™ transforming the cost base: 2009 update 13 november 2009 finance and strategy practice economic...

™

Transforming the Cost Base: 2009 Update

13 November 2009

Finance and Strategy Practice

Economic Analysis and Decision Support Group

™

Executive Summary

ROAD MAP FOR THE PRESENTATION

Performance of All Elite Cost Cutters (S&P & Global)

Appendix A: Performance of S&P Elite Cost Cutters

Appendix B: Performance of Industry Leading Cost Cutters

Appendix C: Stylized Facts About Cost Behavior

© 2009 The Corporate Executive Board Company. All Rights Reserved. 3Economic Analysis and Decision Support Group

EXECUTIVE SUMMARY

• From 1994 to 2004 most companies struggled to sustainable reduce costs (a trend that persists), but an elite set of cost cutters demonstrated the ability to achieve sustained reductions.

• Elite cost cutters did so by focusing efforts on improving supply chain efficiency and on reducing direct costs (COGS) rather than reducing SG&A expenses.

• The strategy of aggressive cost cutting followed by elite cost cutters may have run its course:

I. Declining ability to take costs out the system: Despite the nearly 2% annual reduction in the cost-to-revenue ratio of elite cost cutters over the 1994 to 2004 period, the pace of their gross margin improvements has significantly slowed over the recent past.

• The elite cost cutters within the S&P have seen their COGS-to-Sales ratios increase, albeit slightly, over the last year. While elite cost cutters continued generating cost reductions by lowering SG&A to sales, the potential for sustained reductions here is very limited. This suggests a declining ability on the part of even elite cost cutters to take further cost out of the system.

II. Focus on cost agility: While continuing cost reductions have slowed, elite cost cutters have managed to control the ratio of costs to sales even in recessionary environments. This suggests that elite cost cutters are more cost agile, quickly controlling their expenses as a percent of sales during both good and bad economic times. Our analysis confirms the following:

• S&P elite cost cutters exert tighter control over COGS than other companies do, particularly when sales rise.

• S&P elite cost cutters keep SG&A costs significantly more variable than other companies do.

• S&P elite cost cutters act quicker to adjust SG&A costs in reaction to changes in sales.

• Elite cost cutters are more conservative than other companies in increasing SG&A levels if past sales performance has been good and significantly more aggressive in reducing SG&A if past sales performance has been poor.

III. World-class cost performance comes at the expense of growth: While elite cost cutters are rewarded in terms of total shareholder return and other return-based measures (such as return on investment, return on equity, etc.), they are at a significant disadvantage in terms of revenue growth, growing almost 3.5 percentage points slower than their non-elite peers over the 1994-2008 period.

The strategy of cost-cutting as a source of sustainable competitive advantage appears to have run its course. Moreover, aggressive cost management appears to limit companies’ ability to generate growth.

We recommend that companies re-focus on seeking profitable growth, while maintaining cost agility.


SPOTLIGHT ON COGSPrevious Board research found that although most companies struggled to cut costs, a set of elite companies successfully drove down costs by emphasizing COGS reductions rather than SG&A cuts.

• The average company struggled to achieve sustained reductions in costs over the 1994-2004 period.

• Elite cost cutters drove down total expenses significantly more than other companies over the 1994 – 2004 period.

• Elite cost cutters achieved sustained cost reductions by doubling down on reducing COGS even while tolerating higher levels of SG&A relative to other companies.

Total Expense* to Sales Ratio (1994 to 2004)

SG&A to Sales Ratio (1994 - 2004)

Elite Cost Cutters N = 102

Other Companies N = 378

50%

55%

60%

65%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Elite Cost Cutters Other Companies

15%

20%

25%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Elite Cost Cutters Other Companies

70%

75%

80%

85%

90%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Elite Cost Cutters

Other Companies

COGS to Sales Ratio (1994 - 2004)

* Total expense refers to the sum of COGS and SG&A.


65%

70%

75%

80%

85%

90%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Elite CostCutters

OtherCompanies

COST CUTTING SLOWING DOWN EVEN AMONG ELITE COST CUTTERS

Most companies still struggle to maintain cost discipline and even elite cost cutters are slowing down the rate of cost reductions

• Non-elite companies have seen their costs (as a percent of sales) increase during the 2004 to 2008 period.

