EXECUTIVE GUIDANCE FOR 2013

Doing More with LessProtecting High-Value Services in an Era of Permanent Cost Pressures

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Most companies responded to the global economic crisis of 2008 in a formulaic manner: cut costs quickly, hunker down, and wait for growth to return. However, even after five years of austerity and lackluster margin growth, companies still find themselves facing higher profit expectations from investors.

25%

20%

15%2008 20122010 2014 20162009 20132011 2015 2017

20.0%

18.2%

Continued Margin PressureS&P 500 Operating Margin, Trailing Four Quarter Average, 2000–2017 (Forecast)

Source: CEB, CEB Finance Leadership Council.

Cost-Cutting Mandates and Their Flaws

Analysts expect companies to grow margins by 1.8 percentage points over the next five years.

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Cost Pressures Are Expected to IncreaseBusiness Executive Future Expectations of Revenue Growth and Cost Pressuren = 2,209.

Higher

No Change

Lower

Note: Totals may not equal 100% due to rounding.

Source: CEB, Business Barometer Survey, 2013.

Curbing costs is clearly becoming a major, recurring challenge. Although some organizations have been able to successfully engage in continuous cost improvement—modestly but consistently improving their cost structure each year—the vast majority try to achieve more material savings through large, one-time cost-cutting campaigns—or large-scale strategic divestitures. In fact, a recent PricewaterhouseCoopers survey reveals that 77% of global CEOs have undertaken a significant cost reduction initiative in the past 12 months, and 70% plan to do so in the next 12 months.

This challenge will likely continue to plague senior management. CEB’s Business Barometer Survey for Q2 2013 reports that 67% of executives expect cost pressures to increase across the next 12 months due to macroeconomic factors such as low demand, rising input costs, and strengthening low-cost competition.

0%

50%

100%

23%

13%

64%

16%

18%

67%

Revenue Expectations

Cost Pressure

100%

50%

0%

Source: PricewaterhouseCoopers, “Dealing with Disruption: Adapting to Survive and Thrive,” 16th Annual Global CEO Survey, 2012.

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Major organizational overhauls aside, cost-cutting mandates often take the form of a specific cost-savings target derived from market expectations, mandated by the CEO, and applied evenly across the organization by the CFO. In a recent CEB survey, we found that 39% of CFOs plan to reduce costs in the near term by a specific dollar amount or percentage.

Unfortunately, these kinds of campaigns do not have a high success rate and are frequently unable to generate sustainable cost savings. Only 43% of companies achieve their cost-cutting goals during the first year of such a campaign, and a mere 11% are able to sustain their cost savings for more than three years.

0

50

100100

43

2511

Companies That Launched a Cost-Cutting

Initiative

Companies That Achieved Cost

Reductions During the First Year

Companies That Sustained Cost

Reductions During the

Second Year

Companies That Sustained Cost

Reductions During the Third Year

Most Cost Cuts Are Not SustainableNumber of Companies with Successful Cost-Cutting Initiatives by Durationn = 230 (indexed to 100) S&P 500 companies publicly launching a substantial cost-cutting initiative to reduce overhead costs.

Source: The McKinsey Quarterly.

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1. Cutting Costs Too Quickly to Achieve Lasting Efficiencies

Quickly executed large cuts usually leave no time to make meaningful and lasting changes to internal processes. As a result, companies temporarily run more cheaply but do not actually become more efficient. These cut costs tend to creep back into the system once the urgency for austerity fades.

When organizations are able to identify and remediate real process inefficiencies, they are more likely to control these costs over a sustained period. But this takes time to investigate, plan, and execute—more time than most organizations are willing to wait to report savings. Given this trade-off, many executives sacrifice sustainable cuts for quick cuts.

2. Shooting for the Wrong Target

Executives often set their targets based on inappropriate benchmarks. Too often, cost-cutting targets in the form of a percentage or dollar amount (e.g., reduce total finance department costs to 0.9% of annual sales) are based on consultant-provided, industry-specific benchmarks or a company size bracket that can be out of synch with a given company’s corporate strategy, growth patterns, financial composition, and business complexity.

For example, a multinational corporation in its growth phase that is aggressively trying to win share in emerging markets should probably spend more on Marketing, IT, and Compliance than a similarly sized industry peer that is domestically focused and has depleted its growth opportunities. Setting cost-cutting targets based on numbers derived from companies that are fundamentally different—or “averaged” to the point of irrelevance—will likely result in suboptimal decisions and inadequate investments.

