Friday, July 30, 2010

Pfizer Negotiates Lease Termination in Pennsylvania


MS Health Incorporated (IMS Health) has signed a lease totaling approximately 150,000 square feet at Highview I and Highview II at Providence Corporate Center in Collegeville, Pennsylvania.Highview I and II were developed by BPG in 2002 as a 100 percent build-to-suit lease agreement with Wyeth Pharmaceuticals, which now operates as Pfizer. In 2009, Pfizer chose to exercise its year end 2010 termination option for the lease at Highview II thereby making the space available for re-lease to IMS. Additionally, Pfizer chose to negotiate a termination of its lease at Highview I which ran through 2013 in order to vacate the space and accommodate the expanded transaction for IMS.

IMS Health is a provider of market intelligence to the pharmaceutical and healthcare industries, offering product and portfolio management capabilities; commercial effectiveness innovations; managed care and consumer health offerings; and consulting and services solutions that improve productivity and the delivery of quality healthcare worldwide.

The surrounding area has experienced population and business growth within the past ten years and offers access to highways and commercial centers. Currently, at the interchange, more than four million square feet of office and lab space is occupied by such leading companies as Pfizer, GlaxoSmithKline and Quest Diagnostics.

CFO Best Practice Sponsor:

Cambridge Consulting Group was formed more than 10 years ago to help large organizations reduce their  costs by eliminating their leasing obligations for excess commercial real estate space. Founded by Dave Worrell, a former Corporate/Facility Director, Cambridge Consulting Group offers companies a better option than subleasing office space they no longer need or use. Using a newer financial strategy- Negotiated Lease Buyouts, Cambridge Consulting has saved Fortune 500 companies millions of dollars in commercial lease obligations. For more information please visit their website- www.ccgiweb.com  

Friday, July 16, 2010

Blue Cross Blue Shield May Reduce Real Estate to Save Costs

As reported in News Observer
By David Bracken

Blue Cross and Blue Shield of North Carolina's decision to review its real estate portfolio as it looks to slash expenses is part of a worrisome trend for the local real estate market. Like GlaxoSmithKline, Blue Cross is one of the larger and more stable employers in the Triangle, and one that wasn't expected to be a major contributor to the region's rising vacancy rate.

Blue Cross owns roughly 825,000 square feet of office space in Durham and Chapel Hill. The majority of that space is at the company's 40-acre campus along U.S. 15-501 in Chapel Hill and its customer service center and campus buildings on University Drive.The company also leases about 70,000 square feet in Durham's University Tower.

Although it's too early to tell how much of that space might become expendable, the results of a similar exercise undertaken by GSK are not reassuring.GSK is vacating six Triangle buildings it owns and also leaving nearly 90,000 square feet of leased office space in downtown Durham's American Tobacco complex.

The moves by GSK and Blue Cross are reminders of how the fragility of an economic recovery based largely on corporate cost-cutting is delaying improvement in the real estate market.

CFO Best Practice Sponsor: Cambridge Consulting Group was formed more than 10 years ago to help large organizations reduce their  costs by eliminating their leasing obligations for excess commercial real estate space. Founded by Dave Worrell, a former Corporate/Facility Director, Cambridge Consulting Group offers companies a better option than subleasing office space they no longer need or use. Using a newer financial strategy- Negotiated Lease Buyouts, Cambridge Consulting has saved Fortune 500 companies millions of dollars in commercial lease obligations. For more information please visit their website- www.ccgiweb.com  


Still in Survival Mode

"Every good business person knows that you can't save your way to prosperity," Highwoods Properties CEO Ed Fritsch said. "These are hopefully temporary measures until the economy gets back on its feet ... ."

The Triangle office vacancy rate was 18.3 percent in the first quarter, according to Karnes Research, a Raleigh firm that tracks commercial real estate trends. That's the highest it's been in more than a decade and nearly three percentage points higher than it was in the first quarter of 2009.

While there are local companies that are expanding to meet their own increased demand, iContact and Cree to name two, the majority of businesses continue to be in survival mode.Much of the activity in the market during the first half of the year involved companies searching for ways to reduce real estate expenses, said Rich Harris, managing director at Synergy Commercial Advisors in Durham.

"That's what a lot of brokers have been doing, sitting in meetings where the likelihood that you're going to achieve anything is pretty low but everybody needs to go through the process to see whether there's something that can be done," he said.

As large companies that own and lease space, Blue Cross and GSK are among those able to do something about their real estate costs.

Even the bigwigs haggle

Many large companies also negotiate termination clauses into their lease agreements that allow them to exit early for a fee. GSK, for example, took advantage of such a clause to leave its space in American Tobacco in May.

For others it's a matter of seeking relief from their landlord. One option is to try and reduce the rent by agreeing to a lease extension.When Highwoods considers such a request, it looks at the company's long-term prospects."We don't want to necessarily give relief now only for them not to be around to honor the lengthened commitment," Fritsch said. "You expect that most are and you do your homework."

Highwoods is also in a position to offer cash-strapped tenants other concessions, such as making improvements to a space in exchange for a longer commitment.The companies in the toughest position now are those that signed leases shortly before the economic downturn took hold and rents started falling. With too many years left on their leases, they aren't in a position to renegotiate. and can't take advantage of concessions being offered by landlords.

Harris said he sees signs there will be more serious tenants looking for space in the second half of the year. Venture capital is starting to flow again, and many companies looking have a year or less remaining on existing leases.

