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Not long ago, companies thought cost management was about reducing expenses. The notion then evolved and was viewed as a way to manage costs while also driving growth. Now, cost management is advancing further. Business leaders see it as a strategic initiative that is part of a larger transformation process.
In a conversation with Knowledge@Wharton, Chris Ittner, chair of the accounting department at Wharton, and Omar Aguilar, strategic cost transformation global market offering leader at Deloitte Consulting, discuss their research on how cost management is changing globally. Ittner has previously spoken with K@W about cost management in the digital age.
An edited transcript of the conversation follows.
Knowledge@Wharton: Chris, how did you and Omar start working together on this global cost management study?
Chris Ittner: I’ve been teaching cost management to undergrads and graduate students, and one important question is: “Where’s the biggest bang for the buck? Which things that companies are doing [in cost management] are really paying off?” I got in contact with Omar because of the work they were doing [on this at Deloitte], and we jointly decided, “Let’s add some more evidence-based research on cost management success.” We were able to piggyback on some of the survey work that was being done at Deloitte.
Knowledge@Wharton: Omar, you’ve recently done your second biennial global cost survey. How long have you been doing these surveys, globally and in the U.S.?
Omar Aguilar: We’ve been doing it since 2008 in the U.S. and globally over the last couple of years. We did the first Biennial Global Survey in 2017, and we have now released the second Biennial Global Survey. We also do regional and sector updates.
So, we’ve been at it for 10 years. And the reason we did this is that there’s no empirical-based evidence and no facts on cost management in the market.
Knowledge@Wharton: One of the things that you talk about in this report is cost transformations. What does that mean?
Ittner: This is a structural change in how you run your business. Last time, we were talking about “transforming to grow.” In our last survey we saw that that many people take the savings from their cost management efforts and invest that into growth. The notion in finance is that it’s always cheaper to self-fund. In addition to that, what we are seeing now is: “Let’s not just think about growing or improving our existing business. Let’s completely transform our organizations.” How can we integrate cost management into this? Transformation about processes is different. How we’re going to compete is different. It’s a different mindset. With the “save to grow’’ mindset, people were taking their existing models and doing those better. And they were taking the savings from cost management and reinvesting them. What we’re seeing now is kind of the same idea, but it’s a complete transformation in processes, products and services, to get us more fit for what’s going on in the future.
Aguilar: When you talk about — we call it “cost survey,” because cost is a key word — it encompasses four factors in the transformation. There’s cost, growth, liquidity and talent. Cost is dominant — we wanted to put it in there because we believe that transformation should be self-funded — but there’s also a lot of data on growth and talent, and so forth. So you’re talking about a broader transformation, where cost savings are only a part of it. As Chris said earlier, we were in a “save to grow” environment. Now, companies are concerned not only about saving to grow. Technology and digital enablers are also coming into play. And that’s why we call it “save to transform,” which is a taller order than it was with “save to grow.”
“The problem is around architecting the transformation programs and implementing them. Companies architect an aggressive program but then they implement it tactically.” –Omar Aguilar
Knowledge@Wharton: Before we go into these concepts in detail, could you talk about the state of the market today?
Ittner: We found that the majority of companies — around 71% — are focusing on cost management. People are also going for much higher cost reduction targets. We see a lot more organizations striving for reductions of at least 10% and even more into the 20% range. Companies are trying not to just play around in the margins on the cost reduction. They are looking to make big changes in their cost structure. At the same time, failure rates are going way up. In this survey, around 81% of the firms did not meet their cost management targets. Part of that obviously is because they are setting more ambitious targets.
Knowledge@Wharton: What other factors contribute to the high failure rate?
Aguilar: The problem is around architecting the transformation programs and implementing them. Companies architect an aggressive program but then they implement it tactically. We believe that the programs need to be architected differently, and there’s got to be a focus on different things to make them successful. Further, all the digital enablement that needs to happen in the companies is adding complexities to the programs.
Knowledge@Wharton: If there is so much complexity built into the way these programs are being done, what factors affect the way companies think about cost management? And what can be done about that?
Ittner: It depends on what the objective of the cost management program is. Are we responding to a downturn in our economy? Or is cost management part of a big strategic transformation of our organization? Cost management is not a standalone issue. People need to start thinking about it differently. It needs to be part of a larger transformation. It’s people, it’s processes, it’s talent. It’s various other things. It’s also about having a different mindset than just taking the funding and putting that towards growth in our current business.