Three Common Mistakes of Cost-Reduction Campaigns

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A Not-So-Scientific MethodSources Used to Establish Cost TargetsPrimary Source of Guidance Used, Member Survey, May 2013

0%

50%

100%100%

94%

56%

Benchmarking or Consulting Firm

Historical Finance Spend in My Firm (e.g., 2010 Spend)

Personal Network of Company Executives

Source: CEB, CEB Finance Leadership Council.

3. Assuming All Costs Are Created Equal

In addition to cutting costs too quickly or ascribing false precision to cost benchmarks, functional executives often default to across-the-board cuts rather than consciously differentiating what to cut and what to protect. Cutting an average amount from all things may seem fair and even or can be seen as a way of sparing staff or internal customers from disproportionate pain. However, this broad-brush approach also fails to acknowledge that some teams and services create more value than others within the organization.

One CEB member created a dichotomy between value-creating and value-maintaining activities and distinguished them further as “activities that drive sales or profitability” and “everything else.” Through this lens, it’s easier to see that fair and even cuts miss the point because the value created by different services within functions is unequal. Progressive organizations and their senior leaders realize that when reducing costs, how and where you cut matters far more than simply how much you cut.

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The combination of these cost-cutting mistakes has made it very difficult for executive teams not only to identify and make cuts but also to capture the efficiency benefits originally targeted.

Furthermore, the bulk of the cost mandate falls too often on the general and administrative (G&A) functions—what CEB calls the “corporate core.” We hear every day from heads of corporate functions (e.g., Finance, IT, HR, Legal, Marketing) that they are expected to reduce their contribution to corporate overhead costs this year. Worse, they are being asked to do so while still providing more and better support to the business in an increasingly global and more complex operating environment—essentially to do more with less.

Despite having endured multiple cost-cutting rounds since 2008, functional heads fear few opportunities remain to increase efficiency without significantly impairing service quality—much less improving it. Most executives still face a serious management challenge: how can we get better and cheaper at the same time?

Although some consulting firms describe world-class corporate functions as both efficient and effective in all areas, CEB has discovered it is very hard (if not impossible) for companies to simultaneously get better and cheaper in all but a few areas. Rather, the key to more effective cost management is to make investment decisions that will allow your function to get better at some things and cheaper at others. CEB believes a more structured approach is necessary to make the principled, targeted cuts (and investments) that enable lasting and increased efficiency. CEB calls this “de-averaging.”

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Executives wear two hats: one as head of a corporate function or business line and the other as a fiduciary officer of the company. Therefore, functional leaders set a strategy for their department within the context of corporate strategy and emphasize enhancing functional capabilities that will drive business value. Taking a de-averaging approach to cost management requires executives to focus on maximizing the value their function provides within a set budget, not just meeting a set budget. In other words, progressive cost managers maximize their return on investment by understanding which of their activities provide the most value to their company, protecting their investment in those activities, and accommodating cuts in lower-value activities.

We’ve found that functional leaders at progressive organizations are much more likely to view their functions as a profit center rather than simply a cost center. If you ran a profit center and were engaged in a streamlining exercise—for example, SKU reduction—you would never look only at cost (e.g., production costs for a given product) when making a decision on what to cut. Instead, you would compare the cost of delivering that product to the value it creates in the form of revenue/profit streams.

The best functional leaders also treat their cost centers like profit centers, with a series of “products” or “services” provided to internal customers. Functional leaders assign not only a cost to each service provided but also a value that each service delivered to internal customers. These leaders never fall into the trap of thinking all costs are equal and can be cut evenly and indiscriminately. Leaders who take a de-averaging approach to cost cutting are able to prioritize their function’s activities and make calculated decisions about where to cut and where to invest.

De-Averaging: A Sustainable Approach to Doing More with Less

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CEB finds that leaders who are effective at de-averaging follow a simple sequence of steps to ensure their cost-management decisions are balanced and meet cost objectives in a way that maintains (and protects) the function’s core contributions to the business:

1. Reclassify Your Activities as “Products” and “Services” for Your Internal Customers

2. Identify the Unique and Valuable Services Your Function Provides

3. Use Internal Customer Feedback to Assess Your Service Portfolio

4. Make Principled Bets and Cuts in Your Service Portfolio

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Before you can assign business value to what your function delivers, you must first categorize the various activities your department performs into products and services offered to internal customers. CEB has developed a simple business assessment framework that disaggregates each function along three dimensions to help reframe functional activities to reflect how an internal customer would view the function’s support:

■ Product Offerings—What services are provided to the business

■ Service Approach—How and where products and support are delivered

■ Staff Capabilities—Who delivers these services to the business

Conducting this exercise will allow you to reclassify your activities from the internal customer’s perspective and will provide a refined view of the total of all activities performed. Reconceiving your activities as a portfolio of customer-facing products and services—in effect, your service catalog—will allow you to reevaluate your priorities and narrow your products and services to those that provide the greatest business value.