"The groups that we're seeing out there right now are more real," Harris said. "The probability that they're going to do a deal is higher."
david.bracken@newsobserver.com or 919-829-4548

Read more: http://www.newsobserver.com/2010/07/15/581990/vacancy-rate-may-grow-as-blue.html#ixzz0tqqlLE7d

Tuesday, July 13, 2010

Green Leases Need to Reviewed Carefully

The topic of green leases and ways tenants and landlords can protect the financial interests associated with green building has been a big area of discussion over the last few years — and for good reason. As building owners continue to adopt green building practices both in newly constructed and existing buildings, they want to protect their investment and the value created by earning LEED green certification of their portfolio. On the flip side, many more tenants are looking to lease space in green buildings, are persuading landlords to seek LEED certification of existing buildings as part of the lease negotiation, and are building out tenant space as LEED for Commercial Interiors projects. To assist the industry in navigating this new market reality, the U.S. Green Building Council (USGBC) developed the “Green Office Guide: Integrating LEED Into Your Leasing Process,” a new resource to help tenants and landlords collaborate and provide specific tools and information that will help integrate green decision making throughout the leasing process.

There are now numerous examples of green leases ranging from full lease forms to specific sustainability riders. While these are important tools for the real estate industry, what the market lacked was a comprehensive resource that guided tenants, owners, brokers and attorneys through the process of integrating green thinking into the entire leasing process, not just into the lease terms. The leasing process constitutes much more than just the legally binding agreement. Building qualification and selection, leasing, landlord qualification and green tenant build-outs are complex processes, and while the lease terms frame key legal areas of the tenant-landlord relationship, decisions are made throughout the process that impact the success of the project’s green goals.


Building-Reflected_lg.jpg
Geared toward corporate tenants and their brokers, the “Green Office Guide” provides specific tools that help teams navigate the nuances of successful execution. Building owners, agency representatives and attorneys find value in understanding what prospective sustainability-focused tenants are looking for when selecting a prospective landlord or building. Among the topics covered in the guide include selecting the right team, qualifying and selecting buildings and landlords, lease negotiations and specific legal language, the tenant build-out, and the tenant’s ongoing operations and relationship with an existing landlord.

One of the challenges with green leases is that there is no “one size fits all” when it comes to negotiating a green lease. By educating practitioners on the process and the options, tenants and landlords can better collaborate to achieve a solution that works for both parties. The “Green Office Guide” tackles areas in which tenants and landlords may not be familiar, from background on LEED and green building, to the different steps of the leasing process, to how to actively build green thinking into standard practices. Other invaluable tools such as sample RFP language, site selection checklists, criteria for qualifying brokers and other project team professionals, and sample green lease provisions with extensive drafting notes are all covered.

This resource is the first in a suite of commercial integration guides by USGBC aimed to educate and be a companion resource to those interested in green building but are not immersed in the process on a daily basis. The “Green Operations Guide: Integrating LEED Into Your Property Management” will be released in August 2010 and will be an invaluable resource for those real estate professionals working towards the greening of existing buildings. Practical solutions for energy, water and waste reduction will be discussed and purchasers of the guide will receive access to editable electronic policy templates and tools that can aid in certification documentation. The “Green Retail Guide: Integrating LEED Into Your Leasing Process,” also available this summer, will focus on the nuances of a successful green leasing process with a specific focus on the retail marketplace.

With every sector now playing a vital role in the green building movement, understanding how sustainability can be incorporated and lucrative for all is a vital component of achieving green buildings for all within a generation.


Katie Rothenberg
Katie Rothenberg is manager of the commercial real estate sector at the U.S. Green Building Council.

Monday, July 12, 2010

Some banks have a special technique for dealing with business borrowers who can't repay loans coming due: Give them more time, hoping things improve and they can repay later.

Banks call it a wise strategy. Skeptics call it "extend and pretend."

View Full Image
Extend
Darryl James for The Wall Street Journal

A Portland, Ore., bank has extended the original 2007 loans taken out to purchase this lot. The planned residential community remains undeveloped.
Extend
Extend

Banks are applying it, in particular, to commercial real-estate lending, where, during the boom, optimistic borrowers got in over their heads to the tune of tens of billions of dollars.

A big push by banks in recent months to modify such loans—by stretching out maturities or allowing below-market interest rates—has slowed a spike in defaults. It also has helped preserve banks' capital, by keeping some dicey loans classified as "performing" and thus minimizing the amount of cash banks must set aside in reserves for future losses.

Restructurings of nonresidential loans stood at $23.9 billion at the end of the first quarter, more than three times the level a year earlier and seven times the level two years earlier. While not all were for commercial real estate, the total makes clear that large numbers of commercial-property borrowers got some leeway.

But the practice is creating uncertainties about the health of both the commercial-property market and some banks. The concern is that rampant modification of souring loans masks the true scope of the commercial property market weakness, as well as the damage ultimately in store for bank balance sheets.

In Atlanta, Georgian Bank lent $13.5 million to a company in late 2007, some of it to buy land for a 53-story luxury Mandarin Oriental hotel and condo development. The loan came due in November 2008, but the bank extended its maturity date by a year. The bank extended it again to May 2010, with an option for a further extension to November 2010, according to court documents.

Georgia's banking regulator shut down the bank last September. A subsequent U.S. regulatory review cited "lax" loan underwriting and "an aggressive growth strategy…that coincided with declining economic conditions in the Atlanta metropolitan area." Some of Georgian Bank's assets were assumed by First Citizens Bank and Trust Co. of Columbia, S.C., which began foreclosure proceedings on the still-unbuilt luxury development. The borrowers contested the move, and settlement talks are in progress.
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Also in Atlanta, Bank of America Corp. has extended a loan twice for a high-end shopping and residential project. Three years after a developer launched the Streets of Buckhead project as a European-style shopping district, all there is to show for it is a covey of silent cranes and a fence. The developer, Ben Carter, says he is in final negotiations for an investor to come in and inject $200 million into the languishing development.