During our last survey, the big risks were macroeconomic environments, commodity prices, etc. Those are still there, but not nearly as high as you would think, given the current environment. The big risks today are digital disruption and cyber security; these have to be factored into the larger transformation process. So, cost management in our view is not a stand-alone process. It’s just one component of an overall transformation. If you think about it in isolation, you might meet a short-term target but it will not help strategically. The costs just creep back up.
Aguilar: In 2017, when we looked at external factors, digital disruption was barely on the radar screen. But now, two-thirds of the market is concerned about digital disruption and cyber security. If you look at the internal risk factors, most companies are concerned about their ERP, financial systems and reporting. What’s happening is that a lot of those systems are now obsolete and we need to see how to revamp them. So, what’s changed or what’s adding impetus or focus to the transformation is these risks that are very different than what we’ve seen before.
Ittner: The interesting thing is how companies are responding to these risks. Companies that are responding differently [from the traditional short-term cost cutting] are saying, “I’m going to completely rethink the way we’re doing business and cost management.” The word “management” is important. It’s not about just the savings. It’s about managing cost structures in conjunction with revenue growth and in conjunction with changing the product and service offerings. Rather than just thinking, “Hey, I’ve got digital problems. The other guy out there has gone digital and we haven’t. Let’s just cut our costs in bricks and mortar.” That’s not going to help in the long run.
Knowledge@Wharton: Let’s delve deeper into the survey’s key findings. Could you explain what “save to transform” means and how your findings in the most recent survey differ from the last time?
Aguilar: Transformations can be in a spectrum from [a company] being distressed to being very healthy. A company that is in high distress will be in a “save to turnaround” mode. If you have a more transactional transformation, it would be a “save to fund” mode. Where the market has been over the last few years is in a “save to grow” mode. That means that in addition to cost, growth matters.
I earlier mentioned four factors — cost, growth, liquidity and talent. In “save to turnaround,” the key factors would be cost and liquidity. In “save to fund,” it would be cost. In “save to grow,” we’re looking at cost and growth. Then there is “save to transform.” Here, in addition to growing, companies should be developing more capabilities. They should be changing their infrastructure.
Just think about this. The most complex part of a cost structure of a company is its inherent business, its operating model. How are you going to change a company’s operating model? It is through some of these disruptors. It is through digital enablers. It is through cloud, and so forth. So, in the “save to transform” mode, in addition to cost and growth, technology is making a huge play. If you look at the priorities of the market, they relate not only to profitability and growth, or efficiency and cost, but also to digital enablement and technology transformation.
“Cost management is not a standalone issue. People need to start thinking about it differently. It needs to be part of a larger transformation.” –Chris Ittner
Ittner: Part of the way we tried to understand this was by digging into the digital side. Why are companies doing this, and how effective has it been? We looked at AI, machine learning, cognitive, cloud computing, various types of digital technologies. If you ask people, “Have these met your expectations?” most companies say they have. We think part of the reason for this is because their expectations are very low. They’re doing small pilot studies. They’re not really transforming their organizations.
On the other hand, we have a few cases where the response is that it exceeds expectations, and drives performance on the cost management side. But it turns out that these companies are not necessarily using this technology for cost management. When they say it’s effective for cost management, it’s not because they use it for cost management. They use it to change their product and service offerings. They use it to fundamentally transform their business. The cost advantages came along with that.
Aguilar: Going forward, these technologies are going to converge more to the strategic rationale for companies. It’s going to start changing the operating model and services. It’s going to allow companies to become more effective in the market. We’re not seeing this right now, because these technologies are not being done at scale. But the success with the pilots tells us that game day is now. These things are ready to go, not at a pilot level but at scale. So, one of the call-outs to the market is, use these technologies. They work. You have to be thinking how you can do them at scale to have an impact.
Ittner: A couple of interesting factoids came out of this [research]. For instance, automation has the biggest impact on cost management savings when it is linked to big, hard targets. If it is not linked to hard targets, you don’t get much advantage out of it. The other interesting thing is using automation for productivity improvement and not cost reduction.
Knowledge@Wharton: Very often, the initiatives at big companies are driven by the fact that there is a blurring of industry boundaries. You might suddenly have a competitor come from a different industry and challenge your business models. An example would be, say, a company like Airbnb that has transformed the way business is done. Airbnb doesn’t own any real estate but it is challenging the hotel industry. Have you found, as part of your studies, any effective defenses that these companies have constructed, not just through cost management but thinking strategically about such digital disruption?