Reclassify Your Activities as “Products” and “Services” for Your Internal Customers

1

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Reframe Your Function’s Value by Defining the Portfolio of Services and Products Provided to the BusinessCEB’s Standard Business Partner Assessment Framework

1. Product Offerings

3. Staff Capabilities

■ Policies: Defining and enforcing policies

■ Operations: Executing tasks or providing support to the line

■ Solutions: Providing higher-order support to the line

■ Strategy: Partnering in strategic planning or long-term change initiatives

■ Knowledge: Foundational understanding of the business, function, and technical field

■ Skills and Competencies: Individual staff capabilities and attitudes

2. Service Approach

■ Design: Planning services and relationships for/with business partners

■ Delivery: Providing services to business partners

Overall Business Value ■ Strategic

■ Operational

■ Financial

Source: CEB, CEB Business Alignment Tool. Please refer to p. 21 for more information about this tool.

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Although most executives would like to think otherwise, CEB research indicates that typical functional departments—even at Fortune 500 companies—only deliver a relatively small set of three to five services that are truly unique and differentiated from what peer companies provide or from what is available for purchase on the open market. The rapid growth and adoption of business process outsourcing (BPO) to deliver common or “commodity” processes better, faster, and cheaper supports this viewpoint. To identify your most distinctive, irreplaceable contributions to the business, take the following steps:

■ Self-Assess Your Portfolio of Services on Its Alignment to Corporate Strategy and Performance—Start by asking how important these services are to helping the business meet its strategic, financial, and operational goals. Those activities more aligned to supporting critical business outcomes—such as training and development in a talent-based service organization, support for M&A decisions in a highly acquisitive company, contract profitability analysis in a project-based business, or data analytics in an information enterprise—should have a higher inherent business value and may therefore justify above-normal investment.

■ Use Uniqueness as Your Measuring Stick—Evaluate whether your products can be provided by others or through other channels—especially externally, if a request for proposal (RFP) to conduct those services was issued to BPO providers. Keep the bar for uniqueness high; are you the only and/or best provider? Try to reduce subjectivity and ownership bias when answering this question.

Identify the Unique and Valuable Services Your Function Provides

2

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Internal customer feedback is an essential reality check against your own assumptions and assessments in determining the value and uniqueness of your services. CEB has found that executives and their teams can confidently identify nonunique services that are probably not sources of significant value creation. What remains is a number of services that might be unique and then some you’re not sure about. As you think about these latter two groups of services, use internal customer feedback—whether from business line managers and employees or other functional departments—to help finalize your categorization.

Take the services that fit into the “unique” and “not sure” categories and ask your internal customers for an objective assessment of not only the services’ importance but also your function’s effectiveness in delivering them. The feedback might surprise you. CEB data shows that most functions perform dismally in meeting the expectations of business partners. In fact, in a survey of 475 different companies across 2008–2013, corporate functions under-delivered on business partner expectations for 30% of the activities those partners considered most important to supporting their objectives. Many of those activities were originally categorized as unique and differentiated services by functional heads.

Use Internal Customer Feedback to Assess Your Service Portfolio

3

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Like any customer survey, how you ask questions is very important. Make sure you collect feedback intelligently and fairly so customer responses are accurate and useful—for example, minimizing the risk of false positives or negatives. When asking for business partner feedback, take the following steps:

■ Frame Services in Terms of Business Objectives—Keep in mind that your internal customers care more about process outcomes than the process itself. To ensure they truly understand what you’re asking them to evaluate, don’t use technical or functional terms for the services; instead, describe them with respect to the business goals they support.

■ Force Business Partners to Make Trade-Offs—Position this survey in terms of trade-offs the business must make by using conjoint analysis, forced-ranking, or some other mechanism. Not everything can or should come back as “high importance,” and business partners will often change their responses if they know what these services are costing them in chargebacks and overhead adjustments.