Regulators helped spur banks' recent approach to commercial real estate by crafting new guidelines last October. They gave banks a variety of ways to restructure loans. And they allowed banks to record loans still operating under the original terms as "performing" even if the value of the underlying property had fallen below the loan amount—which is an ominous sign for ultimate repayment. Although regulators say banks shouldn't take the guidelines as a signal to cut borrowers more slack, it appears some did.

Banks hold some $176 billion of souring commercial-real-estate loans, according to an estimate by research firm Foresight Analytics. About two-thirds of bank commercial real-estate loans maturing between now and 2014 are underwater, meaning the property is worth less than the loan on it, Foresight data show. U.S. commercial-real-estate values remain 42% below their October 2007 peak and only slightly above the low they hit in October 2009, according to Moody's Investors Service.

In the first quarter, 9.1% of commercial-property loans held by banks were delinquent, compared with 7% a year earlier and just 1.5% in the first quarter of 2007, according to Foresight.

Holding off on foreclosing is often good business, says Mark Tenhundfeld, senior vice president at the American Bankers Association. "It can be better for a bank to extend a loan and increase the chance that the bank will be repaid in full rather than call the loan due now and dump more property on an already-depressed market," he says.

But continuing to extend loans and otherwise modify them, rather than foreclosing, amounts to a bet that the economy will rebound enough to enable clients to find new demand for the plethora of offices, hotels, condos and other property on which they borrowed. If it doesn't work out this way, the banks will end up having to write off the loans anyway.

At that point, if they haven't been setting aside sufficient cash all along for potential losses on such loans, the banks will face a hit to their earnings.

Banks' reluctance to bite the bullet on some deteriorating commercial real estate can have economic repercussions. The readiness to stretch out loans puts a floor under commercial real estate and keeps it from hitting bottom, which may be a precondition for a robust revival.
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More broadly, the failure to get the loans off banks' books tends to deter new lending to others. It's a pattern somewhat reminiscent, although on a lesser scale, of the way Japanese banks' failure to write off souring loans in the 1990s contributed to years of stagnation.

It's a Catch-22 for banks. As long as some of their capital is tied up in real-estate loans that are struggling—and as the banks see a pipeline of still-more sour real-estate debt that will mature soon—their lending is likely to remain constricted. But to wipe the slate clean by writing off many more loans would mean an even bigger hit to their capital.

"It does not take much of a write-down to wipe out capital," says Christopher Marinac, managing principal at FIG Partners LLC, a bank research and investment firm.

Federal bank regulators tackled the issues in October with a 33-page set of guidelines. Bank regulators have said they were concerned about commercial-property losses and debts coming due on commercial property.

Another problem they sought to resolve was that banks and their examiners weren't always on the same page. In some cases banks weren't recognizing loan problems, while in other cases, tough bank examiners were forcing banks to downgrade loans the bankers believed were still good.

The guidance was intended "to promote both prudent commercial real-estate loan workouts by banks and balanced and consistent reviews of these loans by the supervisory agencies," said Elizabeth Duke, a Federal Reserve governor, in a March speech. The guidelines came from the Federal Financial Institutions Examination Council, which includes the Fed, the Federal Deposit Insurance Corp. and the Comptroller of the Currency.

Although one goal was greater consistency in the treatment of commercial real-estate loans, in practice, the guidelines appear to have fed confusion in the markets about how banks are dealing with commercial real-estate debt. "I just don't believe that the standard is being applied consistently across the industry," says Edward Wehmer, chief executive of Wintrust Financial Corp. in Lake Forest, Ill.

In a May conference call with 1,400 bank executives, regulators sought to clear up confusion. "We don't want banks to pretend and extend," Sabeth Siddique, Federal Reserve assistant director of credit risk, said on the call. "We did hear from investors and some bankers interpreting this guidance as a form of forbearance, and let me assure you it's not."

Restructurings increased at some banks, like BB&T Corp. of Winston-Salem, N.C. Its total of one type of restructured commercial loan hit $969 million in recent months, the bank reported in April. That was a huge jump from six months earlier, when the figure was just $68 million.

The increase was "basically a function of implementing the new regulatory guidance," the bank's finance chief, Daryl Bible, told investors in May. "We are working with our customers trying to keep them in the loans."

BB&T's report showed a significant number of cases where it was extending loan maturities and allowing interest rates not widely available in the market for loans of similar risk.

Banks don't have to disclose how terms on their loans have changed, making it hard to know whether they are setting aside enough cash for possible losses.

In a large proportion of cases, modifying the terms of loans ultimately isn't enough to save them. At the end of the first quarter, 44.5% of debt restructurings were 30 days or more delinquent or weren't accruing interest, up from 28% the first quarter of 2008.

A case in Portland, Ore., shows how banks can keep treating a commercial loan as current, despite the difficulties of the underlying project.

A client called Touchmark Living Centers Inc. in 2007 borrowed $15.9 million, in two loans, to buy land for a development. The borrower planned to retire the loans at the end of the year by obtaining construction financing to build the Touchmark Heights community for empty-nesters.

Because the raw land produced no income, the lender, Umpqua Bank, had provided "interest reserves" with which the developer could cover interest payments while obtaining permits and preparing to build. The bank extended Touchmark a $350,000 interest reserve—in effect increasing what Touchmark owed by that amount.

In December 2007, the U.S. economy slipped into recession. When the loans came due that month, Touchmark didn't pay them off. Umpqua extended the maturity to May 31, 2008.

The bank also added $600,000 to the interest reserves. Though supplying interest reserves is common at the outset of a loan, when an unbuilt project can't produce any income with which to pay debt service, replenishing interest reserves is frowned on by regulators.

Asked to comment, a spokeswoman for the bank said, "Umpqua and Touchmark had determined that the project was still viable but not yet ready for development." Touchmark said it didn't pursue construction financing at that time because "it was not prudent to proceed with developing the property until the economy improves," as a spokeswoman put it.

