November 15, 2021

Strong leadership is a prerequisite for good cost management. Cost leadership starts with the CEO or business unit head and cascades down through the top management team. They need to build a tough cost culture and be good role models in their personal behavior. They need two key staff functions to be very active supporters of cost control – finance and HR. Imprinting a tough attitude to cost right down through the organization takes true grit.

A Challenging Base Case

Your base case position, what you expect in terms of cost trend, will be a big contributor to the cost outcome.

For example, you can start off the annual budget process by telling your business unit heads that this is a year of prudent consolidation, that they should plan on no headcount additions but a 3-4% increase in cost per head plus some small reductions in bought-in costs, and that with that cost base they should be able to manage some modest revenue growth.

Or you could say revenue growth is looking difficult this year and you’d like to see 5% productivity gains, which means that we plan on headcount coming down by 5%, but you don’t want to see any reduction in the revenue plan.

Those are two very different base case positions. Under the first scenario, management gets the message that they can relax a little, they can tread water, put off nasty decisions, and do some strategic thinking. Under the second, their feet are being held to the fire. There’s no standing still. If they’re not growing revenue, they’d better be cutting costs – either way the base case position is that you expect 5% (or whatever percentage works) productivity growth, every year. If you don’t stay paranoid and keep moving forward, your competitors will overtake you.

Once this kind of base case behavior is established, managers will stop coming to budget reviews with a business-as-usual, status quo budget. They will know that won’t survive one minute in the CEO review. The whole tone of the business will have changed.

When you’re doing a house renovation your builders find out fast if you’re a soft touch. At the end of Week 1 they put in for an extra $10,000 because you’ve altered the handles on the cabinets and obviously that’s changed the entire project. Roll over on that and you’re looking at a $50,000 overspend by the end of the month. But if your base case is “no” and you have them accommodate that in the original budget, you can stop cost escalation.

As a strong cost leader, your base case expectation must be for real productivity gains and other unit cost reductions every year. Repeat that message and stick by it, until it is taken as a given by your management team and pushed down by them to the rest of the organization.

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