The big squeeze on margins

As the economy cools, most companies face a slowing growth rate in their revenues while at the same time inflation continues to increase the cost of inputs. We see six factors contributing to downward pressure on revenue growth and upward pressure on costs. These are highlighted in the figure and virtually all industries are susceptible to these factors.

Individually, companies cannot control macroeconomic factors or monetary policy, but they can optimize costs. We see 2023 as the year of cost reduction. While the 2023 data for tech and IT spending is not available, initial surveys indicate a reduction in IT spending as a percentage of revenue. This has increased the importance of cost control measures for CIOs and other technology leaders. They need to act immediately to release margin pressures.

So, what should CIOs do?

Technology’s portion of the total cost has been growing across most industries. Given this trend, CIOs can expect to be asked to contribute to overall cost-reduction programs. We have been here before and believe that a disciplined and thoughtful efficiency program is needed by many CIOs to become leaner and more focused on driving business value.

To this end, we see two major sets of actions, outlined below.

1. Immediately manage costs

• Third-party spend makes up a significant portion of costs and can deliver immediate cost reduction. Conduct a rapid review of all third-party costs across labor, software, infrastructure, and so on, and identify cost-reduction measures. We see programs yielding more than 25 percent reduction with a significant contribution to in-year savings if initiated in Q1.
• Take a hard look at discretionary spending. Leaders need to review and identify what is truly non-discretionary. All requests that fall into the discretionary pool need to be evaluated on a zero base. Ensure strong governance for every dollar being spent.

2. Prepare for future growth

• Evaluate what capabilities are needed in-house versus those that need to be outsourced. Rebalance the workforce to focus on capabilities that drive business, and outsource non-differentiating activities.
• The capability assessment will create a burning platform to review the delivery mix (onshore/nearshore). Target second- and third-tier locations in the US and nearshore locations such as Mexico and Costa Rica to retain in-house talent to prepare the company for future growth.

So, what now?

Act fast, and act decisively to take an action now. Technology is a key cost driver, and leaders need to take swift action to secure significant cost reductions in 2023.

This is not the first recession that many of us have dealt with and most likely will not be the last. What leaders need is a partner who understands trade-offs in a cost-reduction exercise and can help them navigate it successfully.

Answered by

Waqas Khan

Partner

Craig Kane

Partner

Aykut Duman

Principal

Parth Shah

Consultant