In 2008 the bank extended the loans again, to April 2009. During this time, Touchmark began paying interest on the loans out of its own pocket.

Then in May 2009, Umpqua restructured the loans, lumping what was owed into one $15 million loan that required regular payments on both interest and principal. Touchmark paid down the principal a little and Umpqua set a new maturity date—May 5, 2012.

Accounting

With many of today’s companies struggling to weather the storm in a difficult economy, the C-Suite is looking to cut operational expenses and trying to adopt a social responsibility strategy recognizing “green has become the new black.”

Realizing real estate comprises one of the top two or three largest impacts on their financial performance, the three important questions senior management are asking their corporate real estate/facilities executives are:

   1. “What is our total cost of occupancy?”
   2. “How can we reduce it?”
   3. “How can our real estate assets serve our organization’s operational needs and contribute to our company’s desire to achieve environmental stewardship?”

Tough questions? Maybe, if the CRE professional doesn’t have access to the information needed to identify areas where costs can be cut. The first challenge in the equation is determining the cost categories that make up the “total cost of occupancy.”

A great place to start is by taking a look at the International Total Occupancy Cost Code developed by London-based IPD Occupiers. The code includes over 250 categories organized in the five super categories of:

   1. Property Occupation (Rent, taxes, acquisition, debt service)
   2. Adaptation and Equipment (Fit out, improvements, capital investment)
   3. Building Operation (Energy/utilities, maintenance, repair, moves, churn, security, cleaning)
   4. Business Support (Reception, catering, mail room)
   5. Management (Fees for real estate, facilities and project management)

The next challenge is to determine where, within the enterprise, the information resides and be able to summarize and standardize the information across the portfolio of leased and owned properties. Once achieved, (no small feat given the resources available to the CRE professional and silos of information that exist in many organizations) the information is collected, analyzed, and prioritized a benchmark can be developed and the “bigger buckets” targeted for the greatest degree of cost savings.

The information then becomes actionable business intelligence that can be used as a foundation of a strategy.

In typical organizations, the top ten cost items for a leased facility are:

   1. Net Rent
   2. Rates (local property taxes)
   3. Total utilities (energy + water)
   4. Total repair & maintenance
   5. Total property management
   6. Total cleaning
   7. Internal & external distribution
   8. Service charges
   9. Security
  10. Catering & vending

“Think, Build, Operate”

With the total occupancy costs calculated and a cost benchmark established, the CRE professional can now answer senior management’s question #1.

To answer the subsequent questions, the CRE department will need to put together a strategic plan. Through facilitated sessions with internal constituents and outside consultants the process will help to develop a plan that will get the organization to “crawl, walk and then run.”

Along with a consultant CRE departments will co-develop a strategic and tactical solution unique to the organization might utilize a process driven approach that will challenge the internal team to:

THINK: What is the real estate portfolio’s current and desired future state?

BUILD: What are the specific initiatives to be implemented across the real estate/facilities department(s) and portfolio that bring about the desired efficiency, economic and environmental sustainability results?

OPERATE: How/who will implement the plan, what will become the KPIs to measure progress and define success, and how will the momentum be maintained until the desired future state is reached?

Departmental and Portfolio Efficiency

At a departmental level, in order to effectively bring about change, the CRE professional needs to be realistic about ‘where they are’ (current state) and where the enterprise ‘wants to be’ (future state). Is it simply to reduce operating costs, rationalize your portfolio, dispose of non-core assets or something much more?

A key component to determining whether the organization will be heading in the right direction is to articulate the KPIs they will use to assess the portfolio and processes and help them manage change. These KPIs become the “gauges on the dashboard” and determine how to measure success and whether they are driving costs out of the portfolio.

But, before addressing the overall portfolio of leased and owned facilities the CRE professional will be well served to look in the mirror and examine the internal business processes, departmental core competencies and the role outside service providers play. Getting the management piece addressed is the fundamental component can be streamlined and improved to set the efficiency train in motion.

At this stage it’s best to incorporate a plan of how to orchestrate the ”people” (who will implement and affect the desire results?); the “process” (what are the workflows that will be refined or developed that will become the framework for making and managing change?); and the “technology” (how will the use of technologies help the organization measure, manage, automate, and report on portfolio/building information about occupancy costs that will support strategic decision making?).

Tackling the low and high hanging fruit of the economics of the portfolio

The next piece of the puzzle is to identify and implement the specific initiatives that begin to carve out costs. The most efficient building in the portfolio is the one you no longer use because you’ve disposed it. While every organization is unique some common threads of initiatives to cut costs could be:

    * Deploying alternative workplace strategies
    * Addressing operational efficiency of your owned facilities
    * Reducing energy consumption
    * Evaluating and executing leasing strategies into commercial properties that can contribute to your company’s sustainability goals
    * Decreasing the utilization of expensive facilities with space management designed to show vacant and under performing facilities
    * Developing the visibility into your under performing facilities
    * Rationalizing your portfolio and consolidating staff/facilities to dispose of non-core assets

By effectively managing the size and cost of the portfolio, real estate executives can have a dramatic impact to their organizations’ bottom-line and profitability while contributing to corporate social responsibility (CSR) initiatives important to many companies today.

The ‘holy grail’ – achieving environmental sustainability

In today’s new economy the challenge has become how to maintain profitability while moving your organization toward environmental stewardship.

While the debate about whether climate change is truly caused by the emission of greenhouse gases continues, it is clear that adopting environmental sustainability initiatives can contribute to the positive financial performance of the company.

Some of these practices that involve operational efficiency include:

    * ‘Green’ and LEED certified design practices
    * ‘Smart’ building systems
    * Energy demand/consumption
    * Use of renewable energy sources

It makes good business sense to adopt these enviro-friendly principles because it reduces costs and moves the organization toward societal responsibility of the environment. While “green has become the new black” it no longer means it creates “red ink.”

