Two Steps Forward, One Step Back

The fifth annual SG&A survey.

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With some notable exceptions, SG&A costs rose this year. a SLIGHT ADJUSTMENT to Calvin Coolidge’s famous dictum brings the 30th U.S. President right up to date: Nowadays, the business of America is efficient business. Companies that live up to this message practice it constantly, and nowhere with more rigor than in the realm of selling, general, and administrative (SG&A) expenses.

Companies with the lowest SG&A in their respective industries usually credit success to tighter control over a familiar list of cost drivers, from outside consultants to office supplies to travel and entertainment expenses. “None of these would lead to tremendous improvement in and of itself, but the total effect is great,” says Greg Maffei, CFO of Microsoft Corp., which chopped 1.2 percent from SG&A, according to CFO’s 1998 SG&A Survey. With sales of $11.4 billion, restraining SG&A by just modest amounts redirects hefty cash flow to research and development projects or to the bottom line. In Microsoft’s case, lowering SG&A by 120 basis points represents $137 million better applied to R&D.

“If you have too high an SG&A, you actually clog the system,” warns Xerox Corp. CFO Barry Romeril. “This probably means you’ve got too many people making work for other people who make work for other people. I’ve seen that time and time again.” Xerox recently earned kudos from Wall Street for head-count reductions, and process improvements should lower its SG&A for 1998.

Still, Xerox must go further, Romeril concedes, in order to remain the world’s leading provider of digital document processing equipment. Because digital technology is driven largely by descending cost curves in the electronics industry, profit margins shrink steadily unless costs shrink also. “We’ve got gross margin pressures all the time,” says Romeril. “Unless we adjust the SG&A, the operating margin is going to change.” In an increasingly digital world, where everyday products from electric razors to automobiles employ electronic technology, efficiency is paramount. Even where technology is not a factor, stripping mere basis points from SG&A bestows competitive advantage.

This year’s survey, our fifth annual assessment, highlights progress in the battle to control SG&A. Across the board, which spans 42 industries and 1,100 companies with sales exceeding $500 million, the current survey shows a marked upturn in average SG&A as a percentage of sales through year-end 1997.

At the same time, more than half of the industries reviewed managed to reduce average SG&A during the three years from year-end 1994 to year-end 1997. (As in past surveys, four sets of year-end results determine average SG&A. This tends to smooth out distortions stemming from single events, such as mergers or divestitures.) In particular, a robust list of lean companies have continued to cut SG&A the old-fashioned way, by minding the myriad details.

Average SG&A climbed to 18.3 percent of sales, according to the survey, prepared, as in previous years, with Arthur Andersen LLP, using data supplied by Standard & Poor’s Compustat. This reflects a 200-basis-point increase during the past two years, reversing a two-year downward trend since our first survey in December 1994.

At that point, average SG&A for the current list of companies was 18.5 percent. A year later, the average was 18.2 percent. When CFO examined SG&A in December 1996, these companies had slashed average SG&A as a percentage of sales to 18.1 percent, threatening to sneak into the 17 percent range in 1997. Instead, cost-cutting suffered a slight setback as collective SG&A as a percentage of sales inched back up to 18.2 percent.

The 20-basis-point difference from year-end 1995 to 1997, based on total sales of $4.4 trillion at year-end 1997, meant that companies entered calendar 1998 carting an extra $8.8 billion in corporate overhead.

But industry by industry, the 1998 survey displays more hopeful signs. Although SG&A increases by 18 industries tipped the scales the wrong way, 24 industry groups managed to reduce it. To be sure, the most dramatic reductions were slight, ranging from 3.4 percent by the computer and office-equipment business to a slim 0.1 percent by the food and drug industry as well as the entertainment business. The median improvement, for industries that shed SG&A, was 1.7 percent.

In a climate governed in some cases by business cycles and in others by interest rates and the strength of the U.S. dollar, merely cutting SG&A may not mean much. More worthy of praise are the companies that cut SG&A in fast-growing industries. Without waving the tattered banner of reengineering, these companies have internalized its principal lessons, practice them routinely, and compensate managers accordingly.

Maxxim Medical

Maxxim Medical Inc., a $530 million manufacturer and distributor of equipment used in hospital operating rooms, bucked trends. An average company in Maxxim’s industry category diverted 31.5 percent of sales to SG&A expenses in 1997. The Clearwater, Florida- based company walloped the competition on two counts. Besides posting the industry’s lowest three-year average SG&A-to-sales ratio (19.7 percent) as well as the lowest ratio in 1997 alone (17 percent), Maxxim chopped SG&A as a percentage of sales over three years by a whopping 8.2 percent. Its peers, meanwhile, increased the average by 1.5 percent.

