How to avoid value-erosion and cost-leakage in Financial Services
Apr 22, 2013 4:27:00 AM
Cost management and 'cost-out' is critical for any business. As such, cost as a metric will always be near the top of the agenda for any business assessing the performance of their procurement or sourcing function. However, driving costs out of a business is not a one-off project - it's a continuous, evolving process.
Typically, if a project that has taken out cost is NOT then continuously managed afterwards, there is typically 30% erosion of the initial cost-out value year-on-year. So by the end of year three you're back to the point that you were when you thought you'd done a fantastic job, which is crazy.
What causes erosion?
A recent Deloitte study* has found that general education around the need for cost reduction was the biggest barrier, with erosion of savings coming in a very close second.
Deloittes paper cited that "the fundamental problem is that many companies focus their cost reduction efforts on the same business areas year after year". External spend reduction comes in behind the usual cutting back in Admin, Operations and 'organizational streamlining' - or head count reduction.
An example of this (although not in the Financial Services sector, still very applicable) was highlighted by a global airline, which runs a late service to a remote location every day.
Challenging the status-quo to avoid cost erosion
- The airline operator runs a particular route in which their plane has to stay on the ground overnight, taking off at 6am the next morning.
- The standard company policy is to have at least two people cleaning and preparing it for the morning flight.
- A contract was in place with a supplier to provide this service and despite the operator trying to negotiate better terms (e.g. price), no benefit was achievable.
- Rather than follow the conventional approach and follow a sourcing exercise (which had not yielded anything in the past and would take over six months to complete), Proxima thought what could be done differently. We took a commercial approach to the business problem. And we challenged the company policy.
- As the flight stayed for several hours, one person could easily prepare the plane. This reduced the cost by £250,000 a year - and was put in place within two weeks of us getting involved.
The overarching issue here was nobody was pro-actively managing the area and thus the policies around it. All that was done was year after year applying the usual procurement process.
Worse still was that the supplier had been flagging this to the airline for a long time - but no-one was listening. This is often the case - innovation sits in your suppliers, but you have to listen to them to take advantage of it.
Secondly, if you haven't got effective vendor management and contract management in place, how are you going to know what's going on in your supply base? How do you assess risk in your supply base? How do you effectively manage how your business is served by your suppliers?
Were not saying you can't do it, of course you can. You could do it by making big investments in people (hiring scores of category and business partnering experts), processes and technology. Are you going to do that? Possibly, but its going to be an expensive exercise to set-up and run.
As such, many Financial Services businesses are forced to compromise, due to resource limitations, and are left with a team of generalists who focus on those areas which will drive the most one-off savings - leaving a large portion of the total supply base unmanaged. And so the vicious cycle continues.
Five key questions a CFO should be asking themselves to avoid value-erosion and cost leakage:
- Are your spending activities aligned to the corporate aims?
- Are you harnessing the latest market data across all areas of spend to ensure value for money is achieved from your budgets?
- In a changing business environment, do you have the expertise, specialism, capability and resource levels you need to deliver against business imperatives? And is it sustainable?
- Are you harnessing the innovation, insight and competitive advantage suppliers can bring you?
- Analysts suggest that in major FS institutions, regulation has added 4% to the cost base. Managing risk and ensuring compliance across the supply base is now a board level topic requiring specialism at each stage along the way. Do you have the required specialisms needed at the right time? Are you assessing and monitoring risk (including reputational risk) across the supply base?