Sharpen up your cost control

It's time to get tough and no-one's more ruthless at the job than consultant Andrew Wileman. In an exclusive extract from his book Driving Down Cost, this modern Dark Knight shares his axe-honing tips for managing the human side of business.

by
Last Updated: 09 Oct 2013

When it comes to cost-cutting, one of the hardest things you can do as a manager is to hand someone their P45. And because staff costs are the most difficult to manage, it's usually left until last in any cost-cutting programme. But if people-costs are managed effectively right from the start, those unpleasant conversations can be kept to a minimum.

So why is people-cost such a headache? First, once people are on the payroll it's hard to get rid of them. Nobody likes being the bad guy who has to fire people, refuse a promotion, or tell staff they're underperforming. In the West, employees have strong legal protection. Cutting staff can be slow as well as expensive, and a company - or an individual manager - can be sued for discrimination or unfair process.

Second, people form the main area of cost that goes up relentlessly in real terms. Wages in Europe and North America increase over the long run at 1%-2% a year faster than inflation. This is productivity growth and good for the economy, but it is an ongoing cost challenge for any people business.

Third, real people-cost is a lot larger than it seems. People create indirect costs other than payroll - for example, facilities, equipment and travel. The full long-term cost of staff may not show up on today's accounts. Employee stock options dilute future value for shareholders. Unfunded pension liabilities amount to more than half of market capitalisation at several Global 500 companies.

Fourth, headcount tends to multiply like an out-of-control chain reaction. You hire one person, then you find out three months later that the first thing she's done is hire a department around her. For all these reasons, getting a tough handle on people-cost is critical.

Hiring

If you nip unnecessary hiring in the bud you'll save yourself a lot of pain later. Are you hiring another person to do an existing job because the workload has grown? If so, find ways to get more productive with the staff you have, and stay with that approach for a long time before you give up on it. Or are you hiring a new person for a new job? Make sure you can justify that new role as a proper investment case.

A good trick for getting a grip on headcount growth is to treat all hiring decisions as capital investments. Capitalise their likely future cost, then evaluate the hiring decision just as you would a major investment in a multi-million-pound IT project. Say you are thinking of hiring a marketing executive. You've got the candidate, she's been freelancing with you and she wants to come in full-time. She already costs you £1,000 a week as a freelance. On payroll, she'll come in at 20% less than that, but there'll be pension, benefits and payroll taxes on top. Let's say total annual cost is comparable, around £50,000. This is easily within your annual budget approval levels and it doesn't look like a big decision.

It does if you capitalise it. What if she doesn't work out? It might take five years to reverse the hire - and at the end you'll also pay six months' severance. So this hiring decision really is a commitment to five or six years of cost, even if it doesn't work out - £250,000 rather than £50,000. Now you'll be much more cautious.

In the 1970s, ad agencies used to say: 'This is a great business, but the assets go down in the elevator at night.' This was said with regret that the human assets were so mobile and hard to lock down. Unfortunately, it is also true that the human liabilities take the elevator back up the next morning. Get a grip on hiring fever. Capitalise, capitalise, capitalise.

And when you must hire, try to use more short-term contracts and part-time staff. There are obvious benefits for employers: fewer employment liabilities, a more variable cost structure, lower indirect costs. But there are benefits for employees too: being able to work part-time with flexible hours opens up job options to mothers and retirees.

Paying

Once people are on the payroll, the natural momentum of pay rises and promotions takes over. One tedious but unavoidable job you have as a manager is fending off endless moans from your staff that they're undervalued/underpaid/underpromoted (although your own moans to your boss are of course totally justified).

There's no magic bullet for dealing with this, but it soon gets around if you're a soft touch. Always take at least three months to think about it. Never say 'probably' - that will be heard as 'yes'. You should also assume that every pay and promotion decision is public. You may want to do a quiet deal with a top talent who's threatening to leave, but it probably won't stay private for long. Next week there'll be a line of people outside your office demanding to know why they don't deserve the same.

Managers fed up with being pestered on pay might commission a salary survey. They are looking for an objective external measure of what is reasonable pay so the issue can be put to bed. Unfortunately, salary surveys never work like that. The compensation firm does its research and comes back with: here's the range of pay for the job and at the moment you're paying just below the median. Ah-ha! How can you stand tall and say you're a top firm if you don't pay in the top quartile? There you go, you've just increased your wage bill by x%.

So you move your pay levels up to the top quartile. Then your competitor down the road does their annual survey and finds out, whoops, they've slipped from top quartile to below the median and must raise their base by x%! And so on, ad infinitum. You're on a no-win treadmill.

What about variable pay? Increasing the variable component of total pay can be a good idea. But don't do it expecting to reduce cost. Do it to increase staff motivation and to reduce business risk and earnings volatility.

The John Lewis Group is unusual in being the UK's largest example of worker co-ownership. All 60,000 employees are partners and share in the profits. So the variable performance-based part of total pay is unusually high: this year, each employee received 20% of base pay (more than 10 weeks' pay) as profit-share bonus. Customer service and staff attitudes are outstanding, and the group's businesses are gaining market share and have some of the highest profit margins in their sectors.