One company in Maxxim’s peer category, Steris Corp., cut SG&A even more. But even after Steris lowered SG&A by a heroic 18.4 percent as a percentage of sales over three years, SG&A still represented more than one quarter of its sales in 1997–worse than 11 companies with similar businesses.

After Maxxim, the next best cost warrior in its peer group, Tektronix Inc., managed to trim 1997 SG&A to a hefty 34.5 percent of sales–good enough for 18th place.

Packaging sterilized tool trays used in operating procedures generates thin operating margins, usually in the vicinity of 20 percent, observes Maxxim CFO Alan Blazei. Keeping competitive and profitable leaves no room for bloated costs. “We have low margins, so we have to run on low SG&A,” he adds.

Since 1989, when Blazei assumed the CFO’s post at a company with 50 employees, sales have increased 35-fold, to $530 million, while employee head count has burgeoned to more than 4,000. Instead of allowing such rapid growth to lift the pressure on cost controls, Maxxim has redoubled efforts to preserve its fragile operating margin.

“The people I need to keep accountable [make up] a small group,” he observes. This keeps a tight lid on every check, for example. “We still write every check from corporate headquarters,” Blazei observes. No matter how small, checks get approved by one of six top officers at the company. Checks for more than $5,000 must pass muster twice, first with an officer who approves the check and later with another officer who signs it by hand. “It’s a second kick at the can,” says Blazei.

Effective control of SG&A demands unflagging attention to detail. Dues and subscriptions get cautious scrutiny, as do office supplies. “These aren’t the biggest piece of SG&A,” Blazei concedes, “but they help establish the culture by challenging costs.” Operating as a single legal entity in the U.S. streamlines tax processing and garners additional savings for Maxxim. Compliance savings alone run to several hundred thousand dollars.

The gospel of trim SG&A has played out dramatically for Maxxim following each of 17 acquisitions during the past 10 years. “We go in and basically take purse-strings control on day one,” Blazei says. “They do not write another check once the deal is closed. In 30 days the financial systems are merged; in 90 days we replace their operating system or interface it with ours.”

Lone Star Technologies

Few companies matched Maxxim’s achievements. Only six recorded lowest four-year average SG&A in their industries and also cut SG&A more than the next four companies with the lowest SG&A. This list includes beer brewer Anheuser-Busch; Smart Modular Technologies, a designer and manufacturer of computer-memory modules and cards; hotel operator La Quinta Inns; and Volt Information Sciences, which provides temporary computer and technical help. Two more companies on this list, Lone Star Technologies Inc. and Ensco International Inc., both in Dallas, chalked up an even more impressive feat. Besides ranking No. 1 in their respective industries for lowest SG&A-to- sales while cutting SG&A impressively, they simultaneously reduced their levels of cost of goods sold (COGS) and fattened their operating profit margins. “We make a concerted effort; it’s not serendipitous,” says David Mullin, CFO of Smart Modular Technologies Inc. “We work hard at controlling SG&A.”

A concerted effort to lower SG&A distanced Lone Star from 34 other companies in the metal products industry, where average SG&A-to-sales was 20 percent. Lone Star, in contrast, spent just 3.4 percent of its sales on SG&A averaged over calendar years 1994 through 1997. This three-year period was probably the pinnacle of the company’s efforts to trim SG&A, says CFO Charles Keszler. In 1997 alone, SG&A came to 3 percent of sales, a full percentage point better than No. 2 in the metal products industry, Silgan Holdings, which reduced its SG&A by 40 basis points. Along with winning the battle in SG&A, Lone Star also made progress whittling down its COGS by 520 basis points, to 88 percent of sales, and simultaneously boosting operating margins by 780 basis points.

After tumbling into bankruptcy in 1989 and reemerging in the spring of 1991, Lone Star got religion. “We took a top-to-bottom look” at SG&A and other costs, says CFO Keszler. The company took aim at duplicate staff functions and shrank management to four layers from seven between the top echelon and the shop floor. It put MIS in the hands of an outside provider. But rather than seek a cost reduction right off the bat, Lone Star sought ways to improve its management of SG&A in other areas of its business on a case-by-case basis.

“We don’t adhere to the shared reduction phenomenon,” he says, rejecting across-the- board cuts to achieve a corporate goal. “Investment in certain areas of MIS allowed us not to increase back-office personnel when making a push to increase sales,” he adds.

Lone Star prefers to keep its own counsel on moves that have improved SG&A. “Most we’ve done ourselves,” Keszler observes. “We got the largest SG&A benefit from getting rid of consultants.” Since early 1995, Lone Star’s profit-sharing program has paid quarterly cash dividends based in part on savings from SG&A reductions; each dividend amounts to nearly $500 per worker.

