Strategic cost reduction

In times of declining profitability or strategic 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 cost reduction strategically with an eye towards ensuring long term growth and competitiveness will improve the odds of achieving their objectives while minimizing long terms risks.

Cost savings initiatives are not pre-ordained to deliver sub-optimal results.  Failure shares many causes, ranging from timid managers and sloppy implementations to employee resistance and a poor understanding of the firm’s cost structure.  What they all have in common is a tactical, short term approach.  My firm has devised a better way to deliver real and long term cost reduction. Our Strategic Cost Reduction approach considers cost savings activities not as a one-time event but within the context of driving strategic priorities, capabilities and organizational alignment.  We have battle-tested this methodology in over a dozen enterprise-wide, cost reduction initiatives.  Below is a simplified overview of our 3-step approach:

1.         Align on priorities

Common sense dictates that you aim cost savings efforts against non-core, low priority corporate activities. However, in a complicated organization or in the absence of a comprehensive strategic plan these priorities will not always be apparent.  Asking 2 fundamental questions will help shed light on your true cost picture.  i) What are the major short to medium term product priorities and capabilities that guide your capital and resourcing decisions?  To be focused and ensure proper execution, managers should have a list of 4-6 product and capability priorities needed for profitable growth.  And, ii) do the majority of your costs and resources line up against these priorities and capabilities?   

Asking these questions can illuminate a harsh reality. In many companies – particularly large, matrixed and decentralized ones – there is a poor connection between key business building priorities and spending.  This leads to inefficiencies and waste as well as under-investment in vital parts of the enterprise. When capital and management attention are finite, leaders must effectively and efficiently allocate capital to their key priorities. 

2.         Focus your cuts

Once a spend-priority misalignment is identified, the key challenge becomes where, what and how to cut – and where to reinvest for growth.  We have witnessed hasty executives radically cut costs at the same time carelessly damaging key competencies and hurting morale.  On the other hand, we have seen hesitant managers aim only for easy, superficial cost savings, ignoring the considerable amount of fat lurking just below the surface.

This is where SCR comes into play:  managers need to cut spending in areas that do not support growth-focused product initiatives and differentiating capabilities.  At the same time they should reinvest some of the savings in high potential, business-building programs. To find the waste and inefficiency, managers should take the costs that were not directly tied to identified priorities in step 1 (e.g., cross business/functional costs and expenses associated with non-priority activities) and then reallocate them against the same priorities and core capabilities to get a true read on costs. This can be accomplished by classifying spending into one of 3 strategic buckets. Of course, each firm will bucket their costs differently depending on their competitive position and strategic choices

1) Differentiating products and capabilities that drive support their unique value proposition and growth. Priorities like product innovation, analytics and brand development could make up 50% of a firm’s total cost structure.  These will often require more, not less, capital and resources than is currently deployed;   

2) Table stakes operations and competencies. Examples of these market ‘cost of entry’ activities include logistics, customer service and manufacturing.  They can often yield savings of 3-10% by area through operational enhancements such as Lean or strategic procurement.

3)  ‘Keep the lights on’ spending that is used to maintain operations. These cost centers (e.g., HR, facilities management, professional services) frequently have the ability to deliver up to 25% reduction in savings through far-reaching cost reduction strategies like outsourcing or performance cutbacks. 

This analysis can yield telling results.  We have seen organizations allocate 50% of their available capital to ‘keep the lights on’ activities yet spend only spending 20% of their capital against strategic and growth-focused initiatives.  On the other hand, we have seen careless firms expend 55% of their capital on multiple growth priorities (still under spending on each of them!) yet spend only 15% on competitive matching functions that support client retention and basic marketing.

To cut strategically, managers should focus cost reduction efforts against Bucket 3 areas that do not directly support growth, ensure customer retention or build market-beating capabilities. If more pruning is needed, the emphasis would move to non customer-facing Bucket 2 activities.  Leaders should be cautious not to mortgage the future by crudely cutting (optimizing is fine) Bucket 1 expenditures.  

3.         Consider business enablers

In many cases, firms with complex organizational structures, processes and policies will be challenged to cut costs, even with SCR and proven cost savings methodologies.  In these environments, leaders should consider more sophisticated cost reduction strategies such as complexity reduction, supply chain re-engineering or in-sourcing expensive outsourced functions.  Not only can these methods produce compelling cost savings, but they also can help accelerate program execution and further develop core capabilities.

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


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