Monday, February 25, 2013

Cost Centre & Driver Miscalculation


This might sound like a stupid word but it has an in-depth meaning which saves the organization from travelling towards the path of destruction in the long term. Doesn’t every sacrifice long term growth to achieve the forecast? This is one of the biggest mistakes regularly practiced in every industry. As I belong from the financial industry I have been fortunate enough to see the legacy of leaders from lower level management to the middle level management playing actively this game in financial Distribution Industry, Insurance and NBFC.

Well by saying this I might have annoyed my hundreds of friend from the industry but I am compelled to see and write all these facts. In my previous articles I have been hammering that cost reduction is not the path to remain in competitive business neither to earn profit. Reducing cost leads to slow long term death of an organization and its products. Right allocation of cost and identification of such cost centers is a herculean task which can only be executed by proper understanding of cost drivers. Activity based costing has been practiced and calculated by many of us but we never understand the in-depth relation of cost centers. Unless one has an detail idea about the cost and its value proposition one will never be able to assign cost management in an judicious way.

Forecasting is usually married with individual compensation packages expected to be drawn and grow over the years. Financial objectives are designed based upon the compensation packages linking the same with the sales figures to be achieved. Steroids of motivation are being injected; ruthless employee turnover ratio is being activated followed with hammering the vision and mission of an organization. I have found that when you ask an employee of an organization at any management level one will find giving lectures on vision and mission of an organization where as they have forgotten the main mission and vision of the organization. Everyone in the organization is trying to hit around the bush. The path to destruction of an organization has begun come to know from all these variety of mission and vision notes. In this article I have come up with various factors behind fall of a product and its long term sustainability.

Remaining competitive is an easy task since financial management simply understood the cost reduction path just like a blind fellow. But there is a long journey before the cost reduction programme is being activated which is ignored in the first place.  As I have been saying previously that forecasting is nothing but the benchmark which is created by the company to access and guide the motion of an organization. This benchmark is often miscalculated and leads to an killing instinct for the organization.

Cutting down on cost to run the business is not a process of keeping the business alive. It’s the first signal that the business is going to have a hard landing the near future. It also indicates that the organization is prudently achieving short term targets at the cost of long term. Cost Reduction measures will work spell bound in short term but at the same time the organization takes the biggest challenge of meeting the long term goals.

Organization pumps steroids of growth and motivation which leads to flush of ideas from the middle and top management. Compensation packages are linked with the ideas irrespective of how that idea will merge into the organization business plan and its vision and mission. Early stage innovation can lead to a great trap for the long term prospects of the organization. In insurance industry there has been a flush of policies which has acted like a killing trap in the long term. Many insurance companies came up with brilliant projects and policies which helped the organization to achieve stupendous growth followed with fat incentives for the middle and top-level management but in the long term the same management changed jobs and lead the organization die at its own fate.

I find similar story in all industries which leads to product dumping or short lived product into the market. One of the biggest costs associated with this type of business process is that the initial cost of product development, marketing and sales cost which is being absorbed by the product over the projected cash flow is being added up as a burden cost or sunk cost which eats the profitability of other products. In simple terms premature death of a product life cycle happens due to Rushing of Ideas which eats away the long term profitability of the organization.

Hence too much aggressiveness leads to a death trap. Product innovation riding on the wheel of compensation growth is a slow poison.  If management should have been so easy then why strategic cost management should have been required. Cost reduction can be the work of any uneducated fellow but cost management needs cost accountants who are capable to understand the cost driver and cost centers. Well in my next article I will shape out the path of identification of cost centre and cost driver relationship.

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