Deloitte Capital and Real Estate Transformation Newsletter 1Q 2010

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With the recent economic downturn, many companies are increasing their focus on cost improvement to increase shareholder returns. Corporate real estate can play a major role in cost management …

With the recent economic downturn, many companies are increasing their focus on cost improvement to increase shareholder returns. Corporate real estate can play a major role in cost management initiatives as it is typically the 2nd or 3rd largest operating cost in many organizations. Strategic real estate cost optimization opportunities can be identified and achieved quickly through a combination of:
• Spend analysis
• Portfolio optimization
• Organizational structure redesign
• Process improvement

Most organizations have explored the “low hanging fruit”, or those activities that require minimal effort and provide low impact and benefit. However real estate and facilities operations can partner more closely with internal customers and other enabling functions to tackle more challenging initiatives, resulting in more significant cost savings opportunities.

This issue of Deloitte\'s Capital and Real Estate Transformation (CRET) Quarterly provides insight into the real estate considerations that should be an integral part of any Enterprise Cost Management program. We discuss an approach to real estate and facilities cost optimization activities, identify some common real estate cost reduction initiatives and outline some symptoms that may indicate an organization should explore a more comprehensive real estate cost management program.

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  • 1. CRET Quarterly Q2 2010 Real estate and facilities operations in an enterprise cost management environment In this issue Approach to real estate and facilities cost optimization 1 RE&FO cost optimization opportunities 3 In the current economic operating environment, companies These challenges are often magnified by time pressures from are continually facing pressure to reduce costs and increase increased competition and customer demands that require shareholder returns. Real estate is typically the 2nd or real estate to be more flexibly and efficiently delivered. In 3rd largest operating cost behind people (HR Payroll) and addition, reductions in headcount as well as an increased information technology (data and telephony) for some level of merger and acquisitions activity may increase industries. These costs are not often well understood due to constraints on company resources, limiting access to capital decentralized cost management practices. In addition, real for optimizing utilization of real estate assets. These issues estate and facilities are not typically viewed as a strategic can be further exacerbated and “institutionalized” by asset but more of a necessary expense to house employees. traditional operating structures where location management As a result, we believe the Real Estate and Facilities is decentralized and driven by the business unit, leaving the Operations (“RE&FO”) function can be better positioned to RE&FO department with fewer opportunities to leverage significantly contribute to cost optimization initiatives. similar expenses and obtain economies of scale across the organization. This reactive decision-making often creates In today’s market, the challenges begin with increasing ineffective delivery of services and sub-optimal real estate costs and heightened scrutiny on corporate expenditures. solutions. Finally, an issue relevant in today’s real estate From a facilities perspective, some of the typical challenges market is that idle or excess space can be difficult to dispose include: of given the low demand in most commercial markets. • Insufficient or inadequate data about the real estate portfolio and difficulty managing key dates and activities Even under these less than optimal conditions, there still • Budget cutbacks and heightened expense control, may be opportunities for a well developed Enterprise Cost creating a requirement to more accurately allocate Management (ECM) program to help improve business facilities costs to individual business units performance through immediate and sustainable structural • More aggressive billing practices by landlords, increasing changes resulting in cost savings. Through a combination the likelihood of overpayment on lease expenses of organizational redesign, spend analysis and process • Passive or ineffective portfolio management practices improvement, strategic opportunities can be identified (due to technology, capability, or staff limitations), and achieved quickly. A real estate optimization plan that leading to excess inventory and overspending can provide the necessary returns and secure attention • Increased scrutiny on energy related costs and of the C-suite can help push the agenda for instituting a the environmental impact of “greening” the real sustainable solution to reduce overall occupancy costs. estate portfolio
