In a crisis the company P&L statement can be a useful starting point for cost reduction programs. Over the long term, however, general ledger entries do not have the required level of detail to garner the requisite per unit analysis (McKinsey, May 2010). Unfortunately, few companies do not have systems which can analyse the complexity of cost and spend in order to make accurate and detailed changes.
In the following series of blogs we will highlight the problems with standard ICT cost reduction & management programs and detail how to structure and run one effectively.
The key to an effective ICT cost reduction & management program is detailed cost modelling. Most financial systems do not capture costs at the right level of detail for businesses to perform accurate and detailed cost reductions. Businesses need to perform intricate spend analyses and build up intricate cost models for ICT which highlight the following:
- The capabilities which various ICT components support (and where in the Value Chain they lie). Only through this level of visibility can the business consolidate their ICT spend.
- The HR and process dependencies which are indirectly attributed to various ICT elements. Only with this level of detail can ICT remove duplication and redundancy.
In the absence of this granularity, cost reduction programs invariably fail or fail to stick. In fact, McKinsey & Co note that 90% of cost reduction programs fail. Only 10% of these programs actually succeed in realising sustained cost management three years on.
In a typical IT cost reduction cycle the following happens:
- Headcount is reduced. The remaining people then have to work harder (but with fewer skills, because tasks are pushed to the lower pay bands) to achieve the same amount of work.
- Many, often unique, soft skills are also removed (from experienced people in the higher pay bands) in the redundancies.
- Overall service levels decrease.
- Further cost reductions are then required and some applications and services are axed.
In simple businesses this is not a problem. In large and complex businesses the outcome usually follows a vicious cycle, namely:
- The firm still needs to retain a significant management overhead in order to deal with complexity.
- In these cases, poor transfer pricing and high overhead allocations mean that perfectly good, competitive core business process seem cost-ineffective.
- Critically, Kaplan notes in his seminal work “Relevance Lost: The Rise and Fall of Management Accounting” that the increased costs of processes leads to outsourcing of perfectly good processes.
- Capability suffers and the business loses competitive advantage.
- The business is no longer able to deal with the level of complexity and complexity reaches an inflection point. The business outsources the whole problem (eg, large ERM programs with much customisation), getting locked into horrific terms and conditions.
- Core business is lost and competitive advantage is reduced. Remaining managers pad out their budgets with excessive risk and contingency in order to shield themselves from further cost reductions.
- Overheads increase again and the business eventually prices itself out of the market.
In a recent (2010) Accenture survey on general cost reduction effectiveness in the banking industry, 40% of respondents noted that the program has reduced overall ICT effectiveness and impacted adversely on both customer service and general management.
in order to reduce costs effectively without impinging on capability as well as making new costs stick, it is essential to view costs and spend at the most granular level possible.
In our next blogs we will go into detail how to structure and run an effective ICT cost reduction and cost management program including effective ICT cost modelling.