Fairfax, Jetset and the hidden costs of cost cutting

Cost cutting when your costs get too large to handle is an eminently sensible, coherent thing to do in tough times. But while cost cutting can seem like a simple objective, in practice, it’s very complicated, and may not yield dividends for years.

Let’s take Fairfax. Its cost-cutting program is costing it $248 million in cash to ensure savings, by June 2015, of $235 million a year. It’ll be 2014 before Fairfax sees a dime of extra revenue from the massive changes it announced yesterday. Given how quickly the industry is moving, and the changes Rinehart is likely to push through when she’s on the board, who knows what its situation will be two years from now.

Another example. Travel retailer Jetset, partly owned by Qantas, announced yesterday it was spending millions on restructuring costs. It’s firing 110 staff, which will cost it $7.5 million, and is expecting non-cash writedowns of intangible assets costing it a further $11 million. The company is expecting pre-cash profits of $30 million this year, making the costs of its restructure significant for its size.

Why does cost cutting cost? LeadingCompany spoke to David Knowles, a partner at Pitcher Partners, about some of the expenses, as well as some of the ways to limit them.

Staff costs in the transition

Knowles says in a transition, typically everything is done at once. This means a whole lot of costs, which a company would normally incur over time, happen in one big crunch.

The biggest cost, he explains, tends to come from firing people. The bulk of the $248 million in cash restructuring costs Fairfax is facing will be around payouts.

“The sheer cost of redundancies is often prohibitive,” Knowles says. “Once you take out paid holiday leave, redundancy packages, as well as the cost of outplacement services and things like counselling, it can be very, very expensive.”

However, this one-off cost is how Pitcher Partners recommends companies go about redundancies, he adds. “If you take a piecemeal approach to reducing your workforce, there’s a real hidden cost to that. Everyone wonders if they’re vulnerable. But with one cut, you can reassure everyone that’s left that their jobs are secure.”

If redundancies aren’t done all at once, employers risk “a cancer throughout the organisation”, sapping morale and productivity.

One way to avoid having to fire a whole lot of people at once is to rely on natural attrition or offer voluntary redundancies. Such approaches are sometimes criticised for giving your best staff incentive to leave and try their luck elsewhere a severance packet richer, but Knowles thinks this threat is overrated.

“In my experience, people self-select pretty well,” he says. “They know if they’re a good fit for an organisation and a role. People enjoy doing what they do well, if they’re a good fit, they’ll continue. Whereas people who aren’t a good fit, who tend to be lower performers in that company, they tend to know and to take the opportunity to leave.”

Writing-off equipment

Another large cost associated with cost cutting is the write-down of equipment when companies consolidate or sell off parts of their operations.

“Modern factories are very expensive, their money is tied up in expensive pieces of equipment which are only valuable when they’re working,” Knowles says.

For example, Fairfax is selling off its Chullora and Tullamarine newspaper plants, a move the media company expects will cost it $40 million in cash when it strips the plants and sells the land.

One way to limit the cost is to look for buyers for your equipment.

“You might be thinking, who’d buy a newspaper plant,” Knowles says. “But you can always look at alternative markets.”

Knowles says a lot of equipment regarded as obsolete in Australia is viewed as high-tech in emerging markets, meaning there’s often a buyer you haven’t thought of.

“To make the most of it, sell it as a business,” he adds. “Package it up with a few people, who get to keep their job.”

“You can get some value for your equipment, even if it’s not the full value.”

When cost cutting becomes a death-spiral

The cost of cost cutting is a real issue for business, but it shouldn’t dissuade them from making necessary changes.

“I had a client years ago who couldn’t afford to close a factory,” Knowles says. “It was losing a million dollars a year, but there were so many people involved in the business that to make them redundant would cost more cash than they had. So they decided it was cheaper to run at a loss.”

“That’s a pathway to nowhere, but that was the reality.”

On the other hand, some businesses go too far the other way when it comes to managing their costs.

“It’s important to understand the difference between expense and investment,” Knowles says. “Many costs are discretionary. It’s easy to cut things like marketing or research in certain environments, but there is a trade-off between short-term gain and long-term cost.”

Knowles gives the example of the motor industry.

“They cut costs to stay competitive. The market reacts, they boost profits for a bit, then profitability slides because their cuts had a short-term impact that was quickly copied by everyone else in the industry. So they cut again; and every time they do they take something away from their product, which becomes less valuable to customers as a result.”

“It can take you to a point where you’re more and more efficient but less and less effective. You don’t meet the needs of your customers anymore. Cost cutting done badly can make you totally irrelevant.”