  • 2. Approach to real estate and facilities cost optimization Real estate optimization activities should address Using an approach illustrated in Figure 1, companies can costs holistically from both a P&L and a balance sheet use existing internal information to identify opportunities perspective. An effective optimization program should for improvement and to reduce costs. First, develop analyze and reduce the Total Cost of Ownership (TCO), a baseline of real estate-related costs using the TCO which consists of the Cost to Own or Lease, the framework. Second, compare the cost structures internally Cost to Operate, the Cost to Provide Services and the across the organization and externally to effective industry Cost to Manage the real estate portfolio. A thorough practices. Finally, identify variances and develop strategies cost management program should look across all four to act on the opportunities for reduction in real estate- cost categories. related spend. Within the Cost to Own/Lease category, depreciation, lease expense, insurance and taxes should be evaluated. Some Symptoms Indicating Potential RE&FO Cost of the components of Cost to Operate include utilities, Reduction Opportunities repairs and maintenance costs, facilities management, physical security and project engineering. Examples of Cost Based on our extensive experience in this arena, to Service include landscaping, janitorial, food services, Deloitte has identified the following Top 10 transportation, mail services, copier services and common symptoms indicating that real estate and facilities conference room administration. Finally, the Cost to cost reduction should be explored Manage includes expenses associated with management 1. Knowledge and information about the RE&FO operations expenses related to providing multi-site portfolio is lacking services such as strategic planning, fixed asset accounting, 2. The portfolio is not aligned with current and environmental health and safety, and warehousing. future business direction — from physical location or financial perspectives Figure 1: Identifying Savings Opportunities 3. Supply chain and distribution channels have not been optimized 4. Space utilization and location of facilities have Provide Own/Lease Operate services Manage not been challenged 5. Excess properties have not been disposed of 6. Excess properties have not been identified 7. Current market value of properties is not known, or is significantly greater than book value or Maintenance Rent utility value Land Buildings Utilities and operations Information 8. Creative financing structures have not Depreciation systems been considered Baseline Real estate-related costs 9. Operating costs have not been effectively Taxes Service measured and controlled Internal providers staff Improvements 10. Opportunities to leverage volume buying or outsource low-value-added services have not been explored Leading practices 11. Capital projects are not aggressively bid, value engineered or change orders challenged and controlled Compare to industry These symptoms can appear regardless of the and competition size of the company, although they may be more pervasive in larger companies that are managed in a decentralized manner. Opportunities for improvement 2
  • 3. Once the cost reduction opportunities are identified, the RE&FO organization should evaluate and prioritize Project spotlight them based on the time, resources and costs required to implement the initiatives against the overall impact Diversified Financial Services Institution: and timing of benefits achieved. Figure 2 below offers a Comprehensive Real Estate Cost Reduction Assessment representative prioritization matrix that can be used to facilitate decision making. Background This financial services company began to evaluate its position on the heels of a Figure 2: Representative Opportunity Prioritization Matrix severe downturn in the U.S. Financial Sector by choosing their Corporate Real Estate (CRE) function to pioneer a cost reduction project despite its relatively strong Quantify, prioritize and assess effort to capture cost savings standing in the marketplace. High Identify / dispose of Location optimization non -essential properties (consolidate/redeploy) The Challenge Outsourcing, strategic Structured project sourcing, service finance The primary challenge was to identify cost reduction opportunities and drive towards delivery optimization Identify and obtain achieving operational efficiencies and lower cost by $100 million annually, while Portfolio finance (e.g., public incentives for not compromising the company’s vision of being the premier provider of financial Sale / leasebacks new facilities services in every one of its markets. They planned to accomplish this through a Like -kind exchanges / Workplace strategy creative tax structures initiatives strategic sourcing effort to enable them to leverage their purchasing power to Impact (dollars) achieve a lower real estate cost for products and services in four key areas: general Audit leases and Facilities planning / construction, security services and systems maintenance, janitorial services and landlord charges utilities. space standards Analyze and appeal real Capital projects estate taxes reengineering Cost segregation In addition, they also planned to address the lack of an enterprise-wide portfolio CRE operations and Energy management strategy which inhibited them from effectively utilizing their real estate assets. Their technology Low Service Delivery Model had various “shadow” CRE organizations contributing to costly duplication of tasks, lack of coordination, multiple processes and end-user 0 6 12 Effort (months) confusion and dissatisfaction. Finally, they had disparate real estate technologies across the various groups that needed to be centralized to eliminate the costly In our experience, most organizations have explored the proliferation of competing technologies across the company. “low hanging fruit”, or those activities found in the bottom left quadrant, since they require minimal effort and achieve Approach lower relative impact. With a renewed emphasis on cost With a compressed time-frame, Deloitte employed our Hypotheses Based Consulting management and cost reduction, the RE&FO function approach as an effective method to help them in their efforts to focus on core issues is partnering more closely with internal business unit while obtaining feedback and approvals along the way. The company assembled customers and other enabling functions such as IT, HR a team of sourcing and real