Cost Optimization in a Crisis: a Smart Way in Difficult Times

Given the economic situation, as well as the increasing competitive pressure – factors that almost every company faces today – many strive to optimize and reduce costs to increase profitability. Alas, cost optimization without organizational changes will not create a sustainable cost advantage. The typical “ballast overboard” approach, usually used in a “sudden” onset of a crisis or recession, affects only the amount that makes up the costs, but not what those costs are spent on. Costs almost always creep up again after a threat passes or diminishes because the company’s resource allocation policy has not changed.

One of the most commonly chosen solutions, and often for some puzzling me reason the only one, is to reduce personnel and costs. As a measure to restore order and a tool to spur productivity in the short term, this solution is quite effective. At the same time, it raises a question: “Why is the company overstaffed?” In modern companies, the share of personnel costs rarely exceeds 20% (except for some retail, services and high technologies), so if we cut personnel by 10%, the marginal yield is unlikely to increase by 2%. In addition, a decision to fire specific employees made by line managers, and they are not always guided by the company’s main goals. In general, this typical approach to cost optimization leads to a long-term loss.

Cost Optimization Is not About Staff Reduction, even in a Crisis

Instead, the right approach should support a strategy that involves shifting resources to activities that strengthen your ability to differentiate at the expense of activities that do not support it. This type of strategic cost management cannot succeed with a single order of austerity from above. This is an ongoing process, which directs limited resources to high return activities. To channel resources into the company’s unique capabilities, you need to tune every aspect of your organization, from formal structures and processes to informal work habits and thinking patterns.

Five Key Factors Affecting Cost Optimization

You can identify five key organizational elements in any company that are critical to your ability to manage costs wisely.

1. Big Picture and Benchmarking

It is a good step to compare yourself with industry leaders before making a detailed analysis and cost decision. It’s useful to look at your company’s costs and those of your peers in several perspectives to see a potential for reducing them. Cost optimization should not conflict with your competitive strategy. You can’t simultaneously reduce costs in value-adding processes and continue to compete successfully. If you reduce, for example, your sales staff without changing processes (i.e. without changing your strategy), you simply cut off, lose a part of your business.

In a recent joint project with a European consulting company, we analyzed the cost structure of a Russian heavy machinery company. Winkels has an unusually high performance due to the intensive use of outsourcing for semi-finished products along with the focus on high-end products, while also offering additional services for key products that seriously add value for customers. Focusing on a unique value chain and ruthless attitude to non-core costs allows the company to remain in the leaders in terms of profit margin.

A similar approach can be seen at “Magnit” (a national-wide retail chain), where Sergey Galitsky created a unique logistics chain. One of its key features is the storage of inventory “on wheels”. Indeed, why employ a warehouse for storing goods, if it is, in fact, only the costs – buildings, heating, access control, transshipment, working capital, … This approach allows the business model to avoid unnecessary costs and strengthen its competitive advantages, converting them into either a market position or additional profit.

2. Information Flows

A strategy execution requires a clear choice of which company’s opportunities should get more resources and what less. Once such decisions made, leaders must make them clear to everyone in an organization. A few statements “from the top” are not achieving the desired effect. Managers, starting with the CEO and below, should regularly and consistently support the decisions made, explaining the strategic goals and changes in organizational behaviour necessary to achieve them. As the understanding spreads, management and employee choices regarding resources will begin to reflect strategic priorities.

Jack Welch¹ demonstrated the power of information flows three decades ago when he intended to make General Electric “the most competitive company on earth”, focusing exclusively on markets where it can be the number one or number two in efficiency. After outlining the strategy to 500 top managers, he specified the relevant priorities in a series of monthly meetings with the company’s leaders. He broadcasted his vision statement in numerous speeches and brought it to the attention of ordinary employees on weekly factory and GE office visits. Eventually, tens of thousands of GE employees have learned these priorities, and became guided by them in their daily work.

3. Structure

Traditional organizational structures can interfere with cross-functional interactions that are necessary to focus resources on the company’s differentiation capabilities. Departments and divisions are comparting staff and generate redundancy, duplicate effort and reduce the value of performance. Each group has its own agenda, often at the expense of global corporate goals.

