When cost cutting alone isn t enough

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1 Consumer products Of special interest to Consumer products executives Insights for 5executives When cost cutting alone isn t enough Sustainable cost reduction means knowing your culture EY s Global Consumer Products Center recently commissioned a survey of 285 C-suite executives and analysts to understand how volatile economic and demographic environments are affecting operating models and margins of consumer products companies. Here s what we learned: Seventy-four percent of participants think that they need to make significant changes to their business model to sustain historic margin levels. Fifty-one percent of respondents cite greater cost of controls, and 47% cite efficiency improvements as the top areas of activity to deliver the majority of margin improvements. Fewer than 33% say that their company is very good at increasing efficiency or productivity. Maintaining margins demands a continuous focus on cost and efficiency. And yet, despite years of effort, many companies have found that ordering 10% cuts across the enterprise without considering the differential impact those costs may have on individual functions or cost centers hasn t worked. A more strategic approach that aligns cost efforts to the company s broader business objectives can help to make better decisions that reduce costs and improve business performance. But to truly achieve sustainable enterprise value, companies need to look at their improvements through a cultural lens to make sure they are implementing cost reduction programs that are right for the company and its employees.

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3 What s the issue? Most cost reduction programs fail to sustain savings beyond the initial period of management focus. Why? Because for all the focus organizations put on strategic and tactical initiatives to change the operating model and search selling, general and administrative expenses (SG&A) for cost efficiencies, few consider the cultural shift that needs to occur within the organization to make the changes stick. Turning an initial enterprise cost reduction program into a sustainable, ongoing function requires organizations to establish a sustainable program governance structure, align performance management systems and transfer knowledge. But most importantly, it requires that organizations embed a cost reduction culture into their business and people strategies. There are layers of bureaucracy in many of these companies that could easily be slimmed out, but it will take a new way of working that will require a different mindset. Tracey Campbell, SalientBrief * Cost reduction programs that are run simply as one-time initiatives are destined to be repeated. Why now? Consumer products companies continue to experience cost pressures. Inflation in emerging markets, where many consumer products companies find their key suppliers, means import commodity costs are rising. However, with slow annual GDP growth in North America and global economic uncertainty overall, these costs often can t be passed on to the consumer. In our survey, respondents cite availability and cost of raw materials as the biggest increase in risk over the next five years. In fact, 60% suggest that it will become increasingly necessary to secure a long-term supply of critical resources and commodities. From a stakeholder perspective, investors continue to look for companies that operate as lean as they possibly can. They want to put their money in companies that are lean now and that have a plan to stay lean into the future. Investment based on lean operations could drive increases in market capitalization and share price for the company. The fundamental rise in cost of commodity materials over time is inevitable, and inevitable because the initial pace of development of the world s consumers is higher than it s ever been. Bob McDonald, Procter & Gamble * * The quotes were taken from in-depth interviews carried out between February and May 2012, and included in EY s report, Disrupt or be disrupted: creating value in the consumer products brand new order. 5 Insights for executives [Consumer products] 3

4 How does it affect you? Today s consumer products CEOs are not solely interested in reducing the immediate bottom line. They are also interested in strategic solutions that drive long-term enterprise value. Effective, sustained cost reductions release resources to fund growth and expansion plans. They can also often improve quality and alignment with strategy. However, sustainable cost efforts require not only the support of the CEO, but also the employees. Cost reduction measures need to receive employee buy-in to provide sustainable value. If cost reduction efforts cannot be sustained, companies will lose the availability of precious internal resources and the investor confidence that supports the company s market capitalization. Driving out waste and costs and continuous excellence has to be a permanent thing because every organization tends to allow back inefficiency over time. This is a very positive dynamic because it empowers people in an organization like ours to be part of value creation. Paul Bulcke, Nestlé * Companies looking to make sustainable cost-efficiency moves face a predictable inflection point, defined by cultural acceptance 3a World-class virtuous cycle Cultural norms drive continuous improvement of cost and quality. Performance metrics reinforce cost-effective behavior. What makes the difference? Aligning cost reduction to cultural norms Executing an explicit shift of culture where needed Using driver-based insights to improve cost effectiveness decision-making Cost effectiveness 1 2 Initial impact cost reduction programs Work is eliminated. Investments are prioritized. Costs are taken out. New controls and measures Business-as-usual cost are put in place to monitor structure cost efficiency. Costs are unsustainably high compared to competition. Cost structure hampers pricing power and ability to invest. 3b Declining performance vicious cycle Cultural conflict degrades performance. Shadow tools, processes and people spring up. Time 4 5 Insights for executives [Consumer products]

