2023 SG&A Cost Study and Scorecard Highlights – Transcript

Murray Shevlin:

It is really challenging to improve costs on a continual basis. And only 7% of organizations in North America were able to improve their year-over-year cost structure for six out of 10 years. So it’s a little bit higher – 12% in Europe – to be able to improve costs on a year-over-year-over-year basis is really challenging. And the consequence of that – of not having an agile cost structure – means that it’s really difficult to flex based on the market demand. As revenue dips or stays flat, then margins begin to erode. That also means there’s just less funding to be able to invest in R&D to innovate for new products or new services. And similarly, there’s less dollars to be able to invest to penetrate new markets.

Announcer:

Welcome to The Hackett Group’s “Business Excelleration Podcast.” Week after week, you’ll hear from top experts on how to avoid obstacles, manage detours and celebrate milestones on their journey to world-class performance.

Murray Shevlin:

Welcome to another episode of The Hackett Group’s “Business Excelleration Podcast.” I’m Murray Shevlin, and I’m a principal within our Benchmarking practice in North America. Today, we’ll be discussing our new research, which details how difficult it’s been for many companies to sustain reduction in selling, general and administrative costs, or more commonly referred to as SG&A. I’m joined by my colleague Tom Kellaway, who’s also a principal in our benchmarking organization based in London.

Tom Kellaway:

Thanks, Murray. So we are here today because we received some really positive feedback from our SG&A analysis, which we conducted at this time last year. So we thought, why not refresh that analysis. See what’s happened. And it’s really interesting, I think. So Murray, why don’t you first, though, talk to us a little bit about the approach and scope of the 2023 SG&A research that we did.

Murray Shevlin:

Yeah, so we analyzed the financial results of the largest 1,000 companies in North America and did the same for the largest 1,000 in Europe. The time horizon that we looked at was over the last 10 years of their financial results, but really, we took a greater emphasis in year-over-year comparisons over the last several years and even looked within the first half of this year. We specifically focused on revenue changes and SG&A cost changes to determine how well organizations are managing their SG&A cost structure. And as you know, SG&A costs include the cost for functions like finance, HR, IT, procurement, sales, marketing, legal and a few other areas.

Tom Kellaway:

Got it. So why don’t you tell us about some of the macro trends that we observed this year?

Murray Shevlin:

Well first, starting at the top line, just from reading the news, we know that revenue has been pretty strong, or revenue growth was strong in 2021 as well as in ‘22. The numbers though were pretty dramatic. So moving from 2020 to 2021, revenue grew in Europe for those largest organizations by 22% and 21% in North America. When we cast our eye towards those same changes for last year, that growth slowed but still had double-digit improvement with 10% in Europe and 14% revenue growth in North America. And really, that revenue growth is what can attribute, to a large extent, to SG&A cost as a percentage of revenue improvement, which saw unprecedented levels of improvement in 2021, with almost 7% improvement for Europe and 8% for North America.

However, when we looked at ‘22, even with double-digit revenue growth, the SG&A cost as a percentage of revenue was pretty well flat. So you’ve got double-digit revenue growth, and then that cost structure stayed the same, which tells us that costs were growing at the same rate as revenue. But when we look at that and look at the absolute costs – not just the ratio – I think we see some more interesting elements to that. So Tom, I’ll pass over to you to describe a little bit more about those changes in absolute terms.

Tom Kellaway:

Yeah, absolutely. Yeah, so I think as we dug into the data, I mean, unfortunately, we found relatively lackluster cost performance, which is a bit disappointing. What that means is, of the 1,000 companies, almost half in Europe increased SG&A costs over percentage of revenue – that was 42% for North America. So fundamentally, that meant that costs are growing at a faster rate than revenue, right? Clearly, not ideal.

Now that does contrast – so a little bit of good news to those cost cutters. So there were organizations who managed to improve their SG&A costs over percentage of revenue and reduced absolute costs. That was about 23% of European companies – about 15% of companies in North America. So those are the ones that were agile enough to be able to optimize that cost structure – drive down SG&A costs – while at the same time enjoy revenue growth. Now to be fair to the overall population that we’re talking about here, clearly, inflation rates were at record levels. I think, the highest in about 40 years. That created, obviously, some significant headwinds for cost management. North America – what was inflation? It was about the 6.5%. Europe was even higher at 9%. I think even higher in the UK as well.