• Elite cost cutters are still reducing over the 2004 to 2008, but at a much slower rate than they did in previous years.

Total Expense* to Sales Ratio (1994 to 2008)



Elite cost cutters have significantly slowed the pace of cost reduction in recent years.

* Total expense refers to the sum of COGS and SG&A.


15%

20%

25%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

50%

55%

60%

65%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

DOWN TO BONEIn recent years, elite cost cutters have focused more on reducing SG&A rather than COGS in order to control costs.

• S&P elite cost cutters have significantly slowed down their pace of COGS reduction in the last three years years relative to the 2001-2004 period.

• Instead, they have tried to maintain cost discipline by steadily reducing the ratio of SG&A to sales in recent years.

• There appears to be limited potential for further cuts in COGS and SG&A by elite cost cutters.

COGS to Sales Ratio for Elite Cost Cutters (1994 to 2008)

SG&A to Sales Ratio for Elite Cost Cutters (1994 to 2008)



Elite cost cutters have significantly slowed the pace of COGS reduction in recent years relative to the 2001-2005 period.

Elite cost cutters have significantly reduced SG&A in recent years.


7.9%

1.8%

S&P Elite Other S&P Companies

10-Year TSR**, 1994-2008Over the last ten years, the market has rewarded elite cost cutters with significantly higher TSR, despite their lower revenue growth rates relative to other companies.

• Elite cost cutters have almost 4.5 times higher shareholder return relative to other S&P companies.

• However, elite cost cutters have significantly lower revenue growth relative to other companies

Revenue CAGR, 1994-2008

T-Test for Differences in Means

Result: S&P elite cost cutters have significantly higher TSR.

T-Statistic: 4.62

P-value*: 0.000

S&P Elite Cost Cutters N = 69


>

* P-values of .1 or less represent statistically significant differences at the 90% threshold level of significance.

11.5%

15.1%

All Elite Cost Cutters Other Companies


Result: Elite cost cutters have significantly lower revenue growth relative to others.

T-Statistic: -3.17

P-value*: 0.002

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** This analysis includes only S&P 500 companies as we could not obtain comparable TSR data for non-US companies.



HIGHER TSR, LOWER GROWTH

™

Executive Summary







Other Companies79%

Elite Cost Cutters21%

Energy11%

Materials10%

Industrials16%

Consumer Discretionary15%

Consumer Staples19%

Health Care14%

Financials2%

Information Technology12%

Telecommunications0%

Utilities1%

DEFINING ELITE COST CUTTERSElite cost cutters are defined as companies with negative average annual growth of total expenses to sales for both the 1994-2000 as well as the 2001-2008 periods.

• Elite cost cutters are quite evenly spread across various industry sectors.


* Total Expense to Sales Ratio is defined as the sum of SG&A and COGS expressed a percent of net sales.

Elite Cost Cutters

Companies that experienced negative average annual growth of total expenses to sales over both the 1994-2000 and the 2001-2008 periods.

Distribution of Elite Cost Cutters Distribution of Elite Cost Cutters

(By Industry)

N = 480


Total Expense to Sales Ratio, 1994 to 2008

Although elite cost cutters have consistently lowered costs, the pace of cost cutting has declined in recent years.

• Non-elite cost cutters have seen their costs increase steadily in recent years.

• Elite cost cutters have continued to lower costs, even during the 2007-2008 recession. The difference between expense to sales ratios for elite and non-elite cost cutters is at an all time high.

• However, the pace of cost cutting has significantly declined over the last few years.



Elite Cost Cutters

Defined as companies who saw negative average annual growth of expense to sales over both the 1994-2000 and the 2001-2008 periods.


65%

70%

75%

80%

85%

90%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

All Elite CostCutters

OtherCompanies

A CONTINUING STRUGGLE


COGS to Sales Ratio, 1994 to 2008

Although elite cost cutters have consistently lowered costs relative to others, the pace of COGS reduction has has slowed down significantly in recent years.

• Non-elites experienced an increase in their COGS to sales ratio over the corresponding period, leaving the COGS gap between elite cost cutters and others at an all time high.

• However, the pace of COGS reduction by elite cost cutters declined significantly over the recent past.



Elite Cost Cutters



45.0%

50.0%

55.0%

60.0%

65.0%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Elite Cost Cutters

Other Companies

RUNNING OUT OF STEAM


SG&A to Sales Ratio, 1994 to 2008

Elite Cost Cutters have steadily reduced their SG&A to sales ratio over the last 5 year period.

