The anticipated doomsday fiscal cliff fallout has been narrowly averted but many lingering questions remain. Critical components -- the debt ceiling and the sequestration of spending cuts -- remain "to be determined" and debate rages regarding the impact of the compromised deal on the broader U.S. economy. CFOs, should they behave as they have historically, respond to uncertainty by turning a critical eye to their workforce. In other words: job cuts.
The writing -- or cutting, as it were -- has been on the wall. A recent survey by Duke University, "The Global Business Outlook," found that 70% of CFOs are considering a reduction in hiring in response to ongoing economic uncertainty that started, but certainly has not ended, with fiscal cliff anxiety. Moreover, stalwart U.S. companies, bellwether FedEx included, warned of other potential fiscal cliff headcount reduction exercises.
If all this talk of job cuts doesn't raise a red flag, it should. Cutting jobs as a first and quick fix in response to the fiscal cliff or any other external economic factor is not only bad PR, it's often bad business. The problem is, while quick, it's far from a long-term fix. A recently published study, "The $16 Billion/£10 Billion Profit Opportunity," found that companies could enjoy a bigger boost to earnings by trimming operational costs other than jobs.
The research into the annual results of more than 350 FTSE companies found a 1% reduction in non-labor costs could boost average annual earnings by 3.6%. For some industries, the gains are much stronger, including 17% for construction and 11% each for retail and chemicals. By contrast, a similar 1% reduction in labor costs increased profits by only 0.8%. Simply stated, cutting jobs is neither as effective nor as productive as cutting or improving efficiencies among other operational costs.
Job cuts as a knee-jerk response to economic uncertainty not only doesn't work in terms of substantive earnings improvement, it masks other underlying, structural deficiencies that are left lower down the priority list.
The first of those that executives must be aware of is the potential for operational cost management, specifically in non-labor costs. The research demonstrates that even modest reductions in non-labor costs can have a disproportionately significant impact on profitability in a positive way -- five times greater.
Looking for areas to improve operational cost management, however, is often easier said than done, with these costs often spread across the globe and managed by varying budget holders within a business. Getting a grip on these costs might mean reframing other well-intentioned but, perhaps, illogical business debates. The general concept of outsourcing has become a bit of a business and political lightning rod, with rhetoric sharply divided between boosting American jobs at all costs and strategic sourcing decisions to help businesses to remain competitive.
In reality, it's an inaccurate and incomplete debate at best. The choice is never simply between creating jobs at home or offshoring/outsourcing for better value. Businesses now rely on a greater network of specialist suppliers to deliver individual components for their products and services, often requiring coordination of suppliers around the world. So, a degree of both is required, depending on the best service provider or supplier in each case.
And it is the fit-for-purpose (specification, cost, quality, risk mitigation, interpoleratity, scalability, innovative capability and future profits) that should govern the decision behind appointing supplier -- together with those that understand the objectives of your business and the environment it operates within. Look at Boeing, for example. Its latest 787 Dreamliner aircraft comprises a fuselage made in separate parts in the U.S., Japan and Italy, wings from Japan, wing-tips from Korea and a landing gear manufactured in Great Britain. When the aircraft is assembled in Seattle, it is the result of a complex process of design, engineering, development and production but -- and this is often overlooked -- a great deal of cost management.
So, it would be helpful to restructure the debate, from a question of where jobs should be located to a more fundamental interrogation of how and why costs are incurred and expenditures are deployed in the first place. And businesses don't have to build the next mega-airliner to seek or realize those operational cost savings, either. Finance executives in almost every industry can and should seek to control operational costs, and they can start by asking themselves some tough questions about their businesses.
How many finance leaders can hand-on-heart say they are satisfied with the quality of commercial thinking that goes into the management of their third-party costs, and that the millions of dollars they spend are done so in line with corporate strategy? How many are happy with how well informed their senior leaders are when making investment decisions, because that's how third-party costs should be viewed -- as an investment? How many would agree that through procurement they help to future-proof their business, and create levers of control? How many truly believe their cost base is procured in an enduring manner?
Despite its potential impact, operational cost management remains an under-invested discipline, with many CFOs continuing to see headcount reduction as the main source of budget protection. Overcoming this natural tendency requires a cultural shift, one which requires a long-term view and involves finance and procurement working more closely together -- something that is easier to enact in some organizations than others.
It also requires a degree of education -- of employees, shareholders, analysts and suppliers -- as to how non-labor costs interact with the bottom line. If we revisit the research, the afore-mentioned 3.6% earnings boost among the FTSE-350 represents an additional $16 billion of profits to be unlocked, which would go straight to the bottom line. While the same data gathering is being run for companies in the U.S. at the moment, logic suggests that there are similarly significant gains to be uncovered in North America as well.
Compounding the situation is data suggesting that outsourcing jobs offshore might not be the money saver that it once was. Labor rates in China, America's fiercest international trade rival, are on course to converge with underlying rates in the U.S. by 2016, meaning that profitability that was once systemically gained through locating jobs in lower cost markets might be more difficult to unlock in the future.
The combination of these factors highlights two things. First, the extent to which business has changed over the past few decades, with customers demanding products and services that more closely meet their personal needs, and shareholders looking for improved, long-term returns. Second, organizations need to work harder to find new ways of making the way that they do business more effective, efficient and profitable.
There is a latent opportunity waiting to be seized. At a time when budgets are constrained and workforces have been shaved extremely thin, it falls to managers in charge of more complex processes, longer supply chains and service delivery to boost future growth prospects.
The opportunity is there for finance and procurement teams with the entrepreneurial spirit to take a different approach to the way that supplier costs are managed.
Matthew Eatough is CEO of Proxima, an international procurement and sourcing consultancy that takes full responsibility for handling an organization's third-party cost base on an actively managed, long-term basis. With an approach the centers on helping companies spend well and maximize value from their operations, Proxima now manages over £10 billion in operational spend from clients across a broad range of industries, including consumer products, healthcare and media and entertainment. Proxima is headquartered in the U.K. with U.S. offices in Chicago and Los Angeles along with a significant European footprint covering the Netherlands, Belgium, France, Switzerland, Spain, Germany and the Nordics.