It is clear that the current inflation is not just a temporary phase. There is general agreement among economists and business leaders that the increases in prices due to supply chain problems will continue for most of this year, with the increases in prices for labor possibly becoming permanent. Even though the economy is not doing well, businesses can still do things to improve their financial situation.
This is a unique time for inflation because labor markets are unstable, consumer demand has not decreased as it did in 2008, and supply chains are more limited. As inflation rates are expected to rise, companies will need to take action to reduce costs and create growth platforms that can be easily expanded. Investing in programs that make it easier to buy and price goods will help companies be more resilient to changes in the economy. Putting a cost-effective program in place that enables growth in top-line revenue and reduces reliance on unstable labor markets is key to improving employee retention rates. Successful companies deploy six tactics to achieve these goals.
Get spending visibility:
Having high-resolution spending visibility means having a clear view of all of your expenses. This is the foundation of any expense management capability. This tool allows managers to see where money is being spent and who is spending it. It’s important to have a clear understanding of how much is being spent, in what areas, and by which business units during periods of inflation. This information should be easy to repeat and act on. This is the foundation for all other productivity efforts. It allows all decisions to be made with knowledge of how they will affect the organization’s income and expenses.
“Capabilities-driven cost reduction” is a term coined by authors Shumeet Banerji, Paul Leinwand, and Cesare Mainardi in their book “Cut Costs and Grow Stronger: A Strategic Approach to What to Cut and What to Keep.” This approach to cost-cutting assesses a company’s capabilities in order to determine which areas are most important to the company’s success and should therefore be preserved, and which areas can be trimmed without adversely affecting performance.
In this framework, companies first identify their key capabilities. Capabilities are the few strengths that give a company an advantage in reaching and serving the customers they care about most.
Companies need to make sure that their spending is helping them develop the abilities they need. This process is typically based on three questions:
- What do I need to keep the lights on? For example, sales, general and administrative expenses.
- Where am I spending that will make a difference over time in terms of winning in the market?
- How do I keep the rest as lean as possible?
For example, in the early 1990s, Frito-Lay’s sales decreased due to a competing company. Business leaders identified the need for an innovative approach to direct-store delivery that would allow the company to consistently deliver the right products to the right stores at the right time. This would be accomplished by equipping their delivery truck drivers with hand-held computers, a novel concept at the time.
The CEO cut a large amount of general and administrative costs, simplifying Frito-Lay’s management and practices. The company saved money by not investing in certain areas so that it could put more money into the areas it considered more important, such as direct-store delivery, product innovation, and marketing.
Differentiate between strategic and nonstrategic spending:
If there is a lot of change happening, it is more likely that leaders will make decisions that could harm the company’s plans for the future. It is not uncommon for companies to make cuts that are not in line with their strategy. This can lead to a lower return on investment and decreased shareholder value over time. Strategic cost-cutting should be distinguished from nonstrategic cost-cutting, protecting signature customer and employee experiences, and fiduciary requirements. Use consistent, accessible financials to prioritize higher ROI investments. A company’s cost management system should enable it to invest more in strategic costs than its competitors, even during difficult times.
Managers need to figure out where to stop investing and start saving money; where they can cut costs to get a better return on expenses; and where they can increase growth by investing more in the skills needed to get different results. This way of investing sets the scene for changing the P&L, cost structure, operating model, and skills that will make the chosen strategy possible. This helps leaders come to an agreement on which capabilities need to be the best in order to enable and sustain a competitive advantage, rather than being the best in cost. position: It places a company in a strategic position to make better decisions about how to deploy increasingly scarce resources to revitalize its strategy and create maximum shareholder value during times of economic upheaval. That includes investments in people, for example. The decision by companies like Walmart and Target to invest in allowing their employees to pursue debt-free education is a strategic move to make them more attractive to potential employees than their competitors.
Unpack the drivers of spending:
With better visibility into how costs align with strategy, the next step is to develop a stronger understanding of the real drivers of cost in an inflationary environment. It is important to understand both the prices paid for key cost categories, as well as the quantities consumed. This will help to identify potential areas for cost savings. Companies can create detailed and specific initiatives that can be tracked and linked to a particular cost category. This allows for better and more accurate cost management. This creates an opportunity for many different actions. Among the most impactful changes that could be made are establishing a preferred vendor program to increase buying power, reevaluating the right make-vs.-buy mix for core functions like software development, and deploying AI-powered sourcing tools to generate automated insights from spending data, flagging savings and compliance opportunities in real-time.
These steps can deliver real, near-term savings. An energy company found that it could save $10 million a year by getting rid of more than 80 of its applications. It is critical to get a sophisticated view of what is driving spending in order to advance to the next three tactics, especially when inflation is rising.
Using software to increase spending visibility gives companies the ability to see where money is being spent and where they might be able to save. This, in turn, allows them to adjust their budget to match the current inflationary environment. Even if companies are unable to purchase better quality products due to supply chain and producer pricing pressures, they can ensure that they spend their money more wisely. One way to reduce government spending is to have a spending czar or spending control towers. When a global healthcare company realized that too many acquisitions left the company with cost inefficiency, it empowered a spending czar to break down silos and make decisions across the organization. This czar had the ability to negotiate prices with vendors and make decisions about how to best spend the company’s money. This was the first significant step in finding annual cost savings of more than $300 million.
