REQUIRED READING: After growing to record sizes before the financial crisis and adding further operational cost as a result of the need to respond to an increased regulatory burden in its aftermath, many mortgage banks are now contemplating action to address their cost bases. The pressure to maintain and even grow profitability is an increasing focus as banks strive to outperform their competitors while grappling with unprecedented challenges – regulatory reform, shifts in consumer behavior, deterioration in the housing market and an end to the recent refinancing boom.
In particular, the current regulatory environment will make it more challenging for banks to increase revenues and maintain margins. As a result, many mortgage banking executives have been spending time thinking about costs. Even organizations that are considered relatively well positioned are reducing expenses to make sure that they are fit for the future and ready to capitalize on the ‘new normal’ once it emerges.
The pressure to cut costs – whether driven by cashflow, uncertainty, the requirement to invest in emerging opportunities or the need to grow long-term margins and profits – is extraordinary. Technology is opening up new channels and paving the way for new and different customer experiences, but the investment to bring these opportunities to fruition needs to come from somewhere.Â
While an invasive ‘slash and burn’ approach may sound like the best approach to get critical results fast and limit political infighting, it often ends up being  divisive and can only be achieved by a CEO with a strong mandate. As such, it is more often than not a mistake – one that will leave the company weaker, not just smaller. There is, however, a positive side to the current situation – when dealt with strategically, the need for dramatic cost cutting provides the chance to really transform a business model and strategy.
By treating cost as a strategic issue, mortgage bankers have the opportunity to help their organization grow stronger and become more focused. It sounds like a tall order, especially if the clock is ticking. However, by focusing on putting in place four critical elements of strategic cost reduction – a strong foundation, breathing space, a system wide view and a cost-conscious culture – organizations can radically improve their chances of delivering sustainable cost reductions that satisfies short-term necessities while enhancing future potential.
Start with a strong foundation
The most successful and dramatic cost reductions aren't those that are simply kicked off as a result of some challenging financial analyses. These cost reductions occurred when there was a collective belief across the executive group that it had to truly transform, or the consequences would be unpalatable.
At the start, the executive group and the board needs to find time to look at the business from a higher level. They should start by taking the attitude that cost itself is the outcome of the choices organizations make about where to invest. The best way to think about cost, regardless of whether or not the organization is under immediate cost pressure, is to clearly articulate the strategy and the capabilities that support it and use this as the basis for driving decision-making during the cost program.
In effect, the cost program then becomes a matter of deciding which capabilities to invest in and at what level, with a preference for investment in those that will help the organization win in the market place. By thinking about cost in this way the company will be able to deliver transformational cost reductions that represent less risk to the business, minimize the chance of costs creeping back in and position the company to grow more quickly once the industry climate improves.Â
Being clear about strategy and capabilities is not enough to create traction in the program. A credible burning platform for action needs to be built. A climate needs to be developed where the process isn't seen as incremental expense reduction or business as usual – it must create a clear imperative for change and a cost-reduction story that highlights the necessity for action.
It is important that the executive group speak with one voice on both the approach and the size and scale of the challenge. Effort needs to be invested by the CEO and executive group to develop a collective agreement. Individuals all move at different paces in terms of their buy-in to the cost reduction strategy and objective, and this should be reflected in a plan for building commitment across the team. This strategy should be revisited regularly – commitment is a continuous process that is subject to ebbs and flows and those fully committed at the beginning may drift as tough decisions are required during implementation.
Once the overall strategy and burning platform have been established this needs to be translated into a framework that ensures that there is no ambiguity about ‘what’ costs will be addressed and how. Together, the executive team should come up with an overall goal for performance that will define the end-state environment.
This should include top-line performance goals, growth expectations, savings expectations, levels of investment, and the bottom-line cost reductions that the company will need to accomplish everything. These higher-level objectives, for which the leadership team is collectively responsible , need to be broken down into specific objectives owned by individuals who are accountable for delivery.
However, there must be a point of leadership to drive delivery of the overall objective – someone who is responsible for ensuring that targets are not diluted as a the result of the first direct skirmishes with the cost base. This should be a respected member of the executive team – not necessarily the CEO or chief financial officer – and somebody who has the time, tenacity and visibility to make things happen. Part of this role should be to ensure that rather than being seen as self serving, the cost program is viewed as supporting accountable target owners in each area of the business in the delivery of the changes required to help them meet the target. Getting this balance right will be critical to future dynamics, particularly when things get tough.
The executive team will set the process in motion, but it will deputize a group of executives and managers to oversee and manage the cost-cutting process. During implementation, all the people and teams involved need clear and simple guidance to ensure that there is no ambiguity about what costs will be addressed and how they will be tackled.
In practice, this is best achieved through the development of a clear set of principles and boundaries that will guide the program on a day-to-day basis. Without this framework, it is difficult, if not impossible, to ensure that the judgments and decisions made during implementation are consistently in line with the agreed strategic intent.
The final element in building a solid foundation for the cost management is the development of an objective and living baseline of cost related information that will support and enable transparency in decision making throughout the life of the project. Creating and managing against this living baseline is the principal tool in cost management.
The reason for creating an accurate baseline is to help each business unit and functional area to describe and justify its cost landscape and how it changes over time. Only by developing an understanding of cost can one start to sow the seeds of a more sustainable approach to cost management.
Create breathing space
A key determinant of success is the ability to create the belief across the organization that goals can actually be delivered in practice. To catalyze belief early on, it is crucial to engineer some early successes through the implementation of quick-win opportunities. These might include vacancy elimination, an increase the governance process to sign off any recruitment, a review of subcontract spend, procurement efficiencies and the elimination of under spent budgets.
