This week, U.S. Federal Reserve Chairman Ben Bernanke announced that the "recession is very likely over." While there are indicators to suggest the American economy is in recovery, executives at most companies are still grappling with ways to manage costs.
Indeed cutting jobs continues to be a leading method companies use to prop up their bottom line. In August, economic concerns prompted businesses to shed a net 216,000 jobs, driving the national unemployment rate up to 9.7% last month, according to the latest U.S. Department of Labor report.
But is cutting human capital always the best option? Faculty at Emory University and its Goizueta Business School say indiscriminate cuts can yield unintended consequences over the long term, and add that trimming away expenses instead of hacking at them may be a better strategy.
“The steps that companies should be taking during this recession are different from what they usually actually do,” warns Al Hartgraves, a professor of accounting at Goizueta. “Often, they reduce spending in training, maintenance, advertising and other discretionary cost areas just because it’s easier to cut in these areas. That may help profitability in the short term but it may hurt in the long term. Another common solution is an egalitarian approach where each department is required to cut its budget by a fixed percentage.”
But a better alternative is a “zero-based” approach, a sort of clean-slate strategy where each department has to justify and prioritize every component of its budget, he says.
“The advantage is that a zero-based approach adds transparency to the process and may help to highlight the essential costs and benefits of different functions,” Hartgraves explains. “Zero-based budgeting can help management to zero in on strategies that might have made sense during the boom times but are now dragging down earnings.”
Another important issue involves analyzing fixed costs to current revenues, he notes.
“During the boom years when companies expected to continue their growth curve, many firms increased their manufacturing, storage, distribution and other capacity,” Hartgraves says. “But in a downturn, the underutilized assets may have an outsized negative effect on the bottom line. [To counter this,] it may be a good time to dispose of machinery and equipment, buildings and other fixed assets that are older or less productive, thereby lowering their break-even point. When the economy rebounds, those assets can be replaced with newer, more productive assets.”
For decades, companies in trouble have first turned to downsizing, reducing human capital and operations in terms of the number of products and services offered, notes Shawn Davis, a visiting assistant professor of accounting at Goizueta. “However, in times of recession companies should proceed with caution,” she says. “To begin with, businesses should engage in activity-based costing and management: effectively evaluating their core operations and core projected operations to identify and eliminate non-value-added activities and costs.”
Non-value-added activities are operations that are either unnecessary or inefficient, Davis explains. “As such, they’re dispensable and their removal will not affect the quality, performance, and perceived value of the company’s main products and services.”
Externally, a firm also should conduct customer-profitability analysis to determine the activities, costs and profit associated with individual customers, according to Davis. “Companies are likely to make better decisions about customer service if they have a good understanding of which customers are generating the greatest profit,” Davis explains. “Cost-cutting strategies that result in the loss of a profitable customer would weaken, not improve, the company's position. As such, this profitability analysis would better help companies determine where to devote its limited resources in serving customers.”
Davis also says it’s not uncommon for companies to take an axe to research and development efforts in tough times. But they should proceed with caution, she adds.
“R&D tends to be a primary target when cutting costs is underway because these efforts generally do not provide immediate returns,” she says. “The key here is for companies to instead review their R&D efforts and weed out the ones that have the least long-term potential.”
Firms are better served if they forge ahead with efforts that offer a high pay-off expectation, she adds.
“Moreover, statistics indicate that companies that spend more on innovation during a downturn fair much better and get a higher return on capital in a recovery compared to ones that use a downturn as an excuse to scrimp on R&D.”
Quick-thinking firms may even find opportunities in a recession, according to Charles F. Goetz, an adjunct professor of organization and management and a distinguished lecturer in entrepreneurship at Goizueta.
“During a tough economy, many companies scale back their activity,” Goetz notes. “But a business that can invest in its operations may be able to expand its market share.”
Meanwhile, he says, all companies should be looking for ways to cut waste from their operations.
“You have to cut costs in a way that’s appropriate for your individual circumstances,” Goetz cautions. “Let’s say you’ve got a service-based business that rarely brings clients back to its home base. In that case, you may be able to jettison some office space—saving the outlay of lease costs—and perhaps have your people work from home.”
Healthcare and travel costs also represent cash drains that may be addressed and reduced.