Only when people across the organization work together can a company eliminate duplication of effort, reap the benefits of specialization, and ensure that the flow of resources focused on strategic priorities. This will not happen without an organizational structure designed to encourage collaboration.

For many companies, one of the most popular solutions is to centralize support functions in the “public services” model. This model is supposed to facilitate the sharing of functional resources across the company in a way that reinforce strategic priorities. In fact, the most effective organizations with “public services” manage improvement processes by allocating resources on a demand-driven basis, as in a competitive market.

Procter & Gamble embarked on a market-oriented approach to “public services” over a decade ago. Its global business services business unit provides accounting, IT, procurement, and other corporate support services to various areas of the company around the globe. Unlike “public services” businesses that rely primarily on “service level agreements,” the P&G model achieves continuous improvement with methods such as pricing based on profit margin and annual performance indicators. The result is sustainable quality growth and cost optimization.

4. The Way of Thinking

Throughout your organization, employees make thousands of decisions every day about how to spend time, attention and money. Together, these solutions will determine whether your company’s core competences have been adequately resourced to become the real competitive advantage that differentiates your company from its competitors. For years, emerging assumptions, prejudices, habits and unwritten rules have at least as much influence as the CEO’s orders for such choices. If you do not align your thinking with strategic priorities, people will continue to make resource allocation choices without regard to the strategic priorities that support the company’s competitive capabilities.

Methods such as zero-base budgeting and targeted investment policies can help by making managers think about how each cost decision strengthens their unique competitive advantage. A stronger example is the personal example of top managers shaping a new approach to resource allocation. Employees who observe directors who prioritize a company’s competitive advantage will follow suit and implement your new approach to cost at the level of your daily work.

Few companies have been as successful as Toyota in nurturing continuous improvement in thinking through its people. Every employee, from the director’s office to the factory floor, is responsible for following the Toyota Way. This is not an empty slogan, but a codified set of principles that every Toyota employee is expected to apply on a daily basis. Within this responsibility, every employee has the right to suspend or even stop the entire production process when he or she notices a quality problem. In addition, employees are encouraged to suggest improvements in cost, quality, culture, productivity and any other aspect of the company’s life. Together, this continuously reinforced way of thinking has made Toyota’s Lean manufacturing system a reference efficiency model that manufacturers around the world follow.

5. Decision Making Rules

The success of a well-developed strategy depends on timely and informed decision-making. The right decisions will strengthen both company’s capabilities and a strategy. The wrong ones can undermine a competitive advantage you are trying to build. Your chances of making the right decisions more often will improve if the right people authorized to allocate resources. In general, the decision points should be as close as possible to your differentiation opportunities, i.e. competitive advantages that distinguish your company from its competitors. This gives you the speed and flexibility to make important decisions and implement them before opportunities disappear.

For example, companies such as Nordstrom² and Ritz-Carlton, which differentiates based on customer service, tend to give more decision-making power to employees who interact directly with customers and can meet their needs in real time.

Coca-Cola, McDonald’s, and others who focus on branding tend to empower regional marketing units to make the brand more relevant in each market. A similar principle guides the “EuroNet” (national-wide mobile shop chain), giving the opportunity to use local marketing tools in each region. Industrial companies like Caterpillar or DuPont, with their strong manufacturing capabilities, are expanding their decision-making rights deep into the supply chain, where resource decisions directly affect production efficiency.

Overall, the organization is the most powerful tool you have to strengthen a good strategy based on sustainable cost management. By using these key elements, you can be assured that resource decisions made daily at all levels of the organization will increase the company’s differentiation and create real competitive advantage. Difficult times in the economy are a good reason to start working on long-term benefits. It is important not to miss this moment.

Take the first step: create a cost optimization program

in which you can see the potential effect. And you will see that further painstaking work in this direction is not as frightening as it seemed before. And even more so, it’s not just about firing some employees.

1 Jack Welch, CEO at General Electric 1981 – 2001. During his time in office the company’s value has increased by 4000%

2 Nordstrom, U.S. fashion retail chain, above-average class, founded in 1901