In developing a sustainability strategy plan the blue print starts with determining the overall sustainability goals of the organization and identify initiatives are already in place to address sustainability.

A contributing factor to company’s CSR strategy is for the CRE professional to bring the real estate perspective by:

    * Evaluating the financial and environmental impact of capital investment decisions focused on resource consumption and carbon efficiency
    * Outsourcing non-core services to ‘green, cleantech’ providers
    * Streamlining and ’greening’ departmental workflows
    * Automating corrective and preventive maintenance schedules and alerts to maintain facilities at peak resource and energy efficiency
    * Establishing carbon disclosure reports and creating sustainability scorecards
    * Exploring the feasibility and benefits of alternative and renewable energy sources (solar, wind, geothermal, hydroelectric, Co-generation, etc.)

By achieving greater efficiency of business workflows and facility operations, carving out occupancy costs and implementing environmental sustainability measures not only makes good business sense but, it’s the right thing to do for the environment.

Back in the day ‘tree hugging, do gooders’ were pushing for recycling, turning off the lights, adjusting the office thermostat and copying on both sides of paper. Being good to the environment seemed like an expensive nuisance. Now? It makes fantastic business sense due in large part to the fact that, “you don’t pay for what you don’t use.”

What do you think? What are your ideas of how you could implement cost avoidance initiatives that support an overall real estate strategy and help you don’t pay for what you don’t use?


http://cre3.wordpress.com/

Friday, July 2, 2010

Cost Cutting and Cost Containment The Right Way

As published on Harvard Business Review Website

Cut Costs, Grow Stronger

To reduce expenses for the long term and lead the way to recovery, start by taking a strategic view of your capabilities.
by Shumeet Banerji, Paul Leinwand, and Cesare R. Mainardi

If you are a corporate leader, you have probably been spending a lot of time lately thinking about costs. In the aftermath of the global economic crisis of 2008–09, the pressure to cut costs — whether driven by cash flow, shareholders, uncertainty, or investment needs — has been extraordinary. Many businesses are struggling to survive. Others, even if they’re doing relatively well, are reducing expenses to make sure they are well prepared for future uncertainties.

But there is a positive side to this situation. Dramatic cost cutting gives you a chance to refine or even reformulate your company’s overall strategy. After all, you’re never just cutting costs. You’re making a decision that something is no longer strategically relevant, and that other things are essential to keep. Yes, you may have to lose some product lines and activities, and perhaps some of your employees and customers. You also, however, have the opportunity to help your company grow stronger in the process.

We reject the idea that cutting costs in itself makes a business weaker or more limited. To be sure, if you reduce expenses in a panic, or without an eye to strat­egy, you could do great harm to your company’s competitiveness. But if you focus on your priorities and on your future potential, cutting costs can be a catalyst for ex­actly the change a company needs.

Unfortunately, many companies are cutting expenses ineffectively. They either spread the pain as evenly as they can across all parts of the business or they target high-cost areas first. And they look for short-term reductions without fully considering the impact on their long-term position or prospects. Surveys conducted with executives of leading corporations show how strongly these approaches prevail. When companies cut costs in this mechanical, programmatic way, they risk making the enterprise weaker in the long term and (in many cases) doom themselves to needing more draconian cost cuts down the road.

CFO Best Practice Sponsor:
Cambridge Consulting Group was formed more than 10 years ago to help large organizations reduce their  costs by eliminating their leasing obligations for excess commercial real estate space. Founded by Dave Worrell, a former Corporate/Facility Director, Cambridge Consulting Group offers companies a better option than subleasing office space they no longer need or use. Using a newer financial strategy- Negotiated Lease Buyouts, Cambridge Consulting has saved Fortune 500 companies millions of dollars in commercial lease obligations. For more information please visit their website- www.ccgiweb.com  


The right way to think about costs — whether your company is under pressure now or marshalling resources for the future — is to look at the capabilities you need most and to invest only in those that will give you a clear advantage in reaching the customers you care about most. This approach involves a new way of thinking about capabilities. They need to be seen for what they are: a defining factor in productivity, a critical element of success, and a major factor in determining strategy.

Your company’s key capabilities:

    * Drive most or all of your worthwhile discretionary costs.
    * Can be counted on one hand (as opposed to reflecting the multitude of activities that are currently funded within your business).
    * Should be spared in any cost-cutting program (related expenses may even be increased).
    * Work best when they are combined in sets to deliver a unique, hard-to-copy capability system.
    * Are rarely, if ever, bounded by individual corporate functions.
    * Can determine the composition of a high-performing portfolio of businesses — those that pull from similar capability systems.
    * Lend themselves to scale advantages, but need not be built or maintained in-house.
    * Represent, in combination, the difference be­tween what matters and what doesn’t.

Being Strategic When the Clock Is Ticking

It’s all very well to suggest a surgical approach to cost cutting that keeps strategy in mind and leaves key capabilities intact. But is it realistic? After all, depending on your reserves and your cash flow, you may have to act very quickly. Perhaps you don’t have a clearly articulated strategy — and it is very unlikely that you have a spreadsheet that organizes your costs by capability. You probably have your costs organized by function or by business unit, like everyone else. So what are you supposed to cut?

In our experience, the most dramatic, significant, and successful cost reductions, in either the short term or the long run, aren’t those that are simply prompted by financial analyses. They have all occurred in situations when management realized that it had to truly transform. The process wasn’t expense reduction as usual; it involved real fear — a sense that “If we don’t change, we may not survive.” These urgent situations provide exactly the right impetus to make critical strategic changes.

Case in point: Years ago, there was an emergency cost-cutting program at the automobile and electronic components manufacturer Johnson Controls Inc. The crisis began when Sears, Roebuck and Company, which represented 20 percent of Johnson Controls’ business in motor vehicle batteries, pulled its contract. Overnight, Johnson Controls faced huge overcapacity and steep losses.

