The list of challenges facing corporate leaders today is lengthy. It includes globalisation, rapidly shifting market dynamics, fallout from the European debt crisis, and a potential economic slowdown. Companies will also be faced with unexpected turbulence, whether in the form of adverse changes in their business or the arrival of tough new competitors. All this makes it critical for corporate leaders to scrutinise the cost side of their income statement.
It is typically not enough to slash costs through short-term measures such as squeezing suppliers, shuttering facilities and reducing headcount. What is required is to move away from endless rounds of cost cutting and toward true cost excellence. The steps presented here centre on reducing costs in an intelligent and sustainable way. Frequently, these steps also result in other benefits, including increased transparency, improved accountability and policies that prevent a reversion to old, unproductive practices.
These improvements help companies become more agile and less vulnerable to the impact of unfavourable economic forces — a fact that is not lost on investors. Companies with a low cost base, measured by selling, general and administrative (SG&A) expenses as a percent of revenues, tend to generate higher levels of total shareholder return. Our exhaustive analysis across numerous industries consistently finds this inverse relationship to be true.
Six steps to deliver cost excellence
To achieve true cost excellence, companies must improve efficiency and effectiveness. Efficiency is the effort or cost of producing a company’s product or service; effectiveness is the degree to which the product or service produced meets the needs of the customer. Six critical steps can enable companies to deliver significant, and lasting, cost reduction.
Step 1: Build consensus and commitment on scope and goals. Ensuring that company leadership and top management are in agreement about the need for and commitment to change is crucial for success. To secure agreement, management must clearly define the goals of the program, with firm, measurable targets whenever possible. The scope of the effort – the business units or functions that will be included – must also be clear, as well as specific cost-reduction measures that are a ‘must’ or a ‘no go’.
Then, management must decide when and how employees will be involved in and informed about the program – and how their participation will evolve over time. This means establishing clear rules for how the process will move forward and providing a steady flow of information about the program’s progress.
In addition, a compelling message explaining why the effort is critical to the success of the business must be crafted and communicated to all stakeholders.
Step 2: Select the right methodologies. To determine how cost reduction opportunities will be identified and quantified, companies can select from a number of well-established and standardised methodologies as well as the wide variety of tools available for executing them. The trick is to tailor that mix of methodologies to meet the goals and scope of a cost reduction program and a company’s specific needs and challenges. Two major factors in this determination are the industry sector and the type of expenses that are on the table. The company’s culture, the urgency with which cost savings need to be achieved, and the way in which management wants to drive change – through a centralised or decentralised effort, for example – will also lead to the selection of the right methodologies.
Step 3: Determine how efficient and effective the organisation is and set targets for change. With the methodologies and tools selected, the in-depth diagnostics start. Take the case of personnel costs. A common methodology for analysing personnel costs is ‘activity-based optimisation’. This involves studying what tasks people actually do, which is quite different from studying how work appears to be handled based on the company’s organisation chart. The results can then be benchmarked against those of competitors, comparing, for example, what percentage of the total workforce is allocated to each function.
Examining how the organisation is structured and how employees are managed also reveals opportunities to take out layers, adjust pay levels to more accurately reflect the degree of responsibility held by managers, and rework the title structure – all of which help improve efficiency.
Finally, there is the issue of effectiveness – the value that a department, function or operational unit adds. This examination can typically be done by asking the customers of a unit to assess how good that unit is at delivering its product or service, examining ‘functional KPIs’, and benchmarking the results against competitors and comparable companies.
As management studies the business along these parameters, critical deficits emerge – information that management then uses to create a comprehensive list of targeted changes. Such targets will typically include quantitative goals, measurable directly as KPIs, as well as secondary, often qualitative, goals, such as driving faster decision-making within the company.
Step 4: Develop a plan to hit the targets. A bottom-up process is the best way to generate ideas about how to deliver the program’s quantitative and qualitative goals. As part of this effort, managers and employees further down in the organisation outline concrete initiatives that will allow them to hit the targets.
Creating such initiatives is often best achieved through a series of workshops during which managers and employees work out the details. When a process involves several divisions or functions, valuable instruments include value stream mapping, a technique used to analyse and design the flow of materials or information across multiple groups, and kaizen workshops, which involve employees from all affected divisions and functions.
Defining detailed measures is also crucial for successful implementation. Measures should quantify the savings to be generated, the impact on cash flow, costs – such as severance – related to any reduction in headcount, and any investments that may be necessary to accomplish the change. Milestones that outline a measurable outcome and a date for hitting that target should also be set.
Step 5: Drive the implementation of the changes. It is critical to keep the organisation focused on completing discrete components of the plan. Therefore, all measures and milestones should be combined in one comprehensive execution plan so that each can be tracked and steps can be taken to address setbacks, shortfalls in cost savings, and delays. A central project-management office (PMO) frequently monitors the implementation, ensuring there is one central group that has the right tools to keep the effort on track and that has a process for correcting problems.
Step 6: Make the change sustainable. Old habits are often cemented in a company’s processes and can reverse hard-earned progress. But there are ways to make the changes stick – ways specific to each company’s circumstances. For example, manufacturing and service units can establish mechanisms for closely tracking certain critical KPIs. And incentive compensation systems can be changed to drive higher quality.
A corporate transformation
The six steps presented here require an investment of time and resources from senior management. This process is not a simple one but rather a sophisticated approach that aims not only to reduce costs but also to transform companies on every level. In an era of great turbulence and uncertainty, such an approach is more critical than ever.
Gregor Gossy is a principal, and Seungwook Oh and Reinhard Messenboeck are partners, at The Boston Consulting Group. Mr Gossy can be contacted on +43 676 579 7331 or by email: email@example.com. Mr Oh can be contacted on +82 10 4761 4917 or by email: firstname.lastname@example.org. Mr Messenboeck can be contacted on +49 170 334 1244 or by email: email@example.com.
© Financier Worldwide
Gregor Gossy, Seungwook Oh and Reinhard Messenboeck
The Boston Consulting Group