• Other companies have seen their SG&A to sales ratios remain relatively constant over the past few years.

• The potential for further reductions

in SG&A may be limited.



Elite Cost Cutters



15%

20%

25%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Elite Cost Cutters

Other Companies

DOUBLING DOWN ON SG&A


Although COGS tends to vary proportionately with sales for all companies, elite cost cutters variabilize SG&A significantly more than other companies do.

• In general, COGS tends to rise (fall) by 1% for every 1% increase (decrease) in sales.

• Elite cost cutters exert tighter control over COGS than other companies do when sales rise, increasing costs by .99% for every 1% increase in sales, whereas other companies COGS rise by 1.03% for a 1% increase in sales.

• However, elite cost cutters vary SG&A significantly more than other other companies do, especially if sales decline.

• Elite Cost Cutters reduce SG&A almost twice as much as other companies do when sales decline.

THE IMPORTANCE OF COST AGILITY

Cost of Goods Sold Selling, General, and Administrative Expense

Percentage Increase in COGS for a 1% Increase in Sales

Percentage Decrease in COGS for a 1% Decrease in Sales

Percentage Increase in SG&A for a 1% Increase in Sales

Percentage Decrease in SG&A for a 1% Decrease in Sales

Elite Cost Cutters

.99% .99% .71% .71%

Other Companies

1.03% .99% .79% .37%

* Estimated using time series regression analysis (the econometric specification of the regression model is presented in the appendix). The estimation was conducted using the feasible generalized least squares technique, which corrects for biases from heteroscedasticity as well as serial error correlation that arise from the cross-sectional time series nature of the data . Fixed effects were used to control for industry and company-specific influences on costs.

Sensitivity* of COGS and SG&A to Changes in Sales

Comparison of Elite Cost Cutters and Others**

S&P Elite Cost Cutters N = 1092 Company Years

Other S&P Companies N = 3269 Company Years

** Analysis conducted on sample of S&P 500 companies only.

Non-elite companies display significant downward inflexibility in SG&A when sales decline.


Elite cost cutters are significantly more aggressive than other companies at varying SG&A levels if their sales have declined in previous years.

• In general, SG&A is more variable if there has been a sustained increase in sales than if there has been only a temporary increase in sales.

• Elite cost cutters do not vary SG&A as much as others if sales have increased in recent years.

• However, elite cost cutters have significantly more variable SG&A than others if sales have declined

in recent years.

DON’T OVERREACT TO SHORT-TERM TRENDS

Percentage Change in SG&A for a 1% change in Sales after:

Two periods of successive increases in sales

Decrease in Sales followed by an increase

Increase in sales followed by a decrease

Two successive periods of sales decreases

Elite Cost Cutters

.75% .66% .57% .90%

Other Companies

.82% .75% .34 % .47%

* Estimated using time series regression analysis (the econometric specification of the regression model is presented in the appendix). The estimation was conducted using the feasible generalized least squares technique, which corrects for biases from heteroscedasticity as well as serial error correlation that arise from the cross-sectional time series nature of the data . Fixed effects were used to control for industry and company-specific influences on costs.

Sensitivity* of SG&A to Sales Conditional on Past Performance




** Analysis conducted on sample of S&P 500 companies only.

Elite cost cutters are more aggressive than other companies at varying SG&A levels if there have been recent declines in sales.

Elite cost cutters are almost twice as aggressive as others at varying SG&A levels after a sustained decline in sales.


12.0%

9.0%


Average ROI, 1994-2008Elite cost cutters generate a significantly higher return on investment and total shareholder returns relative to other companies.

• Elite cost cutters generate a return on investment that is three percentage points higher than other companies.

• The total share holder return for elite cost cutters is almost 4.5 times higher than that for other companies within the S&P.


Result: Elite cost cutters have significantly higher ROI.

T-Statistic: 2.46

P-value*: 0.014



>


7.9%

1.8%


10-Year TSR**, 1994-2008T-Test for Differences in Means


T-Statistic: 4.62

P-value*: 0.000

S&P Elite N = 69


>

** This analysis includes only S&P 500 companies as we could not obtain comparable TSR data for non-US companies.

REAPING THE REWARDS


11.5%

15.1%


18.4%

13.2%


Average Return on Equity, ’94-’08Elite cost cutters have higher return on equity but significantly lower revenue growth relative to other companies.