Focusing on spending money more wisely can also lead to cooperation among different departments. One technology company found that many of the cost issues it faced while building new facilities were caused by groups that were not involved in the decision-making process for new projects. Working together more often across different departments helped the company reduce the time it took to build something by half a year, which saved them over $400 million. Creating spending controls that span across departments can help companies identify costs that are no longer justifiable, or can be prevented by doing the work differently. This allows the company to prioritize spending and make sure that any savings are not gradually reversed over time.
The most effective way to reduce labor costs and shortages is to eliminate the work itself. Companies that want to improve their productivity should start by looking at how they do work and redesigning it from scratch. This “clean-sheet mindset” can help break old habits and create new, more efficient ways of doing things. This approach requires companies to analyze both the activities performed and the methods used to perform those activities, with specific tools to eliminate unnecessary work and automate processes.
As inflation increases, companies are closely examining their work in order to determine what is most value and necessary, in order to save money and deploy labor resources toward growth. Eliminating work can take many forms. To streamline manufacturing, Mondelez International plans to eliminate one in every four products in its portfolio. This goal was set in the opening months of the Covid-19 pandemic. Hotels are limiting the amount of housekeeping they do in order to save money. This means that they will only clean your room if you specifically request it, as opposed to automatically cleaning it every day.
After eliminating work, the final tactic is to automate. Technologies that automate repetitive tasks like robotic process automation (RPA), workflow, and intelligent document processing can free up workers to do more creative and valuable work. This is an example of how important associates often spend too much time on manual inputting of data, rather than on more strategic activities.
Not only can automation lead to cost savings in labor, but it can also help create a more stable environment within an organization. The research showed that the companies that had invested more money in automation before the pandemic have done better than others during the crisis. Overall, they’ve seen an increase in productivity and fewer issues with their workforce or supply chain. Companies can reinvest the money they save from improved productivity to automating their processes.
Since there is a lack of skilled workers and an increase in salary and benefits costs, it would be beneficial for businesses to explore ways to reduce labor expenses. Although reducing the number of products offered by the company can lead to lower demand, company executives will also need to take a closer look at the labor costs associated with the products that remain. This is because there is a general trend of increasing salaries.
By automating tasks that are currently performed by human workers, businesses can reduce the amount of labor needed to run their operations. This can lead to reduced costs and increased efficiency. This will allow workers to spend more time on activities that will help the business grow and keep employees happy.
Additionally, if you are setting yourself up for success in the new normal of costs, it is essential to consider the following:
Diversify Supply Chains to the Extent Possible, Even if It Raises Costs in the Short Term.
Inflation cannot be predicted or avoided, but companies can take steps to offset the effects. Although you may have implemented some sustainability measures into your supply chain over the past few years, there is still room for improvement.
A supply chain that is lean and cost-effective is more vulnerable to economic shocks.
There are many ways to invest in making supply chains more sustainable and resilient. There are a few ways businesses can sustain production: vendor diversification, domestic alternatives, and keeping more critical materials on hand. There are some things you can do to help offset the effects of inflation, like stockpiling items that are particularly sensitive to price changes.
Other moves are more about being able to get customers what they want, even if that means a higher cost. If you want to avoid having your margins eaten away, experts say it’s a good idea to start testing out price increases. That way, you can avoid having to switch to domestic vendors or splitting orders among multiple sellers. To prepare for supply-induced inflation, it is important to consider supply chain stress tests to ensure a balance. Previously, you may have considered measures to strengthen your position – these should be revisited.
Get Strategic About Pricing.
Inflation increases the operational costs for a business, so it is easy to raise prices to match these increased costs.
Maybe. Increasing prices can stop some of the cost decreases, but there is a chance that customers will stop using your product or service because they don’t think it is worth the new price. In the end, businesses have to think about their broader market and what other companies are doing, not just inflation.
The pricing strategy should take into account the four main factors: customers, costs, competitors, and cash flow.
Customers: How important is price in customers’ purchasing decisions? Do your customers predominantly buy your products and services because they love the quality, or do they mostly buy based on price? High price sensitivity means that companies should stay near the average price for goods and services.
Costs: How is inflation affecting your costs? Are supplies or labor significantly more expensive?
If your competitors have increased prices, it may be worth considering increasing your prices to match. The only time this wouldn’t be the case is if your company has the ability to keep prices stable in order to gain more market share.
The ability to hold prices steady will depend largely on your company’s cash flow.
businesses that must raise prices to cover costs usually do so by increasing prices across the board. Although an increase in prices may be met with some resistance, especially from companies who have price-sensitive customers or a lot of competition, there are some strategies that can be used to make the increase less noticeable. This can be done by bundling products together, or by unbundling them, adding or removing features, or by changing the pricing model for different varieties of products.
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