Using cost reduction as a strategic transformation tool

Proactive cost management and reduction should be on the minds of all managers regardless of their financial situation – highly profitable companies can become more profitable and/or create headroom allowing investment that drives future growth.

However, cost reduction becomes most urgent when an organisation is facing significant profit compression, at which point many companies resort to ‘slash and burn’ tactics. In our experience, this might yield a few quick improvements, but often yields lower savings than a more strategic approach, and builds up other problems for the future.

With more than 25 years leading and delivering corporate restructuring and cost transformation programmes, we have identified three key characteristics of programmes that deliver the greatest profit and strategic improvements:

1. Follow a rigorous process: Understand and address the root causes of cost increases
2. Focus on rapid thematic improvements: Utilise top-down functional identification? of improvements as well as bottom-up idea generation
3. Initiate transformation: Use the cost reduction programme to deliver meaningful and lasting change

These guidelines are equally valid for successful companies seeking to increase their operating margins, as they are for those that are struggling (we would advocate a different approach, improvement levers, and specialist skills for those organisation in deeply distressed financial situations).

RIGOROUS PROCESS

A ‘quick and dirty’ evaluation of the organisation’s cost structure will always highlight a few areas of potential reduction, but will not identify the full set of improvements required to deliver a step change in performance. Too frequently, senior managers will use the exercise to pursue their own agendas, whilst protecting their personal fiefdoms.

It is imperative that the programme deploys a well-structured process to define the areas under evaluation and identify potential improvements – the individual steps will depend on the company’s specific circumstances and available resources, but will typically address five themes:

• Define the cost baseline clearly and be strict on any out-of-scope areas
• Understand the key cost drivers and assess the future trajectory
• Deploy a variety of tools and approaches to maximise idea generation and insight
• Use the strategic objectives of the organisation as a key guide to evaluate improvements
• Communicate to all stakeholders as part of the overall change management of the programme

Creating a well-defined cost baseline provides the teams and individuals pursuing cost reductions with clear guidance of which areas they should and should not be examining, makes it easier to quantify potential savings, and allows the business to track success. Rigorous criteria should be defined at the outset to determine any areas to be excluded from evaluations to avoid pet projects, ‘sacred cows’, etc. being protected, when these can frequently be the cause of rising costs.

As part of the initial set-up and analyses companies should evaluate why individual cost lines have changed over time: have the number of staff or individual salaries risen; is the organisation purchasing more units or paying more for each; was the purchase a one-off or recurring? Clarity on these factors can rapidly highlight improvements.

Prompting teams to think differently and challenge cost structures can sometimes be difficult and needs a different set of tools to identify the maximum savings. Lean manufacturing tools such as ‘8 wastes’ and ‘5 whys’ can provide new insights. Similarly, asking teams to identify ‘stupid rules’, excessive reporting, and other forms of bureaucracy can help to eliminate unnecessary activities and the associated costs.

Business strategy should focus on making decisions about where, how, and when to compete, and accordingly where to deploy capital and resources (perfect guides to identify and evaluate potential improvements). In our experience, many organisations develop strategies which are too broad, insufficiently focussed, and lack granularity thereby often leading to poor effectiveness and corresponding cost increases.

Even early rumours of cost reduction programmes can create significant anxiety amongst staff, customers, and suppliers. Clear, transparent, and honest communication about the cost reduction programme can help to minimise the adverse impact and be turned into an advantage. In many programmes that we have led, stakeholders will provide improvement ideas even if it puts their sales, or even their role, at risk.

Setting the programme up correctly from the start can help to ensure its success and lay the foundations for more significant transformation of the organisation as a whole.

RAPID THEMATIC IMPROVEMENTS

For an organisation facing profit challenges it is always tempting to jump straight into action and start brainstorming potential improvements. This can undoubtedly create momentum and engagement (at least for those invited to the brainstorming sessions), but frequently ends up with a piecemeal set of ideas, skewed by individuals’ prejudices and vendettas.

Whilst brainstorming has its place in any improvement programme, it is better incorporated into a more structured set of analyses rather than in isolation. Again, the precise thematic or functional workstreams to be pursued within the overall programme will depend on the organisation’s specific sector, business model and circumstances, but areas that we have seen deliver substantial and fast improvements include:

• Business portfolio review
• Network and footprint optimisation
• Operating model analysis
• Lean review of ‘production’ areas
• Digitisation and automation
• Strategic procurement

Although organisations should be evaluating their portfolio as part of their corporate and business strategic planning processes, it sometimes takes additional prompts and pressures for them to consider major changes that can streamline the business. During one restructuring programme we led, two business units were identified as non-core and were successfully divested, thereby creating focus within the business, yielding additional cost savings from management delayering, and generating cash from the sale.

Similarly, cost reduction programmes can lead organisations to evaluate their operating footprint with a higher degree of rigour than they might apply during ‘business as usual’, and should cover all facilities – offices, warehouses, depots, and factories. This evaluation can yield significant savings if underutilised sites and facilities can be released, particularly as the organisation increases its focus. During one programme we closed the standalone North American headquarters of a company and consolidated the activities into another facility which was much closer to key customers. This led to more satisfied customers and improved relationships between them and the business.