In general, making compensation more variable doesn't cut long-run cost. Most people are unwilling to accept cuts in base pay in exchange for the possibility of a larger variable payment. An increase in the variable component becomes an add-on to a current base package. Even if the recipient agrees to forgo increases in base for two years to fund the extra variable, total cost rises.

There is also the problem of defining the basis for paying out the variable - the performance targets. I used to think you could get really scientific about using targets to change and motivate people. An enterprise software sales team in the US beat this delusion out of me. I was CFO and had to construct the sales commission model. Despite my cunning plans, it had no observable impact on what the sales teams did. Worst of all, the commission payments bore no relation at all to whether the business was doing well. One month we had zero sales but the sales director calculated that he had met all his MBOs (management by objectives), such as motivating his team, so he was still due 40% of maximum bonus payout. We had reached the nadir of paying sales commission on zero sales.

The best way to pay large bonuses or commissions is to pay them based on overall business results, not individual micro-targets. So it's an unequivocal win-win for the business and for the bonus recipient, and there's no argument about how to measure outcomes.

Technology

New technology can transform the people-cost equation by radically increasing productivity or by completely automating or eliminating labour processes. Take personal sales in a business-to-business environment. Historically, this activity was not automated. Individual productivity depended on the personal character of your salesperson. Team productivity depended on informal and unreliable personal interaction.

But now even this low-tech stronghold is being invaded. New software offerings such as salesforce.com give you tools to manage and prioritise sales time and to leverage assets better across a whole sales team. Multi-channel selling tools allow you to slice and dice sales contact, and so sales cost, between face-to-face, phone, e-mail, messaging and self-help.

Investments in new technology should be made only after all possible productivity gains have been achieved without new technology - by simply working on activity logic, flow and workforce behaviour. It's a basic premise of good IT projects: don't automate bad practice.

Firing

Why do managers find it so hard to confront firing decisions, even in clear situations of underperformance or failure? Is it because they are deeply caring individuals who can't bring themselves to be unkind? Well, maybe. More often, it's because they don't want to be seen as the bad guy. Or have unpleasant termination conversations. Or because their peers tell them that firings will devastate morale.

Getting rid of underperformers lets an organisation breathe. It removes a burden of cost and wasted time. It raises morale. A few weeks after you do it, the people who were saying that it would destroy team spirit are asking why you didn't do it sooner.

There are two main approaches to getting rid of dead wood. You could say, I'll do it as and when it's necessary. So one year, 15% of heads get chopped, the next year zero. The level of chopping could be down to staff performance or to business results. This is OK, but it doesn't force managers to make tough people-decisions regularly.

An alternative is forced ranking. Every year, each manager has to rank staff from top to bottom, by name, and the bottom x% have to go. You could structure this ranking by function, by job level, by business unit. Jack Welch used this approach at GE. Many consultancies use a variant: up-or-out until you reach partner.

Forced ranking is controversial, nevertheless. It is used a lot in America but little in Europe. Critics see it as heartless, denying any long-term duty of care and nurture, dumping people the moment they lose utility. European companies are uncomfortable with such a tooth-and-claw approach to staff. I take a mid-Atlantic position. I like a rolling two-year forced ranking, combining tough performance management with a reasonable commitment to try to recover bad performers. Every year, you do the ranking and if someone stays in the bottom 5% or 10% for two years running, they are out. That gives you (and them) a year to try to turn them around, with the spotlight full on.

If you practise tough people-management, you have to be seen to be fair and consistent in how you arrive at tough decisions. A good appraisal and review process, one that you stick to, is vital. Consultancies are good at this usually. I have worked with Booz Allen, BCG, OC&C and PricewaterhouseCoopers - and in all cases, the process was taken seriously and followed through.

In contrast, I could come up with a long list of organisations that are poor at this. They talk about being people-and-talent businesses and on paper they have detailed appraisal and review processes, policed by large HR departments. But in practice, appraisals and feedbacks only get done if they are good news. Nothing that really matters - like promotions, salary increases or terminations - is tied to the process. Everybody ducks the confrontation of underperformance - especially close to Christmas.

Firing at Christmas is a difficult issue for many. It's early December, you've just analysed the cost base and you need to get headcount down by 15%. Do you fire now or wait until after Christmas? The answer is, fire now.

The obvious reason for firing before Christmas is ... well, obvious. If you're going to get cost out, get it out as soon as possible. But there is another reason. It's actually fairer and nicer to staff to fire them before Christmas. The main reason managers don't do it is not because they're really all that caring. It's because they don't want to come across as hard-hearted bastards. But that serves their interest, not that of the staff getting fired.

We had this situation at a West Coast company in the US that I was working with. Everybody knew the business was in trouble and terminations were on the cards. We had the analysis and we knew the names to go. But the CEO didn't want to be a bad guy. All the staff worked 12-hour days throughout the festive period. They didn't cut back on their Christmas spending. When the terminations came in January the staff were overspent and they'd missed the chance to at least have a relaxing time with the family before they went job-hunting. Fire before Christmas. Grit your teeth and be Scrooge for the season.

