Share prices rise with operational efficiency

Investors reward firms that increase their operating efficiency, suggests a recent study by Deloitte Research. During the strong economy of 1997-2000, the ten large banks with the best cost efficiency improvements saw their share prices increase by an average annual rate of 19.2%, against the 9.6% gain for the 100 largest banks overall.

The new Deloitte Research report, Fit for the Future: Building competitive advantage through strategic cost reduction, indicates that insurance, securities and investment management firms that aggressively manage their costs also outpace the competition. And by adopting a strategic approach to cost reduction throughout the enterprise, financial institutions can build competitive advantage and create shareholder value.

Strategy first
"Cost optimisation and business strategy are joined at the hip. A cost reduction programme that doesn't consider a company's overall strategy puts long-term strategic goals at risk," said Dennis Yeskey, principal of Deloitte and Touche. In setting goals for a cost reduction programme, firms can analyse their competitive position, evaluate potential savings across each line of business and determine the level of cost reduction needed to support the firm's current share price.

Pierre Buhler, principal of Deloitte Consulting Financial Services Industry, added that "there are both short-term and long-term initiatives to become more cost efficient. Long-term cost efficiency is about changing the culture, not knee-jerk reactions. A key issue is how to manage incremental growth and understand the true cost of each additional dollar of new business."

Ten steps to saving 20%
The report estimates that firms may achieve savings of 10% to 20% by using the following top ten initiatives:

1. Severance Payments: Firms may reduce the traditionally high expense of layoffs by paying severance benefits from the firm's qualified pension plan, thus lowering the total cost of severance benefits.
2. Employee Benefits: By consolidating pension and benefit plans, firms may reduce both their vendor and internal administrator fees while at the same time lowering total costs.
3. Compensation Structure: Performance driven equity plans and strategic performance management systems have the potential to reduce a firm's cost of sales by 3% to 6%, and to retain the strongest performers.
4. Re-engineering: Well planned and managed re-engineering programmes often yield cost savings of 25% to 30%, whilst improving service levels and time to market. Re-engineering business processes to fundamentally change how work is done may achieve long-term gains in increased operational efficiency and in reduced errors.
5. Outsourcing: Firms should not only consider outsourcing new functions but also employing new business models. Entering into relationships with vendors that are more like strategic alliances, rather than the traditional vendor relationship, can make savings of more than a third of business-as-usual operating costs from outsourcing.
6. Strategic Sourcing: A strategic sourcing programme (renegotiating contract rates, competitive bidding, using a central contract database, and enterprise-wide sourcing) may reduce a firm's annual telecommunication expense by up to 15% over a period of two years.
7. E-Procurement: Companies that go beyond simply purchasing online to automating their entire purchasing process can eliminate the invoice and simplify the reconciliation process, allowing them to update financial data in real time.
8. Renegotiating Leases: and contesting real estate assessments: Depending on their negotiating power and the dynamics of the individual market, some companies could gain reductions of up to 10% on their leases. Firms that own property can potentially reduce their property tax liability by contesting their assessments, which have often been established when property values were higher.
9. Tax-Efficient Structuring: Firms should review financing, leasing, research and development, and corporate restructuring in the area of tax. These cost reductions may be substantial but will vary widely depending on a company's characteristics and country-specific tax regimes.
10. Seeking Business Incentives: Companies can often apply for business incentives from state and local governments - such as reductions or deferrals of property and sales taxes.