Why cost cutting can cost so much

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.”

To learn why cost cutting can become a death spiral, head to LeadingCompany.