“Outsourcing your employees, through professional employer organizations (PEO), may save money,” Goetz says. “Besides taking care of administrative tasks, PEOs may be able to group together large numbers of small business workers under a single PEO umbrella and offer more leverage when it comes to negotiating healthcare coverage.”
Businesses also should reconsider their inventory order processes and such mundane matters as travel policies, he says.
”If your company maintains inventories of items, can you reduce your stock of goods?” Goetz asks. “Consider analyzing your inventory levels to see if you can maintain a leaner volume of goods, and see if you can negotiate with your suppliers for discounts, longer payment periods, or both. Additionally, try to convert fixed costs to variable costs that more closely track your sales by taking such steps as outsourcing more processes and leasing your equipment instead of buying it.”
If a business’s owners decide they need to cut salaries to survive, it is important to consider the psychological impact as well as the financial impact, Goetz notes.
“Make sure that top management is also taking a cut in salary, and it may be a good idea for the owners to take an even larger percentage cut,” he says. “Let the employees know that management is sharing the pain; otherwise you’ll have disgruntled employees who may hesitate to put much effort unto their jobs.”
One of the simplest and least painful ways to cut costs involves eliminating unnecessary product lines, or SKUs [stock keeping units], according to Jagdish Sheth, a chaired professor of marketing at Goizueta. The problem is that many companies focus on the wrong attributes when they pursue this strategy, he says.
“When companies reexamine their SKUs, they frequently focus on the cost of production, but ignore vital issues like logistics and storage costs,” he explains. “They also need to execute a thorough profitability analysis to determine if they’re carrying too many lines of products.”
As an example, Sheth cites consumer products companies that may produce multiple varieties of toothpaste and shampoos, manufacturers that make a wide range of appliances that serve similar functions with minimal differentiating characteristics, or flavor and fragrance firms that make a wide variety of flavors and fragrances that are essentially variations on a few central themes.
“Along with too many SKUs, companies with multiple product lines tend to lose sight of their individual products’ profit margins,” he cautions. “The aggregate business may be profitable, but a close examination may reveal that certain product lines are operating at a loss and are being subsidized by other, successful ones.”
“In a slow economy, it may not be advisable to keep carrying the laggards,” he counsels. “This may be the time to jettison the unprofitable lines unless there are compelling reasons to keep carrying them.”
The challenge has been compounded by the trend of “bundling,” or offering a variety of services (or occasionally goods) at a discounted price. One example is automobile companies that offer option packages, or suites of add-on configurations, like a larger engine, a specific transmission and perhaps an upgraded sound system. Another example is cable companies that offer bundled telephone, Internet and television packages that cost less than the total of the individual services purchased separately.
“For a long time, bundling was seen as a positive move since it enabled a company to get more of a customer’s business,” Sheth says. “The disadvantage is that it can mask cross-subsidies that may actually eat into a business’s profit.”
Firms should review their customers to determine if too many resources are being devoted to clients that are minimally profitable, Sheth adds.
“Some of the larger food production companies will service their bigger customers directly from company-controlled distribution centers,” he says. “But their smaller or less profitable accounts could be outsourced to third-party logistics companies that can still turn a profit with the smaller client companies.”
In some cases, it simply may not be worthwhile to keep a customer, Sheth adds.
“An effective analysis will utilize activity-based costing to allocate all of the related costs, including transportation and other overhead, by each customer,” he explains.
“Companies often overlook costs like vendor management and support activities including accounting, finance and procurement that are tied to specific customers but are not accounted for. Even worse, some of these overhead support systems may be unique to the customer, instead of being performed as part of a centralized department that can at least deliver economies of scale,” he says.
Analyzed like this, it is not unusual for some companies to find that 80 percent of their profits are generated by 20 percent of their customers, adds Sheth.
“If you discover this is the case, then some tough decisions may have to be made,” he says. “We’re already seeing this in some service firms, like accountants and lawyers who set up new offices or expand existing ones to make it easier to service a key account, only to shut down the new locations after discovering that the marginal growth did not yield the anticipated profits.”
At a time when the economy is spurring companies to reduce costs, executives must remember to balance expense reduction and quality, Sheth warns.
“Keep in mind that good service tends to increase revenue, so don’t compromise on quality,” he said. “On the other hand, bureaucracy and other inefficiencies hurt your bottom line. So be sure to keep your priorities in order as you seek to improve your operations.”