■ Identify the True Customer—If you do not consider the service to be optional because of corporate governance norms or regulatory requirements, do not leave it out of the survey. Instead, survey the true customer (e.g., board members, CEO, or CFO) who is the recipient of, or accountable for, these services. Even though the end product (e.g., a quarterly risk review for the audit committee) may be nonnegotiable, these stakeholders may have suggestions on how to improve process efficiency while still delivering what they need.

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Executives are perfectionists and want to be great at everything, which puts them in a position that often prevents trade-offs. But de-averaging cuts is all about making trade-offs. Once progressive leaders know which services are of highest value, they can treat the mandate for cutting costs as a portfolio management or SKU reduction exercise. Using this approach, they can protect their ability to provide the most critical and high-impact services by disproportionately cutting low-value activities.

Using your internal customers’ feedback, identify where and how to cut costs by considering the overall importance of the activity and your relative effectiveness at providing it. Start by creating a simple chart that plots each activity by its strategic importance on the vertical axis and by your (customer-rated) effectiveness on the horizontal axis. This chart will guide your cost-management decisions by classifying your services into three useful categories:

■ Unique Functional Strengths (high customer importance and high delivery effectiveness)

■ Low-Hanging Fruit (low customer importance across all levels of delivery effectiveness)

■ Achilles’ Heels (high customer importance and low delivery effectiveness)

Make Principled Bets and Cuts in Your Service Portfolio 4

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Assess Functional Activities by Importance and Effectiveness to Guide Your Cost-Management Decisions Sample Service Portfolio Segmentation MatrixCompliance Function, Illustrative

Imp

ort

ance

to

Sup

po

rtin

g C

orp

ora

te

Stra

teg

y an

d B

usin

ess

Nee

ds H

igh

High

Lo

wM

ediu

m

Low Medium

Delivery Effectiveness According to Business Partners

ACHILLES’ HEELS UNIQUE FUNCTIONAL STRENGTHS

LOW-HANGING FRUIT

Regulatory Training

Response Time

Cost-Effectiveness Manager Training

Disciplinary Guidelines

Regulatory Updates

Standards and Procedures

Risk Mitigation

Analytics

Risk Assessment

Ethical Leadership

Corporate Monitoring

Risk Monitoring

Culture Assessment

Compliance and Ethics Helpline

Scenario-Based Training

Source: CEB, CEB Business Alignment Tool Survey.

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Progressive organizations use the following cost-management approaches for each of these three segments:

■ Protect Your Unique Functional Strengths—This set of services is highly important to business partners and typically defines your most unique, valuable contributions to the business. Maintain your ability to deliver them at a continued high-quality standard by protecting them from cuts and possibly (and counterintuitively) increasing your investment. Communicate the value of these services (and your team’s proficiency) internally and externally, even after the cuts, to build your brand for these services and reinforce your function’s commitment to high-quality delivery.

Services That Can Be Closely and Directly Linked to Organizational and Business StrategyServices Most Likely Rated Most Important, by Businessn = 475 companies across 2008–2013.

Finance

■ Profitability Assessment Services

■ Management Reporting

■ Agile Resource Allocation Processes

Human Resources

■ Leadership Development

■ Succession Management

■ Employee Branding

■ High-Potential Employee Management

Other Services Across the C-Suite

■ Audit Committee Reporting

■ IT Security Risk and Compliance

■ Supplier Negotiation and Management

■ Product Quality Assurance

Source: CEB analysis.

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■ Pluck Low-Hanging Fruit—Because these services either do not support corporate strategy or are not critical to business partners’ objectives, they are areas where you can “dare to be adequate.” The returns resulting from raising service levels here would be low; in fact, you may be over-invested in providing these services right now. Activities likely to fall into this category are discretionary in the eyes of the business—including but not limited to reporting, vendor management, project management, or policy development and monitoring. Cut them disproportionately to fund your most valued services (i.e., your unique functional strengths).

Progressive organizations have identified useful guidelines for managing costs in this “low-hanging fruit” category:

— Reduce service quantity where importance and value are questionable—For services that are nice to have as opposed to necessary in the eyes of business partners and have no larger strategic or governance purpose, consider cutting them entirely (e.g., reduce SKUs or shrink your service catalog). The opposite approach—reducing resourcing for these services to enable your function to deliver a greater number of services at mediocre levels of quality—will hurt your team’s internal brand in the long run.