The executives of Johnson Controls recognized the gravity and urgency of the situation. They had huge decisions to make and almost no time to make them. But they made the time to look at their business from a higher level, and in less than a month they came to some realizations. Most important, they saw that the complexity of the company’s product line was hurting its long-term profitability and needed to be addressed. Johnson Controls’ huge volume of sales (in particular, to Sears) had covered up the fact that certain parts of the business were subscale; they required an investment in capabilities that was greater than what they earned back in profits. The capabilities (which were focused on manufacturing, sales, and certain types of R&D) required to produce and market high-volume batteries turned out to be very different from those required to make and distribute the wide variety of batteries for more specialized or lower-volume vehicles.

In part by focusing on their mass-market, high-volume customers, the managers at Johnson Controls were able to immediately identify 35 percent cuts in overhead, in areas as diverse as accounting, human resources, and information technology, without hurting the most profitable parts of their business. They understood that they might make some mistakes in doing this, but they knew that this strategy would let them act decisively, with confidence that they could fix any errors later. From there, the management team went on to reconfigure the manufacturing footprint, closing certain plants and rethinking the roles of others. In the past, the company had been reluctant to transport auto batteries because they were so heavy. It maintained plants around the United States that each produced a wide range of automobile batteries and shipped them within the region. But now, the company’s leaders realized they could save more by reducing in-plant complexity than they would spend transporting batteries long distances to their customers. The production of lower-volume batteries was concentrated in a few plants. The total savings from all these changes amounted to about US$150 million annually.

This became a moment of transformation for Johnson Controls, an example that the company drew on in rationalizing the rest of its businesses. The executive team members knew individually what had to be done, but together they needed to think through the implications to convert that knowledge into action. And by doing so, they developed a new capability that has been a foundation of the company’s success ever since: the ability to effectively manage complexity by making appropriate trade-offs in both the choice of products to manufacture and the way they configure their supply chain.

Most management teams display a surprising amount of lucidity about which costs are important when they have to. They may not be 100 percent right, but they won’t be anywhere near 100 percent wrong.

Did Johnson Controls really need a crisis to figure out which costs were essential? Theoretically, of course, the answer is no. A company might choose to cut costs and grow stronger as way to realize its aspirations, not just to deal with a crisis. In reality, though, crises can provide powerful stimuli. To paraphrase Samuel Johnson, nothing focuses the mind quite like the prospect of your imminent removal from this world. Absent crises, companies often lose focus and habitually accept expenses that don’t really serve their interests.

Your opportunity — at all times, but especially during a crisis — is to grow stronger by building your critical capabilities, even as many of your competitors pursue a more incremental, across-the-board approach to cost cutting. Now is when you need to invest heavily in the capabilities that matter, and make the difficult choices that great companies make.

The Meaning of Capabilities

These days, any discussion about great companies and what they’ve done well usually turns to capabilities. “Procter & Gamble wins,” someone might say, “because it knows how to innovate.” Or “Renault has taken advantage of its ability to manage joint ventures.” Or “Haier is unmatched in customer service in China.” To a great extent, capabilities have bypassed assets (such as technology, capital, facilities, property rights, or brand names) as a means of creating value.

There are a few reasons for this. First, as industries mature, assets often become “table stakes”; everyone in the game has them. You and your competitors have long since caught up to one another with your brands, patents, and manufacturing. Second, in an era of outsourcing, the importance of asset scale (as achieved, for instance, through the economies of a broad-based manufacturing footprint) has faded. Thus, in many industries, the traditional role of large assets as barriers to entry by competitors has disappeared as well. Third, assets (such as patents, brands, land, facilities, and machinery) are often by their nature more difficult than capabilities to leverage across diverse portfolios. Finally, time has a way of eroding the value of assets. New technologies may come along and make old machinery obsolete, the value proposition may move away from the assets themselves toward related services, or the assets may be based on patents that eventually expire.

Capabilities, by contrast, need never expire; in total they represent an engine for creating assets. Consider the difference between an oil company strategy that relies on the oil fields the company already owns (its assets) and a strategy aimed at expanding the ability to discover and develop new fields (a capability). A strategy for building highly sophisticated capabilities — perhaps for extracting maximum value from assets or for conducting operations with a lower carbon emissions footprint — might be more valuable still.

When you think about your costs in terms of capabilities, it becomes much easier to create capabilities that will set you apart. A company with a concentrated cluster of capabilities is more likely to come up with blockbuster hits in the market. And the lack of focus on capabilities is probably the single biggest driver of strategic confusion — the ongoing, habitual way of thinking that makes prioritization painful and difficult.

One company that has shown how far a capabilities-driven cost initiative can go is Tata Steel Ltd., a division of India’s well-known Tata Group. Like all the other Tata companies, it had local origins, and it had worked hard to be a values-based corporation, balancing financial success and a commitment to employees, its community, and to India’s development. Tata Steel was also a leader in cost per ton of product; it was frequently cited as the lowest-cost steel producer in the world. Then in 1997, after several years of a very successful technology-modernization program, the senior leaders of Tata Steel realized that they were ready to expand around the globe. Indeed, if they didn’t expand, they might become vulnerable to competitors in their home market.

The executives identified a number of areas where they needed a step change in capabilities to accomplish this expansion. They needed to learn, for example, how to find and work with raw materials suppliers outside the familiar, but limited, low-cost sources in India. And they needed skills in developing and managing joint ventures — a complex capability involving several different functions, which they built by borrowing, in part, from other companies in the Tata Group. The company leaders deliberately applied these capabilities in ever more complex environments, moving from Thailand to Singapore to China, and ultimately acquiring the Corus Group, a major Anglo-Dutch steelmaker, in early 2007.

