Spend Smart, Survive Anything: The New Rules of Cost Management

Barnali Chaklader
Dean of Academics and Professor (Finance)
Institute of Management Technology Ghaziabad

During the COVID-19 pandemic, we realised in a big way that global supply chains are interconnected. When shipping containers piled up at ports, the entire world faced a severe shortage of parts, from big automakers like Toyota to small electronics businesses. Those who survived did not necessarily freeze budgets and cut overheads but diversified their supplier base and maintained a buffer. The companies that survive, and even grow, are those that have stopped waiting for stability to return.

Russia- Ukraine war, Red Sea crisis and now Iran- Israel war have spiked energy and food prices due to the blockage in the supply chain. But pro-activeness and well-framed strategies are proving to be differentiators. German Chemical company BASF managed shocks better during the Russia-Ukraine war, which spiralled the energy prices. BASF had hedging in place and had invested heavily in the BASF Ludwigshafen complex, making it energy-efficient and resulting in cost savings. During 2021-22, when container prices soared on some routes, IKEA was better off than its competitors because it had pre-negotiated freight agreements. Also, IKEA has a history of signing long-term timber, cotton, and freight contracts well ahead of the season. Apple was least affected during the global chip shortage in 2021 due to its long-term supply contracts and supplier diversification. Unilever’s hedging position bailed them out during the sunflower, palm, soybean oil, and energy crises. Amazon’s internalised logistics network acts like a natural cost hedge during price hikes and logistics constraints. Capital investments during smooth times are a smart strategy to manage costs in the long run and during difficult times caused by geopolitical factors.

The usual tendency of firms is to shield against expected unfavourable changes once they start approaching or have already approached them. When macroeconomic factors such as interest rates, policies, political and global situations, technological changes, or consumer preferences start affecting businesses, firms act to ensure their profitability is not significantly affected. Any forecasting of a decline in sales revenue due to uncertainty prompts the firms to cut costs. Creating a tight budget, reducing promotional costs, implementing salary reductions or job cuts, and controlling overheads are among the many ways to cut costs. An approach to a slowdown or recession sees the axe fall on costs in the name of “managing costs.” One needs to consider whether “cost-cutting” is the same as “managing cost management”. It has been observed that companies spend more during ‘good years’ and avoid spending during ‘not so good years’. One has to unravel if such a strategy is the right one.

Cost management does not start when the urgency to reduce costs arises. It is a round-the-clock process built into the business processes. The business ecosystem should accommodate the organisation’s cost management techniques, thereby raising an alarm when costs deviate from standards. For example, the system should alert if production process wastage exceeds the standard. An early warning sign can lead to further resource losses if corrective actions are not taken.

How should companies approach cost management amid global disruption and uncertainty?

Rather than unthinkingly reducing overheads, decide if the spending is required. Travel expenditure could be avoided by conducting the meeting virtually, but determining whether the impact would be the same as in a physical meeting is difficult; after all, a human touch is not expensive! Unnecessary overheads, including idle time and waste, have no place in the process. It is better to eliminate any activity whose cost exceeds its value, for example, duplication of work. Similarly, proper human resource planning and selecting the right number of candidates and the right candidates can reduce resource waste in the present and the future. Prioritise spending. Never postpone a scheduled maintenance activity to save on current costs, as it might result in future heavy expenditure. Avoid process flaws to prevent product calls and rework.

Companies that invest in renewable energy and build energy-efficient infrastructure have a permanent cost advantage.

Building a resilient and flexible supply chain helps. A business’s value chain plays a prominent role in managing costs. During uncertain times, dependence on external suppliers is susceptible to shocks. Moving upstream and taking control of raw material can eliminate supplier price volatility and supply chain disruption. Moving downstream, like Amazon, Nike, and Reliance Industries, can help reduce exposure to freight and logistics cost volatility in the current uncertain situation. Decisions should be data-driven, based on real-time information rather than assumptions. Disruption is no longer an event that ends after some time; it is a continuous state of being that businesses should learn to operate in, be prepared for, and not escape.

Companies that build resilience into their operations have a chance to survive. Now, cost management is not a response to a crisis but a part of everyday business processes. Companies must distinguish between operational and capital expenditures that create value and those that increase overhead.

In a world where geopolitical shocks are becoming the norm rather than the exception, the question every business leader must ask is not “How much can we cut?” but “How well did we prepare?”

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