Published: Monday, 20 Jul 2009 | 8:56 AM ET

Text Size

Much of Corporate America has slashed costs to stay in the black during the recession, but welding the knife too heavily could also remove the ability to grow in a recovery.

iStockphoto

"If you cut into flesh long enough, eventually you find bone," said David Rosenberg, chief economist at Gluskin Sheff in Toronto. "Cost cutting is not a bottomless pit."

Firing people, introducing hiring freezes, halting investments, trimming budgets or even skimping on office supplies are time-tested ways to prove the old adage that a penny saved is a penny earned.

A slew of companies reported better-than-expected first-quarter results because aggressive budget slashing more than made up for falling sales. According to Rosenberg, 40 percent of companies missed their top line expectations in the first quarter.

And as the bulk of results for the most recent quarter hits in the next two weeks, many U.S. companies are expected to do the same again. Some already have.

Perhaps the biggest example so far has been General Electric, which managed on Friday to report earnings that whizzed past expectations despite a drop in revenue that was more dramatic than Wall Street had predicted. The major reasons: cost cutting and a dip in its tax rate.

• Slideshow: The Leanest Companies in the S&P 500

Mind you, investors can be smart to the numbers game. They question the quality and sustainability of such results — and despite the earnings beat GE's

GE loading...

Quote  |  Chart  |  News  |  Profile

[GE  Loading...      ()   ]shares dropped more than 5 percent on Friday.

Another example was Yum Brands

YUM loading...

Quote  |  Chart  |  News  |  Profile

[YUM  Loading...      ()   ], parent of the Taco Bell, Pizza Hut and KFC chains, which last Tuesday also surpassed earnings forecasts but was light on the revenue side.

A cut in its full-year sales forecast triggered a decline of about 8 percent in its share price over the rest of the week.

Mattel

LUV loading...

Quote  |  Chart  |  News  |  Profile

[LUV  Loading...      ()   ] posted a bigger-than-expected 82 percent jump in quarterly profit as cost cuts offset a sales decline that was also much steeper than forecast. But the market was heartened by the toymaker's ability to control costs, and its shares rose 7 percent.

"So far, earnings season is good, but if you were to call it revenue season, it'd be more of a mixed bag," said Peter Boockvar, an equity strategist at Miller Tabak in New York. "What this shows is that companies are able to deal with cost structure, but that the revenue is light shows that we're still in a difficult economic environment."

Although cutting costs can help a company hunker down for the downturn, academics and economists warn in the long term cutting too deeply can hamper its ability to compete and grow.

"If you cut too much then you will be very poorly positioned when the recovery comes," said Russell Walker, a risk management professor at the Kellogg School of Management.

Others, however, warn additional cuts are needed to match the fact Americans are saving more and have less access to credit.

Print

Email

Text Size