Article 1 of a Series on the How to Reset/Reboot my firm’s operational objectives and cost structure
How do Corporate Operational and Technology Cost Get Out of Control?
For the past 30 years I have operated software and technology companies and assisted private equity and investors with evaluating and acquiring firms in the entertainment, technology, nonprofit and transportation industries. From initial due diligence, to the setting of new corporate objectives and goals, I have facilitated the implementation of strategies and controls to reduce risk, restructure cost, and streamline operations. Throughout these transitions I have learned that most of the strategic objectives I have implemented, and their eventual success or failure, all started and ended with people – executives, staff, vendors, and consultants – who were already directly or indirectly associated with the acquired company. Different personalities, misconception, defensive posture, inexperience, and natural biases are generally the root cause of many of the ailments affecting overspending. In the current employment environment, everyone has a specific title and/or role, thus leading to rigid structure in process without observation of alternatives. It is natural that long-term management of any business department or sector can causes blindness due to the daily minutia, this is human nature. This along with our inherent lack of time is one of the largest contributors to this mindset. When someone is stretched for time, they are less likely to be concerned with looking for cost savings and improvement in efficiency of their actions, so much as just being concerned with the daily grind of completing all their tasks. It is important to understand that all companies and employees – even the best ones– have vulnerabilities and areas they can improve on. Working with one’s staff to overcome these pre-misconceptions is not always easy, but in the long run worth the time investment.
When I first begin diligence of a new company for acquisition, I am always looking for opportunities to rescale and improve efficiency. Even though the process of a M&A transactions always allows for air cover to reset corporate usage of resources, I am always intrigued by the reasons executives and managers often have do not made changes on their own, even when they are financially struggling. Post M&A transaction, most employees are expecting some restructuring changes to be made to satisfy projected performance requirements by investors. This alone is generally enough motivation to proceed and evaluate corporate expenses. It is, however, very difficult to do much more than scratch the surface, unless there is a concerted effort to engage and partner with existing management and staff. To significantly move the needle on overall cost savings many people within the organization need to be involved and working on the problem. Many times, existing staff fear the risk of upsetting normal operations, over the benefit of making changes that could improve their effectiveness. Corporate culture needs to shift to allow decision makers to be more comfortable with looking for and making those improvements. I have watched executive management attempt to brand themselves and motivate changes in behavior by telling staff to “think like a startup would.” Unfortunately, this is the worst perspective to take, as in most cases, it is not the costs that you initially contract for that are the problem, it is the costs that have aged themselves away from their initial objectives. Many times this happens faster than anyone counts on.
Even for those companies that are not in transition, there are many lessons that they can learn and apply from utilizing techniques that new ownership and management would apply to measure performance more broadly. Many people ask me, “How do I know if my company spending is within reason?” Many consultants and advisors will make general comparisons to industry metrics by industry. While these statistics can be helpful when viewing your corporate spending from thirty-six thousand feet, these statistics can be horribly inaccurate when evaluating your own company up close. An example of this is IT spending by industry. A 2019 report from Computer Economics reviled retail spending in IT can be between 1.2-3.0% of revenue while financial services can be 4.4-11.4% of revenue. It becomes clear that each of these industries have a wide variance even within their own industry of more than 200%, and between different industries of up to 380%. Statistics are only useful as very general guidelines but are useless as precise measurement tools.
More important than trying to stay within industry standards is taking the time to look at actual spending and determine if each item is appropriate. Identifying how to improve each spending area should include understanding what weakness contributed to the imbalanced spending in the first place. Contributors to this problem can be varied and compounded, including but not limited to, lack of analytic tools, misguided bid management process, weak vendor management programs, no auditing and analysis of spending, buying the wrong products and services, working with the wrong vendors to supply a specific item, becoming victim of unilateral vendor agreements, and lack of sufficient resources. Resolving any one of these issues has the potential of uncovering large hidden saving and resources for the company.
During normal corporate operations, real in-depth review is normally only applied to RFP’s and vendors qualifications the first time a contract is requested. Analyst studies predict that the vast majority of a typical company’s vendor service bills are never audited and are simply paid. Major expense solutions providers like SAP/Concur say that that almost 20% of expenses fall outside of policy. After properly auditing bills, many find they are paying items that are unnecessary. They may discover items like a multitude of cellular phone lines that are no longer being used and need to be disconnected or living with an outdated and expensive service contract. A company may realize the special pricing they negotiated for their network connectivity has expired and they are paying above industry standards. Additionally, they may learn they are paying for expensive industry licenses or publications for employees that are no longer with the company. Making sure to regularly review and evaluate all large expenditures in detail is an important step in reducing overall costs.
Another area of excessive spending can occur when companies do not have detailed corporate spending policies in place, such as spending limits and preapproved supplier relations. These can be a large source of cash flow bleeding. According to a 2016 research report by The Hackett Group, a Miami-based business consultancy, on the website Supply Chain Management an estimated 29% of indirect spend is off-contract and unexpected spending levels and can reach as high as 80% of total spend in some organizations. Additionally, as many as 50% of companies that do have corporate spending policies and guidelines in place many do not regularly adhere to or monitor their own policies.
Even from the point an RFP contract is signed it is almost guaranteed that there will be many requirement changes before usage or implementation begins. Research shows that by the time implementation of a technology contract occurs, operational requirements can quantitatively shift up to 10-15% without the vendor or company being aware of the shift, according to a 2018 Computer Economics article. Flexibility in contracts that can allow for shifts in company usage and size are a must, and will allow the company to adjust to these changes.
The largest risk for a variance between required and contracted spending is during contract renewal. It is very difficult for departments to predict true supply usage requirements, but it is even more difficult to test actual usage. To further complicate matters many departments and managers will tend to overstate their requirements and usage to reduce the risk of losing already approved budget. There for as much scrutiny and diligence that went into the signing of the original contract should be applied to its renewal.
The more complicated the needs and requirements of a department get, the more risk there will be a significant discrepancy between the contracted products and services and the products and services used. Technology is an excellent example of this. I have seen companies double their telecom hardware maintenance cost by simply not understanding what software and services they licensed versus what they used. This same issue exists for any software licenses and service that is contracted. Microsoft Enterprise agreements are a perfect illustration of this. Without engaging in a corporate use study, a company can be significantly misaligned with its licensing cost. An example of this is contracting for full Microsoft Office licenses on every computer owned by the company, when many employees might only use Word and/or Outlook. This complication deepens when analyzing server client licenses due to the many different models Microsoft will allow for usage.
A lot of these issues are due to “set it and forget it” corporate practices. Financing, leasing, and long term licensing are giant contributors to leakage in these areas. Many senior executives do not engage in the process of evaluating how effectively used large capital expenditures are post acquisition. Rescaling a company’ financing, production and fixed asset usage should be a regular auditing process in any medium to large organization. Information technology, aircraft, transportation and manufacturing spending should be regularly analyzed and rebalanced with contractual obligations. Leaving doors open to corporate rescaling is everything when trying to be efficient and nimble.
In the end, approaching how company resources should be spent and managed may be in many cases the largest issue facing corporate profitability. It is very hard sometimes for corporate executives to fully understand, or even want to manage this detail. There are generally many tedious steps to being able to analyze usage against contractual obligations. Many times, it takes obtaining information from several employees in different departments to coordinate information to obtain the appropriate information to make the required decisions. Each one of these obstacles makes it more tempting for executives, and employees alike, to go with the status quo and keep their usual spending patterns. However, taking the extra steps to reducing, eliminating and managing unnecessary cost and expenditure is the key to increasing corporate profits during economic booms and sustaining longevity during eventual downturns.