Between 1997 and 2008, the company went from producing less than 3 million tons of steel per year (at a single plant in eastern India) to producing almost 20 million tons, making it the fifth-largest steel producer in the world. Several million more tons are expected to come on line soon. One Tata Steel executive, looking back on this evolution, specifically credited the rapid but sustained growth of the company’s capability-driven strategy. Step by step, Tata Steel built skills and systems, moving them from one region to another and, ultimately, around the world.
Capabilities as Strategy

When they hear the word capabilities, many businesspeople think of intangible assets: employees’ skill sets or the quality of work done by a corporate function such as research and development or supply chain management. But we use the term in a more specific way: Capabilities are the defining strengths your company must have to help it compete.

Consider the essential two or three capabilities exhibited by the world’s most successful companies. What makes Frito-Lay a great company? Or Google? Or Nokia? Or any company that you admire? The answer is typically more difficult to discern, and more precise, than it might seem at first glance.

In the case of Frito-Lay (a subsidiary of PepsiCo Inc.), one key capability is the ability to serve the needs of small stores up and down city streets and rural roads on several continents. That’s it. Of course, that is not something that can be described in broad terms as a world-class capability in sales or distribution or marketing. Frito-Lay’s capabilities are more specific than that. The company has fleets of trucks with drivers who are highly motivated to sell, and it gets products to flow appropriately via those trucks with technology support, a good value proposition, and good judgment (and great information) about which products to put in or pull out. These capabilities are hard to replicate, in part because (like all other key capabilities) they’re intricate, interdependent, and cross-functional.

Similarly, Google Inc.’s capabilities include not just maintaining and improving the company’s search engine, but continual innovation of Web-based applications that will attract consumers and the ability to translate those consumer populations into advertising revenue. These capabilities allow the company to boost the value of its online advertising by creating new services and offering them free.

The Nokia Corporation is known for its distinctive capabilities in rapid prototyping, customer-centric design, and global merchandising, all fitting together around products that must consistently stay one step ahead of competitors in both usability and cost. Every company known for its capabilities — Caterpillar, Toyota, HSBC, Procter & Gamble, NestlĂ©, Tata Group, Johnson & Johnson, Huawei, and many more — has earned this reputation through a series of sustained investments that apply across product lines, functions, and geographies, and that work together to give the company a broad-based edge in the marketplace.

The best definition of capabilities, in our view, reflects this essential quality: Capabilities are the interconnected people, knowledge, systems, tools, and processes that establish a company’s right to win in a given industry or business. The right to win, in turn, is a clear path to sustained profitability, higher market share, or both, supported by the critical set of capabilities that will make a difference in that market.

It might seem that companies in the same sectors would need the same capabilities to win in the market, but that is rarely the case. Apple and Dell both compete in the computer market, but their capability sets are completely different. Apple’s success depends on continued product and service innovation combined with a deep understanding of the way in which people interact with technology; Dell’s success depends on rapid delivery, low-priced customization, and high-quality customer service. Something similar is true for automakers BMW and Lexus (Toyota): same markets, different points of attack. Fashion company Zara International Inc. furnishes yet another example of winning in a unique way. This division of Spain’s Inditex does most of its production in-house, distributes in small batches, and does not hesitate to build up excess capacity at the right point in production. It does these things — all of them taboo from a traditional cost perspective — to execute its strategy of delivering the right trends at the right time. As a result, Zara has consistently sold almost 85 percent of its goods at full price (versus the industry average of 60 to 70 percent), with gross margins about 55 percent higher than those of its competitors.

These examples make clear that it’s not just the dynamics of a market, but how a particular company chooses to play in that market, that determines the required capabilities. This point is important in a cost discussion because it’s not at all uncommon for companies to tie up resources in capabilities that their competitors have, and that they covet but may not need. All too often, functional leaders ask, “What are my competitors doing?” and request funding for initiatives to build capabilities in perceived gaps. However, if all you ever try to do is match your competitors’ capabilities, you can never create or sustain a real right to win.
Capability Systems

Cutting costs while growing stronger thus requires that you understand not just the dynamics of the market you’re competing in — where it is now and where it’s heading — but how you will play in that market. Hence the importance of a coherent capability system. Your company’s most important capabilities generally come in groups (or systems) that logically fit together and reinforce one another. They match up well against the markets you’re facing, the assets you’re supporting, and the customers you’re dealing with. On its own, for example, PepsiCo’s high-performing capability for launching new food and drink products might not amount to much. But PepsiCo also has a related capability: a world-class skill at retail outlet distribution. That capability has made PepsiCo one of the most successful food companies in the world.

Stock market analysts and company managers typically measure portfolio strength financially. If a com­pany has a group of high-performing business units, these analysts are likely to say, “There’s a strong portfolio.” If it has poorly performing businesses, the analysts label these units “fix” or “exit.” This view of portfolios is incomplete; it has only one important metric: relatively short-term financial performance.

Our view of strong portfolios is quite different. Instead of measuring only the financial performance of each business, we ask why these businesses are in the same portfolio to begin with, and we judge their potential according to the coherence of the capabilities that are required to manage them all together. We see leaders at the most successful companies doing the same. This explains, for example, why a company like Procter & Gamble can be successful with so many different brands that compete in seemingly unrelated consumer product segments, such as cosmetics, cleaning products, and disposable diapers. The brands all take advantage of P&G’s formidable capabilities in the areas of consumer insight, breakthrough innovation, and merchandising. At Procter & Gamble, the pieces of a winning portfolio are coherent. They benefit from the same capabilities. The job of the strategist, therefore, not just at P&G but everywhere, is to achieve capability coherence: to assemble a portfolio of businesses that benefit from having a coherent “winning set” of capabilities. Accomplishing this goal means classifying each part of the business not just through financial metrics, but also through its alignment with the overall strategic direction of the enterprise. This view of the corporate portfolio makes the task of cost cutting infinitely easier. It becomes much more obvious which capabilities to select for investment. No longer do you have disparate needs that all require some investment to sustain, leading to spending spread evenly across functions and businesses. Now you can focus.