An organisational review is normally a key component of most cost reduction programmes, but is frequently pursued with insufficient rigour and can lead to ongoing disruption within the business long after the programme has finished. The key to truly transformational organisation change is to focus on the underlying activities and deliverables, rather than the individual roles, and to seek to identify inefficiencies and unnecessary work at that level. Once removed, the corresponding roles can be freed-up yielding substantial cost savings without overburdening the remaining positions within the business, and actually making them more effective.

The use of Lean Manufacturing tools to prompt idea generation has already been mentioned, and their application can be extended to rigorous analysis of all major ‘production’ areas – we use this term to describe all parts of the organisation where there is a high-level of intense activity and can include back-office functions, call centres, and other processing functions, in addition to the classic manufacturing and supply chain areas where Lean tools are most commonly deployed. The savings can be substantial as well as improving the underlying efficiency and effectiveness of core processes, and identify sustainability improvements, as covered in a previous article.

This form of process analysis frequently highlights areas for digitisation and automation (physical and virtual). In the past, rapid cost reduction programmes have avoided evaluating digital tools, but with recent innovations and advances, including artificial intelligence (AI), these can now be deployed very quickly and effectively.

Another area which is often deprioritised due to perceived complexity and time to analyse, is the supply base. However, a structured review of procurement and supply chain can deliver substantial savings, release cash, and provide more far-reaching benefits. These benefits can be yielded quickly if pursued with pace and rigour – developing insightful sourcing strategies for major spend categories elevates the discussion beyond simple requests for price reductions, which frequently fall on deaf ears.

Assessing the organisation’s cost base at a more strategic level and using structured frameworks and tools can turn a tactical cost reduction programme into a strategic transformation tool.?

INITIATING TRANSFORMATION

The implementation of the changes arising from a major cost reduction programme will inevitably cause disruption within the organisation (and if it doesn’t, then maybe the changes have not been sufficiently far reaching) – switched-on companies use this disruption to unlock the organisation and set themselves up for long-term strategic success as well as enhanced profitability.

There are several key success factors which the most transformative organisations deploy to deliver the greatest level of positive change. These include:

• Set stretching targets for the programme
• Challenge the status quo
• Focus on removing waste
• Build a continuous improvement culture
• Engage staff

In common with many change programmes, organisations frequently set their targets for cost reduction programmes too low – if a 5% improvement closes their profitability gap they might target this improvement, but it will not prompt transformational thinking, and may well fall short overall as the business looks for evolution rather than revolution. Setting stretching targets of 20% or even 30% can spur new ideas, and in our experience, these stretching targets are frequently achieved. Similarly, by setting its sights high, the organisation avoids having to go back for another round of cost reductions in the future – the dreaded salami slicing. One organisation we encountered was renowned internally for reorganising every 18 months, as improvements failed to stick.

‘Doing the same thing over and over again and expecting different results’ is a frequently used definition of insanity (often wrongly attributed to Albert Einstein), but remains a behaviour demonstrated by many organisations. Breaking out of legacy ways of working and truly challenging the status quo is one of the key ways to deliver major steps forward in performance, particularly when they have led to the organisation being burdened by excess costs. Such an expansive mindset needs to be a key part of a major cost reduction programme.

A major fear of staff during cost reduction programmes (and other poorly structured transformations) is that they will just be asked to work harder without any fundamental change in what they are being asked to do or to deliver. This can be avoided by looking to remove ‘waste’ and inefficiencies, enabling individuals and the organisation as whole to work smarter and be more effective.

The initial focussed activities and breakthrough mindset during the cost reduction programme can be used as a starting point for a more enduring change programme and as an important signal of change to the organisation. Training and developing staff in the core cost reduction techniques and frameworks at the beginning of the programme will not only contribute to its success, but also act as the basis for ongoing continuous improvement activities, which can help to embed the identified improvements, prevent the organisation from falling back in its cost competitiveness, and identify further savings opportunities to move the company forward.

All major transformational initiatives require the commitment and contribution of staff, and this is particularly true for cost reduction initiatives due to their intrusive nature, broad impact on the organisation, and the anxiety they can engender. Creating true two-way communication and engagement can establish the optimum environment to get the highest levels of contribution from all involved. Even when staff have to be released through the process as part of cost reductions, it is important to treat them fairly, with respect, and provide appropriate support. We have been involved in programmes where staff have acknowledged how well they have been treated and leave without a sense of resentment. This in turn is reflected in positive impressions by their colleagues who remain.

By proactively using the cost reduction programme as the start of broader transformation and structuring activities, organisations can turn what can be a particularly difficult period into a positive experience and a starting point for longer-term sustained improvements.

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With the current sociopolitical and economic uncertainty, cost reduction programmes are likely to be a necessity for many organisations in the short to medium-term; even highly profitable organisations will (or ought to) be seeking to shore-up their profitability.

Leading the cost reduction in the right way can deliver significant profit, cash flow, strategic, and cultural benefits. If you would like to discuss how this could be addressed for your organisation, to think through potential options for which initiatives to pursue or to plan your approach, please get in touch at [email protected]

Emery Quinn Smart Sustainability ltd #CostReduction #Transformation #BusinessStrategy #OperatingModel #StrategicProcurement #ChangeManagement

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