Identifying Cost Drivers to Achieve Long-Term

Brief

Non-Personnel Costing Excellence

2 min Read | FINANCIAL INSTITUTION, MANUFACTURING, SERVICES

Authors

Sullivan Mcdermott

Partner, Singapore

At a Glance

Companies work hard to keep non-personnel costs low. As a mismatch between product or service quality and internal customers' needs, as well as ineffective demand management.
Rather than avoid dealing with non-personnel costs, leaders must confront them. The goal should be to optimize non-personnel costs intelligently and sustainably.
The non-personnel cost approach has four steps. Our methodology allows companies to examine current costs and drivers and compare them to external standards.

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Intense pressures from a variety of sources, including low-cost competition and growing raw material prices, have led corporate leaders across many industries to pay closer attention to the cost side of their income statement. Capital markets and shareholders have demanded that corporations respond to these constraints by more efficiently and effectively controlling costs.

Non-personnel costs within selling, general, and administrative (SG & A) expenses are a vital but generally underappreciated area for cost reduction. These include costs for facilities, information systems, outsourced labor, transportation, travel, and utilities, among many other ordinary overhead items. If the company outsources a lot, non-personnel expenses can make up 40% to 50% of SG & A expenses. This is based on the industry and the amount of work the company does. Because these expenditures have typically gotten less attention than labor costs, the potential savings are usually substantial. However, lowering non-personnel costs and making the adjustments stick are difficult challenges. Executives must choose where to focus their efforts and how to save expenses while addressing the needs of internal and external stakeholders.

We have established a complete strategy to assist businesses in identifying and quantifying possibilities to cut non-personnel expenses, selecting targets and improvement strategies, and sustaining improvements. The strategy focuses on the “drivers” that govern the levels of non-personnel expenditures, such as head count or utilisation. This technique assists in cost reduction without sacrificing efficiency or effectiveness, while also generating widespread acceptance of the cost reductions throughout the firm.

Non-Personnel Costs are difficult to manage

Most businesses currently make major efforts to keep non-personnel costs low, such as through monitoring tenders. However, we frequently notice that these efforts are insufficiently effective, as shown by a mismatch between the quality of products or services and the needs of internal consumers, as well as insufficient demand management. Several common issues contribute to explaining why firms fail to properly control non-personnel costs:

Non-personnel costs are often not budgeted at the business level. Because each business unit or function creates its own budget, organizations lack a complete view of non-personnel costs and may overestimate their importance. Furthermore, the lack of a single “owner” of these expenditures makes them difficult to identify and regulate.

Companies rarely use tight demand-management systems to centrally control the number of non-personnel-cost commodities procured. As a result, even if the corporation negotiates cheap unit pricing at the corporate level, total expenses in categories such as air travel or IT services may be high.

Managers are unsure about the best improvement strategies to implement in order to minimise non-personnel costs, as well as the suitable cost levels to set as targets. As a result, they are often unaware that improvements can be achieved swiftly and painlessly.

Because managers and employees may want to keep access to products and services, discussions about cost-cutting opportunities are sometimes based on emotions rather than facts about the value given.

These difficulties make it difficult for businesses to control non-personnel costs using the same sophisticated methodologies that they use to calculate budgets in other areas. During good times, they tend to base non-personnel budgets on the previous year’s spending or to adjust them based on how head count has changed. During times of austerity, they decrease costs indiscriminately.

The Effort Invested in Cost Excellence Is Worth It?

Rather than avoiding the challenges of managing non-personnel costs, CEOs must confront them head on. The goal should be to achieve cost excellence by intelligently and sustainably optimizing non-personnel expenditures.

Non-personnel costs can be classified into eleven categories. The proportional relevance of the cost groups will differ depending on the industry and firm. Buildings and equipment, property management, fleet management, and employee services and human resources are often the groups responsible for the lion’s share of spending. We don’t include an IT cost group since IT costs are determined by certain causes and are already thoroughly evaluated by top management due to their size.

The overall savings opportunity for a specific organization is determined by its existing cost levels and whether or not it has already undertaken cost-cutting strategies. Marketing savings could range from 20 to 35 percent; facility management savings could range from 15 to 25 percent; travel management savings could range from 10 to 20 percent; buildings and equipment savings could range from 5 to 20 percent; fleet management, business services, and utilities savings could range from 5 to 15 percent; and employee services and HR savings could range from 5 to 10 percent. These estimates of cost savings reflect cost savings from both lower prices and lesser amounts purchased.

Measures to limit non-personnel expenses, in addition to their considerable potential for savings, can typically be adopted rapidly and with very little up-front input (for example, by changing travel guidelines). As a result, companies might see the bottom-line benefit sooner than when personnel costs are reduced. In addition, unlike other areas of cost reduction, most employees will not notice reductions in non-personnel costs such as building leases or utility prices.

The advantages go beyond simply increasing the bottom line. Reducing non-personnel costs can boost and support the expectations of capital markets and shareholders by proving that the company is adaptable enough to withstand the impact of unfavourable economic factors. Our research across multiple industries has consistently revealed that companies with low SG & A expenses as a percentage of revenues achieve greater levels of total shareholder return. Furthermore, firms with steadily declining costs generate higher levels of TSR than firms with stable or growing costs. Because non-personnel costs account for a sizable portion of SG & A expenses, market analysts consider their evolution to be a key statistic for evaluating top management’s capacity to improve internal resource allocation. They frequently analyze how a firm handles non-personnel expenditures over time and compare them to its peers’ success.

