What are Cost Benchmarks? The Ultimate Guide For Finance Professionals

Introduction

In today's macroeconomic landscape, cost management is crucial for the success of every company. One valuable tool that is used by businesses to understand and optimize their costs is benchmarking. In this guide we will look at:

• What Are Cost Benchmarks?
• Four Key Benefits of Cost Benchmarking
• How to Start Using Cost Benchmarks in Five Simple Steps
• Conclusion

Whether you're new to the concept of cost benchmarking or looking for a refresher, this ultimate guide for beginners will provide you with a comprehensive understanding of cost benchmarks and how they can benefit your organization.

What Are Cost Benchmarks?

Cost benchmarks are used to evaluate the costs of a business against industry standards or a group of similar organizations. Benchmarks provide a valuable perspective on how efficiently a company operates in terms of expenses, helping to identify areas for improvement and potential cost savings.

There are many ways that a company can benchmark their costs. The standardized approach is to measure a specific cost as a percentage of revenue. For example, if you are concerned that your IT spend may be excessive then you could measure the total IT costs as a percentage of revenue in your company and compare these to benchmarks.

Now with the knowledge of what cost benchmarks are, let’s look at the two most common types:

External Benchmarks

External benchmarks (also known as Industry Benchmarks) allow companies to compare their costs to the average or median expenses within their specific industry. This type of benchmarking provides a clear picture of how an organization stacks up against its competitors.

External benchmarks typically focus on the cost of specific functions or processes within an organization. With people being a significant cost for many businesses, external benchmarking data providers like CompanySights can provide useful functional headcount benchmarks. Then you can quickly convert these headcount benchmarks to costs using your company’s average cost per head.

Search functional benchmarks to assess people costs here

Internal Benchmarks

Internal benchmarks (also known as Historical Benchmarks) involve comparing current costs as a percentage of revenue to those from previous periods. This type of benchmarking is particularly useful for tracking cost trends and assessing the impact of cost-saving initiatives over time.

For example, you could measure total people costs as a percentage of revenue, which may be 65% in the current financial year, but was 55% in the previous financial year. The key question to ask is what has caused this 10% increase? The answer could be as simple as inflation, or something more difficult to diagnose such as a lack of cost controls that require operational changes.

Four Key Benefits of Cost Benchmarking

There are many benefits to cost benchmarking for organizations. Here we have shortlisted the top four based on our experience, which are:

1. Performance Evaluation

Cost benchmarks provide a clear view of an organization's cost performance relative to industry peers or historical data. Basically, they can quickly assess how much they are getting for the money that they spend. This evaluation allows businesses to identify areas where they excel and areas that need to be addressed and improved.

2. Cost Optimization

By identifying areas of higher costs compared to benchmarks, companies can pinpoint opportunities for cost reduction. This can lead to increased profitability, or at times when there is softer demand and lower revenue then this exercise can really help to maintain profitability.

3. Informed Decision-Making

Benchmarking helps to make informed decisions by providing actionable insights that can be used to determine cost management strategies. Companies can set realistic cost reduction goals and track progress more effectively with the help of cost benchmarks.

4. Competitive Advantage

By consistently monitoring and improving cost efficiency, businesses can gain a real competitive advantage in the market. This usually leads to more money being available for the business to reinvest, which can ultimately drive increased market share and higher rates of customer satisfaction.

How to Start Using Cost Benchmarks in Five Simple Steps

Benchmarking occurs all the time in business. So, if you have a good baseline understanding of benchmarking, then getting started with cost benchmarks should be relatively straight forward. With that said, do not worry if you don’t have any experience. Simply follow these steps:

1. Identify Benchmarking Partners

Select your benchmarking partners carefully, whether they are industry peers or data providers. The quality of your benchmarking data is critical to the accuracy of your assessments. Some professionals decide to manually build peer sets, however this can be a very tricky and time consuming exercise.

CompanySights is a leading provider of headcount benchmarking data. Save time and search here

2. Define Metrics

Determine the specific costs that you want to benchmark. Then convert them into standardized metrics, which are typically an operating cost as a percentage of revenue or a cost per unit.

For example, if you want to benchmark the cost of your HR function then you will need to calculate the total HR costs (including HR employee costs, HR systems costs, and recruitment agency costs), then divide it all by the annual revenue to get to a percentage that you can compare to benchmarks.

3. Collect and Analyze Data

Collect accurate and relevant data from both your organization and your benchmarking partners. Ensure that the data is consistent and comparable. It is difficult to get directly comparable data, so invest time in sourcing relevant external data and then ensuring your company data is in a similar format (refer to the example outlined in 2. Define Metrics above).

4. Set Goals

Based on the benchmarking results, set realistic cost optimization goals and develop strategies to achieve them. This typically involves targeting either the median or top quartile (25^th percentile) of the benchmarking dataset. Whatever you decide, it is important to set targets and outline a plan to achieve them.

5. Continuous Improvement

Cost benchmarking is an ongoing process. Regularly review and adjust your strategies to stay competitive and maintain cost efficiency. Other times when benchmarking exercises typically occur include during mergers and acquisitions or large transformation projects.

Do you need help with functional cost benchmarking? Get in touch here

Conclusion

Cost benchmarks are an invaluable tool for businesses aiming to optimize their costs, enhance competitiveness, and achieve sustainable growth. By comparing costs with industry standards or peer group data, organizations gain the insights needed to make informed decisions and drive continuous improvement. Embracing benchmarks as a core component of your cost management strategy can set you on a path toward greater efficiency and profitability.