, etc. But the primary reason why most companies do cost management today has nothing to do with a problem that they need to address. What they are trying to do is free up resources and reinvest that money in the firm.
In finance theory, it is cheaper to generate your own cash than to go out and borrow it. So what lots of companies are doing is using cost management — getting rid of inefficiencies — and using that extra money for growth. This is a very different way of thinking. Using cost management as a strategic lever, as opposed to a defensive response, creates new opportunities. It is no longer a reactive tool. It is a proactive way to become more competitive in the global environment.
Knowledge@Wharton: Deloitte did a global study on this. What were the key findings?
Ittner: Deloitte has a biannual global cost management survey. According to the survey, most companies that do cost management don’t hit their cost targets. They don’t even get close to it. One of the key findings is that if you want to make cost management effective, make sure you’ve got a good strategic reason for doing it. It could be that you have a problem you have to solve and you have to cut costs. If that is really imperative, then, yes, you are going to cut costs, right? Otherwise, you’ve got to have a strong strategic imperative to cut cost and then reinvest it. These are the two groups [of companies] that hit their cost targets. But the companies that pursue cost management in response to growth imperatives are also the only ones that grow their revenues at the same time. The companies that do not do well are the ones who want to do cost management but don’t have a strong strategic imperative to do it.
Another thing that makes a big difference is: Who is in charge of the cost management? The higher the person is in the organization, the more likely it is going to be strategic and sustainable. It is going to be [more effective] if you’ve got a CEO who is responsible for this, or a major division head, as opposed to pushing this down to lower-level managers or staff.
A critical element is the information systems companies put in place to support this, which brings up the whole notion of digital. In the survey, we found that the people who have hit their cost targets and saved more money are the ones who have put in new digital technologies. They are putting better forecasting systems in place and better budgeting systems. The big thing we are seeing is the use of technologies like artificial intelligence and machine learning to understand cost structures better, to try to optimize what these companies are doing.
“Using cost management as a strategic lever, as opposed to a defensive response, opens up new opportunities.”
But even more than that, with the digital technologies that are now available, you can completely transform the way you do business. For example, take software service. Traditionally you’ve always had a big IT department and that’s a huge fixed cost. But now, using cloud computing, I could use software as a service. I am only paying for what I use. I can completely change the cost structure of my organization. So it is not just optimizing your current operations, it is how can I think outside the box in terms of how I deliver products and service to my customers, and what does my cost function look like.
Knowledge@Wharton: Some of the data I found really interesting, especially in terms of the responses of some of the Chinese companies that took part, was that just 35% of the Chinese companies were able to hit their cost reduction targets. If you look at the companies that were able to both cut costs and also increase their revenues by at least 10%, that number was even lower at about 12%. What are some of the reasons for that?
Ittner: This is true worldwide. It’s not just Chinese companies. Across the board, the percentage of companies that hit their cost management targets is far below 50%. And since a lot of them are using it to cut costs and not to grow their firm, they have not put into place a system to figure out which cost management efforts they can use and how they can redeploy those assets into some growth opportunity. We don’t see many companies that have been able to both cut their costs and grow their revenues. The ones that have done this have done cost management very differently.
Knowledge@Wharton: What sets apart companies that are able to both cut costs successfully and increase revenues, from those that are unable to this?
Ittner: The biggest difference is that they are using new technologies. They are not just taking the existing technologies and processes and trying to do them better. They are thinking outside of the box. They use new tools, new techniques, completely new cost structures that not only reduce costs, but also free up money for growth.
Take Amazon, for example. They have a huge IT infrastructure because they need it for their business. It’s cheaper for Amazon to have it in-house than to outsource it, and its part of their cost structure. Amazon’s thinking is: Now that I have this capability, I can take advantage of it to grow a whole new business. There is a whole new revenue stream for me — by selling cloud services. This is a very different way of thinking. It is not about cost management; it is about profit optimization. And notice that it is not called cost reduction, it is called cost management.
Knowledge@Wharton: Are there any other examples apart from Amazon, say in a different industry like finance, where you see the same thing happening — the creative use of digital technology to both manage costs as well as increase revenues?
“Across the board, the percentage of companies that hit their cost management targets is far below 50%.”
Ittner: A lot of cost management is happening in areas you never traditionally thought about, like overhead and indirect costs. We can start adding robotic process automation, we can use facial recognition. Take insurance companies. They have a lot of processes, a lot of forms that need to be filled and so on. These companies are now using technology, instead of human beings, for many of these things and therefore are able to process the customers’ claims much faster. So, not only are they cutting down their costs by using technology, they have the strategic advantage of making their customers happier.
