Corporate cost-cuts: early gains soon turn to pain?

CHICAGO – Much of Corporate America has slashed costs to stay in the black during the recession, but welding the knife too heavily could also remove the ability to grow in a recovery.

‘If you cut into flesh long enough, eventually you find bone,’ said David Rosenberg, chief economist at Gluskin Sheff in Toronto. ‘Cost cutting is not a bottomless pit.’Firing people, introducing hiring freezes, halting investments, trimming budgets or even skimping on office supplies are time-tested ways to prove the old adage that a penny saved is a penny earned.A slew of companies reported better-than-expected first-quarter results because aggressive budget slashing more than made up for falling sales. According to Rosenberg, 40 per cent of companies missed their top line expectations in the first quarter.And as the bulk of results for the most recent quarter hits in the next two weeks, many US companies are expected to do the same again. Some already have.Perhaps the biggest example so far has been General Electric Co, which managed on Friday to report earnings that whizzed past expectations despite a drop in revenue that was more dramatic than Wall Street had predicted. The major reasons: cost cutting and a dip in its tax rate.Mind you, investors can be smart to the numbers game. They question the quality and sustainability of such results – and despite the earnings beat GE’s shares dropped more than five per cent on Friday.Another example was Yum Brands Inc, parent of the Taco Bell, Pizza Hut and KFC chains, which last Tuesday also surpassed earnings forecasts but was light on the revenue side. A cut in its full-year sales forecast triggered a decline of about eight per cent in its share price over the rest of the week.Mattel Inc posted a bigger-than-expected 82 per cent jump in quarterly profit as cost cuts offset a sales decline that was also much steeper than forecast. But the market was heartened by the toymaker’s ability to control costs, and its shares rose seven per cent.’So far the earnings season is good, but if you were to call it revenue season, it’d be more of a mixed bag,’ said Peter Boockvar, an equity strategist at Miller Tabak & Co in New York. ‘What this shows is that companies are able to deal with cost structure, but that the revenue is light shows that we’re still in a difficult economic environment.’Although cutting costs can help a company hunker down for the downturn, academics and economists warn in the long term cutting too deeply can hamper its ability to compete and grow.’If you cut too much then you will be very poorly positioned when the recovery comes,’ said Russell Walker, a risk management professor at the Kellogg School of Management.Others, however, warn additional cuts are needed to match the fact Americans are saving more and have less access to credit.EMPTY PIPELINETiming is everything in the cost-cutting game because it can only make up for a recession for so long. The quicker recovery comes, the fewer cuts.Evidence on whether we have hit the bottom is mixed.The pace of job losses has eased, but nearly a half million Americans joined the ranks of the unemployed in June. The decline in US house prices has slowed, but property values are still falling. Same-store sales fell 4,9 per cent in June.Durable goods orders in May, however, were up 1,8 per cent, though it was unclear thus far whether that meant demand was really coming back or if companies faced with empty shelves were starting to rebuild inventory.If we are not at the bottom, then eventually slashing costs will no longer be able to help companies beat expectations.’There is no evidence that you can maintain profit recovery on cost-cutting alone,’ Rosenberg said.He added that when multiple sectors cut costs, it creates a snowball effect that in turn hurts everyone.’It’s one thing when one or two sectors are cutting costs,’ he said. ‘But when it happens in every sector, this ends up eating into aggregate demand.’Not all companies, however, are cutting costs. Walker said, for example, Southwest Airlines Co – which has not pulled back to the same degree as some of its rivals – should have an advantage as the economy recovers.’When you cut costs and a competitor isn’t, you’re ceding market share,’ he said. ‘When you abandon competitive ground on the battlefield, it’s very hard to get it back.’Fariborz Ghadar, a finance professor at Penn State’s Smeal College of Business, said there were numerous long-term pitfalls to cost cutting.Hiring freezes can lead to a dearth of middle managers – not a problem in the short term, but more so a decade down the line when top executive jobs need to be filled from those middle ranks – and reducing spending on research and development while competitors in other countries expand can undermine a company’s ability to prosper and win market share, he said.’From the perspective of human resources, research and development and products, you may be faced with a pipeline that all of a sudden is empty,’ Ghadar added. ‘Then when recovery comes you will have to pay a premium to hire the right people and you will likely have lost the loyalty of your team.’But Peter Schiff, president of brokerage Euro Pacific Capital, said more cost cutting is needed to match America’s new economic reality.’We have excess capacity in a lot of sectors that needs to be taken out,’ said Schiff, who predicted as early as 2006 the financial market meltdown and the current recession. ‘Companies are going to have to stay in business with a lower level of business.’Some companies are reluctant to make capacity cuts because they assume there will be a recovery,’ he added. ‘But a lot of people don’t realise this is not a temporary recession. This is a permanent condition.’-Nampa-Reuters