HomeAnalysisOptimisation is still the goal

Optimisation is still the goal

Brian Makwara
IN the ever-changing environment, this old school thinking is obsolete in the new world characterised by new tariff regimes and escalating inflation.

“Prices for nearly all supplies have been rising in tandem globally, and labour market disruptions have affected nearly everyone” www.mckinsey.com

The invasion of Ukraine by Russia has plunged the world economy into many pass-through consequences, ranging from price escalation in gas, agriculture produce and minerals. Companies, especially from Europe and the Americas in line with their governments sanctioning Russia, have had to relook at distribution routes to bypass Russia or Ukraine. This eventually affects prices and cost of a product or a service.

Global inflation trends have been revised upwards. The consumer price index rose by 8,5% from March 2021 to March 2022 in the United States, a 40-year high, 7,5% in the Eurozone, and 7% in the United Kingdom. Locally, the country is in hyperinflation, as of March 2022, year-on-year inflation rate stood at 72,7% ,which was an upward increase from 66,11% in the prior month, it is not an uneducated guess to project that inflation is still going to further deteriorate even with our best efforts but pass-through effects of the world economy will drive us upwards.

At the time of writing this article, due to surge in covid-19 cases, Shanghai is in a near total lockdown, shortage of truckers at the ports and shipping costs are spiralling due to lockdown-enforced delays and one wonders the ripple effects on costs across the world.

With such a background, cost optimisation cannot remain our key focus area as management. It is crippling to hold onto this style of analysing results by mere comparing costs movement from the prior year. Many organisations are in this Pandora’s box where they refuse to move with the times or the new reality that costs are increasing and it is not a simple measure of inefficiency anymore.

Such organisations are losing staff as they do not want to see the “staff overhead line” higher compared to prior year so salaries are static. Increases in costs must be embraced and not feared. Business leaders have to come back to the drawing board on how to navigate this new terrain and still give value to the shareholders.

Wage pressures are an everyday occurrence. It is disheartening to note that business leaders in this country shun this reality and play hide and seek with workers and pretend that there is no pressure and simply ignore the fact that cost of retaining employees is increasing as each day passes.

In my world, audit firms ignored wage pressures for a considerable time and come 2022, audit firms are suffering massively as they just do not have high quality staff. Simple benefits like fuel allowance were totally ignored.

Recently the Zimbabwe Stock Exchange extended the reporting deadline for December year-ends by another month, all for the simple reason in my view, that the auditor does not have capacity and the finance team as well has reduced capacity or has new staff.

The government has for so long ignored wage pressures among the civil service and the impact it has had on service delivery is massive. Do we even still have enough nurses, teachers or qualified personnel in government departments or are we just left with those waiting for retirement?

Cost models on current reality
Businesses need to rethink cost models based on current reality and not on past trends. The reality is diesel and petrol were trading at US$1,30 and US$1,33 respectively on June 30, 2021 and today are US$1,71 and US$1,63.

We cannot simply be happy that you have maintained the distribution costs at 2021 levels when fuel has increased significantly. To me it is poor management if I see distribution costs the same as prior year and points that something was wrong.

There is this over sensationalism of using 2016/2017 numbers as the true United States dollar costs in many organisations when the reality is the landscape has changed significantly since then. We cannot still hedge on that period as the true USD cost. Businesses need to relook at cost models, find efficient ways to still produce a service or a good and not just merely looking into ways to cut cost, in actual fact we should never be talking about cost cutting in 2022.

A tonne of ammonium nitrate used to land in Zimbabwe between US$450-540 a year or two ago and today it is in excess of US$800, which further speaks to rethinking cost models in the agriculture value chain. Businesses make better decisions with the correct costing in place based on current reality.

Backward integration
Top chief executives (CEOs) are seized with exploring backward integration into their value chain, not to optimise cost but to remain resilient and still remain relevant to the end consumer. I am encouraged by companies like United Refineries Limited, who are spearheading backward arrangements with soya bean farmers. Such initiatives enable a company to remain relevant and harness its cost model.

By engaging into contract farming for soya bean with a farmer means to a certain extent you can control the input price as opposed to waiting for forex allocation from the auction and import oil or soya which currently has been deeply affected by the Russia-Ukraine invasion. Report from South Africa Media recently stated that consumers in that market should expect to pay between 40-55% more for cooking oil due to shortage of sunflower oil and canola oil.

Repricing
Repricing is no longer an option but a norm. Instead of focusing on cost optimisation, rather focus on research into your market dynamics as to what extent of the new cost realities can be passed to the consumer through repricing.

Repricing can be done successfully without even losing market share. Some organisations are finding new uses of their products and consumers are educated so that they can even view the new repriced product as a better product than the old.

Customer engagement can also lessen backlash as customers can be made aware of developments on the supply side and cost push factors which ultimately led to the repriced product.

Biggest challenge in this market is wanton repricing which is purely speculative and not based on meaningful cost changing realities. New performance measurement models

Instead of an archaic focus on costs growth and optimisation, analysts and companies should focus on measures, which track costs build up or growth to show how management has been able to remain resilient amidst such growth.

Cost growth compared to growth in inflation, revenue growth, volume growth and productivity growth rates can be invaluable. Margin analysis can be a good tracker to see how a business has managed to maintain or reduce significant pressures on margins and general strategy assessment on how the business has dealt with cost push factors.

I read recently a certain company disclosing that they had to do a customer value quadrant study on their customers and grouped them based on payment and service need such that they now focus on the customer quadrant with high paying customers and lower service requests and let go of high demand customers, who are also low paying customers as well.

In the study they found out that it is the low paying but demand intensive customer who is the loudest, complains a lot at the same time contribute very little to the margin.

Spend more time on your product
If as much attention that is being spent on cost reduction and optimisation was spent on improving our product or service offering, we would be creating giant industries in this country. You cannot control the input price, but you can control how well your product meets your customer needs or how you want it to be perceived by the customer. That is value creation. Elon Musk is well known for saying that he spends more time in sales and production than in meetings as this gives him an idea of what the customer is looking for and how they are making the product and what can be changed to meet the customer needs.

Most business leaders locally do not even visit the manufacturing plants. They just read reports from their well-ventilated offices. I once worked in a place where even head office staff rarely saw their CEO in the passage, what more staff in the retail shops.

How can a chief financial officer (CFO) and a marketing executive make cost decisions when they are detached on what the customer is saying about their product.

We are used to spending hours and hours cutting the budget as opposed to aligning the budget to what the customer is looking and willing to pay for.

Its high time procurement, product development and marketing are no longer led by old and market detached employees whose claim to fame is 20 plus years in the same chair with no market or technology centricity. Every CEO and CFO have direct supervision of these functions. I take courage that there is a breed of chartered accountants like myself, who are in the oven waiting to take over industries in this country.

  • Makwara is a chartered accountant with both local and international experience and currently is working as the group financial manager of a local listed entity.

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