• Not surprisingly, elite cost cutters have more than a 5 percentage point advantage in terms of return on equity relative to other companies.

• However, elite cost cutters have significantly lower revenue growth compared to other companies.

Revenue CAGR, ’94-’08


Result: Elite cost cutters have significantly higher ROE relative to others.

T-Statistic: 2.20

P-value*: 0.030


Result: Elite cost cutters have significantly lower revenue growth relative to others.

T-Statistic: -3.17

P-value*: 0.002



<

>


A MIXED BLESSING


APPENDIX

™

Executive Summary







S&P Elite Cost Cutters25%

Other S&P Companies75%

Energy14%

Materials7%

Industrials9%

Consumer Discretionary17%Consumer Staples

20%

Health Care14%

Financials3%



Utilities0%

DEFINING S&P ELITE COST CUTTERSThe Board also examined the behavior and performance of elite cost cutters within the S&P 500.

• S&P elite cost cutters are fairly evenly distributed across various industry sectors.

S&P Elite Cost Cutters N = 69


S&P Elite Cost Cutters

S&P companies that experienced negative average annual growth of total expenses to sales over both the 1994-2000 and the 2001-2008 periods.

Distribution of S&P Elite Cost Cutters Distribution of S&P Elite Cost Cutters

(By Industry)

S&P Companies N = 275


65%

70%

75%

80%

85%

90%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

S&P Non-Elite

S&P Elite

Total Expense to Sales Ratio, 1994 to 2008(S&P 500 Companies Only)

Although S&P 500 elite cost cutters significantly reduced costs, the pace of cost reductions has slowed significantly in recent years.

• Other S&P 500 companies witnessed an increase in their expense to sales ratios over the corresponding period, leaving the gap between S&P 500 companies and others at an all-time high.

• However, the pace of cost reductions by elite cost cutters has declined significantly relative to to 2002-2005 period.

S&P Non-Elite N = 206

S&P Elite N = 69

S&P Elite cost cutters have lowered their expense to sales ratios even during the current recession.


Defined as S&P companies who saw negative average annual growth of expense to sales over both the 1994-2000 and the 2001-2008 periods.


COGS to Sales Ratio, 1994 to 2008(S&P 500 Companies Only)

After a long period of consistent increase in gross margins, the rate of COGS-to-Sales reduction experienced by S&P 500 Elite Cost Cutters has declined in recent years and even shown signs of increase between 2007 and 2008.

• S&P 500 companies witnessed an increase in their COGS to sales ratio over the last five years.

• The long-term strategy of COGS reduction by S&P elites appears to be loosing momentum.


S&P Elite N = 69



45%

50%

55%

60%

65%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

S&P Non-Elite

S&P Elite


15%

20%

25%

30%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

S&P Non-Elite

S&P Elite

SG&A to Sales Ratio, 1994 to 2008(S&P 500 Companies Only)

S&P 500 Elite Cost Cutters have slightly reduced their SG&A to sales ratio over the last 5 year period.

• Most S&P 500 companies have experienced an increase in their SG&A to sales ratios over the 2005 to 2008 period.

• Although in the past S&P elite cost cutters had higher levels of SG&A, they lowered their SG&A to sales ratio below other S&P companies in 2008.

• However, the potential for further SG&A reductions by the S&P elite cost cutters might be limited.




S&P Elite N = 69


21.5%

16.4%


21.5%

16.4%


Average Return on Equity, 1994-2008S&P elite cost cutters have

equivalent levels of return on equity and revenue growth relative to other S&P companies.

• Although S&P elite cost cutters generate somewhat higher return on equity, the difference between their ROE and that of other S&P companies is not statistically significant.

• While S&P elite cost cutters have experienced lower growth in revenue compared to other S&P peers, this difference is not statistically significant.


Result: S&P Elite cost cutters do not significantly differ from others in terms of ROE.

T-Statistic: 1.573

P-value*: 0.118

S&P Elite N = 69

Other Companies N = 206* P-values of .1 or less represent statistically significant differences at the 90% threshold

level of significance.

