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Friday, August 29, 2014

Here’s a Winning Strategy: Cut Costs, Not Labor

Although the worst of the recession and uncertainties over Congressional budget fights are over, unemployment is still high in the U.S. (the official unemployment rate in March was 7.6%, although the government’s U-6 rate was 13.8%) and some companies are still trimming worker rolls as a cost-cutting measure. However, according to a recent report, pruning workforce numbers may not shore up a company’s bottom line as much as conventional wisdom might suggest.

Workers

Credit: stockimages on FreeDigitalPhotos.net.

In recent postings I have written about the challenge to procurement departments this year of contributing to enterprise revenue goals with fewer resources and no commensurate sales growth.

At least one study I cited advises that revenue growth can be achieved through innovation, creativity, improvements to cost management and enhanced supplier relationships, among other initiatives. A recent study by FTI Consulting of London backs this up with three years of data taken from the average performance of FTSE 350 stock-index companies in Europe.

FTI found no meaningful returns in EBITDA (earnings before interest, taxes, depreciation and amortization) when companies reduced their labor force. Non-labor cost reductions, however, averaged more than 3 times the savings. A 1% reduction in labor costs increased EBITDA by only 0.8% on average for the FTSE companies from 2008 through 2011. A 1% reduction in non-labor costs, in contrast, generated a 3.6% rise in EBITDA.

“The scale of the potential uplift in profitability from investing in better cost management is substantial,” FTI concludes in the study.

These numbers are especially meaningful when labor and non-labor costs are measured as a percentage of revenue. FTI found that in 2009 labor accounted for 15.7% on average of the FTSE companies’ costs, while non-labor expenditures were 65.6%. By 2011, perhaps as a result of the recession, labor costs had declined to 12.9% of revenue and non-labor costs had risen to 68.3%.

Some industries had hugely different numbers in each category. In energy, labor was 3.1% of revenue while non-labor costs were 84.2%; in automotive, labor accounted for 27.3% of revenue and non-labor costs consumed 63%. Yet the results were the same: reductions in non-labor costs always yielded greater EBITDA for the FTSE 350 than cutbacks in labor.

Of course, if a factory closes or a major customer is lost, layoffs are usually unavoidable. But it’s clear that cutting personnel to firm up a bottom line, or worse, demonstrate to investors how “serious” management is about increasing profits, will produce shallow results that ignore key areas of savings, and hence, new revenue.

For departments such as procurement, the point is obvious: Significant gains can be made in revenue generation by thinking outside the box when it comes to reworking major cost areas that do not involve personnel.

I will take a closer look tomorrow at some of the findings and numbers generated by FTI in its study.

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