More than ever, financial institutions need to get the basics right in term of cash, cost, control and culture (see Figure 1). Within this context, we believe there are more options than many people may be aware of. To discover them, the first and most important step is to involve the right people in looking at strategy and operations, and in spotting the real risks to the business. If this is a short, sharp downturn, the last thing a company wants is to lose core skills in its businesses.
If one assumes that the securitisation markets have contracted permanently, then the appropriate way to think about the business may be in a pre-securitisation baseline, adjusted for key acquisitions/divestitures, etc. This means that the proper mindset to consider when formulating business strategy and budgeting may be a pre-2004 or 2005 operating model and cost structure.
It is not safe to presume, however, that financial institutions can shift their operating models rapidly while undertaking large cuts in staff. What we are seeing is that in some roles, the actual workloads have increased – so, by implementing broad cost reduction measures, financial institutions are increasing the risk they face. An example is reductions in control-type functions whose activities are independent of volume, (for example, the review of key reconciliations,) which can jeopardise the ability of organisations to keep in check any further cost blow outs or operational losses.
Secondly, financial institutions with back office operations or shared service centres in low-cost countries often have other issues to contend with. Laying off staff is frowned upon by local governments, and – more importantly – local labour laws and regulations could make this an expensive option. This puts some financial institutions in a quandary: they need to reduce staff costs in the short term, but this could threaten future relationships with governments and affect future expansion into some emerging markets. The cost savings may not be high on a per person basis, and the impact on reputation in the marketplace could be devastating.
Executives need to act decisively without mortgaging the future of their organisation. In some cases, drastic measures to manage cash flow and reduce costs are unavoidable, but the long-term strategic impact of these actions should not be ignored. Even at the strategic level, some institutions are now focusing on threats and opportunities affecting the organisation over the next six months, rather than thinking three or four years ahead. What complicates the situation is that good information for decision-making is scarce, with finance departments at full stretch, reacting to management requests to provide critical data.
To get the short- and long-term balance right, executives need to take into consideration controls and culture, even if their main focus is on cash flow management and cost reduction.
Most financial institutions will have exploited the most obvious opportunities, so finding the remaining ones requires special effort. The first and most important step is to get the right people on board. Now is a great time to re-evaluate the staffing mix and opportunistically hire candidates who otherwise would have not been available except at a large premium. Institutions around the world have faced a fierce war for talent in recent years – and they now have an opportunity to selectively bring top-quality staff on board.
Typically, organisations use three approaches to cost cutting. The first is a top-down review of the business, with a high-level performance analysis of all major areas. Changes are typically organisation based (i.e. which departments are not adding value?).
The second is the slash-and-burn approach, in which business continues as usual but costs are cut by reducing operating plans in line with a set target. Overall cost-saving targets are set by the chief executive or chief financial officer and functional heads are responsible for delivery. These measures are often temporary because costs will climb again when the economy improves (for example, business class versus economy class airfares).
Finally, there is the boil-the-ocean approach, requiring a bottom-up detailed analysis across all departments to identify potential opportunities.
PricewaterhouseCoopers recommends using the strongest characteristics of each of the traditional cost reduction approaches. Use the top-down approach with executive workshops and task forces to take stock and set the general direction. Use the bottom-up approach to dive deeper into opportunity areas and identify, validate and manage sustainable cost reduction opportunities.
In any case, sustainable cash release and cost reduction efforts should be multidimensional, considering all aspects of the business and their impact on both the balance sheet and profit and loss (see Figure 2)
This approach has been successful in many organisations by focusing on immediate cost reduction, improvements to cost management and control processes, and performance measurement. The key is to develop management processes which create a cost-conscious culture and drive continuous improvement. By approaching these collectively, organisations can set the stage for – and perhaps self-fund – more transformational activities. Given the challenges posed by the global economy, a rapid and thorough review of the operating model will deliver more value than just cutting headcount.
The risk is that if costs are reduced without a clear understanding of the implications for strategy and the effects on customers, the damage caused can outweigh the costs saved. Despite this, many financial institutions have been running lean for a number of years. In middle and back office functions (including finance) there had been a lack of investment in systems and processes, resulting in a heavy reliance on people, at a time when the finance sector generally has been booming. As a result, the current drive to reduce head count is now increasing operational risk – first, because a number of key support functions are already underinvested, but also because there are increased regulatory demands and reporting pressures with which the current systems and processes are struggling to cope.
In many instances a lack of understanding of the way in which organisations are linked from front to back office has resulted both in inefficiencies in process and in operational risks – through trading positions that are supported by manual processes, for example. Right now it is critical to understand not just the financial risks, but also the operational risks and these interlinkages from trading through to processing. This view also helps identify areas of inefficiency and potential cost reduction that have previously been hidden or ignored as a result of business unit silos.