11.8%12.7%


Revenue CAGR, 1994-2008T-Test for Differences in

Means

Result: S&P Elite cost cutters do not significantly differ from others in their revenue CAGR.

T-Statistic: -0.64

P-value*: 0.534

≈

≈


7.9%

1.8%


13.7%

10.4%


Average ROI, 1994-2008Over the last ten years, the Wall Street has rewarded the S&P elite cost cutters with significantly higher TSR and return on investment relative to other S&P companies.

• S&P elite companies have more than a 3 percentage point advantage over other S&P companies in terms of return on investment.

• They have almost 4.5 times higher shareholder return relative to other S&P companies. 10-Year TSR, 1994-2008


Result: S&P elite cost cutters have significantly higher ROI.

T-Statistic: 2.38

P-value*: 0.012



T-Statistic: 4.62

P-value*: 0.000

S&P Elite N = 69


>

>


™

Executive Summary







Other Companies75%

Industry Cost Cutting Leaders

25%

Energy6%

Materials16%

Industrials24%

Consumer Discretionary20%

Consumer Staples8%

Health Care8%

Financials6%



Utilities2%

DEFINING AN INDUSTRY COST CUTTING LEADERIndustry cost cutting leaders

are defined as the companies whose cost grew at below-average levels relative to their industry during 994-2000 as well as 2001-2008.

• Industry cost cutting leaders represent a variety of industry sectors.

Distribution of Industry Cost

Cutting Leaders

N = 480

Distribution of Industry Cost Cutting

Leaders

By Industry

Industry Cost Cutting Leaders N = 119

Industry Cost-Cutting Leaders

Defined as companies that experienced below- industry average growth in expense to sales over the 1994-2000 as well as the 2001-2008 period.


45.0%

50.0%

55.0%

60.0%

65.0%

70.0%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008


Other Companies

COGS to Sales Ratio, 1994 to 2008(Industry Cost Cutting Leaders vs Other)

Industry cost cutting leaders have significantly lower COGS than other companies, but the pace of COGS reduction are slowed significantly.

• Most companies have experienced a steady increase in COGS over the last 5 years.

• Although industry cost cutting leaders continue to have much lower COGS to sales, they have significantly slowed the pace of COGS reduction over the last five years.


Defined as companies that experienced below- industry average growth in expense to sales over the 1994-2000 as well as the 2001-2008 period.




0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008


Other Companies

SG&A to Sales Ratio, 1994 to 2008(Industry Cost Cutting Leaders vs Others)

Industry cost cutting leaders and other companies have held SG&A levels relatively constant over the last few years.

• Industry cost cutting leaders have had consistently higher SG&A levels relative to other companies. However, their SG&A-to-Revenue showed signs of decline in the last five years.

• Most companies have held SG&A levels relatively constant in the last five years.


Defined as companies that experienced below- industry average growth in expense to sales over the 1994-2000 as well as the 2001-2008 period




11.6%

15.2%

Industry Cost Cutting Leaders Other Companies

15.8%

13.8%

Industry Cost Cutting Leaders Other Companies

Average Return on Equity, 1994-2008Industry cost cutting leaders

have equivalent ROE but lower revenue growth relative to other companies.

• Industry cost cutting leaders and others are statistically indistinguishable in terms of return on equity.

• Industry cost cutting leaders generate significantly lower revenue growth relative to other companies.


Result: Industry cost cutting leaders do not significantly differ from others in terms of ROE.

T-Statistic: 1.12

P-value*: 0.231


Revenue CAGR, 1994-2008T-Test for Differences in

Means

Result: Industry cost cutting leaders have significantly lower revenue CAGR relative to others.

T-Statistic: -3.34

P-value*: 0.001<

≈




Elite cost cutters generate significantly higher TSR but also significantly lower revenue growth relative to other companies

• Companies that minimize the growth or volatility of expenses to sales generally have higher ROI relative to other companies.

• However, elite cost cutters are also at a significant disadvantage relative to other companies in terms of revenue growth.

DEFINITIONS

• Elite Cost Cutters refers to companies with negative average annual growth of expense to sales over both the 1994-2000 and the 2001-2008 periods.

• S&P Elite Cost Cutters refers to S&P 500 companies who saw negative average annual growth of expense to sales over both the 1994-2000 and the 2001-2008 periods.

