This week in Alrroya Aleqtissadiya, the United Arab Emirates (UAE) business and financial daily, I argue that 'cost cutting' as the omnipresent theme of the shareholder value rhetoric could see a decline in its importance. Citing the case of BP's Deepwater Horizon rig explosion, I explain that 'cost-cutting' beyond a limit is destructive of the very shareholder value it pretends to protect. Executives, as agents, owe it to the capital markets to defend the need to maintain costs at a certain level if the business is to stay competitive in the long-term.
Cost-cutting may become the silent casualty of BP’s Deepwater Horizon rig explosion. Once hailed as a sure boost to profitability, investors have swung to the opposite extreme of caution about its implications for the future of corporations. After revelations that aggressive cost-cutting was a principal cause for the malfunctioning pedals in Toyota vehicles and the catastrophic oil spill from the explosion on BP’s Deepwater Horizon there is a real possibility that the term is on its way to becoming politically incorrect.
In fact, it is not unthinkable that rather than issue a Buy recommendation when a company announces several billion worth of cost cuts, in the future, sell-side research analysts would be just as likely to fire off Underweight and Sell marks when such drastic shavings are announced . The cult of rampant cost-cutting with its formulaic stripping could well be entering its decline.
Nonetheless, tempting as it is to finger corporate executives as the evil hand behind muscle cutting, the sobering reality is that capital markets have left them with little choice in the matter. Companies are expected to deliver a certain amount of earnings growth every year and they must find ways to meet those promises under pressure from investors. The punishment for missing these targets include a higher cost of capital, sustained decline in the share price and a drying up in the market for the companies’ securities. In this era of financialization, financial markets, financial institutions and controllers of massive blocs of capital exert an overbearing influence over the design and execution of corporate strategy.
In their provocative book, ‘Financialization and Strategy: Narrative and Numbers,’ the authors, Julie Froud, Sukhdev Johal, Adam Leaver and Karel Williams explain that ‘the intrusion of the capital market, signaled by increasingly vociferous investor demands for “shareholder value” since the late 1980s in both the UK and USA. . . makes the narrative and performative more important because every giant company now needs a story of purpose and achievement that can be rendered more plausible by initiatives.’ Cost-cutting is at the center of that narrative.
The relentless focus on efficiency, which elsewhere is a malleable rhetoric subject to the subjective biases of in situ management, pushes many companies to keep reducing costs even when there is overwhelming internal evidence that it can have dire consequences.
For example, while the initial culprit in the March 2005 explosion at BP’s Texas Refinery was compromised process safety, the Baker Panel Report on the accident identified ‘budgetary challenges’ where ‘the company did not always ensure that adequate resources were effectively allocated to support or sustain a high level of process safety performance’ as the real villain. The unremitting elimination of expenditure to the detriment of the long-term health of the business is an indictment of both the company, on the micro scale, and also the dominant market culture, which demands these sacrifices to deliver on the shareholder value rhetoric.
All of this raises the question: how long before the cost retrenchment orthodoxy is challenged by the most influential voice of all in determining where those cost cuts occur, that is, management? Over the last two decades, the trend towards management compensation and incentivisation with stock awards has tied their interests much closer with non-insider shareowners and the fate of companies. Meanwhile, calls for limitations on the exercise of executive stock options till years after retirement or exit from the company will align their interests even better.
If the goal of shareholder value is to ensure the sustainability of businesses, it is critical that investors understand the importance of reinvestment, plant and property upgrades, capital expenditure and appropriate staffing numbers. Killing the goose that lays the golden eggs through indiscriminate cost cuts damages a company’s ability to throw off financial surpluses to shareholders in the long-term.
Boards and managers face the challenge of revising their narratives from an emphasis on costs cutting for short-term profitability to investment for value in the long-term. Waste will always be waste and has no place in well run operations. However, a unitary obsession with constant reduction in costs is irretrievably hurting businesses as BP, Toyota and so many other companies have learned to their regret. Executives need to drive the discourse towards why it makes good business sense not to cut costs beyond a certain point and how expenditure above a certain point creates long-term shareholder value.
These changes will not happen overnight. Investors who are long used to the catechism of cost cutting will not embrace its revision immediately. But it is the responsible thing for companies to do. It is one thing for companies to recognize that the competition for capital is fierce and quite another to cut corners just to measure up in time for the next few quarters’ earnings estimates. Markets will not come to that realization by themselves. The duty to evangelize this new doctrine lies with the companies themselves. Indefinite weight loss is not dieting. It is a destructive psychosis called bulimia nervosa. Obsessive and eternal cost-cutting is its corporate equivalent.
The original article can be read here on the Alrroya Aleqtissadiya website.
One cannot help noticing how Niyi Meka Olowola, Oando's Head of Corp Comms, is nodding in approval. Maybe Goldman Sachs can learn lessons.04:47:49 PM January 25, 2012from HootSuite
It's at times like these companies praise heaven for media-savvy CEOs.Among Nigerian business leaders,Wale Tinubu, is easily among the best.04:46:01 PM January 25, 2012from HootSuite
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