Salaries are a typical corporation or organization’s largest expense, excluding raw materials. When boards demand cost cuts, executives are hesitant to take aggressive action to cut employees. The results are a tuck here and a nip there. When pressure from the board subsides, costs invariably creep back up. The cuts are equivalent to a cleanse where you lose 20 pounds drinking lemon water for 10 days.
What should an organization do when it’s time to get serious about cost cutting? The typical method includes increasing span of control and creating division of labor by cutting positions at the bottom of the organization. Once cost cutting pressure is off, these positions are added back. The traditional methods alone do not work. We recommend a different, three-step approach, resulting in permanent cost reduction.
Set Internal Targets
Every organization is comprised of a basic set of operating units or profit centers where products or services are supplied and direct costs are incurred. Each unit requires a level of operational or administrative support from headquarters or local personnel.
To set the target, evaluate how many administrative personnel are needed to support a single operating unit. For example, a drilling company might estimate the need for one accountant to handle general accounting, reporting, billing, and payables for one rig. If the company has 30 drilling rigs and 48 accountants, the additional 18 personnel needs to be justified. Valid explanations might include the need to support public company audit requirements, SEC reporting, or international tax requirements. Otherwise, accounting should be challenged to better understand what is happening in the organization.
Gain a Deeper Understanding
Why does the drilling organization need 18 more people to support accounting? Most executives often trust their managers to determine the need for additional resources to perform a task. Unfortunately, managers use fear to defend the position of needing more resources—“If we don’t have a tax accountant in every country, you’ll go to jail, CFO.”
Inefficiency exists everywhere and can be revealed with objective investigation. Listening to operations first then balancing operational needs with functional support activities always reveal inefficiencies. For example, accountants are laboring over spreadsheets to provide operations with unused detailed reports. Buyers are creating complex purchase orders containing a level of detail irrelevant to operations or vendors. HR has created an elaborate hiring process which operations sees no value in following. Identifying inefficiencies and eliminating waste can be performed with a deeper and objective evaluation of what is really happening.
Rationalize the Executives
Determine the level of experience needed to oversee each part of the organization. Why have a vice president over a part of the organization versus a director or manager? A simple way to rationalize executive positions is to consider three points: fiduciary accountability, risk mitigation, and number of people requiring oversight. For example, a mid-sized manufacturing company had 24 VPs earning $500,000+ per year, but was able to rationalize the VPs into nine.
The company used three criteria to decide whether a function or a set of operating units justified a dedicated VP:
1. Fiduciary Accountability: Is the role accountable for more than 30% of the company’s costs, working capital, or revenue? VP roles overseeing the manufacturing plants, finance, and sales are justifiable. The accountability yardstick forced the company to consolidate regional VPs into a smaller team of hemisphere VPs.
2. Risk Mitigation: Does the role mitigate risks with the potential to cause operating losses? Justifiable risk mitigation roles typically include General Counsel and Safety Compliance roles.
3. People Oversight: Does the position oversee more than 100 people within the organization (after right-sizing, of course)? The role would be an executive running the plants or the sales organization.
The company applied a similar criterion with similar hurdles to justify director and manager roles within the company.
The three-step process will be disruptive, but without disruption, advancement never happens. Anyone who wants to live a disruption-free life should shed their belongings and move into the woods. On the flip side, people within an organization who truly believe they are doing the right thing for the company will jump in head first and be a part of the team leading disruption. Read more here.
Trenegy is a non-traditional consulting firm helping businesses reduce costs across the organization. With an effective organization structure, business can benefit from efficiencies and improvements. Ask us how at email@example.com.