• Industry Cost-Cutting Leaders are companies that experienced below- industry average growth in expense to sales over the 1994-2000 as well as the 2001-2008 period.

Comparison of Elite Cost ManagersBy Financial Performance (all companies)

Return on Equity

Revenue CAGR

Return on Investment TSR

All Elite Cost Cutters Significantly higher

than other

companies

Significantly

lower than other

companies

Significantly higher

than other

companies N/A

S&P 500 Elite Cost

Cutters

Statistically

indistinguishable

from other

companies

Statistically

indistinguishable

from other

companies


than other

companies


than other

companies

Industry Cost Cutting

Leaders

Statistically

indistinguishable

from other

companies

Significantly

lower than other

companies


than other

companies


than other

companies

Financial

MetricDefinition

Of Elite

** Statistically significant differences were assessed using a 95% threshold level of significance in a two-sample t-test.

™

Executive Summary



Performance of S&P Elite Cost Cutters

Performance of Industry Cost Cutting Leaders

Appendix: Stylized Facts About Cost Behavior


MEASURING COST RESPONSIVENESSThe Board used an econometric model of cost behavior to test for the responsiveness of costs to changes in the volume of activity.

• The regression equation helps estimate the responsiveness of costs to both increases as well as decreases in sales.

• The regression approach also controls for the effect of company- and industry-specific influences via fixed effects.

The Econometric Model Explained


)()()()()(2,

1,1,4

2,

1,3

1,

,,2

1,

,10

1,

,

ti

titi

ti

ti

ti

titi

ti

ti

ti

ti

Sales

SalesLogD

Sales

SalesLog

Sales

SalesLogD

Sales

SalesLog

Cost

CostLog

Dependent Variable:

Current-Year Growth in a company’s costs

Fixed Effects to control for company- and industry-specific influences

Current-Year Growth in a company’s sales

Growth in a company’s sales in the previous period

Magnitude of decrease in a company’s current period sales growth, if a decrease occurred, otherwise zero.

Magnitude of decrease in a company’s previous period sales growth, if a decrease occurred, otherwise zero.

Interpretation of Regression Coefficients

β ‘s are the cost sensitivity coefficients associated with each variable on the right hand side of the regression equation. They represent the percentage change in the dependent variable (costs) as a result of a 1% change in the right hand side variables.

D is a dummy variable that takes the value 1 if sales decreased in a particular year relative to the previous year, and 0 otherwise.


Although cost of goods sold (COGS) tends to vary proportionately with sales, S&P elite cost cutters exert tighter control over COGS than other companies do when sales rise.

• In general, COGS tends to rise (fall) by 1% for every 1% increase (decrease) in sales.

• S&P elite cost cutters exert tighter control over COGS than other companies do when sales rise

ELITE COST CUTTERS: TIGHT CONTROL OVER COGS

)()()()()(2,

1,1,4

2,

1,3

1,

,,2

1,

,10

1,

,

ti

titi

ti

ti

ti

titi

ti

ti

ti

ti

Sales

SalesLogD

Sales

SalesLog

Sales

SalesLogD

Sales

SalesLog

COGS

COGSLog

Sensitivity of COGS to Increase in Sales

Sensitivity of COGS to a Decrease in Sales

All S&P Companies 1.02 (p-value 0.00)

1.06

S&P Elite Cost Cutters .99 (p-value 0.00)

.99

Other S&P Companies 1.03(p-value 0.00)

.99

)( 1

Econometric Model

* P-values of .1 or less represent statistically significant differences at the 90% threshold level of significance. The estimation was conducted using the feasible generalized least squares technique, which corrects for biases from heteroscedasticity as well as serial error correlation typically arising from the cross-sectional time series nature of the data .

)( 21

Regression Estimates

All S&P Companies N = 4361 Company Years



S&P elite cost cutters vary COGS less than proportionately to sales relative to other S&P companies when sales rise.


Elite cost cutters ‘variable-ize’ their SG&A costs more than other companies do.

• In general, SG&A costs increase more when sales rise than they decrease when sales fall.

• For the average company, SG&A costs increase by .78% for a 1% increase in sales but only fall by .46% for a 1% decrease in sales.

• This downward inflexibility in costs typically arises from fixity of costs as well as adjustment costs of reducing resource levels.

• However, Elite Cost Cutters vary their SG&A costs proportionately to the volume of sales so that costs change proportionately (.71%) in the direction of sales growth/decline.

