Are we there yet? Achieving optimal SG&A spend for US companies
As we continue to emerge from the deepest recession since the Great Depression, there’s a general sense that most companies have cut costs as much as possible. Many management teams believe that they have slashed Selling, General and Administrative (SG&A) costs ‘to the bone’ and they are shifting their focus to growth and other pursuits. Yet our analysis shows that US-based companies are actually spending more on SG&A expenses, both in total dollars and as a percent of sales, than they did prior to the downturn.
In most industries, we find wide variation in SG&A spend as a percent of revenue across similar companies – suggesting better performers know something that under performers in the same industry don’t. Further, our analysis shows that companies with higher Gross Margins than others in their industry often spend more on SG&A as a percent of sales than their counterparts, suggesting that companies, in essence, spend on SG&A up to their ability to do so. Despite all of the efforts to trim expenses in past years, we believe most companies still have an opportunity to further optimize their SG&A spend, whether to stimulate growth, become a more efficient company, or both.
In growth companies, SG&A costs have generally scaled up in a linear fashion with growth, suggesting they’ve achieved little real productivity in SG&A spend. That said, leading growth companies are able to leverage their SG&A scale and grow that cost at a fraction of the rate of top line growth. Companies in more mature industries, by contrast, have little choice but to continue focusing on reducing costs to survive—driving costs out of SG&A for them may, in many cases, require new business models, differentiated service levels and expectations, and a relentless focus on execution. In general, especially as the economy continues its sluggish recovery, executives must continue to focus on better SG&A productivity.
LOSING FOCUS ON EFFICIENCY?
Companies now spend more on SG&A than ever before. We analyzed the SG&A spend of 1,900+ public and private companies based in the U.S. generating annual revenues of over $500 million. Collectively, these companies span more than 75 industries and had revenues in 2010 of $11.6 trillion. SG&A spend for this group of companies increased from just under $1.5 trillion in 2006 to an all-time peak of around $1.8 trillion last year ($1.65+ trillion adjusted for inflation), while sales increased from $10.1 trillion to $11.6 trillion over the same time-frame ($10.6+ trillion adjusted for inflation). SG&A as a percent of sales over that time period increased by more than half of a percentage point in absolute terms—from 14.6% to 15.2%.
Over half (56%) of the companies in our research saw an increase in SG&A as a percent of sales from 2006-2010. Had this group of companies been able to maintain their 2006 proportion of SG&A spend to revenue, they could have saved over $145 billion, thereby increasing operating income by 10% (figure 1). Had these companies been able to maintain SG&A spend at the leanest annual level realized in 2008, they could have saved $238 billion— a whopping 17% increase in operating income.
Second, we find SG&A expenses vary considerably by industry due in part to general industry conventions. In some industries, such as automotive and aerospace, SG&A generally encompasses only sales and overhead functions; in others, such as retail, it can include in-store personnel. Analyzing SG&A spending by and within a given industry group reveals significant variation within most industry groups—greater than a 2x difference between the 25th and 75th percentile within a specific industry across a majority of the industry sectors analyzed (figure 2). Moving companies with a higher than- median spend level to their current industry mid-point would equate to a $291 billion reduction in SG&A, leading to a 21% increase in operating income.
Finally, companies with higher Gross Margins tend to spend more on SG&A than their counterparts in similar industries. While some SG&A expense does drive gross-margin improvement (e.g. through brand-building or infrastructure improvements), many companies are likely over-spending on SG&A. From our analysis, it appears that companies with more operating ‘degrees of freedom’ tend to spend more than companies with leaner margins in the same industry. If companies with relatively high SG&A spend were to move to industry average spend levels, that would lead to an SG&A savings of $177 billion. Dramatically greater opportunity could be realized from matching industry ‘best practice’ levels of efficiency (figure 3: dashed line level of performance for each industry would equate to well over $300 billion).
HOW TO OPTIMIZE SG&A
It’s not uncommon for management to think, “We’ve already cut SG&A as much as possible,” or “It’s difficult to realize lasting improvements in SG&A.” However, companies with stubborn SG&A spend levels can still reduce costs by 10-25% more, much faster and more durably than they realize.
SG&A reduction efforts often stumble for specific reasons, including:
- Insufficient leadership and/or senior management engagement
- Over-reliance on top-down (e.g. across the board target) or bottom-up (e.g. exhaustive, inflexible process) approaches
- Limited use of process-specific, value-based metrics
- Inability to overcome internal inertia and/or politics
- Inadequate management of the overall change program
- Inability to strike the right balance between ambition and follow through
Achieving the optimal level of SG&A is unquestionably a challenging task. Doing so requires a candid analysis of the business, willingness to push through difficult trade-offs to get to decisions and overcoming the biases of numerous, and sponsorship of senior stakeholders.
There are three primary steps that must be taken to achieve more optimal SG&A productivity:
1. Align Overhead Spend with Strategy/Future Demand
- Incorporate frank assessments of future demand and margins by business sector; assess scenarios and likely probabilities
- Evaluate the strategic alignment of SG&A spend components with future business objectives and expectations; make strategic shifts in SG&A spend
- Set overall objectives for optimal SG&A and demonstrate full leadership support
2. Assess Overhead Value Creation
- Assess SG&A activities along a spectrum of mandated to discretionary functions
- Determine what’s valued by business segments (customers of SG&A) and what they’re willing to pay for
- Utilize a range of analytical approaches to assess cost or efficiency of specific functions
- Deploy a proven framework that designs improvement levers (eliminate, automate, consolidate, invest, business model redesign, etc.) by function
- Quantify the value (benefit and cost) of various functions/improvement actions using process specific analytics
3.Use a Proven Approach to Identify and Implement Improvements
- Utilize a “fair” approach that deploys the same process across all functions (no “sacred cows”)
- Have a clear and explicit decision-making process to approve actions and make trade-offs
- Drive an aggressive but attainable set of expectations (timing, results) that rewards progress, makes lasting improvements and manages workload
- Use a focused program management process that deploys a systematic process to define specific targets and milestone, measures progress over time and address issues
Broadly speaking, companies with relatively high SG&A often have an opportunity to reduce costs by 10-25% through a series of actions that can be implemented in 12-18 months. Alternatively, growth companies can often realize single-digit revenue growth with little to no increase in SG&A spend, and/or double-digit growth with fractional increases in SG&A. Opportunities come from a myriad of business model, organizational and expense opportunities unique to each individual company’s situation.
SG&A cost management continues to be a persistent challenge for healthy companies and a business imperative for challenged companies. Companies in most industries face an increasingly competitive global economy, new entrants based in low-cost countries, and uncertain economic times—it is imperative that forward-looking companies revisit the value and efficiency of their SG&A spend through a systematic, value-driven approach.