In the spotlight: High-Performing Organisations

Fit for Growth: the smart way to cut costs, restructure and renew

Companies across industries and geographies are realising that the only way to unleash profitable growth is to cut costs as rigorously as they concentrate on growing revenues. As with any living organism, there’s no profitable growth without equally robust pruning. To get fit enough to thrive in an increasingly tough environment, you need to focus on a small number of differentiating capabilities, align your cost structure to these capabilities, and organise for growth. In this article we look at how the world’s fittest companies have mastered these three components to achieve and maintain healthy, profitable growth – and at the principles that can enable companies in this country, to to prune their business for sustained success.

Niklas Hoppe

Niklas Hoppe

Partner, Strategy& Switzerland

Why you have to cut to grow

Gardeners know that the healthiest growth comes when you prune. The same applies to any business: by cutting back, you make sure vital resources get to where they’re essential for profitable and sustainable growth. But gardeners will also tell you that it requires skill and knowledge to know precisely where and how to prune, and the courage to make the necessary cuts. The Fit for Growth programme developed by the consultants at PwC’s Strategy& helps companies prune their business confidently and skilfully to make sure they have the right amount of resources they need to compete effectively – no more, no less – at precisely the right places.

The threefold path to getting fit for growth

Being fit for growth isn’t just a matter of innovation, entering new markets or showing expertise in acquisition. It means having your resources and cost structure aligned to your overall strategy – in other words, deploying your resources for the right businesses, initiatives and capabilities to execute your growth agenda.

In the course of helping dozens of companies become competitive, we at Strategy& have identified clear patterns in the way successful organisations get fit for growth. Essentially we’ve noticed that they do three things consistently and continuously:

  1. They focus on a few differentiating capabilities.

  2. They align their cost structure to these capabilities.

  3. They organise for growth.

It’s not enough to succeed in just one of these dimensions. You have to get all three right.

Focusing on differentiating capabilities means first building a clear identity based on the things you do better than anyone else. These capabilities − the three to six combinations of processes, tools, knowledge, skills and organisation that enable you to outperform – are absolutely central to getting fit for growth. Working out what you do well and basing your strategy on these things gives you a clearly defined, focused goal that everyone in your organisation can see and work towards.

Once you’ve identified these capabilities you can align your cost structure to them. In other words, you can devote your resources to the areas that really count, avoiding distractions and the temptation to invest time and money in areas that won’t actually get you any further down the path to growth. Cutting costs isn’t easy for any manager, however tough, but aligning your efforts to your capabilities gives you the clarity to make the right decisions and the certainty that you’re doing the right thing. In the best case, people within the organisation will be motivated by the knowledge that resources are being channelled to areas that really matter to the survival and success of the business, and the sense of purpose that comes from working towards a clearly defined goal.

Organising your business for growth – again guided by your differentiating capabilities – makes everyone’s life easier, allowing them to work more efficiently, make decisions with greater certainty, and act more decisively. Companies like IKEA (more about them later) have mastered this approach so completely that it pervades their entire corporate culture – including their suppliers – and shapes the positive experience of their customers.

Where companies fall short

Perhaps the best way of illustrating the importance of this threefold approach is to describe the symptoms when companies fail to align their cost structure and organisation to their differentiating capabilities.

If an organisation lacks this critical focus you can generally tell by the distractions that exist. There are so many initiatives that employees are spending all their time in meetings on completely unrelated topics, and the best people are burning out because they’re involved in so many high-priority programmes. The company is spending so much on the distractions that it’s failing to invest in the things that really give it a distinctive edge.

Based on our experience, here are some of the tell-tale signs:

  • Functions from marketing to HR and risk management are spending lots of money trying to be "best in class", whether the function is strategically critical to the company or not. They haven’t realised that you don’t have to be best at everything, and that outsourcing would be more than adequate in certain areas.

  • Legacy programmes with little impact continue to get funding and become self-sustaining organisations in their own right, while critical growth initiatives fail to get off the ground.

  • Budgeting is done on the basis of "last year plus 3 per cent", staffing levels get out of balance, and every couple of years there are desperate attempts to cut costs – only to have these costs steadily creep back.

If some or all of these sound familiar – and especially if your internal bureaucracy has got so out of hand that it takes weeks to make and implement important decisions − you need to start focusing on what you do best, align your cost structure and organise to support your strategy. You have to accept that you need to cut to grow.