ELITE COST CUTTERS: ‘VARIABLE-IZING’ SG&A

)()()()()&

&(

2,

1,1,4

2,

1,3

1,

,,2

1,

,10

1,

,

ti

titi

ti

ti

ti

titi

ti

ti

ti

ti

Sales

SalesLogD

Sales

SalesLog

Sales

SalesLogD

Sales

SalesLog

ASG

ASGLog

Sensitivity of SG&A to Increase in Sales

Sensitivity of SG&A to a Decrease in Sales

All S&P Companies .78 (p-value 0.00)

.46


.71

Other S&P Companies .79(p-value 0.00)

.37

)( 1

Econometric Model


)( 21






Elite cost cutters do not carry over cost changes from previous years sales activity, and instead choose to fully adjust costs to reflect changes in sales in the current year itself.

• In general, SG&A costs respond to sales with a lag, rising .04% in the current year for a 1% increase in previous year’s sales.

• However, Elite cost cutters do not carry over the effect of past changes in sales on current year SG&A levels.

• In general, cost stickiness does not revert in future periods for non-elite companies (i.e., downward inflexibility of costs continues to persist).

ELITE COST CUTTERS: ACTING DECISIVELY

)()()()()&

&(

2,

1,1,4

2,

1,3

1,

,,2

1,

,10

1,

,

ti

titi

ti

ti

ti

titi

ti

ti

ti

ti

Sales

SalesLogD

Sales

SalesLog

Sales

SalesLogD

Sales

SalesLog

ASG

ASGLog

Sensitivity of SG&A to Increase in Previous Year Sales

Reversion of Cost Stickiness

All S&P Companies .04 (p-value 0.00)

-.04(p-value 0.00)


-.02(p-value 0.34)

Other S&P Companies .04(p-value 0.002)

-.05(p-value 0.001)

)( 3

Econometric Model


)( 4





These estimates are statistically indistinguishable from 0, implying that the effect of past declines in sales do not carry over to current-year SG&A for elite cost cutters.


Elite cost cutters are significantly more aggressive than other companies at varying SG&A levels if there if sales have declined in previous years.

• In general, SG&A is more variable if there has been a sustained increase in sales than if there has been only a temporary increase in sales (.81% as opposed to .73%).

• Elite cost cutters vary SG&A less than others (.66% as opposed to .75% for others) if the decline in sales is temporary and reversed in the following year.

• However, they vary SG&A more than other companies (.57% as compared to .34%) if there has been a sales decline in the past year.

• Further, elite cost cutters are significantly more likely to vary SG&A if there has been a sustained decrease in sales.

ELITE COST CUTTERS: MANAGING COSTS CONSERVATIVELY

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Sales

SalesLogDD

Sales

SalesLogDI

Sales

SalesLogID

Sales

SalesLogII

ASG

ASGLog

After Two periods of successive increases in sales

After Decrease in Sales followed by an increase

After Increase in sales followed by a decrease

After Two successive periods of sales decrease

All S&P Companies

.81 (p-value 0.00)

.73 (p-value 0.00)

.39 (p-value 0.00)

.63 (p-value 0.00)


.75 (p-value 0.00)

.66(p-value 0.00)

.57 (p-value 0.00)

.90 (p-value 0.00)

Other S&P Companies

.82 (p-value 0.00)

.75 (p-value 0.00)

.34 (p-value 0.00)

.47 (p-value 0.00)

)( 1

Econometric Model


)( 2

Sensitivity* of SG&A to Sales Conditional on Past Performance





The I’s represent dummy variables that take the value 1 for years where sales increased relative to the previous year and, zero otherwise.

The D’s represent dummy variables that take the value 1 for years where sales decreased relative to the previous year and, zero otherwise.

)( 3 )( 4

Elite cost cutters are almost twice as aggressive as other companies at varying SG&A after experiencing two successive periods of sales declines.

CORPORATE EXECUTIVE BOARD

WWW.EXECUTIVEBOARD.COM

™

Economic Analysis and Decision Support Group

Randeep Rathindran Director

Oleg Polishchuk Senior DirectorAnil Prahlad Managing Director

EADS contact information:

571.303.6257

[email protected]

™ transforming the cost base: 2009 update 13 november 2009 finance and strategy practice economic...

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