Over the years, capability coherence has been shown to correlate strikingly with corporate perfor­mance. For example, Booz & Company tracked the coherence of a variety of consumer products companies. We found that companies that focused their portfolio on a few key capabilities delivered higher earnings before interest and taxes (EBIT) margins than those whose portfolios were less coherent. We have found the same sorts of correlations in other industries, such as automobiles and telecommunications. In the end, one of the most critical roles for senior executives is choosing which capabilities to invest in and providing the organization enough specific direction to follow through. This means building capabilities that are unique and synergistic, aligning the portfolio around those capa­bilities, and enacting an operating model that supports and leverages the capabilities that deserve the most support.

Providing this sort of consistent, reliable focus, is, of course, one of your own most im­portant capabilities. Releasing what isn’t essential in difficult times will give you greater clarity of purpose, and will expand your critical capabilities for use in good times. Every day, that more accurate self-definition will ensure that every investment decision, every portfolio decision, and every operating decision reinforces the coherence of your strategy. Yes, that will help in terms of cutting costs. But it will help even more in overall strategy.

Indeed, just being armed with the clear objective of protecting and growing your company makes the pain of the next cost reduction a bit more palatable. And that will have an effect on people within the company. More of them will feel engaged, because they will recognize what the leadership is trying to do. As the com­pany’s sense of purpose becomes clear, they will become optimistic again, and they may see opportunities where before they merely saw pressure. It won’t hurt that they will see tangible results: Costs come out and stay out, and people are less likely to feel that their work is going to waste. Most important of all, the weight of the orga­nization is now balanced appropriately, propelling forward the capabilities that create your right to win.


Author Profiles:

    * Shumeet Banerji is chief executive officer of Booz & Company. Prior to that, he was the managing director of its European business. He has served clients in both the public and private sector from offices around the world. Previously, he was a member of the faculty at the University of Chicago Graduate School of Business.
    * Paul Leinwand is a partner in Booz & Company’s global consumer, media, and retail practice. Based in Chicago, he serves as chair of the firm’s Marketing Advisory Council. He supports clients undertaking significant strategic opportunities, and in building capability systems in marketing, innovation, and customer management.
    * Cesare R. Mainardi is managing director of Booz & Company’s North American business and is a member of the firm’s Executive Commit­tee. Based in Cleveland, he works with Fortune Global 500 companies to help them achieve major business transformations. He has served as global leader of Booz & Company’s functional practices and has led the firm’s global consumer products and health practices.

    * Reprinted with permission from Cut Costs, Grow Stronger: A Strategic Approach to What to
      Cut and What to Keep, by Shumeet Banerji, Paul Leinwand, and Cesare R. Mainardi, Harvard Press. Copyright © 2009 by Harvard Business Publishing; all rights reserved. This electronic book is available at www.strategy-business.com/ccgs_book and at online booksellers, including a Kindle version at Amazon.

CFO for Banks Need to Look at Branch Real Estate For Cost Savings

This article was published in October issue of CFO Magazine. This is importnat topic for banks to address as they continue on their road to recovery.

Underutilizing office space is frustrating and costly, but there are ways to minimize the impact.

Alix Stuart, CFO Magazine
October 1, 2009

Long rows of darkened offices and cleared-out cubicles are not only bad for morale, they're bad for the bottom line. Today, many companies find themselves with as much as 50% of their office space going to waste, according to Kevin Farrell, CEO of corporate-real-estate advisory firm Northmarq. Even more frustrating, most are locked into rents that are much higher than current asking prices, as rates in major cities like New York and San Francisco have dropped about 10% in the past year. While it's hard to get out of leases entirely, experts say there are some ways to mitigate the drag of excess space.

Organize. Many companies don't even have all their lease documents in one place, leaving them vulnerable to excess maintenance charges and automatic lease renewals at above-market rates. Farrell says the lease database and auditing services his firm offers have been growing in popularity, with demand up 30% in the past year. The cost is usually less than that of a lease automatically renewing, says Farrell, and leads to an average 10% reduction in lease operating costs.

CFO Best Practice Sponsor:
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Early extensions. Companies with good credit that have two years or less left on their lease may find better terms if they agree to extend the lease for five to eight years, says Bill Goade, CEO of real-estate advisory firm Cresa Partners. In doing so, they can usually opt to either get better rates per square foot or pay slightly above-market rates to shed some of their space. "Landlords are certainly willing to work with creditworthy tenants to stabilize their buildings," says Goade, "but it's a give-and-take. If you cut space, they'll build in some premium to the rent to offset it." At the other end of the spectrum, those with bad credit may be able to threaten bankruptcy, he says, but success with that gambit is limited.

Outsource. A growing number of firms are handing over the keys — or at least the talk about the keys — to outsourcers, who can handle lease negotiations as well as cut better deals for services like security or cleaning, says Rakesh Kishan, CEO of UMS Advisory, which helps companies structure outsourcing arrangements. That can yield 15%–20% savings on real estate, he says.

Telecommute. One option that may be particularly appealing for smaller companies: eschew real estate altogether. Sharon Gottlieb, CFO of Logicmark, estimates the Virginia-based company saves at least $60,000 per year by having its 7 employees work from home, a model it has used since she and her husband started the medical-alert device maker in 2006. Part of the savings comes from outsourcing warehousing and fulfillment tasks to a Wisconsin-based company and manufacturing to China. Employees meet once a month to share ideas and concerns. "This model really works for us," Gottlieb says, "but it would be very, very hard to have 100 employees and do it."


© CFO Publishing Corporation 2009. All rights reserved.