Why Keeping a Tight Control of SG&A Expenses May Backfire

Companies that are constantly trying to cut down on selling, general and administrative expenses (SG&A) may actually hurt their long-term competitive position. This perspective is highlighted in a recent study by the consulting firm CEB.

Industry-leading companies have higher SG&A

CEB, recently acquired by Gartner, constructed a group of 60 overperforming companies in their industries in terms of revenue and profit growth. For each of these industry-leading company, the study also identified another company in the same industry that has less than a 25 per cent difference in revenue to create a control group.

The study found that industry-leading companies’ SG&A expenses are 16 per cent higher than those of the control group’s companies. Furthermore, companies in the overperforming group have 36 per cent lower working capital turnover and 4 per cent higher effective tax rate. These findings go against the conventional wisdom that companies should keep their shareholders happy by tightly controlling their spending.

This is not the first time CEB comes up with this observation. The consulting firm has drawn the same conclusion multiple times before, which has put it at odds with many CFOs. But why do companies with higher SG&A spending actually outperform their rivals?

“Companies that win in the market have G&A resources available to actually hire people on the ground, for example, or connect (disparate) systems because they have IT business partners,” explains Dennis Gannon, a principal executive adviser at CEB.

Strategic initiatives vs. operational efficiencies

In addition to higher SG&A expenses, industry-leading companies also have 15 per cent more cash on hand compared to the control group. Keeping too much cash is another practice that many shareholders may not agree with, but it helps companies drive initiatives more quickly when needs arise.

There are, of course, other areas where the overperforming companies excel. They have 32 per cent and 10 per cent higher return on assets and capital investments respectively, and 28 per cent less debt as a percentage of total assets. Most notably, they enjoy a 79 per cent greater return on R&D (research and development) spending.

In other words, companies that focus more on long-term performance and less on short-term efficiencies tend to fare better.