Cost Optimisation is Not an Optional Extra

Non-profit organisations like to think that they are prudent and good at optimizing costs. After all was this not the mantra of the 90s with a relentless drive to cost reduction? However, the 2000s were mostly good; growth and innovation have led to many gains but also some waste and as a result there are opportunities to revisit costs in leaner times. There is acknowledgement that we are in a deep recession.

The uncertainty is how deep or how long it is going to be. When a downturn threatens, non-profit organisations must proactively take decisive steps to really understand what this means for them. Reductions in income, increased demand for services, tougher funding agreements and rising costs are some of the issues that need to be understood. Cost optimisation is one of the key factors to consider and organisations that address this and related issues will come through lean times re-energised and fit for the future.

The big risk arising from the uncertainty of present times is that there will be kneejerk reactions and unconsidered cost cutting. Another risk is that organizations bury their heads in the sand and hope the problem will go away. The fact is that most charities are expecting reductions in their forecasts for income, if this is true then there are two options - draw on reserves, if you can, or reduce the break-even level - and this means cost management. However, the options are not mutually exclusive and the organisations that succeed are not those that look at cost management as a one-off exercise in lean times, but ones that have a constant focus on cost management and productivity gains. At the start I should emphasise that cost effectiveness or cost optimisation is not necessarily the same as cost reduction but cost optimisation can lead to cost reduction or cost shifting and getting more for the same cost. That is, a cost-optimisation exercise could and should also lead to productivity gains. I hear many different reactions to the present market conditions ranging from 'the last recession did not make much of an impact on us so it's business as usual' to 'we will not be able to survive and need to think about a merger'. Whatever the answer, cost management is still relevant and inertia in this area is not really an option. Of course the organisation should not just focus on costs. Incoming maximisation is important too but income initiatives usually take longer to deliver.

Understanding processes and activities
As organisations have grown and times have been good, inefficiencies and breaks in workflow have crept in to processes and there is often scope to review the way things are done with the aim of increasing productivity and/or reducing costs. Many years of uninterrupted growth have allowed unnecessary complexities to flourish in organisational processes and structures and revenue growth is often to blame for not taking a good hard look at how efficiently activities are carried out and services are delivered. Activity-value analysis is a good way of deciding which activities add value and which do not.

As activities develop, errors and waste often creep in and reworking and correction time is accepted as routine. For example, it never fails to surprise me how many charities fail to integrate fundraising and finance systems better. Data is inputted into the fundraising system and somebody else keys it in again into the finance system. This doubles the input costs and increases the risk of error, resulting in no single version of the truth and even more time and cost expended in trying to reconcile and correct differences. To understand how to save costs on activities, it is important to understand the core processes and the sub-processes and their relationship to achieving the expected deliverables and the overall organization strategy. It is important to know what the organisation is expecting to get out of the process. This may be tangible deliverables such as services or products or alternatively some processes may have soft deliverables such as information, advice and control. Are they all needed? Are they being carried out in the right way at the right location and by the right people?

If the organisation was to start with a blank sheet of paper and review what activities are really needed to deliver its objectives, how would that compare with the activities that are actually being carried out now? In my experience adopting this zero-basing approach is a good way to implement a plan to improve processes, optimise costs and deliver productivity gains and such an exercise always highlights cost-optimisation opportunities. I have carried out a number of such reviews and there are many easy wins. Take for example purchase ledger processing - a key cost driver is the number of invoices processed. Simply requiring suppliers to consolidate them and setting up a system where they can be received electronically reduces volumes and costs dramatically. All this seems like common sense but it is amazing as to how often no one looks at why and how an activity is carried out and challenges old concepts. There is often a lack of linkage between processes and a failure to understand how a change in one process impacts on another. There is the well documented story of a major retailer that had a multitude of staff hours spent on checking that the prices displayed on the shelves matched the prices on the electronic point-of-sale system on the tills. This was done with much pride that the process was working until someone pointed out that some years ago the process had been changed and that the shelf prices were being printed out by the same point-of-sale system so they must always be the same.

Understanding costs
It is important to get a grasp on:
fixed costs and variable costs;
direct costs and overhead costs;
and identify what these are associated with so that there is more clarity on their relationship with activities and which are controllable and by whom. Certain direct and variable costs reduce with activity and can be more easily managed but other costs are not controllable by those that are 'responsible' for them. For example if a department has most of its costs allocated as overheads the department manager is not going to be in a position to make much impact on cost reduction.

Most people understand that certain costs may be fixed costs and may not vary with activity, but the term 'fixed costs' should come with a caveat - fixed costs are fixed only for the short term. Recognising that fixed costs do increase in steps and knowing where you are on the staircase is very relevant. Space costs and staff costs are a good example - they generally stay the same for a period of time but if the organisation is close to maximum capacity then an increase in activity is likely to lead to a large step increase in costs.

