A Cost-Reduction Approach

Richard L. Sandenaw
December 9, 2008 | COMMENTS

Credit union executives, like other business executives, know how to cut operating expenses when the need arises. This is a management task that generally requires a watchful eye and a proactive approach. But how cost reduction is done is critical to the future success of the credit union.

There are the easy cost reduction targets that are often considered first, such as reducing staff and cutting travel and conference expenses. The result of these cuts, however, might be a loss of member satisfaction if there are too few employees to cover the branches and call center effectively. Member service can also suffer from poor or inconsistent staff training. A CEO has to think carefully before making these cuts. The wrong cuts might cause dissatisfied members to go elsewhere for their financial services. If they do leave the credit union the impact may not be known for many months in the future thereby possibly necessitating another round of cost cutting. The CEO should also think about the opportunities that might be lost because new ideas were missed. What if competitors adopt strategic improvements first and gain market share

This is not a new concern but it is one that must be stressed before cost reduction steps are carried out. One cannot risk being short-sighted and encountering unexpected results. For example, a well-intentioned credit union CEO decided to cut annual operating expenses by ten percent. The credit union was profitable and had substantial net worth. The goal of the cost reduction emphasis was to change the business strategy to that of being a low-cost provider of member services. It was thought that the low-cost strategy would enable the credit union to lower rates on loans below those of their competitors. The CEO thought their members were more concerned with loan rates than service. The CEO's assumption might be true, but it was an assumption. The credit union management team had not surveyed its members. They did not understand their brand or member loyalty. They simply did not know what brought their members back for repeat business. They had overlooked their members' average age and the credit union's inability to attract younger members. Maybe a business strategy other than cost reduction would have better results.

The point is that a credit union's management team should always be focused on ways to improve revenues as its top priority. In the example above, there was no pressing need for cost reduction. It was a change in business strategy. Another alternative might have been to stress member service while developing a robust website with the ability for members, and potential members, to use the Internet to open new account relationships and to apply for loans of all types. A different approach may have served existing older members needs while attracting new younger members. Another strategy might have been to develop new loan programs and to offer more channels for providing loans. Again, the Internet might be a way to serve the preferences of more potential borrowers using a remote banking interface to consumer and mortgage loan decision systems. There are other revenue-enhancing examples that might be explored but each situation will be different.

After exploring ways of enhancing revenues, the recommended approach to cost reduction is to develop cost-reduction strategies. This approach begins with identifying controllable expenses that are out of line. Next is the need to identify management priorities and long-range business strategies that must be preserved as controllable costs are reduced. The best approach is to evaluate the lowest-impact ways for reducing targeted expenses while maintaining, or growing, the programs that will produce future revenues. This is the point in time when the entire senior management team should weigh in. There should be a thorough discussion of long-range plans and priorities. The process should be like a negotiating session with the goals, needs, wants, and preferences of the participants out of the table. At the end of the day, the CEO will have to decide what goes and what stays, but he or she will benefit from a diversity of viewpoints. The negotiation might produce alternatives that were not under consideration before, and it might produce a group consensus about the organization's goals and best approach for what needs to be done. If not, the process will still be a success even if the CEO learns that the management team isn't on the same page. That may mean it's time to reconsider before moving ahead.

What are cost-reduction strategies? This might best be described as a deliberate plan or set of plans to affect the desired results. The key is to fully understand the desired results. The process begins with an analysis of the credit union's operating expenses to determine what is controllable. And, that in turn also depends on the time frame in mind. For example, if one of the culprits is high data-processing expense, the management team must consider if those costs can be addressed in the required time frame. How long will it take to make a system change? What is the outlay that will be required? Will a data processing conversion project lead to increased employee expenses for several months? Will a system change produce the desired results in the necessary time frame?

Alternatively, what if the analysis indicates that payroll expense is too high? Again, the undertaking should consider the time frame required. Does the credit union need to shrink quickly or is there time to reduce staff through attrition? The first approach, a layoff, will have long lasting consequences. The most obvious is the adverse affect on morale. The good employees will conclude, rightly or wrongly, that their future is not too secure and decide it's time to look for other employment opportunities. The credit union might find after several months that the very best employees, the ones needed the most, have gone.

The cost-reduction approach initiated above should also include a comparison of controllable expenses to the credit union's peer groups' expenses. This can be done with information from the NCUA website or through available peer-to-peer comparison models. This comparison is useful but again each situation is unique. For example, a credit union may have higher personnel costs because of its business strategy. It may rely on providing the best member service in the community as its method of gaining member referrals that lead to new members. It would be risky to reduce personnel expenses in this example. The goal in this phase of the analysis process is to those identify costs that appear out of line and understand if there is a valid business reason for the variance. If so, look elsewhere, and make sure that the board and other senior managers know why. It may not be obvious to all that there are some business costs that are justified. Another important factor is to keep a long-term perspective if the situation permits. For example, staff reduction through attrition beats a layoff and costs that can be reduced incrementally over time allow for a change in course if new factors emerge. The CEO who reduced staff quickly learned how hard it is to recruit and train new managers and member support representatives.

So far we have stressed revenue enhancement, and then identifying controllable expenses that are out of line. We have covered the need to identify management priorities and long-range business strategies that must be preserved as controllable costs are reduced. We have agreed that the approach depends on the time frame in mind, and we have promoted the need for the senior management team to negotiate the priorities and tradeoffs. The CEO who listens to his or her subordinate will be less likely to take the wrong course of action. Then the plans of action must be formulated. Each action step should have a desired outcome, and a way to measure the results along the way. If the management team isn't forced into action by a serious profitability problem, it is best to communicate what is being done and why it is being done to the entire staff. Why? They'll hear through the grapevine anyway, and the rumor mill will trigger suspicion and mistrust. Even a staff reduction through attrition can be managed if the employees see the results are consistent with what was announced by senior management.

The other key point to include in each action plan is a description of the desired outcome, and a way to measure the results along the way. The description helps keep things on track and the measurements let the senior management team know if progress is being made. The measurements also provide for mid-course correction if the results are not as expected. It's better to have time to adjust action plans than to face the need to overcome unexpected problems. The CEO who cut staff too quickly might face at least a short-term deterioration of member service if too many new employees need time to learn the credit union's products and services on the job.

What if the credit union has a serious bottom-line problem? It can happen. There are ways to cut expenses quickly but there is a pressing need to understand what caused the problem. For example, if poor loan quality caused an increase in charge-offs that in turn adversely affected income, the fix might not be as simple as a quick reduction in controllable expenses. The fix might require a strategy for reduction of certain expenses and a plan for fixing loan quality. Alternatively, a significant reduction in staff at a credit union's sole sponsor might necessitate another strategy. In all these situations, the best course of action will be a well-thought-out process, not an event. An executive should seek other opinions and possibly an objective outside source for weighing the choices. A carefully designed and implemented strategy, like all thoughtful business planning, will produce the best results.  

Richard L. Sandenaw is managing partner for Strategic Mark LLC, a business consulting firm specializing in credit unions. Contact him at 915-588-9024 or rsandenaw@strategicmark.org.