In any organisation, there are always people who, if there were any justice, would be the first to go in any cost-cutting programme. But there they are, year after year, still being promoted. We need to recognise these beasts and their tricky survival strategies.

The classic example in the consulting world is the admin partner. He or she starts off with the accurate title of office manager and does all the boring stuff: HR, accounting, payroll, buildings and so on. Then at some point the other real partners, who sell big fat projects to clients, are nagged into turning this into a profit-sharing partner position. From then on, the admin partner is the single biggest and least justifiable overhead cost in the business.

When I was working at Booz Allen, I did an internal project looking at how to cut the firm's office-overhead costs. We took the Chicago office as a trial analysis, investigating all the costs of all the back-office staff. One number stood out: we had an admin partner - call him Bill - overseeing the whole overhead. Bill was on about $600,000 a year, including his profit share. That's an expensive office manager. We were asked to present our initial ideas to the assembled Chicago back-office team. We put up a current org chart with all the titles and actual names. Then we put up a proposed new org chart with half the current names missing - in particular, no more admin partner.

There was mayhem in the meeting room. Silence from Bill at the back. He raised his hand for quiet. 'What Andrew's saying is only what's right for the business,' he said. 'It's what we get asked to do for our clients. We have to do it to ourselves too. I guarantee we can make these savings. And I'm volunteering now to lead the taskforce that's going to achieve them.'

This was breathtaking and it had to be admired. Three years later, Bill was the only member of the group still there, still drawing his $600,000 a year. So watch out for those who volunteer to lead the cost-reduction taskforce.

Managing Mr/Ms Average

In the half-light between obvious stars and obvious firings sit the majority of employees, the average performers. Problems of people cost management can centre on the challenge of these people. Average performers are frustrating because they're not as good or as productive as we'd like them to be, but they're not bad and they can work long hours with a lot of commitment, so it's hard to give them a tough appraisal. This can be OK when the employee is fresh in the job or the organisation is young. But as time passes, inertia sets in and productivity really starts to decline. Employer and employee get more frustrated and unhappy. Are there any solutions?

A total up-or-out culture won't work in many larger organisations with a broad base of job types and talents. But most organisations could and should operate much closer to that consulting model than they do. First, they should institutionalise a strong appraisal process. This is the sine qua non of people-management. A strong process has to have the elements described in consulting: rigour, consistent follow-through, leadership and involvement from senior line managers, 360-degree input, full documentation and a record trail.

Second, even if an organisation cannot implement a real up-or-out dynamic, it should set up a proxy. This can be as simple as forcing the appraisal to judge whether an individual is on an upward, static or downward track and communicating that to the employee. That judgment can lead to concrete recommendations and actions, for the person or the organisation.

Subcontracting and outsourcing

Given the difficulty of managing people-cost, a central strategic principle is to keep the core organisation of full-time staff down to an absolute minimum. For example, you could contract out most of the components of a product or service and keep in-house only the higher, value-added activities, like design, final assembly and brand management.

But the hollowing out or unbundling of an enterprise is not just about managing people-cost. A narrow focus on a few core businesses and a few core competencies is likely to maximise corporate value. You can also minimise the core organisation by outsourcing whole administrative functions, such as IT, personnel records, payroll, financial processing - huge businesses have been built around this trend.

As with component suppliers, there can be reasons other than people-cost for outsourcing. In IT, for example, a large specialist can get scale advantage in the cost of data centres or networks or hardware purchasing, and can stay up to speed more easily on developments. Yet a prime motivation for most outsourcing moves is to shift the burden of people-cost management outside, onto the outsourcer.

Fighting back

Let's switch sides for a moment. Maybe you aren't a hard-driving CEO with a £10m package and a slash-and-burn paradigm of productivity. Instead, you're a harassed middle manager on a modest salary and 2% bonus, 10 years to go to pension. Bad luck: Psycho Boss just announced a strategic review. The axe-wielding consultants are coming in. The phrase 'dead wood' is in the air.

Just to even the odds, here's how to survive the corporate purges. When the consultants come to interview you, don't say: 'I haven't got time for this. We can't get any more cost out. You consultants don't understand the business. We're only doing this so Psycho Boss can strut around being macho with the press.'

No, no, no. You're signing up to the Dead Wood Society. Say this: 'What a great opportunity. I've been saying for months we're organisationally overweight. That's a great list of questions - I'll get my team to give you the data tomorrow. What I like about Psycho Boss is he grips the bull by the horns, no bullshit.'

Remember, Beria survived 20 years of Stalin, living to put the old bastard in his coffin.

So, whichever side you're on, remember that the human side to cost-cutting is about gritting your teeth and just focusing on the figures. You'll soon be wielding your axe as forcefully and as gleefully as the Dark Knight.

- Extracted from Driving Down Cost: How to manage and cut costs - intelligently by Andrew Wileman (Nicholas Brealey Publishing, June 2008, RRP £18.00). To pre-order your copy with free UK p&p, call the credit card ordering number on 020 7239 0360 or e-mail sales@nicholasbrealey.com, quoting ref MT.

Find this article useful?

Get more great articles like this in your inbox every lunchtime