Knowledge@Wharton: One outcome of using digital technology is that you get a lot more data than you did before. What kind of insights into managing costs can you get through big data and analytics?
Ittner: When we talk of big data, it’s not just a lot of things I can throw into an Excel spreadsheet. Data could be anything. It could be what is called soft data. Facial recognition is data: I can see how the person looks. I can see what kind of words you use. With technology, we can translate a lot of unstructured data into structured data. We can do the analysis. We also have algorithms and predictive analytics and cognitive technology and machine learning and artificial intelligence to let the computer identify some underlying relationships we never really thought about. Leveraging these underlying relationships can lead to big paybacks.
Knowledge@Wharton: One of the things you write in the paper is that in the past, cost management was often very tactical. But, as a result of some of these changes, it is becoming a lot more strategic, and allows companies to transform their operating models. Is that a fair summary?
Ittner: Yes, it is. Simple things like using cloud computing versus having an IT center can completely transform the business. Because I am not stuck with a bunch of fixed costs it changes strategically what else I might do. Part of the whole thing with digital is that the world is changing a lot faster and we have to respond accordingly. You have to start thinking digital.
Knowledge@Wharton: What are some of the most important digital cost management solutions involving analytics and cognitive technologies that companies are deploying to do more effective cost management?
Ittner: Artificial intelligence and machine learning have exceeded expectations, but blockchain appears to be falling behind.
Knowledge@Wharton: Why is that?
Ittner: Well, I think a lot of people don’t actually know what to do with it. It sounds like a great idea, but it is an emerging field. To be honest, it’s not like blockchain provides insights like cognitive and artificial intelligence does. Blockchain is a better way of doing what we did before, which is maintaining ledgers and so on. It is more secure, which is a big thing now because of cyber security, and we can do things more efficiently. But, effectively, it is a ledger, which we have always had. The difference with cognitive, machine learning and AI is that these provide brand new insights that we didn’t have before and which we can take advantage of. They are delivering a lot more than we ever thought about in terms of information that we can use to transform our business.
Knowledge@Wharton: What impact has robotic process automation had on cost management? Has that met expectations?
Ittner: Robotic process automation is helping us to do things better, more efficiently, but it hasn’t taken the step forward of transforming our business. We are not using it for strategic advantage as yet.
Knowledge@Wharton: How are companies using predictive analytics to optimize costs and improve productivity?
Ittner: Oh, this is huge. Whichever industry we look at, people are using predictive analytics. By understanding the consequences of our actions, we can understand what drives our costs — and once we understand the drivers, we can manage them. Predictive analytics can also help us to forecast better. And if we can forecast better, we can plan our resources better. Here’s what my demands are on the cost side, here is what my revenue demands are. I can go borrow money, I can plan resources. If I can’t forecast well, I will either spend too much or not have enough resources available.
We have done some work on this, where people are doing stochastic modeling using artificial intelligence and are able to come up with much better management earnings forecasts in terms of what our earnings are, when they are going to show up, what our costs are going to be, and how much capital do we have. So now I can match my resource demands and my expenditures much better because I can forecast a lot better. These models are helping us a lot in terms of understanding the dials we have to play with.
“We need people who can understand digital, but can map this into business questions.”
Knowledge@Wharton: What surprised you most in this research?
Ittner: What is surprising is how many people are now doing this as a growth strategy. It is a fundamentally different way of thinking. People who are embracing digital are not just using it to improve productivity, they have been able to transform their business. This is still in its infancy, but I strongly believe that going forward this is what people are going to have to do. We are moving into a digital world. It is a world that is changing a lot faster. We have to incorporate that into our organization. Knowledge is expanding a lot faster, so being able to process more information is very important. More importantly, we need to translate that into something that will allow us to make better business decisions.
What we are finding is that in a lot of companies, there are great data scientists and great business people but what is missing is business people who know enough data analytics to say, here is the problem I would like you to help me with. And then they can take the outcome from the data scientists and see how they can best leverage it. That is where we must get to in the next couple of years if we want to take advantage of the digital technologies.
Knowledge@Wharton: What does the future look like to you? What will the next generation of digital innovation look like for companies that want to think strategically about cost management?
Ittner: With robotic process automation, we can automate a lot of what we are doing. So one issue we will have to deal with is: What is the role of people? How can we elevate people to their highest valued use? People are the ones that are going to be doing things out of the box, so we are going to have to figure out, how do we transform our workplace?
Knowledge@Wharton: Are there any final issues you would like to emphasize?
Ittner: I want to push this notion that we need people who can understand digital but can map this into the business questions. If we want to take advantage of digital either on the revenue or on the cost side, those are the people we need. We can’t assume that the data scientists will be able to do this on their own.