estate stakeholders across their major business units and Finance to tackle more challenging initiatives that can to develop the cost baseline and identify key opportunity areas. Deloitte used a result in more significant impact and benefit. We have seen collaborative approach to help the company in their efforts to assemble a cross- the execution of real estate strategies generally achieve enterprise real estate portfolio and cost baseline that became the basis for the savings between 10–20% of the total baseline cost, but evaluation. Finally, Deloitte helped them develop a detailed implementation if approached comprehensively and aggressively with roadmap for each of the opportunities identified. other enabling functions, we have seen the overall savings approach 25%–30%, depending on the level of savings Results already achieved through previous initiatives. Business cases for Strategic Sourcing involving a combination of supply side and demand side components that the company expects will yield over $20 million in annual cost savings. Most of the opportunities were derived from the highly fragmented existing sourcing model that inhibited their ability to use their enormous buying leverage in the marketplace. Additional business cases around optimization of the real estate portfolio, standardization/governance, transformation of the CRE organization, and redeployment of back-office functions, totaling an additional $85 million in potential annual savings. 3
  • 4. RE&FO Cost Optimization Opportunities 4. Restructure the RE&FO Service Delivery Model; Real estate and facilities cost optimization opportunities Increase Outsourcing of Commodity Tasks can range in difficulty from relatively straightforward • Determine which commodity services are most activities such as lease auditing to very complex effectively delivered using external resources and implementations such as alternative workplace strategies. establish contractual agreements to address your Identifying which opportunities to assess and implement company’s needs will vary depending on a RE&FO organization’s internal • Determine the optimal RE&FO service delivery model, resources and competencies and their willingness to leveraging both internal and external resources outsource some or all of the program management. Below are seven common RE&FO cost optimization initiatives and 5. Rationalize the RE&FO IT Platform; Plan For and their related objectives which we have seen contribute to Implement an Integrated Solution decreasing costs and improving shareholder value. • Provide the information technology required to enable all key RE&FO business processes 1. Optimize the Portfolio; Monetize Underperforming • Minimize the number of applications in use to or Underutilized Assets support the RE&FO function, thereby minimizing the • Focus portfolio on locations with the strongest cost associated with supporting multiple platforms business case for reducing total costs and attracting and applications talent • Exit excess (underperforming, underutilized, etc.) 6. Centralize Control of Real Estate and Facilities space through dispositions and subleasing options Assets • Minimize vacancy in retained space • Establish a set of global cost center codes for all real estate and facilities operations activity 2. Restructure the RE&FO Organization; Combine • Provide RE&FO with the ability to actively manage Roles & Responsibilities; Integrate Operations into costs across all business units a Single Function • Enable RE&FO to serve as the central point for • Integrate the RE&FO groups into a single function infrastructure and facilities capital planning enterprise- with global scope of responsibility wide • Implement a process-based management model, establishing leadership positions for all key 7. Establish an Enterprise Asset Management capabilities across RE&FO Viewpoint to Optimize Deployment • Minimize layers and hierarchy, pushing decision • Provide the RE&FO function with the ability to authority to the appropriate levels inventory and manage assets on behalf of the enterprise 3. Implement Advanced Workplace Concepts to • Enable RE&FO to actively plan for optimal Optimize the Office Space Portfolio deployment and re-deployment of enterprise • Reduce the cost of providing effective and efficient assets (real property and personal property) workspaces to your company’s employees • Optimize capital spend across the enterprise • Increase the amount of shared and teaming space • Standardize service levels where appropriate provided in each office, to better support new ways of working • Improve employee recruitment, retention, and productivity 4
  • 5. Summary 4. Balance short-term and long-term improvements — Real estate spend has a direct impact on the balance sheet Given the long timelines associated with real estate and is often overlooked as a cost reduction opportunity transactions, it is important keep in mind future needs because a significant portion of real estate costs are when negotiating or making changes for short-term perceived as fixed, causing inefficiencies that can take a benefit. With economic and corresponding real estate long time to correct. While some aspects of real estate lifecycles, the demand drivers can change over the life decisions have long-term implications on the financial of a lease so contraction today can quickly return to performance of the enterprise, others can be addressed seeking growth options in a year or two. and managed in the short-term. In either case, these costs need to be actively and strategically managed to achieve a 5. Choose the right business model for the RE&FO positive impact on performance. Deloitte thought leaders function — In some cases, the most effective way have developed the following list of lessons learned to help for a RE&FO