“In the ‘save to transform’ mode, in addition to cost and growth, technology is making a huge play.” –Omar Aguilar
Aguilar: This is the whole essence of “save to transform.” In the past, the only companies that were disrupting you were startups. Now, you have massive competitors from different industries and different ecosystems. They have the DNA, the digital enablement, to disrupt any industry, any ecosystem.
Our view is simple. The “save to transform” process should not be done tactically. It is a means for you to transform your go-to-market, your operating model, to be able to withstand that disruption. You should move away from efficiency, automation, productivity, and instead look at different operating models that could enable [something that is] totally different. That’s the core of it.
Ittner: The whole point of this transformation is to create flexibility and the ability to rapidly respond to changes, whether you notice them first or you are responding to what somebody else did.
Aguilar: Let me expand on that. We’re STEM type of people, right? We’re grounded in analytics and we call it the future of an operating model, or disrupting an operating model. Let me bring in the other side. Many people would call this the future of work. That is the other side of this coin that we cannot ignore. How are people going to work in the future? What is going to provide value? How will they work with new operating models that are now emerging?
Knowledge@Wharton: One of the things I found interesting about your study is the fact that it is global. Did you see significant differences in various parts of the world? Are there regional lessons that might be of interest?
Aguilar: One of the questions that we probed was cost maturity. Do companies have policies [to manage costs]? Do they have the process? Are they really effective at it? Not surprisingly, we have the U.S. leading on cost maturity. But on the other extreme, you have Latin America, which is a developing region. But not far behind you see Europe. And then you see Asia-Pacific. There are cultural implications to this. Interestingly, we have longitudinal data. In the last global report, companies in Europe were not as active in cost management because there are a lot of cultural [and] regulatory challenges to Europe. They must be more active now. So you see the targets being higher in Europe, and them being more aggressive in cost programs.
Cyber and digital are generally the main risks except in Latin America. What that means is that in Latin America they have a double challenge. They need to be concerned about currency fluctuations and macroeconomic issues, but the real danger that they cannot even see or focus on, is digital. The internal risks also are different. We see ERP and [other] systems, globally and in the U.S. But if you look at some regions, you are concerned about talent in APAC, you are concerned about plans for business continuity in Latin America. We believe you should take into account these insights to make sure that you can be successful.
“One thing we worry about is people cutting back on these transformations if there is an economic downturn.” –Chris Ittner
Ittner: The notion of cost maturity — which is not the specific practices you do, but the process you put in place to always be thinking of cost management — is going to be critically important. Do we have somebody in charge at the executive level? Do we have policies and procedures to get people to think about it? Some of these regions that have not put the basic cost maturity process in place put you at a fundamental disadvantage. You’re at a strategic disadvantage going forward. I think it’s that infrastructure. If companies haven’t done it yet, that ought to be a key part of any cost management process. It has to be iterative. It’s a rapidly changing world, and it’s transformational. It’s not transactional.
Aguilar: That’s one of the main reasons we had the failure rates. Failure rates are high because you don’t have that infrastructure in place to make it happen. It’s through implementation. Implementations are not working.
Knowledge@Wharton: When you look at these issues through the lens of different sectors, what are some of the key differences you have found there?
Aguilar: Our survey takes into account a two year time frame. Two years in the past, two years in the future. And by and large, what we saw was a very positive outlook. But then we started to see some softening. We see some credit risk. We see some consumer demand decreasing. Our survey already indicated some of the slowdown.
We’ve seen that disruption is hitting some sectors more than others. If you look at retail, for instance, it is a highly-impacted sector because of the digital disruption that goes in there. You look at technology, media, telecom — it is ground zero of digital disruption. You also see disruption taking place in some of the commodity-based industries. By and large, we saw that the sectors where they’re doing more digital enablement are the ones that either have more resources, as in life sciences, or have more urgency and need, as in technology.
Ittner: One thing we worry about is people cutting back on these transformations if there is an economic downturn. That will be a very short-term, tactical response to a downturn in the economy. The only way to survive going forward is to invest now in transformation.
Knowledge@Wharton: Are there any concluding comments that you would like to make?
Ittner: One striking result that’s come up every time we’ve analyzed any data is the importance of putting in better forecasting and planning systems. And this whole movement towards digital is just making this better. You have much more capabilities, through AI and machine learning and analytic methods, to do the scenario planning. It’s improving our ability to try to understand scenarios and build around those.
Aguilar: I would echo that. It is not only about the transformation. You also need to have some volatility modeling, some scenario planning modeling. You should be looking at that at the board level, at the CEO level.