Upon close inspection it is possible that the benefits arising from the increased activity may be outweighed by the larger step change in costs (because of the capacity problem) and, as a result, it might make more sense to defer the expansion to better times. Understanding the nature of costs will allow the organisation to plan its reserves policy and its development strategy. For example, if the organisation is one with many fixed costs then it may need to remember it is vulnerable to 'supertanker trends' - as income deteriorates it may not be able to reduce costs at the same speed. By the time the supertanker has the rocks in its sights it can run out of clear water to change direction in time. The 'clear water' for a charity that is trying to react to reducing income may be generated by sufficient reserves or by taking early action on costs. Beware the trap of cutting activities and expecting that this will result in all their costs being removed. One well-known non-profit entered into a laudable project of considering which of its activities were providing the best return and then cut out the less 'valued' ones expecting to see a reduction in all related costs. However, many fixed costs that had been allocated to these activities then had to be absorbed by other activities.

Marketing costs
Marketing and fundraising costs are often seen as an easy cost-reduction option. Many boards are reluctant to cut missionrelated expenditure and fundraising costs are often the target. The conventional wisdom is that this is not a good idea and that there is a greater need to protect value and the brand during a recession. If donors and supporters are under pressure in a recession then they need to be approached with different value propositions. As others cut back on fundraising and marketing costs it is usually possible to reach more supporters for less expenditure.

There are some great deals to be made with desperate media channels. Buyers are able to drive harder bargains with agencies and improve payment terms. For example at present billboard advertising is almost being given away and agencies are allowing shorter more flexible contracts. There are good opportunities to increase your share of voice and build the brand. Procter & Gamble CEO A G Lafley has stated: 'We have a philosophy and a strategy. When times are tough, you build share.' But it is not as simple as that. The maxim 'look after the brand and everything will be all right' needs careful consideration. For a start, not every organisation has the reserves to afford to do it. In any case, just spending more on donor care does not mean that donors will give more when they themselves have a lot less. This is a flawed premise and while it is important to continue marketing, it is even more important to ensure that costs are optimised.

Marketing costs cover a wide array of areas. This is the time to focus on what delivers value and to avoid the frills. The organisations that do this well are reassessing marketing activity and setting clear objectives and targeting their spend. The mantra from many of the gurus is 'reduce, reuse, recycle'. This means that while it is important to consider the new environment there is no need to reinvent the wheel. Content themes or creative work that have worked before could be reused without incurring significant additional costs. When considering marketing costs there are therefore two basic questions (see the case study):
are we spending too much?
are we spending enough?

Staff costs
Every recession comes with its stories of massive staff cuts but sometimes this leads to throwing the baby out with the bathwater, and crude headcount reductions coupled with recruitment and salary freezes can hinder recovery strategies. Despite this, headcount reduction continues to be the single-largest cost-cutting strategy for many organisations in a downturn. But redundancy costs can be expensive and if they are likely to be followed by recruitment costs when the market improves, this option needs to be considered carefully. A vital consideration is what level of staff the organisation will need in the next 12 to 18 months - if it is likely that it will have to recruit within this time period it needs to consider whether headcount reduction is the best option.

Looking beyond the obvious is important and the use of flexible working arrangements such as job sharing can mean that when the recovery comes it makes it possible for the organisation to be nimble and react appropriately. In some cases downsizing may be inevitable and the aim is to use a highly targeted approach. The activity and process analysis above can provide opportunities for redeployment as well as making the right cuts. This article has many references to downturns and recessions but the underlying good practice principles are relevant at all times. Cost optimisation has better results when incorporated into normal management routines when the organisation is in a position of strength rather than when the options are limited.

Case Study
Some time ago a major charity was very pleased to see big reductions in its fundraising cost ratios. Income was increasing and fundraising costs were actually reducing. They scored highly in the ubiquitous cost ratio comparisons (such as the cost of fundraising compared to income raised). The director of fundraising made many presentations both within and outside the charity showing this. He was headhunted by another charity.

The new director of fundraising started increasing costs and there was a significant change in cost ratios. The board was concerned and I was asked to investigate. The answer was simple but not one that was liked. The previous director of fundraising had been living off the investment in earlier years and had not been investing in donor acquisition, donor care and new initiatives - donor attrition was kicking in and increased investment was necessary. The board had failed to understand that with most forms of fundraising there is very little correlation between what is reported as fundraising costs in one year and the actual amount raised the same year - the return on investment can often take several years to mature. The most extreme example is a legacy campaign where the money is spent in one year and the legacy income is realised many years later. Even direct mail campaigns show little correlation between reported income and expenditure and income in one year is often a result of expenditure in an earlier year. Cold mailings lead to poor cost ratios, even negative cost ratios, but they are still important as they generate new donors and ratios are improved in future years. The moral of the tale is that fundraising requires sustained investment.

Pesh Framjee is head of the unit serving non-profit organisations at Horwath Clark Whitehill. He is also the special adviser to CFDG.

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