Data gathered from the accounts of the constituents of the FTSE-350 between 2008 and 2011 shows that, on average, non-labour costs outstripped labour costs by a factor of more than five to one annually, averaging 68.3% of revenue in 2011 compared with 12.9% of revenue spent on labour.
The research, conducted by Proxima, Europe’s leading procurement services provider, highlights the changing nature of business’ cost base. In doing so, it identifies an untapped opportunity for finance leaders to unlock substantial enhancements to profitability through focusing on operational spend, rather than the traditional tendency to view headcount as the primary source of cost reduction.
The Proxima Profit Enhancement Potential index
The research introduces the Proxima Profit Enhancement Potential index (P-PEP), which provides a ratio by which finance leaders can assess where and how reductions in non-labour costs can influence profitability. Based on the data available for the years being assessed, the P-PEP index compares the ratio between labour and non-labour costs and determines that, between 2008-11, a one per cent reduction in operational spend across the FTSE-350 would produce an EBITDA uplift of £10.5 billion. In percentage terms, averaged across the index, this reduction produces a 3.6 per cent uplift in EBITDA, compared with a 0.8% increase resulting from a one per cent reduction in labour costs.
The “Hot Sectors” and the double impact
Some sectors inevitably offer greater opportunities than others. For the construction materials, chemicals and retail sectors, profits could be boosted by 17.2 per cent, 11 per cent and 11 per cent respectively in return for a one per cent reduction in non-labour costs. The equivalent labour cost reduction produces uplifts of 5 per cent, 0.9 per cent and 1.5 per cent respectively.
These sectors are core economic barometers. For example, the UK’s GDP figures for the second quarter of 2012 highlighted a notable impact on the construction industry, with output down more than 5%. Against this backdrop, improving non-labour costs provides a compelling answer to the question of how companies can protect the value delivered to shareholders when conditions are challenging.
For the retail industry the potential rewards for stronger cost management are also sizeable. With low consumer confidence and structural shifts in their behaviour – which has already led to the closure of a number of household brand names – the potential cost management benefits are significant.
Cultural hurdles often the barriers to progress
The research also polled 275 senior finance and procurement leaders on their attitudes towards cost management and to gauge overarching priorities. While 88% of finance leaders believe that their focus on cost savings has increased, 71% of them are seeing indirect (or non-core) costs growing.
58% of leaders see their ratio of non-labour costs to revenue expanding, which has led a similar number to focus more on this area of spend. Almost three-quarters of respondents think this intention is a result of the economic climate. However, our research shows that the changing shape of business supply chains and resulting cost bases – as companies evolve the way that they develop solutions, services and products for their customer base – is also a significant factor.
While 80% of finance leaders are confident of procurement’
The way ahead
Within an era of increased scrutiny and growing demand for financial responsibility, the research’s findings offer clear opportunities for finance leaders to set in place foundations for future growth, including enhanced shareholder value, an ability to preserve employee morale through fewer instances of headcount fluctuation in tougher conditions and long term improvements to the way that costs are managed. In turn, these factors enable greater reinvestment back into the business and lead to better prospects for the future.
Matthew Eatough, CEO of Proxima, said:
“The results of this research demonstrate, starkly, the scale of the opportunity facing finance leaders and the fact that it is manifestly being squandered by a good number of Britain’s blue-chip companies.”
“Our experience shows that removal of excess costs produces deep and long term benefits to these businesses. And they are not just fiscal benefits – better buying behaviours, improved value and performance from suppliers, boosted employee morale and an increased ability to reinvest in the business, all result from bringing third party costs under control.”
“However, even a deeper analysis of costs may not be enough. So, the Proxima Profit Enhancement Potential is a tool that we believe can help finance leaders to target areas of spend that are weighing on the overall cost base and plan adequate investment to bring them under control. It’s about boosting visibility of cost areas that are not delivering the right value for money and reapportioning investment into making them more effective.”
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Proxima is a dynamic international business, specializing in procurement outsourcing.
We approach things differently. Working closely with you, we improve business performance by making procurement deliver more. Our approach goes beyond driving efficiency. It's about enabling change, enhancing management control and delivering results that exceed your expectations.
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