Hot Features
Premium
Register for real-time alerts, custom portfolio, and market movers
As I was saying yesterday, investors, especially those with large amounts at stake, need to take a closer look when the company in which they are investing indicates that they are on a cost-cutting campaign. This discussion was motivated by the Royal Bank of Scotland’s (LSE:RBS) computer system crash that, among other things, blocked customers access to their accounts at ATM’s. The bank blamed the incident on decades of neglect of updating their IT technologies. This revelation should not be ignored just because the system is up and running again. This is a major disaster still waiting to happen, and it is a result of board room incompetence as the bank sought to cut costs since 2008.
I say “incompetence” without any reservation. This, and any similar cases at other entities, is a result of sacrificing the permanent on the altar of the immediate. It is failing to give adequate consideration to determining unintended consequences. It is a failure to ask the questions, “What if we do this?” and “What if we don’t do this?” It is a result of being highly focused on one aspect of the business to the detriment of all the others. It is proof positive that, just because a person holds an executive position, it doesn’t mean that they can or will make wise and appropriate decisions that protect the company and its investors over the long haul.
We all get a bit upset when we see incompetence rewarded with obscene executive compensation. In this case, I’d like to take those responsible and kick their arses into the Thames. I’m not so lacking in compassion that I would not throw them a rope. Unfortunately, as a part of my own cost reduction program, I had to cut back on the length of my rope. All I have left is two feet – and those are at the end of my legs.
Other than the circumstances that we discussed yesterday, investors should favor companies that focus on cost avoidance. If cost avoidance were steering a boat away from a storm, capex cost reduction would be cutting off the entire bow section so that the boat would not reach the storm. Capex cost reduction is exactly what took place at RBS – and it is taking place at many other companies right now, right under our noses. It’s just so easy to say “No” to spending money to upgrade infrastructure and equipment. It would be fair to say that most who make capex cost-reduction decisions look like heroes for the moment, but know they likely will not be around when the real cost of their decision is exposed.
Just for clarity’s sake, cost avoidance may be defined as “a cost reduction that results from a spend that is lower then the spend that would have otherwise been required if the cost avoidance exercise had not been undertaken.” I’m telling you right now that, beyond the purchasing arm of most companies, little attention is paid to cost avoidance. I believe that there are at least four basic reasons for that.
- Executives don’t understand cost avoidance.
- Cost avoidance is a lot more difficult than cost reduction, especially capex cost reduction.
- Everyone is too busy “doing their job” to make cost avoidance a part of their job.
- The results are not immediate.
So, what is the takeaway here? It is that investors need to become investigators when a firm announces that it is taking large cost-cutting measures. If those measures are the “good kind” that I mentioned yesterday, such as, eliminating unprofitable, non-core business, that’s fine. When it is a reduction in executive salaries, that’s fine. When it is a decision to not invest in infrastructure and capital equipment, the future is going to be at risk. And so will your investment. Capex cost reductions kill companies from the inside, but rarely does the fickle finger of fate point to them as a reason for a company’s failure, because they are not in the budget, the P&L or the balance sheet.
I’ve always defined success in terms of how much I have done compared to what I could have done. Do you wonder what RBS could have done to avoid the IT failure? They could have spent the money necessary to keep their system up to date. But they didn’t.
On a final note, the RBS story is another example of the axiom that cause (capex cost redutions) and effect (IT crash) are not necessarily related in time and space. Investors, beware.
On a final, final note, the pig in the picture is not related to the ones pictured with Tom Frew’s article today entitled “UK to Export £45m’s Worth of Pig Semen to China.” (How much is £45 million worth.)