Now, having said that, when we think about those more agile organizations – even when we take that inflation to account – 13% to 14% of companies actually managed to increase costs at a slower rate than inflation. So you do also have some inflation beaters within that group as well. And I guess, the last pocket of organizations are maybe what you might call the ratio managers. Those are companies that increased absolute costs at a faster rate than inflation. But thanks to revenue growth as well, those organizations managed to improve their SG&A performance as well. So about 15% of European and about 29% to nearly 30% of North America organizations.

So that’s a lot of data. But just to recap on those key points, almost half of organizations increased their SG&A cost as a percentage of revenue during the same time period where revenue had double-digit growth. A much smaller fraction actually reduced SG&A cost as a percentage of revenue and also cut their absolute costs as well. So it is possible, as I say, to cost manage even in those trickier times when you’re dealing with headwinds like inflation.

Murray Shevlin:

Yeah, that’s good, Tom. Thanks for recapping those points. So really, even while revenue improved over that time frame, only a small proportion of those companies were actually able to reduce SG&A costs or manage their cost structure in a way that actually positively impacted margins. The majority of those companies, though, the margins actually eroded, even with revenue growth, which that revenue growth, in contrast to the cost structure, actually masks inefficient cost structure. So to say that in a different way – as we’ve got revenue that’s growing, if costs are growing at the same or higher rate, that positive revenue growth kind of masks some organizations that are more inefficient.

So we’ve been talking about that year-over-year growth and cost impact. What’s interesting, too, is when we looked at what’s going on in the first half of this year and what should be alarming for those companies that aren’t managing their cost structure very well is revenue change was pretty well flat for most organizations.

So based on the results we’ve discussed so far, I would expect SG&A cost as a percentage of revenue to increase, which will really expose those organizations that have been growing their SG&A costs in an unmetered fashion. It’s always much harder to turn back the spigot than it is to increase investments. So I’d say, it’s really challenging to improve costs on a continual basis. And the way we measured that is that we looked at that 10-year time horizon we talked about earlier, and only 7% of organizations in North America were able to improve their SG&A year-over-year cost structure for six out of 10 years. So it’s a little bit higher percentage of 12% in Europe, but what that’s telling us is to be able to improve costs on a year-over-year-over-year basis is really challenging.

And the consequence of that – of not having an agile cost structure – means that it’s really difficult, if not impossible, if you don’t have a structure in place like that to flex based on the market demands. So what that means is, as revenue dips or stays flat, like the first half of this year, and that cost structure isn’t flexible, then margins begin to erode. Or when revenue takes a dip, that also means there’s just less funding that’s available to be able to invest in R&D to innovate for new products or new services. And similarly, there’s less dollars to be able to invest to penetrate new markets. So it can be kind of a double consequence of your cost structure is going up and you don’t have the flexibility to then fund to be able to grow the top line with new products or entering in new markets. Another way is, or another issue is, organizations that don’t have that agile cost structure. It’s much more challenging to have that buffer when you do run through rocky times where revenue is more challenging or the outlook is more suspect.

This kind of paints a bleak picture for most organizations. But on the flip side, we talked about, during this same time horizon, some organizations were flourishing. So where it may be a negative picture for some, and even the majority, it creates that opportunity to be able to outpace your competition. So at Hackett, when we look at and define what are those top-performing companies, we call those top-performing companies Digital World Class. And by leveraging our benchmark datasets, we’re able to analyze what makes these organizations unique. So Tom, would you like to describe how we define or elaborate on how we define Digital World Class and really why it matters?

Tom Kellaway:

Yeah. Sure, absolutely. So as Murray said, obviously, by leveraging Hackett’s proprietary database of organizations that Hackett has benchmarked, and obviously, we’re doing a ton of these benchmarks continuously every year. So we’ve got a wealth of data and those organizations who achieve what we call top-quartile performance in both operational excellence – so that’s around cost productivity, but also business value that’s around the effectiveness, the experience, the return on that investment – they’re what we call Digital World Class organizations.