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Friday, September 18, 2009
Can Companies Maintain Quality as They Cut Costs?
Tuesday, October 14, 2008
Southeast Venture Conference Announces Call for Presenting Companies
PRNewswire/ -- The 2009 Southeast Venture Conference announced it is actively seeking showcase companies for its third annual event set for March 11-12, 2009 at Atlanta's Intercontinental Buckhead Hotel.
The conference selection committee, made up of top venture capitalists from around the region, is seeking high growth, innovative companies from a multitude of industries and stages. Southeast Venture Conference presenting companies will have proven management teams and unique market and/or technology positions.
The conference will feature a combination of both early and later stage firms, with previous presenting companies ranging from pre-revenue to firms with over $30 million in revenue.
Over 40 presenting companies will showcase their technologies before a regional and national audience of venture capitalists, private equity investors, angel investors, investment bankers and the technology service community. Presenting companies must be headquartered in one of the following: Alabama, Florida, Georgia, Maryland, Mississippi, North Carolina, South Carolina, Tennessee, Virginia or Washington DC.
The application deadline for presenting companies is set for November 14th, 2008. Additional details on presenting or registration information can be found at www.seventure.org .
The sold-out 2007 and 2008 SEVC's held in Research Triangle Park, NC and Tysons Corner, VA respectively featured over $80 billion in private equity investment capital represented in attendance.
In addition to presenting companies, the conference will feature exclusive networking opportunities, featured speakers and a number of investor/executive oriented panels.
Tim Draper, founder and managing director of venture capital heavyweight Draper Fisher Jurvetson, has been announced as one of the conference's keynotes.
About the Southeast Venture Conference
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Wednesday, September 24, 2008
U.S. Hotels to Bottom Out in 2009
PRNewswire/ -- A new study released today by PKF Hospitality Research (PKF-HR) reveals that demand for U.S. hotel rooms will contract for the next two years. Compounding the negative impact of declining demand is a projected concurrent increase in supply. PKF-HR is forecasting a combined net increase in 2008 and 2009 of nearly 275,000 new hotel rooms compared to year-end 2007. This represents a 6.2 percent jump in accommodations over this two-year period.
With supply and demand levels moving in opposite directions, occupancy rates are projected to decline in both 2008 and 2009. Considering the 0.3 percent occupancy decline reported by Smith Travel Research in 2007, the result is three consecutive years of fewer accommodated roomnights for the average U.S. hotel.
These findings are based on the recently released third quarter 2008 edition of Hotel Horizons(SM), PKF-HR's quarterly forecast report for six U.S. chain-scales and 50 major markets. The forecast was released at The Lodging Conference 2008 in Phoenix this morning.
"Because of the extended slowdown of the U.S. economy, compounded by the negative consequences stemming from airline capacity cutbacks, we are now forecasting a 0.2 percent decline in lodging demand in 2008, followed by another loss of 1.1 percent in 2009," said Mark Woodworth, president of PKF Hospitality Research. "According to data from Smith Travel Research, this is the first time since 1988 that the U.S. lodging industry will experience two consecutive years of decline in lodging demand."
Slow ADR
Through the first half of 2008, the one saving measure for hotel owners and operators was the ability to maintain rate integrity. Despite a 2.5 percent decline in occupancy during the first six months of the year, managers were able to raise their average daily room rates (ADR) by 4.2 percent. Persistent yield management plus contractual rate agreements helped to buoy room rate levels.
"With supply and demand moving in opposite directions, the typical hotel manager will not be able to maintain their aggressive approach to raising room rates," Woodworth commented. "Accordingly, we are forecasting ADR growth for the entirety of 2008 to be 3.6 percent, followed by a minimal 1.3 percent gain in 2009." Looking forward, PKF-HR does not foresee ADR growth to exceed the pace of inflation until 2012, according to Woodworth.
Declining occupancy, plus slow ADR growth, combines for a dismal near-term outlook for revenue increases. PKF-HR projects RevPAR to increase a mere 0.8 percent in 2008, followed by a 3.2 percent decline in 2009. Given the strong contribution of rooms revenue, PKF-HR is forecasting total hotel revenues to remain virtually flat in 2008 (0.2 percent increase) and then decline in 2009 (negative 2.5 percent).