But as we saw before, you have to make the cuts skilfully in the context of a clear strategy. In our book "Fit for Growth: a Guide to Strategic Cost Cutting, Restructuring and Renewal", we look at the real-life example of Circuit City, a company that made all the wrong cuts in response to financial adversity. The main problem was that they failed to identify and focus on their differentiating capabilities – in Circuit City’s case a network of prime outlets and a workforce of seasoned salespeople who had built the trust and loyalty of customers over many years – and subsequently cut costs in the worst possible areas. Instead of getting fit for growth, Circuit City eroded the confidence of employees and customers and rapidly destroyed any basis it would have had for recovery.

Which companies are getting it right?

Contrast Circuit City with IKEA, a company that has elevated cost optimisation to an art form. In our book we look at the way IKEA has laser-focused on its strategy and differentiating capabilities, aligned its cost structure to reinforce these capabilities, and organised itself to enable profitable growth. IKEA employees are relentless in looking for opportunities to save costs in everything but the quality of their products, the customer experience and the efficiency of their operations. These are the company’s key capabilities, areas into which it ploughs savings generated elsewhere.

IKEA considers design, cost and price all together in the product innovation phase. Because it has a clearly defined strategy and everyone – including its suppliers – is pursuing the same goals, there are relatively few trade-offs. It’s this rigorous and continuous focus on what they do best when it comes to allocating costs that distinguishes IKEA from Circuit City. Unlike Circuit City, which responded to the 2008 recession by dropping core businesses and demoralising the entire workforce with layoff after layoff, IKEA continued investing in its differentiating capabilities − not only building new stores, but expanding and extending existing ones. Circuit City has since gone out of business. IKEA, in stark contrast, has managed top-line growth of around ten per cent since 2001 and has kept its margins stable despite ongoing price reductions and the economic pressure of recent years.

Where’s the evidence?

To back up our observations about the qualities that make companies fit for growth, we at Strategy& developed the Fit for Growth Index. This is a quantitative metric that measures companies’ adherence to the three elements of the Fit for Growth framework: focusing on a few differentiating capabilities, aligning cost structure, and reorganising for growth. We correlated the index scores of around 200 companies in different sectors with their financial performance (expressed as total shareholder return or TSR) adjusted for industry-specific factors.

As Figure 1 shows, we found a clear correlation between a company’s fitness for growth in terms of our index and its financial performance, with almost three quarters of companies with high index scores having high or medium high TSR scores. The reverse is also true. As Figure 2 shows, companies with low index scores generate lower returns.

Figure 1: Fit for Growth companies generate higher returns

This diagram shows the comparative placement of 197 sample companies on scales showing performance (two-year normalised total shareholder return on the y-axis) and readiness for growth (the Fit for Growth Index score on the x-axis)
Figure 2: Distribution of normalised TSR scores by Fit for Growth Index score
Fit for Growth Index score 42% 31% (26 companies) High 27% (107 companies) Medium high 16% 27% 45% 12% 19% 34% 47% (64 companies) Low and medium low Low TSR Medium low TSR Medium high TSR High TSR
Fit for Growth Index score (26 companies) High 27% 31% 42% (107 companies) Medium high 12% 45% 27% 16% (64 companies) 47% 34% 19% Low and medium low Low TSR Medium low TSR Medium high TSR High TSR

Analysing our data in more detail also underscored the validity of our Fit for Growth approach. High-performing companies closely link their growth and cost agendas, understanding what capabilities are critical and funnelling their resources accordingly. Companies need to combine all three elements for outstanding results: those that integrate and align differentiating capabilities, cost structure and their organisation to get the highest Fit for Growth Index scores and the best financial returns; getting just one component right won’t yield the same results. We also found that very few companies were actually fit for growth, with only six per cent demonstrating strength in all three elements identified in our approach.

As we have seen, the formula for success is clear and common-sense, and the benefits of getting it right are substantial. We would also like to encourage companies to think about how they could adopt a more coordinated approach to cost reduction. If managed skilfully and sensitively it can be a constructive and even uplifting exercise that can make your company more competitive, more profitable and better prepared to grow.

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Niklas Hoppe

Niklas Hoppe

Partner, Strategy& Switzerland

+41 58 792 2875