5 What s the fix? There are three areas upon which consumer products companies can focus to drive sustained enterprise value: 1. Know your operations. At a tactical level, your company needs to have a depth of insight into its operations to be able to make the right costcutting decisions at a detailed, program-by-program level. It s about knowing which cost reduction opportunities will provide the most value. 2. Align decisions to the business strategy. In addition to using insights to make program-by-program decisions, companies should be taking more strategic measures. Linking cost reduction efforts to the broader business strategy and to the operating model enables you to be deliberate about where to invest in cost savings. Using tools such as driver analytics provides a framework to structure decision-making. 3. Apply a cultural lens. To make the right cost reduction choices, you need to understand the cultural fabric of your company. To apply a cultural lens to your decision-making, consider the following: a. Understand your culture s ability to embrace change. What degree of culture change are you trying to drive? Is it a minor cleaning or a complete overhaul? How will your people react in each of these situations? b. Determine which kind of enterprise cost reduction efforts would best align to the culture. You don t want to ruin advocacy for the brand or the employee relationship. Know which cost reduction efforts add value and which don t. c. If you need to shift the culture, be deliberate about how best to do it. Make sure the cost reduction program you need to implement is supported by an equally robust organizational change management program that incorporates ample communication. d. Link the culture shift back to strategy. Make sure decisions make sense to the strategy of the business and the employees. In addition to addressing opportunities in these three areas, you will want to introduce a cross-enterprise program management initiative to provide a level of rigor that enables you to make driver-based decisions market-bymarket, leader-by-leader and function-by-function to avoid value leakage. By simultaneously implementing a people and organizational change management program, you will strengthen your cost reduction messaging in a way that sustains employee engagement. 5 Insights for executives [Consumer products] 5

6 What s the bottom line? Cost pressures for consumer products companies are set to continue for the foreseeable future. Companies that take a tactical approach to cost-cutting may find success initially. However, that success is often short-lived. A more strategic approach enables companies to be more targeted in their cost reduction efforts, investing in areas that will maximize enterprise value. However, none of these initiatives can be successful in the long term without knowing and taking into account the company s culture. By applying a cultural lens to decision- making and linking those decisions back to the company s business strategy, companies can help employees to remain engaged and supportive of the changes that occur. Ultimately, applying a cultural lens to enterprise cost reduction will produce much more than sustained savings and long-term value for the company. It can free up much-needed resources to invest in growth initiatives. And it can give investors the sustained confidence in the company s ability to achieve its strategic view of the future. 6 5 Insights for executives [Consumer products]

7 A company should consider any improvement through the lens of its corporate culture the culture s ability to embrace change and the steps it would need to take to ensure the necessary engagement to effect that change. Gregg Clark, Americas Advisory Consumer Products and Retail Leader, EY * Want to learn more? The answers in this issue are supplied by: Gregg Clark Americas Advisory Consumer Products and Retail Leader Ernst & Young LLP gregg.clark@ey.com Gregg D. Sutherland Global and Americas Practice Leader for Strategic Direction Ernst & Young LLP gregg.sutherland@ey.com For related thought leadership, visit 5 Insights for executives [Consumer products] 7

8 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. About EY s Advisory Services Improving business performance while managing risk is an increasingly complex business challenge. Whether your focus is on broad business transformation or more specifically on achieving growth, optimizing or protecting your business having the right advisors on your side can make all the difference. Our 30,000 advisory professionals form one of the broadest global advisory networks of any professional organization, delivering seasoned multidisciplinary teams that work with our clients to deliver a powerful and exceptional client service. We use proven, integrated methodologies to help you solve your most challenging business problems, deliver a strong performance in complex market conditions and build sustainable stakeholder confidence for the longer term. We understand that you need services that are adapted to your industry issues, so we bring our broad sector experience and deep subject matter knowledge to bear in a proactive and objective way. Above all, we are committed to measuring the gains and identifying where your strategy and change initiatives are delivering the value your business needs Ernst & Young LLP. All Rights Reserved. SCORE No. BT0325 ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com/5 We want to hear from you! Please let us know if there are subjects you would like 5: insights for executives to cover. You can contact us at: fiveseries.team@ey.com Let s talk optimization Changing consumer behaviors. Aging workforces. Global supply chains. Rising commodity prices. In an increasingly complex environment, organizations are looking for new ways to keep costs down, increase efficiencies and improve performance. Organizations have to constantly assess how operations, IT, finance, marketing and other critical business units are executing against their strategic objectives. They need to improve the effectiveness of business processes and organizational structures. But more importantly, they ve got to sustain the improvements to achieve long-term value. Learn more at