MANY companies responded to the 2008-09 downturn with rapid and often significant cost reduction and restructure activities. As recovery continues the challenge is how to maintain defensive strategies while remaining agile enough to capitalise on emerging opportunities.
The focus on costs is often reduced following a downturn; however this is an ideal time to revisit your cost position to ensure costs don’t creep back in.
One of many approaches to examining costs is Dupont analysis, which breaks return on equity into three key ratios. These reflect the elements of margin, asset turnover and leverage. Analysis of these ratios highlights that a weakness in any one ratio can drive particular cost reactions.
If we focus on the margin component we can highlight a number of cost areas that can be analysed to identify potential savings.
• Costs associated with revenue: There are often significant cost improvements to be obtained by scrutinising the sales and marketing processes. Ensure you maximise volume of the highest margin products, particularly average and incremental margin.
• Labour costs typically make up a significant part of a miner’s budget, but is equally applicable across other industries. Areas for analysis include duplication that exists in the service and support functions. Labour-hire contracts are often an area that yields savings, so it is important to ensure that costs and the rationale for the contract are still appropriate.
• Consumables such as fuel, tyres and explosives are a significant budget item for mining clients. Regardless of industry, analysis should reveal your top 10 consumables and for each make sure there is an understanding of the physical driver, unit cost, usage and efficiency. Physical drivers of each consumable should be managed to ensure effective and efficient usage. Importantly key consumables should have a negotiated supply contract with a unit cost discount for quantity. Critically ongoing analysis should involve regular review of price and volume variances and tracking of key consumables on ‘as received’ and ‘as used’ basis.
• Contractors are often a source of cost savings due to inconsistent application of management processes. Importantly, contractor usage in a turning market can be used as an efficient way to rapidly adjust costs. As with consumables, it is important to know your top 10 contracts by value and who is accountable for their management. Key performance metrics should been written into these contracts and processes should enable review of work completed by contractors against the agreed performance metrics. Reconciliation of invoices received from contractors against contracts can often reveal cost savings.
• Improving operating and maintenance practices can be a source of cost savings both in the short term and longer term. Deferment of major activities should be carefully reviewed. You should identify your top 10 ‘bad actors’ – the least reliable, least available and most costly assets and cross reference this against the top 10 cost consumers (people), areas and assets. Understanding the cost of maintenance as a percentage of total operating costs allows for more detailed benchmarking.
Other fruitful areas of analysis include knowing the percentage of planned, corrective and breakdown maintenance and establishing appropriate targets based on this.
Understanding the percentage of assets that have a formal maintenance program that was reviewed in the past 12 months can help identify assets that may be incurring higher than necessary costs.
• Value add analysis. This can be used to identify activities/functions that are adding little business value relative to the cost incurred.
The areas discussed provide a snapshot of the margin components in our mining clients that surface areas of cost reduction. Applying similar rigour to the components of asset turnover and leverage will yield further areas for consideration.
While the scale of cost reduction activities vary across our clients, we typically see minimum bottom line benefits that can be achieved are in the order of 20 per cent operating cost reduction, 40 per cent of capital cost savings optimisation and 20 per cent revenue. This is, of course, dependent on the current state of operations but the vast majority of companies exceed these minimum targets.
A formal cost reduction program that engages with your staff and is supported by a strong tracking and monitoring program can yield significant savings and provide a secure cost base to support growth opportunities.
Are you managing your costs or are they beginning to creep back in?
Paul Thomas is manager of Oyster Consulting, which provides corporate strategy and management planning to the resources industry.
Contact Paul on 9320 9999 | mobile 0411 446 674
www.oysterconsulting.com