Lone Star exemplifies a trend that any analysis of SG&A uncovers: a high correlation between low SG&A and high levels of COGS. After recent cuts, average COGS at Lone Star was still higher than for any other company in the metal products group. Well aware of the lopsided correlation, Keszler attributes it to the vagaries of his business, which is strongly affected by fluctuating steel prices. “We can improve efficiency, but the cost of the raw materials is beyond our control,” he says. “SG&A is something we can control.”

Ensco International

Rigorous attention to SG&A catapulted Ensco International to best in its class, mining and crude-oil production, for 1998. All top-five companies in this cost-conscious industry slashed SG&A, but none more aggressively than Ensco, which lowered COGS by an even more impressive 18.5 percent of sales, to 37.6 percent of sales in 1997–20 percentage points better than the industry in that year. The oil- services company cut its average SG&A to a very thin 2.4 percent versus 7.6 percent for a typical company in this group.

Lest anyone underestimate the weight Ensco’s management attaches to SG&A, paychecks supply a reminder. “Part of the company’s key- employee incentive program rewards includes a couple different measures of SG&A,” says CFO Cris Gaut.

Besides benchmarking general and administrative components of SG&A against principal competitors as a percentage of revenue, Ensco International performs similar analysis using the percentage of capital employed as the yardstick. “We are in a cyclical business, and we want to run a lean operation,” Gaut explains. “In good times, we maximize margins and profitability; in lean times, we preserve our staying power.”

USG

Maintaining a lid on SG&A and COGS warrants concerted efforts at Chicago-based USG Corp., where beating annual SG&A targets boosts compensation for key employees. “We measure spending against the target,” says CFO Rick Fleming. “If we’re above that target, I get a smaller bonus.”

Meeting strategic goals governs 40 percent of the annual bonus that senior managers collect, and lowering costs warrants a top priority along with boosting the top line and minimizing cost of capital. Attention to costs took 90 basis points out of SG&A and 230 basis points out of COGS, according to the 1998 survey. These efforts lowered average SG&A to 10.2 percent of sales, fifth place in that category, and average COGS to 71.9 percent of sales, a less-impressive tie for ninth place out of 14 companies.

Nevertheless, solid cost controls and strong revenue growth helped lift operating margins by 730 basis points, worth roughly $210 million using 1997 sales of $2.9 billion–a hefty boost to the bottom line.

“The trick in this business is to be at the front of the cost curve,” explains Fleming. USG does this in several ways, not least by restraining head count during periods of growth. In 1994, when the company recorded $2.3 billion in sales, it counted 12,300 workers, of whom just 168 were corporate staff. Sales are expected to top $3 billion in 1998, a 30 percent increase, but the workforce has increased by less than 6 percent.

“Staff at the trough and outsource at peaks,” declares Fleming. When there is a case for increasing SG&A, chop SG&A somewhere else to provide the cash. Transforming old technologies to new ones doubles efficiencies on the COGS front. Savings in SG&A are harder to find.

Computer Associates

Overall figures notwithstanding, victories on the SG&A front seem to increase steadily in number. Computer Associates Inc. lopped 1,030 basis points from average SG&A in the current survey, topping the list of 205 industry leaders. For good measure, the Islandia, New York­based supplier of software for large businesses also slashed COGS by 1,230 basis points. Such cuts explain much of the 1,110- basis-point boost seen in Computer Associates’s operating margin.

Senior vice president of investor relations Doug Robinson, who was CFO of Cullinet Software before it was swallowed by Computer Associates, credits improvement to multiple initiatives. Not least, a satellite launch of a new series of systems products, the IT Series, reduced marketing costs by several million dollars, which a conventional, face-to- face global rollout requires.

At Microsoft, CFO Maffei concedes that seren- dipity plays a part in the battle against SG&A. “We are blessed with an environment in which IT is a good business to be in,” he says. The progression from floppy disks to CD- ROMs, wider acceptance of online manuals, and increased licensing of software technology that eliminates piece-by-piece distribution to large corporate customers have added an edge.

But vigilance remains essential. It’s no accident that Microsoft has lowered the cost of providing customer support to less than 4 percent of sales from 6 percent–a difference worth more than $200 million a year. This has been accomplished through technology and by outsourcing about half the customer-support volume, mainly for low-end desktop products. “We’ve attacked costs in a lot of ways,” says Maffei. And Microsoft does not win at every turn. Home runs are scarce; patient attention to detail decides the outcome. Says Maffei: “None of it happens in a minute.”

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