So, super important. It’s not the cheapest organizations. It’s those organizations that are, what is hyper cost-effective. So when they’re making an investment, there is a tangible return for that, right? That’s what we call a Digital World Class organization. So they’re doing the right things, and they’re doing the right things really well. Now, what that translates to in terms of efficiency savings, in relation to obviously the cost reduction and the SG&A analysis that we’ve done, is that there is a significant financial price for those organizations.

So if you take a typical $10 billion company, and you look at those SG&A costs for a Digital World Class organization and then compare that to a typical average performer, the difference in that cost profile for a $10 billion company, within their SG&A costs, the difference is $317 million – $317 million – that is not pocket change. Think about those things that you could be doing. Murray, as you mentioned earlier, in terms of entering new markets, launching new products, returning that to shareholders, whatever it is, that’s a significant price. It’s even significant when you say, narrow it down a little bit. So if you just look at say, the finance, HR, IT, procurement functions, that opportunity is $100 million. So even just in those four functions – outside of sales, marketing and the other SG&A functions, just in those four – it’s $100 million for a $10 billion organization. That is significant.

And, of course, as I say, it’s not just about that better cost structure as well, we’ve got lots of LC stats around how you measure business value. But I’ll give you, very simply, within those Digital World Class organizations, on average, 44% more likely to be viewed as a valued business partner to their internal customers, and they’re delivering better insights about support decision-making. They’re supporting the enterprise agenda that much more effectively.

Murray Shevlin:

So Tom, with such a material improvement like that or improvement between Digital World Class and the middle of the pack, how do you think the Digital World Class organizations are able to do that? I mean, how are they striking that right balance of being a better business partner, as you mentioned, and at the same time operating with a much leaner cost structure?

Tom Kellaway:

What are Digital World Class organizations doing differently? Well, firstly, they’ve got much more efficient access to information and management information to be able to make decisions much faster. Again, talking about that theme of agility. They’re leveraging automation tools, technology – not just for that core process automation, but also around that self-service enablement and supporting that user experience. But, of course, it’s not easy. It doesn’t happen overnight. It is very much a journey, and it certainly doesn’t happen without a plan. So obviously, what I’m just going to say, you’re going to say, “Well, of course, Hackett, you would say you need to start with a benchmark.” But in all seriousness, when we look at those organizations within that SG&A profile, and I look just through the names of those organizations – those cost cutters or those inflation beaters – I recognize a lot of them, right? There are a lot of those organizations are Hackett clients, and they’re on that journey to Digital World Class performance.

But it starts by clearly understanding and quantifying the opportunity – not just at an overall level by function, but getting down into the nitty-gritty. Where does that cost opportunity reside? What are the drivers of that improvement? And what are the levers that you can start to pull? You can’t cost cut your way to Digital World Class. You need to transform your service delivery model in order to be able to do that. So you need to be able to prioritize as well, right? Everyone’s super busy. OK, what Digital World Class organizations are really good at is understanding where is good, good enough, versus where do they need to excel. And part of that is around that prioritization of where to act. They clearly need to be able to set themselves credible, realizable targets, so using that outside-in perspective through the benchmarking data to understand what’s right for them. What is that size of the price? And, of course, they need to learn from other organizations. So part of what we do is helping organizations learn from those who have already achieved and are on that journey to Digital World Class performance.

You don’t need to always reinvent the wheel. You can steal with pride from other organizations in terms of some of those fundamental best practices, both best practices at being best practice in things like process ownership, use of shared services, global business services – for a long time. But, of course, also emerging practices around things like AI and other areas where people are getting really excited about. Then you’ve got to execute. You’ve got to be able to deliver on that road map.

In terms of the journey, as I say, it doesn’t happen overnight. Typically, the journey to Digital World Class, it’s all relative – where you’re starting, where exactly you want to go, but typically, it’s about two to five years, maybe it’s all about averages, two and a half to three years. But you can obviously build quick wins into that transformation journey as well. So typically, most organizations would aim to look for unlocking at least a third of those efficiency savings within the first 12 to 18 months. You want to drive those quick wins, build credibility around your transformation journey and then continue to execute. And in our paper, we try to articulate, I think, some of the key elements that you need to incorporate into that improvement plan.