Heads of organisations should be demanding to see operational assessments of end-to-end processes and systems, with actions and mitigation plans attached to the risks and opportunities. In particular these plans should focus not just on short-term cost reduction, but also structurally on how savings can be maintained as the economy improves. Many global financial institutions are looking at how they can better utilise their back office/shared service centres.
A priority will be to understand what infrastructure an organisation will need in the longer term and, as a result, what steps need to be taken now. This is not only to survive but also, importantly, to be scalable when there is a turnaround and to make sure that bad habits are not repeated. Scalability will be critical as high profit levels may not return for the next few years: it will be efficient organisations (not necessarily lean organisations) that will be in the best position.
Leaders need to walk a tightrope between making hard decisions which can affect many employees and maintaining employee commitment to deliver results. Success in these times may be defined entirely differently from how it was defined a year ago. Clarifying what success really means, setting the priorities and refocusing the organisation on shorter timescales is critical. Leaders will also need to be brave to take the decisive action that will frequently be required over the coming months.
Communication plays a vital role in keeping employees on board and aligned. Executives need to make an extra effort to clearly communicate business plans and objectives, be open about the realities of the situation, illustrate the actions that can be taken and how each employee can contribute. Too often, executives just assume that employees know the strategic direction of the organisation and what they need to do to, without taking the appropriate steps to ensure that this is actually the case.
Although we do not necessarily advocate a boil-the-ocean approach, it is important that employees do not feel threatened and consequently become blinkered in their view of their role in any recovery. It is important that employees are engaged up front, that they clearly understand the timetable for change and are also included in discussions around operational improvement and cost reduction initiatives.
Some practical advice to get your cost-saving initiative right:
Cost management is a key issue today and for the foreseeable future.
The market is experiencing a severe liquidity crunch and the explosion of a global asset bubble well beyond sub-prime. The root of this crisis lies not only in asset values, but also in the amount of capital in the financial system today versus the size and liquidity of the balance sheets (and off-balance sheet commitments) of financial institutions. This situation is not likely to reverse itself for a number of years. In an environment of de-leveraging and capital scarcity, we believe that business strategies, operating models and cost structures need a fundamental rethink.
A pre-securitisation baseline may be appropriate.
If one assumes that the securitisation markets have contracted permanently, then the appropriate way to think about the business may be in a pre-securitisation baseline, adjusted for key acquisitions/divestitures, etc. This means that the proper mindset to consider when formulating business strategy and budgeting may be a pre-2004 or 2005 operating model and cost structure.
Understand the genuine cost and profitability of each business unit.
Having focused on growth over the past few years, this is not the case for many financial institutions. Many of them do not understand the true profitability of their business at the proper level of granularity and – more importantly – the inter-relationships between different businesses, products and geographies. This information is essential in assessing the overall impact of any decision made. Importantly, this means understanding the linkage between up and downstream costs and risks rather than just focusing on activities that are specific to each business unit.
Don’t confuse cost postponement with cost reduction.
Many organisations simply stop investing in new projects and new people during difficult times. This often comes with a hidden price, for example the future development of the institution, staff morale, customer loyalty and long-term profitability. The resulting costs could outweigh what was saved.
Focus on both direct and indirect costs.
Financial institutions have focused most previous cost-cutting efforts largely on back office operating costs, sometimes resulting in increased operational risk and a back office that cannot support the business as normal. Areas such as front office costs, the costs of risk management failures and funding costs will have to be considered in new ways to achieve a cost baseline that is acceptable in today’s markets. Operating costs will also have to be re-examined, of course, and perhaps in different ways. This is a real concern, given that many back office functions are already operating under constrained budgets - care needs to be taken when undertaking broad-based cuts that may increase operational risk and delay the ability for an organisation to recover.
Understand the risks and strengthen risk management.
It will be critical that management look again at the interplay between front, middle and back office functions. We are now seeing the increased importance of finance and risk in organisations and the value they provide in managing the risk. Leaders need to make sure they understand that while the front office might make the money (from a mark to market perspective), it is the middle and back office who help make sure that these returns are tangible through appropriate risk management processes and controls.
Ongoing review and monitoring to ensure effectiveness and avoid control slippage.
Of course, it would be ideal to have a robust financial management framework to keep track of everything. But in many cases simpler dashboard tools with the right key performance indicators are sufficient to monitor the effectiveness of your actions. It’s crucial to use an ongoing end-to-end program that has the support of top management.
Before making any decision, it will be vital to look at the problem from different angles, involve the right people, foster open debate, generate options and explore the risks and rewards of the alternatives. There is no such thing as a purely short-term action. Everything has its consequences, but there are always more options than you think.