When cost reduction becomes a priority, one of the first places executives look for savings is general and administrative (G&A) expenses—the cost centres that provide front-line support and back-office functions such as finance, information technology and human resources.
There are good reasons why G&A represents such an attractive target. When business is growing, companies tend to add support services. But in a downturn, it becomes painfully apparent that some incremental support services don’t contribute enough to sales or earnings, and many executives react with across-the-board cuts in G&A.
This slash-and-burn approach may remove some unnecessary expense. But it often also destroys value—eliminating G&A activities that drive sales and profits.
There is a better approach that is almost as quick as the slash-and-burn method and, in our experience, produces sustainable cost savings, typically in the 10-30% range. It also improves the productivity and effectiveness of support functions, helping improve a company’s front-line performance—a powerful advantage in a downturn. Let’s look at the steps involved.
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Invert the pyramid. The first step in streamlining G&A is to follow the customer. The usual organizational pyramid shows customer-facing front-line staff close to the base. Support functions are somewhere in the middle and senior management at the top. Turning the pyramid upside down emphasizes those people who provide the products and services that customers value. Below them are the support and back-office functions that help the front line deliver the goods or services. At the bottom is senior management, whose fundamental job is to help the organization work effectively. The inverted pyramid provides an acid test for support services by helping executives determine which services are essential to the front line.
Reduce, redesign, and restructure. There are three ways to maximize front-line benefits while eliminating unnecessary support expense. The key is to understand which services should be reduced, redesigned or restructured.
To reduce, companies clarify what support functions are expected to deliver and eliminate non-essential activities. They start with internal customers and their demand for services, rather than service providers and what they currently supply. Best practice is to triage—spend more money on critical services while eliminating those which do not increase value.
Redesign requires companies to scrutinize the processes that deliver support services. They can streamline some—often by automating certain steps—and purchase better or lower-cost inputs for others. They design processes that are different depending on the value implications. Restructuring usually involves consolidation or outsourcing. The goal is to ensure that support services are performed effectively at lowest cost.
What can you expect from this approach? A combination of reduction, redesign, and restructuring can save about 10-30% of G&A costs. In our experience, reduction of use usually accounts for about 25% of total savings, redesign 35% and restructuring about 40%. By focusing on effectiveness and efficiency together, these savings can be sustained.
To see how this approach works in practice, consider the case of an office products company that faced fierce competition from overseas suppliers and retailers selling private-label goods. Part of the answer lay in slashing costs for more competitive pricing. So the company centralized support functions, eliminating duplication across business units. The company also saw a big opportunity to improve performance through more effective marketing and research and development (R&D). Some of its customers bought primarily on price. So in certain product categories the company slashed support spending to compete with ultra low cost private-label goods. But other customers preferred brand-name products. In these categories, the company had to keep investing in innovation and marketing support. Finance staff needed to analyze which features would enable market share gains and high profit margins. Most cost-cutting campaigns target R&D, marketing support and finance staff. But, for this company, an across-the-board cut would have been a mistake. By cutting costs judiciously, it generated greater productivity and sales in core product lines.
Speed is paramount in turbulent times. But ineffective support services slow organizations. A global entertainment company wanted to grow audiences by adding shows. But it found costs were rising faster than revenues. Adding shows threatened to flatten margins instead of boosting profits.
The problem was twofold. First, the company had a tangle of back-office services, such as finance and human resources, which were duplicated for each show. Second, many crucial support services, from costume making to casting, were world-class and were treated as such—quality first. This was hardly surprising: the company’s core asset was its ability to put on unique, high-quality events that commanded a premium ticket price. The company’s challenge was to rework its processes without disrupting the artistry that appealed to customers.
Some solutions were obvious, like centralizing and streamlining finance and HR. Originally, transactions for as little as $20 had to be centrally approved. Processing a transaction could cost more than the amount processed. The company resolved this by providing credit cards to staff for small purchases.
Other solutions were less obvious. HR, for instance, had invested heavily in a candidate database for the most skilled positions. It spent less time collecting names of less-skilled players. When the company scrutinized absentee rates and back up depth, it realized the greatest need for replacements due to injuries or illness was among rank-and-file performers—the most-skilled roles had extra back ups. That meant it could invest less in recruiting starring-role understudies. HR could focus on what was needed most, while spending less overall.
Sometimes, back-office processes interfere with mission-critical customer-facing activities. It is one reason why inverting the pyramid and listening closely to the front line are key.
Consider the approach taken by state-run Union Bank of India. It streamlined back-office functions last year by outsourcing operations like advanced due diligence, valuation and document verification for loans. As part of this process, the bank is setting up an outsourced call centre this year.
Now the front-line staff spends more time marketing products to customers while speeding up the loan-approval process. Revamping its back-office has helped the lender’s profits; its net profit rose 84% in October-December 2008 to Rs670 crore.
G&A opens opportunities for lowering costs and improving performance quickly in a downturn. But the current downturn won’t last forever. When it ends, companies will need to take their foot off the brake and step on the gas. Wholesale G&A cuts are likely to slow results now and hinder acceleration later, but smart, strategic measures will help a company both survive the turbulence and accelerate out of it.
David Mountain is a partner with Bain & Co. in India and leads the financial services practice. Hernan Saenz is managing partner of Bain’s Dallas and Mexico City offices and a leader of Bain’s performance improvement practice. This is the third in a Bain series on managing turbulence that is being published by Mint.