Seven ways to making cost reduction stick


One of management’s dirty little secrets is that most cost reduction initiatives fail to produce significant long-term savings.  According to recent McKinsey research, many executives expect some proportion of the costs cut during the recent recession to return within 12 -18 months.  Earlier research found that only 10 percent of cost reduction programs show sustained results three years later

To be fair, some savings have been easier to achieve than others.  For example, total cost of goods sold have fallen by more than2.5% over the last 10 years due to manufacturing relocation, outsourcing of non-core operations and exploiting lower input costs & IT innovations.  However, selling, general & administrative costs (including R&D) have actually remained flat over the same period reflecting higher labour costs and increased system complexity.   

In the short-term, most companies are successful at generating cost savings of up to 10% through a variety of proven strategies like improving purchasing efficiencies, outsourcing and tactical headcount reductions. Soon afterwards, however, these savings are lost as firms and individuals lose their cost cutting zeal and regain the bad spending habits that got them into trouble in the first place.

Cutting deeper and then making those savings stick requires managers to tackle the root causes of cost and inefficiency.  To do this, firms need to address messy and difficult product, structural, cultural and management challenges:

Product

Many consumer and industrial goods companies as well as service firms market too many underperforming stock keeping units (SKUs) which generates system complexity, increases error rates and prevents the firm from maximizing scale economies.  

Structure

Structural challenges prevent companies from cutting more aggressively.  These barriers include: supply chain resistance, poorly designed & administered purchase controls and siloed & overly-hierarchial organizational structures that minimize scale economies and data flows.  In addition, a lack of circulating information on internal costs and peer performance prevents managers from identifying and quantifying larger reduction opportunities. 

Culture

Many organizations have a growth-focused culture – with enabling performance-measurement systems – which is out-of-sync with an aggressive cost cutting mandate.  In these firms, serious cost cutting programs will dictate people changing attitudes, practices and priorities, something that is not easily done without change management methodologies and patience.  

Management

Generating meaningful cost reduction usually takes more time, communicating and management commitment than is usually bargained for. Furthermore, instituting major headcount reductions and role changes is not something that many EQ-focused managers would willingly embrace.

Increasing competitive and shareholder demands are dictating firms target deeper cuts.  To do this, they will need to go beyond traditional cost reduction strategies towards a more systematic and holistic approach.  There are a number of ways that managers can approach this:

Link cost reduction plans to overall corporate strategy to avoid the wrong kind of cuts that will reduce key capabilities, penalize high performing business units or starve new initiatives.   

Look at cost reduction as a change management issue in addition to a financial one.  As well, consider changing the reward system to incentivize individuals and departments towards driving and sustaining savings.

Clarify roles, decision rights, and information access so that the right individuals at the right level have the right information and empowerment to drive cost reduction.

Pursue SKU rationalization and input harmonization initiatives in order to reduce complexity and achieve scale economies.

Consider vertically integrating some key cost centers like production and logistics in order to capture greater operating leverage.

Explore ‘out of the box’ innovations like crowdsourcing whereby your customers undertake key operations like support, product testing and word-of-mouth marketing.

Treat cost reduction as an ongoing management priority that is measurable and where best practices are shared internally.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

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3 comments so far

  1. […] set of policies and procedures to guide hiring practices and wage levels.  The company used a comprehensive change management program to roll out this framework across the organization and made compliance part of the performance […]

  2. […] set of policies and procedures to guide hiring practices and wage levels.  The company used a comprehensive change management program to roll out this framework across the organization and made compliance part of the performance […]

  3. […] inertia, many managers will hastily launch cost reduction programs. Unfortunately, many of these one-off efforts will fail to hit their financial targets while producing collateral damage to the firm’s morale and capabilities.  Companies who approach […]


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