The financial services industry is highly competitive. Companies face increasing pressure on margins in the 1% world. To be successful a company must maximise the value of its spending. To achieve this most companies embark upon cost cutting. Yet these exercises almost invariably fail.
The reason is that there are two dimensions to spending:
Efficiency - getting the maximum outputs for a given level of spending.
Spending mix - optimising how much the company spends on each area.
As companies usually fail to differentiate these two aspects they tend to think of the control of spending in purely efficiency terms. Cost cutting exercises are seen as the way to boost efficiency. Such exercises often fail because:
- Cost cutting only boosts efficiency where there is excess fat to cut Unless this is the case then cost cutting reduces spending but does not increase efficiency.
- Cost cutting invariably changes the spending mix. By making the spending mix sub-optimal it can cause considerable damage to the company’s competitive position.
The way in which efficiency gains or spending mix changes can change profitability is illustrated in these diagrams.