— Reduce service quality where activities are required but not by critical customers—For services that must be maintained for strategic reasons or because of regulatory or statutory requirements, identify where you can afford to be good enough instead of being world class. Confer with stakeholders to see if your current “platinum” approach could be reduced to “gold,” “gold” reduced to “silver,” and so forth.

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— Outsource deliberately and with caution—Most large organizations are experimenting in some manner with less costly delivery methods (outsourcing, offshoring, or shared services) for services in the “low-hanging fruit” category. Although often successful, these approaches can take a long time to execute effectively—often longer than the short-term deadlines needed to realize cost cuts—and are often burdened by political considerations. Outsourcing these activities is the most controversial of these strategies. Unfortunately, a large number of companies that previously outsourced their functional activities are now in the process of bringing them back in house due to intense internal customer dissatisfaction. Moreover, outsourcing contracts that promise savings in the short term are often incompatible with long-term cost-savings goals because they typically have built-in year-over-year cost increases.

— Be prepared to defend your decisions—Whichever approach you pursue to execute your disproportionate cost cuts, we recommend you retain the collected business partner feedback data to explain why you are reducing your standards for service delivery or cutting services altogether. Educating business partners about your trade-offs given limited resources, and that their input helped inform the changes, will help obtain their buy-in. Highlight the impact of these cuts on reducing business partners’ overhead charges to gain their support.

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■ Fix Delivery of Your Achilles’ Heels—This category is the most vexing because it includes services where the importance ascribed by business partners is high but your function’s perceived level of effectiveness in delivering them is low. In other words, your function is currently under-delivering against your internal customers’ expectations, yet the organizational appetite for discontinuing these services is low. As a result, you need to determine whether you must work to change those expectations or potentially re-scope or relaunch the services.

As you evaluate services in this category, start by examining the underlying drivers of the performance gap (e.g., timeliness, errors, lack of understanding of the business needs), and use this analysis to initiate discussions on the investments needed to meet business partner expectations, their opportunity cost, and the likely returns. This will help you take decisive action on whether the service should be re-sourced, redesigned, or reinvested in.

In understanding the true drivers of underperformance, you and your team can improve your practices and the delivery of services in the “Achilles’ Heels” category. Solutions will vary, but leading organizations consider changing a wide range of factors, including staffing assigned to the task, reporting relationships, job design, or other organizational constructs. In addition, process improvements such as increased automation, standardization, or centralization are often required to improve performance. When it makes sense, some organizations have also used outsourcing strategies to improve processes (and thus service delivery) rather than to cut costs.

Finally, one course of action to avoid is pushing responsibility for conducting “Achilles’ Heel” activities back to business partners. Organizations pursuing this strategy offer an illusion of lean corporate functions but create less-scaled “shadow costs” throughout the organization. In aggregate, corporate costs for these organizations tend to rise.

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Cost-cutting mandates from the CEO or CFO usually aren’t optional or negotiable, but there is a right way and a wrong way to respond. Successful functional leaders take a deliberate, targeted approach to applying cuts across their budget, head count, and activities. These leaders de-average cost cuts so they can protect the most unique, valuable, and important services their functions deliver. They use internal customer feedback to evaluate their services, and they seek to disinvest only in their lower-value activities. By protecting activities that create value and cutting back on those less vital to the company’s success, executives who use the de-averaging approach are able to sustain both their efficiency gains and contribution to firm performance.

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The quick-win cost savings have long been captured. To navigate the next wave of cost cutting, executives must make hard trade-offs to protect the activities that matter most to business partners while cutting down on those that don’t. Without objective views of these differences, there’s a real risk that cost pressures will undermine your ability to drive business value—in turn making your function more vulnerable to future cuts.

CEB’s Business Alignment Tool (BAT) will help you assess the performance of all major corporate and G&A functions based on the value delivered to business partners.

Use this tool not only to identify how to de-average cuts when executing a cost-reduction campaign but also to:

■ Raise functional performance by targeting improvement efforts in the areas of highest ROI,

■ Gauge alignment with business partners’ expectations and perceptions of performance,

■ Build the function’s plan based on key strengths and critical performance gaps,

■ Evaluate your service portfolio to ensure it is aligned with business partner needs, and

■ Measure business value delivered to internal stakeholders by the function.

The Business Alignment Tool is available to most corporate service functions—such as HR, Finance, IT, and Legal—at no additional cost to Leadership Council members; contact your account manager for details about how it can help your organization develop a fact base for the functional improvement process steps outlined in this document.

How CEB Can Help

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