Unstable global credit markets and diminished project finance options make it challenging for mining companies to acquire funding for ongoing exploration and development projects. During an economic downturn, asset conservation and cost control is emerging as a short-to medium-term strategic option to preserve shareholder value.
Why do things unravel?
In this challenging business environment, knee-jerk reactions can do more harm than good. Ad-hoc spending cuts can damage reputation and infrastructure and demoralize employees. For cost conservation and reduction measures to stick, companies must clarify the cost drivers of the business and use that knowledge to create a culture of cost consciousness, in both bad times and good.
The essential elements of a cost reduction and cost management and control framework include financial management and control, procurement and supply chain, business process execution, and performance management.
Frequently, companies swing between the two extremes of cutting short-term costs and placing big bets on transformational plans. Sudden measures driven by “We need to reduce costs now, and I don’t care how” are reactive and unsustainable.
Large-scale, ambitious plans executed during times of extreme stress are equally risky because they tend to implement a system the company may not need, may not be suited for, or cannot handle.
Here are three common cost reduction methods and the reasons they unravel:
Senior management focuses on transformational opportunities to reduce costs. The company is hoping that a single solution will solve its long-term cost issues, without paying attention to the behaviours and decision-making processes that drive costs in the first place. If the existing spend behaviours at the company haven’t changed, any new savings will not be sustainable.
Organizations conduct business as usual, but departments are directed to reduce spending by a set target. The target is often arbitrary and reactive to market conditions. This results in cost cutting without long-term action, management, or tracking plans. And because of the random nature of the cuts, there’s likely to be a negative impact on morale and culture.
All departments conduct extensive interviewing, process analysis, and benchmarking in order to improve efficiencies, leverage technology, and identify cost savings. This is an unwieldy process with an open-ended time frame and typically results in a loss of momentum and focus. Departments become personally invested in their own budgets and rarely find waste. In the end, the process produces a list rather than creating sustainable cost reduction.
A strong foundation is critical
Establishing a strong foundation is
essential to sustainable cost savings. The management team must understand its cost baseline and view cost as a result of the business decisions it makes on a daily basis. The journey to a strong foundation and sustainable cost savings involves the following:
Reducing non-essential spending.
Clarifying business cost drivers and improving accountability.
Taking control of third-party spend.
Tackling the company’s cost culture and behaviors.
A culture of sustainability: where to start
Set an environment for cost reduction. Confirm the cost reduction targets and process, agree on the in-scope cost base, and complete a preliminary reduction analysis.
Agree on cost ownership. Agree up front on who is responsible for challenging which costs. Working from a pre-allocation cost basis will prevent any costs from falling through the cracks.
Challenge the financial plan.
Have operating managers clarify cost drivers, challenge operating cost assumptions, and reduce discretionary spend.
Look for contract leakage. A forensic review of suppliers may uncover recoverable claims, cost avoidance areas, and off-contract savings opportunities.
Gauge performance by measuring results. Do so by monitoring activities, capturing related spend results, and producing robust reports for senior management. At the same time, focus on these cost management and control activities:
Rigorously control spending. Immediately establish a tighter span of control for spend approval to begin the spend culture transformation.
Stabilize cost controls. Complete a gap analysis of critical cost management and controls to identify immediate actions required to stop the bleeding and create a culture of cost awareness and ownership.
Using cost management and control processes, successful companies often strategically position themselves during downturns to emerge stronger after the economy recovers.
This article by Paul Murphy from PWC, was originally published in the Canadian Mining Journal in 2009. For more information visit: www.pwc.com/ca/mining