The pitfall every leader undertaking a cost program should avoid

When industrial goods companies have to reduce costs, they often hit the “easy button.” They cut travel and expenses, reduce R&D, stop hiring, and launch voluntary separations. They hit pause on strategic initiatives, even projects with a clear near-term payback.?But this turns out to be a pitfall. Those actions may help a company’s quarterly earnings in the short term – but come back to haunt them later.

Why? Pent up demand means after a time costs come roaring back. Leaders need to visit their teams in person, so travel explodes. Cutting projects in R&D hurts growth and creates a bigger backlog. A hiring freeze means missing out on great talent. When hiring resumes, recruiters are overloaded attempting to fill a backlog of open positions. During a period of cost consciousness, a company’s business can suffer from lack of investment in strategic initiatives with a strong payback that lay the groundwork for sustained competitive advantage.

There is a better way. Based on BCG’s research and work with industrial goods companies across North America, we believe that taking a strategic, balanced and outcomes-based approach to cost management can efficiently and effectively transform an organization’s business for both near-term gain and long-term advantage. And the results can still be quick, but they will last.

A sustained, structural cost reduction approach?

The outcomes-based cost management approach we recommend doesn’t ebb and flow with the crisis of the day.?It starts by linking cost reduction goals to objectives for strategy and growth. The next step is creating a clear picture of structural costs, the recurring costs that enable a business to operate, and tying cost reductions to specific actions that can be sustained over time. An appropriate portion of cost savings is set aside to be reinvested into growth initiatives. C-suite leaders are able to monitor cost management progress because back-end governance is set at the beginning of the process that delineates cost avoidance from structural cost reduction.

Based on our experience, industrial goods companies commonly take some or all of the following six steps to produce structural cost reductions. They:

• Use zero-based budgeting to reduce work and streamline management overhead. They analyze data as the basis for rethinking resourcing needs, management overhead and the underlying work that really needs to get done rather than applying an incremental reduction to what exists today.
• Analyze product cost. They reevaluate every aspect of their products, including design, features, and options, and draw from customer feedback to determine which elements generate sufficient value to keep and which could be simplified or minimized to reduce costs.
• Adopt agile ways of working and digital tools in R&D. Modern methods reduce R&D costs by increasing productivity, helping engineers do more with less – especially in areas such as software development and new product launches – without sacrificing critical programs that drive growth.
• Take a 360 degree approach to procurement spending. Involving C-suite executives and senior leaders in discussions with top-tier suppliers creates a more strategic dialogue, identifies win-win opportunities, and helps secure beneficial long-term agreements – all of which can improve savings.
• Apply digital technologies to augment lean manufacturing. AI and other advanced technologies can generate additional value in areas such as production scheduling, supply chain monitoring, predictive maintenance, equipment effectiveness optimization, and labor productivity.
• Perform a holistic assessment of the manufacturing and supply footprint. Companies become more resilient and improve their cost structure by adopting a “market-back” approach that uses the end market as a starting point for designing a comprehensive manufacturing and sourcing footprint strategy, as my colleagues and I outlined in a recent ?article on global manufacturing trends.

One industrial company’s cost management success

A structural cost reduction approach sets industrial companies on a path toward a sustained completive advantage. We have seen industrial goods companies that apply the actions I described reduce their total costs base by 10% to 30%.

One industrial manufacturer we worked with recently had undertaken a cost program. The program yielded short-term savings. However, over time, those reductions were offset by cost increases that dwarfed the original savings.??

We helped the client prioritize and focus on structural reduction opportunities, including pulling of the levers from the list above. Today, the company’s margins are among the best in its industry, allowing its total shareholder return to outperform that of its peers.?

Given the current macro environment and economic uncertainty, more C-suite leaders are focused on managing costs to better allocate scarce resources to fund elements critical to growth and business transformation. With the 2024 budget planning season upon us, it’s an opportunity to optimize your company’s financial fitness, enhance essential functions, and minimize wasteful expenditure so you can direct valuable resources to where they matter most.?

***

BCG’s integrated approach to effective cost management rapidly identifies the deep-rooted issues affecting an organization’s cost structure and implements customized, industry-specific initiatives to revitalize performance and enhance value. Click here to learn more about our capabilities and impact.