Expense Controls
"Historically, U.S. hotel managers have answered reductions in revenue with more vigilant cost containment. Fewer rooms occupied do lessen the need for staffing, plus inspire management to find expense reductions throughout the operation. Unfortunately, less controllable costs, such as utilities, property taxes and insurance, are on the rise," Woodworth noted.
PKF-HR believes that average operating expenditures will drop 1.0 percent in 2008, thus allowing unit-level net operating income (NOI) to increase 3.1 percent. However, the forecasted 2.5 percent decline in revenue for 2009 will be too much to overcome. Despite another 2.3 percent reduction in operating costs, the average U.S. hotel is projected to suffer a 3.0 percent decline in NOI during 2009. For the purposes of this analysis, NOI is defined as income before deductions for capital reserve, rent, interest, income taxes, depreciation and amortization.
"Fortunately, the U.S. lodging industry was in good financial shape entering the current trough in the business cycle. Unlike other forms of real estate, lodging was not experiencing any material amounts of foreclosures," Woodworth said. "A sample of 1,500 hotels that participated in our annual Trends in the Hotel Industry survey generated sufficient cash from their operations to cover their reported interest payment by a ratio of 1.86. This implies that most U.S. hotels can withstand a fairly substantial decline in NOI and still have the ability to meet their debt service obligations."
On The Horizon
"The current credit crisis may be unfairly punishing developers with sound market and financially justified projects. However, the lodging industry will eventually benefit from the near-term development difficulties," Woodworth noted. "PKF-HR believes the existing restrictive financing environment will linger into 2009, thus delaying or preventing the start of hotel projects currently in the pipeline. Given the 12 to 24 month time needed to construct most hotels, PKF-HR projects a window of one to two years when the amount of hotel openings will be very limited. The pace of new supply growth is forecast to drop to 1.4 and 1.8 percent, respectively, in 2010 and 2011.
"By 2010, we will start to see a reversal of current trends. While the pace of supply growth will be waning, we will start to see a return in the demand for lodging accommodations," Woodworth said. PKF-HR is forecasting a 2.2 percent increase in demand for 2010, followed by another 3.1 percent gain in 2011. With growth in demand exceeding supply, national occupancy levels will begin to rise again in 2010 and continue to increase through 2012.
Despite the forecast of growth in occupancy from 2010 through 2012, the outlook for increases in ADR is somewhat constrained. "As we have observed during the initial years of historical periods of recovery, occupancy gains precede ADR growth. Given the depth of the projected lodging industry slowdown in 2009, the newly built competitive properties added to most markets, and forecasts of below average CPI growth, we are forecasting average daily room rates to increase at a compound average annual rate of 2.7 percent, just equal to the long-term rate of growth for ADR," said Woodworth.
A Trough In 2009
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Tuesday, June 10, 2008
State of Georgia's Revenue Collecctions for May 2008 Cause Concerns
State of Georgia's Revenue Collections for May 2008 Cause Concerns: Governor Should Appoint Commission to Study Revenue Structure
The latest Georgia revenue figures released by the Department of Revenue show that revenues have declined by 0.1 percent through the first 11 months of the fiscal year. The Governor's FY 2008 revenue estimate is based on revenue growth of 2.7 percent. If revenue growth remains flat in June, the FY 2008 Georgia budget will be facing a $500 to $600 million shortfall.
"Because of the Governor's wise fiscal management over the past four years, the state has healthy reserve funds. These reserves put the Governor in a position to manage the economically driven revenue shortfalls without cutting vital government services," said Alan Essig, the executive director of the Georgia Budget and Policy Institute. The Revenue Shortfall Reserve (RSR) contains over $1.5 billion. If revenues remain sluggish throughout FY 2009, it is expected that almost all of the $1.5 billion of reserve funds would be needed to cover budget shortfalls.
"The continued revenue slowdown highlights the fiscal irresponsibility of those legislative leaders who proposed significant tax cuts this past legislative session. Along with this slowdown, there are continued needs, such as trauma care, full education funding, the mental health system, and health insurance for children who are eligible but not enrolled in Medicaid and PeachCare. In light of legislators wasting time with politically motivated tax cut rhetoric, the Governor should take the responsible action of establishing a blue ribbon commission to study the revenue and budget realities of Georgia," Essig concluded.