A Cost-Reduction Strategy Based on Drivers

Four elements comprise our driver-based approach to achieving excellence in non-personnel costs. The methodology enables businesses to examine their present costs and underlying factors and compare them to external standards. Companies utilise the information to set goals and enhance processes. The ultimate goals are to put the changes into action and keep the improvements going.

Examine Non-Personnel Costs & Factors that Influence them

Companies must define cost groups and subgroups, determine the total costs generated by each, and identify the key cost drivers in order to acquire a standardised view of their non-personnel-cost base across all business units and cost categories.

To help with this effort, we’ve created a standardized list of cost groups and subgroups, as well as their associated cost drivers. Exhibit 2 depicts this distribution for several expense groups. The standardised list is applicable to all business units and enterprises and serves as the foundation for internal and external benchmarking. To allow for like-to-like benchmarking, a company can change its nomenclature for each cost group and subgroup to reflect company-specific titles and cost allocations; but, its categories must correspond in substance to those on the standardised list.

To ensure consistency and quality, the central controlling function of the organization should be in charge of collecting data for benchmarking. By collecting historical data on cost drivers over the last three to four years, the organization may have a dynamic perspective on how expenses have changed over time.

Following the collection and validation of all relevant data, the organization can provide organized overviews of total costs as well as detailed breakdowns for each cost area. At this point, the company should focus on preliminary findings for key cost areas and understand how they relate to the costs and drivers of comparable organizations.

Assess nonpersonnel costs and their drivers

To obtain a standardized view of their nonpersonnel-cost base across all business units and cost categories, companies need to define cost groups and subgroups, determine the total costs generated by each one, and identify the primary cost drivers.

To facilitate this effort, we have developed a standardized list that sets out cost groups and subgroups, as well as their respective cost drivers. Exhibit 2 illustrates this breakdown for several cost groups. The standardized list can be applied to all business units and companies, and thereby provides the basis for internal and external benchmarking. A company can customize its terminology for each cost group and subgroup to reflect company-specific names and cost allocations; however, its categories must correspond in substance to those on the standardized list in order to permit a like-to-like benchmarking.

To ensure consistency and quality, the company’s central controlling function should be responsible for collecting data for the benchmarking. The company can obtain a dynamic perspective on how costs have changed over time by gathering historical data on cost drivers during the past three to four years.

After collecting and validating all the required data, the company can develop structured overviews of the total costs as well as in-depth breakdowns for each cost group. At this stage, the company should focus on the initial findings for key cost groups and understand how they compare with other companies’ costs and drivers.

To Acquire Relevant Insights, Compare Expenses & Drivers

Traditional efforts to benchmark a company’s non-personnel expenditures frequently fail to produce actionable insights because these costs are difficult to evaluate, whether internally (across multiple business units and over time) or externally. Companies can do an effective like-to-like comparison of cost groups and drivers by drawing on a standardized list of cost groups and drivers and its extensive database of non-personnel costs across industries.

Simply comparing a sales organization’s travel costs across numerous years, for example, would not give significant information. The high-level, absolute cost statistics could fluctuate for a variety of reasons, including head count and the regularity with which personnel in a specific location or position travel. Gathering data on the number of sales full-time equivalents, the number of trips per year, and the expenses of each trip, on the other hand, allows the organization to identify the true drivers of variances in travel expenditures. For example, it may be discovered that, despite relatively flat absolute travel costs over time, costs per sales FTE have actually climbed. Similarly, instead of comparing absolute prices of company vehicles across business units, organizations should evaluate the number of FTEs eligible to hire vehicles and the cost per rented vehicle per eligible FTE.

Establish Goals & Measures for Improvement

Companies can use the benchmarking information to identify the best cost-cutting targets and the best improvement actions to achieve those aims.

Companies should use benchmarking results, as well as insights on typical savings possibilities acquired from experience, to develop top-down targets. In addition, they should conduct qualitative interviews with managers to determine which cost groupings and subgroups offer the most substantial potential. To make the selection and implementation of cost-cutting strategies easier, the savings targets for each cost group and organizational unit should be defined as precisely as possible.

Companies can determine improvement measures for each cost group and subgroup using this fact base. In order to determine acceptable measures, we examine both the efficacy and efficiency of the linked expense items.

The effectiveness evaluation aims to discover opportunities to substitute less costly suppliers (such as lower-cost insurance providers, travel agencies, or airlines) or meet the needs of internal consumers with lower-quality services (for example, by reducing the scope of management reports).

The efficiency review looks for ways to eliminate or reduce activities (for example, by using more severe demand management or novel technologies to minimise the quantity of products purchased or leased) or to reduce the frequency and level of services (for example, by deploying videoconferencing technology to lower the number of business trips).

By using this approach, we have created over 200+ suggestions and best practices for picking improvement measures relating to certain cost groups and subgroups. These ideas have been used by top companies to find ways to improve that have a big impact.

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