department to achieve the required companies in their efforts to evaluate these costs savings savings may be through a transformation of its opportunities: business model, including capability development and revised ways of assessing and managing the 1. Decide how much cost improvement or reduction demand for space. is needed — When it comes to reducing costs, different companies have different needs. Is there an 6. Protect strategic investments — In their zeal to executive mandate related to real estate? If so, how cut costs, some organizations make the mistake of strong or aggressive is it? Is the objective incremental slashing investment in areas that are critical to the reduction (increased efficiencies, small percentage long-term operations. A classic example is to continue cost reductions, etc.), or substantial and potentially to extend deferred maintenance on key assets. Short disruptive change to achieve greater magnitude term delays may be acceptable now, but at some savings (portfolio or key location changes)? point, it will cost more to make up for the delayed maintenance. 2. Start with the obvious or low impact changes — For many companies, the most immediate real 7. Actively manage change — Once an organization estate cost savings can likely come from tracking has made the decision to transform its cost structure, and managing demand that may be driving external one of the biggest challenges can be overcoming spend. These can be as simple as redefining food resistance to change. Successful approaches include service hours or better matching energy use to actual strong leadership communications, clear supporting demand (lighting, heating, cooling, etc.), as well as messages about what’s changing and why, and general efficiencies in various processes. The question multiple channels for employees to find out more many companies ask is what could we change that information and also provide feedback. employees wouldn’t object to or would understand why it’s necessary. An effective real estate optimization plan incorporating the various aspects of organizational structure redesign, 3. Take an enterprise view of real estate costs — process improvement, portfolio optimization, and Identification of opportunities should include looking aggressive cost management can help improve business beyond organizational silos to include cost reduction performance in the short term and provide sustainable cost opportunities across the entire enterprise. This could savings. We believe the timing for such initiatives is optimal mean pooling vacant space (rather than departments today, as the current market dynamics are favorable and keeping it to themselves) or managing leases in the support cost reduction opportunities. The high degree of same geographic region to be coterminous, which will competition in today’s real estate services market can also provide relocation/renegotiation options at lease end. provide the RE&FO function with additional negotiation These are examples where a centralized view of real leverage as it works to drive sustainable, enterprise-wide estate can put multiple small opportunities together cost management strategies. that individual business units would not recognize as significant savings opportunities. As used in this document, “Deloitte” means Deloitte Consulting LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. 5
  • 6. Project spotlight Global Pharmaceutical Company: Operations Assessment Background This global pharmaceutical company had a geographically dispersed real estate portfolio with more than 31 million square feet of corporate, R&D, and manufacturing space. The real estate function was highly decentralized with several organizations providing and managing facility related services with a significant degree of out-tasked contractors. The Challenge The company was looking to increase centralization and emphasize cost reduction and realize efficiencies through space optimization. Deloitte was engaged to help them in their efforts to perform an operations assessment, including an assessment of strategic planning and space-related processes and enabling technologies. Approach: Deloitte helped the company in their efforts to design a new, centralized, global real estate services function and associated business processes to support the optimization of their global portfolio. To support implementation efforts, we helped them through a detailed process design and functional requirements identification exercise and also supported the identification of additional business process definition based on a growing base of management responsibility. Finally, we helped them develop a business case to present to their Chief Financial Officer. Results The company expects to achieve $30M in improvement opportunities associated with their efforts to better plan and manage their real estate portfolio. The company expects this design and development of a centralized function will contribute to significant cost reduction and cost avoidance associated with their global real estate portfolio and associated service delivery. Within three to five years, the company expects to be able to achieve a total of $45 million per year in cost reduction, which is a 50 percent increase above initial estimates. 6
  • 7. Contacts CRET Quarterly Contributing Editors Francisco Acoba facoba@deloitte.com Jamie Baker jamesbaker@deloitte.com Ken Meyer kenmeyer@deloitte.com Kurt Ochalla kochalla@deloitte.com Production Manager Gale Young gayoung@deloitte.com This publication contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this publication, rendering business, financial, investment, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this publication. Copyright © 2010 Deloitte Development LLC. All rights reserved. Member of Deloitte Touche Tohmatsu