These quick wins, which in general can be implemented with limited organizational effort, create breathing space in the program. Without early runs on the board, a sense of panic can set into the program that can result in pressure to introduce arbitrary cost-cutting to get back on track. The can ultimately cause long-term damage to the organization.
Consider opportunities
The current situation in the mortgage market is challenging, complex and changing, but there is real positive side to the situation. The requirement for dramatic cost reduction, which is defined as part of a platform for change, provides an opportunity to be clear that significant and sustainable cost reduction requires fundamental choices around strategic objectives and the business model. This not just about cost-cutting – this is about making decisions that something is no longer as strategically relevant and that other things are essential to keep or invest in.
Successful organizations use the burning platform for cost reduction to make explicit choices for transforming the organization. There is a need to clearly articulate the strategy and the capabilities that support it at the start of the program and use this as the basis for driving decision-making. In practice, this will mean developing an assessment and prioritization framework that reflect the strategic priorities of the organization and that are linked to an overall roadmap for change.
This needs to be in place to assess the stream of opportunities that will emerge. You can never have enough opportunities, because some of the initial-cost saving initiatives may fail to materialize or under deliver. To ensure focus on targeted goals and to avoid a narrow focus on across-the-board cost reductions, it is best to adopt a broad-based search for opportunities.
A combined top-down and bottom-up approach to opportunity identification will help ensure that no stone is left unturned. This should be supported by an analysis of vertical accountabilities in business unit and functional areas like origination and servicing, as well as in central functions. Themes like procurement, estates, organization design and technology rationalization should also be considered – this will ensure that broader cross-organization opportunities are not missed.
Looking at cost using this multi-lens approach will increase the scale of potential benefits and provide an exhaustive view of all the opportunities. Ensuring that the assessment, selection and prioritization of these opportunities are linked back to strategic priorities will result in an accelerated definition of and movement to a transformed future organization.
Embed a cost conscious culture
Many organizations will be feeling a sense of déjà -vu when they approach cost. It's not unusual to hear executives saying, ‘Didn't we take these costs out two years ago?’ There's a good reason for why this happens. It is normally the result of a failure to focus on three key factors that support a cost conscious culture – clear direction, tight business management and focus on behavioral change.
Direction and clear communication from the start is paramount. Consistency in this communication will also be important – the wider business must see that cost performance is a collective issue and priority of the entire executive team to ensure that it starts to permeate the bedrock of the organization. Consistency between the messages that executives give and their own practices is also important.
Failure to walk the talk will result in an inconsistent message that can be seen as hypocritical and can cause serious cultural and even PR-related issues. It is difficult to justify expensive limousine transport back and forth to the airport when the company Christmas party was abrputly canceled. In addition symbolic changes taken by executives help develop peer pressure – when employees see their CEO traveling in economy class, it is extremely difficult to justify a more expensive option.
Communication of cost priorities and issues is sufficient but not enough to ensure that cost becomes an area of day-to-day focus for everyone. Success will be influenced by the degree to which strategic cost goals in the short term, and continuous improvement targets in the long term, can be made explicit at executive, business unit and functional levels. These should not just be one-off targets but an integral part of the organization's objectives on a yearly basis.
Tighter business management is also important and is normally the result of a focus on three principles. To ensure that the costs do not start to creep in again, you need to continue to evaluate costs from a strategic perspective as a regular part of the business planning and review cycle. Even as the good times start coming back in and there's less pressure on operations, it is important to create a sense of urgency that cost is still an important issue to address.
Regular and challenging reviews of how the organization is investing its resources will help identify things that no longer fit with business objectives and that represent further cost-improvement opportunities. The bottom line is that you need to be thinking about how cost relates to your strategy and what sets you apart on a day-to-day basis.Â
The second area that will help tighten the system is to incorporate the benefits achieved into the budget. Often we see organization's defining next year's budget based on this year's financial result. While this may move the overall cost curve in the right direction, it ignores the full impact of initiatives delivered later in the year and may be distorted by one-offs. Focusing budgeting on the underlying costs going into next year is a better indicator of what will be.
Also, unless there is a feeling amongst cost managers that there will be meaningful consequences for failure to comply with and deliver on cost-management disciplines and objectives, there will be little incentive for them to make it a priority – especially in the early days of the development. To make it clear that things are going to be different going forward, there needs to be meaningful and escalating measures for failure to comply with cost management disciplines and practices.
Behavioral change is the final component in the cost-conscious culture and the factor that has the greatest impact on the development of cost awareness as a strategic asset. In the cost-conscious organization, managers need to have absolute clarity about their responsibility for cost control. For many, this will represent a significant change in focus and will require them to develop new skills that take them outside their comfort zone.
It is important to address the skill-development requirements that will support them in the delivery of ongoing reductions and continuous improvement. Any skill-development program should also recognize that it is not just about cost. It should be about developing managers and staff to understand the value – as well as the cost of what they do.Â
To fully square the circle and align strategic cost objectives with behavior on the ground, companies need to link these objectives with performance management. Managers and staff must see a positive link between good cost-management performance and their own performance appraisal and believe that doing well in this area will improve their career prospects.
Striking the right balance across the four core elements of cost management is the key to success, and each organization will have a different emphasis, depending upon its circumstances and challenges. Approaching cost in this way and focusing on realigning your organization for the future will provide the platform for delivering long-term cost performance, improving employee engagement and realizing tangible results
Richard Altham is managing director in PwC's consumer finance group, and he can be reached at richard.d.altham@us.pwc.com. Nathan Parry and Nick Tilston are senior managers in the same group, and they can be reached at nathan.e.parry@us.pwc.com and nicholas.p.tilston@us.pwc.com.
