Options for Optimizing Cost in the
wake of the current global financial
crisis
OPENING THOUGHT FOR FOOD
Competitive and aggressive business leadership have crossed the
line and our system of taking money from investors and
reporting on corporate performance no longer works. The
financial manipulations that have emerged over the years are
no long tolerable in the “new economy” or on the global
economic planet. Indeed, the damage and upheaval caused
by trading manipulations and accounting fraud, monitored by
politicized enforcement, could be seeds of serious calamity in
the future. What is true about the troubles in our markets is
doubly true around the world.”
……A Larry Elliot & Richard J. Schroth(2002), “How companies
Lie : Why Enron is Just the Tip of the Iceberg””
INTRODUCTION
• The current global economic crisis sent a big
shock all over the world
• Its impact has led to the liquidation of many
hitherto strong financial and commercial
enterprises and the death by suicide of those
who lost money in its wake.
• In addition to these Equity Markets, global
output, Fiscal balances in decline and Global
trade have been negatively impact. Every Nation
is battling to manage the situation.
INTRODUCTION
• A corporate level, the turnover of most organisations (
including insurance companies ) were also negatively
affected . In the face of reduced or slow growth in
turnover or even risk of failure , one of the few directly
manageable profit drivers is cost management.
• Cost management is a challenging aspect of business
governance. This is because of the need for it to be done in
a way that delivers revenue growth and profits in the
future, without destroying long-term shareholder value.
• This papers seeks to share ideas and facilitate discussion
of how cost management can be effectively done.
INTRODUCTION
• My presentation will deal with the following :
– Clarification of the concept of cost and what I
consider optimal cost
– Options for achieving and maintaining option cost
in financially turbulent times
CONCEPT OF COST
There are four noteworthy fundamental cost
concepts• True cost
• Opportunity cost
• Cash Cost
• Incurred Cost
CONCEPTS OF COST
Definitions
• True Cost: This is the specific loss, consumptions or
surrender of resources, value, benefit or welfare that is
involved in a situation , process or activity.
• Opportunity cost: is the measure of benefits forgone by using
scare resources to follow one option to the exclusion of the
next best option. The opportunity cost of the use of funds to
open a branch office in another city for an insurer is the loss
of funds that could have been applied for promoting its
business in an existing branch.
• Cash cost :is the actual amount of cash paid for items ,
resources or benefits received
• Incurred Cost: includes all true cost whether they have been
paid for in cash or not.
CONCEPTS OF COST
Information On Cost
• Cash and Incurred cost can be found in the
financial accounts.
• True and opportunities costs are not routinely
recorded in financial accounting records or
report. They have to be derived through a
appropriate model.
CONCEPTS OF COST
Optimal Cost
•
Optimal cost is an
– ideal true cost for business,
– the lowest possible cost for a given level of benefits,
– one that is not at the expense of either current revenue or long term performance of the
company.
•
•
•
•
•
•
It is an incurred cost
The concept of opportunity cost helps in determination of costs that can be
considered optimal
Can be difficult to measure or determined, sometimes involve mathematical
models and calculation.
In the absence of such relevant models and tool for their application, Optimal cost
are only intuitively determined even if the extent to which they are ideal cannot
be easily or objectively measured
In intuitively - chosen optimal cost level, it is the reasonableness of the options
applied in managing cost that gives the decision maker or business the confidence
about the extent to which his cost levels can be considered ideal.
This paper does not intend to discuss any mathematical model
OPTIONS FOR OPTIMAL COST MANAGEMENT
Approaches to cost Management
• Haphazard = indiscriminate or arbitrary
reductions
• Across the board = use a same basis for all
cost items without regard to value added by
relevant activity e.g. 10% of all costs
• Measured = reasoned, methodical and
balanced
OPTIMAL COST MANAGEMENT
Background
• Optimal cost management is a measure approach to managing cost
• It times of crisis the issues or approach to cost management is determined
by the strategic response of each enterprise to the situation, namely
– Contraction
– Holding and maintaining
– Expansion
• Within this framework, the options applied will depend on a host of
situational factors that include:
– leaders based on their cost profile and impact of crisis of on their sector of
the national economy.
– Competitive context
– Cost profile
– Relevance of options
– Availability of data required for applying each options
FOR OPTIMAL COST MANAGEMENT
Categorisation of Options
There are two categories of cost management
options applicable
• Cost Reduction Options: to bring cost down to
levels considered optimal
• Cost control Options: to maintain costs at
desired levels
OPTIMAL COST MANAGEMENT
Cost Reduction Options
1.
2.
3.
4.
5.
6.
7.
8.
9.
Eliminate zero value adding activities
Minimize or improve low value adding activities
Activity based Budgeting
Converting fixed to variable cost
Outsourcing
Leasing instead of outright purchasing
Simplify product/ service offerings
Strategic supplier partnership
Cost avoidance techniques such as tenders for
purchases, negotiation etc
10. Change employees attitude to cost
OPTIMAL COST MANAGEMENT
Cost Control Options
1. Sustain low cost platforms created as above and resist priceincrease ploys
2. Eliminate commercially unaware behaviour across the
company
3. Collaborate to create value from co-operative sources
4. Compete to outmanoeuvre and extract value from
exploitative/high-priced sources
5. Gain sharing
6. Strategic planning
7. Relating cost to result achieved
8. Penalizing waste
9. Continuous improvement
OPTIMAL COST MANAGEMENT
Options
Let us examine some these options in some
details
EXAMINING COST REDUCTION OPTIONS
Eliminate zero value adding activities
There are three types of activities in any company
• Customer value adding: Activities that result in
benefits for the customers such claims payment
process.
• Business value adding: Activities that benefits the
business but do not the customers such as filing
of claims paid.
• Zero value adding: these are value activities that
cost money but do not add value
EXAMINING COST REDUCTION OPTIONS
Eliminate zero value adding activities
The process of eliminating zero value adding
activities involves
1. Determining the value of processes
2. Determining the activities within each process
3. Assessing each activity for value addition
4. Eliminating all activities that do not add value
EXAMINING COST REDUCTION OPTIONS
Activity based Budgeting
• ABB is a method of budgeting for the cost and cost
objects.
• Assigns cost to activities based on their expected
use of resources and assigns cost to cost objects
based on their expected use of activities. ABB
recognizes the causal relationship between cost
drivers and activities.
EXAMINING COST REDUCTION OPTIONS
General- Converting Fixed to Variable Cost
• Fixed cost are incurred irrespective of level of
revenue performance
• When part of cost varies with revenue, cost
will move in line with revenue to the relevant
extent
• Example paying staff part salary and part
commission or profit
EXAMINING COST REDUCTION OPTIONS
Outsourcing
• In outsourcing get a supplier to provide a
service or product you need for your business
instead of arranging to provide it yourself.
• Examples : human resources function.
Accounting, management of drivers,
CONCLUSION
• The challenge of cost Management is not new
• What is new is the shock of the current economic crisis
• Companies should establish/review their cost
management system and use the tools of scenarios
planning to facilitate their preparedness for possible
economic contexts
• Overall, my recommendation
– Companies should enthrone value habit.
– Understand their business model and competititive and
economic context
– Consider availability of information