Murray Shevlin:

Yeah, that’s right, Tom. And there are a few elements that we recapped in the paper, but one of those centers around deploying the right tools and the right technology to meet organizational objectives. Now, first, technology is definitely not the silver bullet and crafting the right solution is unique to every organization and has to fall in line with what that organization’s requirements are – goals, objectives, budgets, time horizon, risk tolerance and so forth. But one of those key pieces is the tool and what’s the technology to deploy to be able to solve the right business solutions? And investing in the right solution is a really critical element to that. And a couple of the fundamental things to do is projects need to have a clear business objective or you could end up just deploying the wrong solution that ends up occupying a lot of capital, a lot of time and it doesn’t solve or address what that core challenge was.

And in our 2023 Key Issues Study, we found that companies are investing in things like AI or RPA or transactional automation to be able to enable the workforce to be able to get the right information to the right team members in order to make better and faster decisions. And most of those organizations reported that those projects met or exceeded those goals. However, I would suggest, in line with some of the data that we saw, to start with a pilot. To really flush out what’s going to have the biggest impact for your organization. And then that way you can rule out some things that aren’t going to move the needle, and then double down on those projects that are going to have a much more sustainable, high-impact set of results and really change the way business is executed.

Building on that last point, and Tom hit a few of these as well, by having a fact-based set of results, it helps with prioritization. And that prioritization is a really critical element because you know you can’t solve every problem in year one. So where is the low-hanging fruit? What do we need to do today that’s different so we can realize some of those quick wins? And by capturing some of those quick wins, it’s going to build momentum that’ll increase the level of credibility so that, all right, we’re willing to invest in this area because we’re seeing some of those results. And ideally, those become self-funded initiatives and then that creates capital that’ll then translate over into other areas to improve. And then you could start addressing those root-cause elements that are really impeding performance. And by changing those, you can create a lasting set of changes that maximize the investments and both realize the functions to operate at a lower cost and at a higher quality level.

I had one client that I worked with that the results to show what their spend savings or what they were foregoing in spend savings was the missing element to justifying a business case to invest it in an
e-procurement platform. So this particular CPO had been trying to get funding to invest in that
e-procurement platform for years and was unsuccessful because they didn’t have numbers to be able to say, “By investing in this, this is what we’re going to save.” And in that particular case, the business case was centered around driving out or reducing spend within their supply base. So by having that information that came through an analysis that we did, that was then that element that helped justify the business case. And when they looked back on it, that implementation actually had a payback of less than 18 months.

So by having that data that we’ve been talking about to empirically prioritize what initiatives to fund and have a clear business objective that they’re trying to tackle and help that particular organization justify that investment and realized a pretty quick payback.

Building on that procurement example, a third element that we highlighted in the paper was having procurement professionals to have excellent visibility into what you’re spending so you can manage categories better, you can see what are we spending with suppliers, so that you can put together programs to help protect yourself from inflationary price increases or minimize supply chain disruptions. And perhaps even more impactful is to collaborate with suppliers to be able to generate value that’s mutually beneficial by having more transparency and forecasts, by having a better understanding of what the products that you’re trying to create, to sell, and then how that connects back with your suppliers so they can provide the right materials in the right manner to be able to help capitalize on that.

So Tom, what else would you suggest organizations have as inputs into their plan to help drive toward Digital World Class performance and improving their SG&A cost structure?

Tom Kellaway:

Yeah, absolutely. And again, I think this is one way you see the biggest difference between average performers and those Digital World Class organizations. And unfortunately it’s one of the hardest to crack, but it’s data. It’s about treating and leveraging data as an enterprise asset. And that data is obviously going to be used, ideally, for the Digital World Class organization to improve that analytical capabilities – to be able to make quicker, faster, smarter decisions. And certainly, one of the big trends we’re seeing is breaking down silos around that data so as to say about data as an enterprise asset. So breaking down those functional silos, looking at data end-to-end. Obviously, that involves a couple of different things.

