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Managing costs back in focus as inflation and labor costs rise

After two years of taking on new responsibilities at their firms, CFOs are turning their eyes back to their bread and butter – managing costs, said panelists at Private Equity International’s CFOs & COOs Forum in April.

High inflation, soaring labor costs and historically high valuations are becoming defining characteristics of the new, “post-covid” environment, for now. That means CFOs are focusing on creating value for the firm and their investors by reining in costs while balancing the need to attract and retain talent.

At a panel discussing the results of EY’s 9th annual global CFO & COO benchmarking survey, audience members were polled as to how they’ve handled margin erosion due to inflation and fee pressures over the last two years. Thirty-eight percent said they used a combination of strategic spending and short-term tactical expense reductions. Another 20 percent said they were spending more to capture future cost benefits. But fee pressure isn’t the problem for many, the poll showed. Thirty-six percent said they haven’t had any pressure from LPs.

“With larger funds, I understand fee pressure because of economies of scale that a larger firm has available to them as opposed to smaller funds,” said the CFO and CCO of a Boston-based private equity firm. “To me, it makes no sense for smaller funds to feel fee pressure. If an LP is committed to a smaller fund, then it has to be able to support the management of that smaller fund.”

But with inflation tearing away at value, another mid-market firm CFO said she is keeping a close eye at costs at the management company level, as well as “putting more scrutiny” on those allocated to their current fund as it continues to make investments.

“We need to think carefully before we put something to the fund, largely because it can affect the carry,” that CFO said, mindful of remaining competitive in the talent market.

She added that the firm has become “careful” about using its subscription lines to manage those costs.

And a Chicago-based CFO and CCO said that as revenues have thinned, his firm has had to shuffle costs, including recently moving to a new office space with a rent that is just 25 percent of the firm’s previous space, though he said he expects it to increase to 60 percent as the firm expands.

“The pandemic has allowed us to rethink how we do our office, so we’ve realized a significant cost savings related to office space,” the CFO and CCO said. “And this savings can be used on people. We can hire two new associates with the money we saved on rent.”

He added later: “Our employees are our highest cost center. Employee compensation can be 40 to 70 percent of revenue, depending on where we are in our cycle.” And upward pressure on compensation continues in this hot talent market.

Firms should not only look at where they can save money or shuffle costs, but also re-think how they operate, he said. “I think firms are moving beyond just doing things in a certain way just because that’s how it’s always been done. In what I’ve seen, managing directors are focusing more on those reporting to them internally, and asking more questions about how things are done.”

The Boston-based CFO and CCO agreed, saying executives at her firm are getting more involved in operations in order to understand how things are done and where changes can be made to manage costs.

“We’ve seen partners who have not paid attention for a decade all of a sudden trying to understand management company matters,” she said.