Lots of organizations that we work with in terms of those Digital World Class performers, creating centers of capability around data governance. That, obviously, allows an organization to be able to not only pull the data but be able to pull together the talent – that might be data scientists, that might be business analysts – in order to be able to design, deploy the right tools to be able to tap into, ideally, a single source of truth, to be able to drive a common methodology, consistent results also around measuring the right thing.

So we’ve got one client who’s on the way to Digital World Class. They’re using data to be able to align their procurement, supply chain, maintenance and operations target-setting to be able to make sure that they’re all consistently measuring the same things. A simple example – the procurement organization measuring savings, while actually, the business was more interested in on-time delivery. To be able to create that transparency around what’s happening, why are certain things happening, how do we drive that root-cause analysis to be able to stop that issue, to be able to improve performance. But also, just simply, making sure you’re measuring the same things based on what the business outcome is that you are trying to drive.

The other importance of data is, of course, everyone’s favorite topic at the moment is AI. Well, at the end of the day, if you have bad data, the AI isn’t going to work. If you’ve got a human analyzing unreliable data, you’re going to get bad decisions. Exactly the same thing applies to AI. So addressing the data component of your service delivery model has probably never been as important as now. And then, I guess the other one is obviously around maybe what you might call corporate courage, is around having that strong executive leadership to be able to create, encourage, and reward high-performing organizations driving that culture of high performance, embedding consequence management, creating transparency on performance, celebrating successes, but also holding people to account when things don’t go quite to plan. And, of course, part of that high-performance culture is you’ve got to have the right talent. You’ve got to be able to attract, you’ve got to be able to retain, and you’ve got to be able to develop the right talent. And that’s absolutely critical in terms of being able to unlock value. We can’t forget the importance of people and human capital to, again, that holistic approach to a service delivery model.

So I guess to wrap up let’s reflect a few key points from what we’ve discussed. So obviously, in terms of that SG&A cost research, so effectively, what we’ve seen, record revenue growth over the last couple of years, but half of companies have increased their SG&A cost of essential revenue. Come on folks, that’s really disappointing. What are we doing? Another third increased absolute cost, but that was masked by that revenue growth. But really, what we’ve also seen is there are organizations who’ve been able to beat that. They’ve brought down absolute costs. They’ve improved that ratio as well. How have they done that? They’ve built that holistic service delivery model. They thought about people, process technology, etc. They’ve built a plan. They’ve held themselves to account. They’ve target-set based on that benchmarking capability and obviously, bigger picture, if revenue growth starts stalling this year, and we’ve seen some of that for certain organizations in certain industries especially. Then margins are going to be negatively impacted unless you can address that SG&A cost performance.

And as I say, it doesn’t have to be just cost-cutting, right? It’s not about cost-cutting. It’s about driving efficiency through your service delivery model, [which] allows you to be operating at a lower cost, but at the same time, it allows you to be able to deliver higher value to the business. It is possible Digital World Class organizations do it. These are real organizations out there even being able to get that right. Murray, I guess, any closing points or comments from you?

Murray Shevlin:

Yeah. First, just thank you for taking the time to listen to this podcast and downloading the SG&A papers. And we’ve created separate research pieces covering North America and Europe, and that’s really what we’ve been discussing and recapping here today. And both of these papers are available for complimentary download with registration from our website. You’ll find links to the downloaded pages in the show notes or on the Enterprise Insight page of our website.

Second, I would just close by saying, I recommend getting started on your journey to create a Digital World Class organization so that you can establish an agile SG&A cost structure that is then poised to be able to efficiently scale during times where you’re growing and the organization’s expanding – whether that’s through acquisition or through organic growth. And then similarly, to be able to flex when there are downturns and to be able to quickly respond to do that. So understanding where you are today – to be able to then use that to quantify the improvement opportunity. Then use that to prioritize, well, where do we need to focus? Then create a plan and then execute against the road map to then drive toward that future state design and improve your overall performance across these functional areas. So, thanks for listening and hope you join us again soon.

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