Given the economic environment and increasing competitive pressures — factors that almost every company faces today — many are seeking to optimize costs, cut costs and improve profitability. Alas, cost optimization without organizational change will not create a sustainable cost advantage. The typical “ballast overboard” approach, which is usually used in the “sudden” onset of a crisis or recession, affects only the amount that makes up the costs, not what these costs are spent on. Costs almost always crawl up again after a threat has passed or diminishes, because the company’s resource allocation policy has not changed.
One of the most commonly chosen solutions, and often the only one for some reason, is to reduce personnel and its costs. As a measure to restore order and a tool to boost performance in the short term, this solution is quite effective. At the same time, it raises the question — why is the company overstaffed? In modern companies, the share of personnel costs rarely exceeds 20% (except for some retail, services and high-tech), so if you reduce staff by 10%, marginal profitability is unlikely to increase by 2%. Additionally, the decision to fire specific employees is made by line managers, and they are not always guided by the main goals of the company. In general, this typical approach to cost trimming leads to long-term losses.
Cost optimization is not about staff reduction
Instead, the right approach should reinforce a strategy that shifts 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 by a single top-down austerity order. It is a ongoing process that allocate limited resources to high-impact activities. To channel resources into the company’s unique abilities, you need to customize every aspect of your organization, from formal structures and processes to informal work habits and ways of thinking.
You can identify five key organizational elements in any company that are crucial to your ability to manage costs efficiently.
1. Big picture and benchmarking
Before a detailed analysis and cost decision is made, a good step would be to compare yourself with the industry leaders. It is useful to look at the costs of your company and similar in several ways to see the potential to reduce them. Cost optimization should not contradict your competitive strategy. You cannot simultaneously reduce costs in value-adding processes and continue to compete successfully. If you cut back, for example, on your sales staff without changing processes (i.e. without changing your strategy), you simply cut off, lose part of your business.
In a recent joint project with a European 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 and along with the focus on high-end products, and at the same time offers 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 (retail chain), where Sergey Galitsky created a unique supply chain. One of its key features is the storage of inventory “on wheels”. Indeed, why 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
The strategy execution requires a clear choice of what of the company’s opportunities should get more resources and what less. Once these decisions are made, leaders must make them clear to everyone in the organization. Several 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 staff 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 the planet”, focusing exclusively on markets where it could be number one or number two in efficiency. After he outlined the strategy for 500 top managers, he specified the respective 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 visits to GE plants and offices. Eventually, tens of thousands of GE employees learned these priorities and became guided by them in their daily work.
Traditional organizational structures can interfere with cross-functional interaction, which is necessary to focus resources on the company’s differentiation capabilities.
Departments and divisions are comparting staff and produce overcapacity, duplicate efforts and reduce the value of the 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 productive fruits of specialization, and ensure that the flow of resources is focused on top 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 service” model. This model is supposed to facilitate the exchange of functional resources throughout the company in such a way as to reinforce strategic priorities. In fact, the most efficient organizations with “public services” manage improvement processes by allocating resources based on demand, as in a competitive market.
Procter & Gamble had embarked on a market-oriented approach to “public services” more than a decade ago. Its global business services division provides accounting services, IT, procurement, and other corporate support services for various areas of the company worldwide. Unlike the “public services” divisions, which 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. As a result, quality growth and cost optimization have been sustained.
4. The way of thinking
In your entire organization employees make thousands of decisions every day about how to spend time, attention and money. Taken together, these decisions will determine whether your company’s key capabilities have the resources to become a 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 agree on a way of thinking with strategic priorities, people will continue to make choices about how to allocate resources without taking into account the strategic priorities that support your company’s competitive capabilities.
Techniques such as zero-based budgeting and targeted investment policies can help by making managers think about how each cost decision strengthens their unique competitive advantage. More powerful is the personal example of top managers, who are shaping a new approach to resource allocation. Employees who watching the directors who prioritize the company’s competitive advantage will follow suit and implement your new approach to costs at the level of daily work.
Few companies have been as successful as Toyota in fostering continuous improvement in thinking through staff involvement. Each employee, from the director’s office to the factory floor, is responsible for the following 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. As part of this responsibility, every employee has the right to suspend or even stop the entire production process when they notice quality problems. 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” production system a benchmark model of efficiency that is emulated by manufacturers around the world.
5. Decision making rules
The success of a well-designed strategy depends on timely and informed decision making. The right decisions will strengthen the company’s capabilities, and strengthen the strategy. Incorrect decisions can undermine the competitive advantages you are trying to build. Chances of making the right decisions more often will improve if the right people authorized to allocate resources. In general, a place for decision-making should be as close as possible to your differentiation opportunities, i.e. the competitive advantages that distinguish your company from your competitors. This gives you the speed and flexibility to make important decisions and implement them before the opportunities disappear.
For example, companies such as Nordstrom2 and Ritz-Carlton, which are differentiated 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 expand the capabilities of regional marketing units to make the brand more relevant in each market. A similar principle guides the Euroset (mobile shop chain), giving the opportunity to use local marketing tools in each region. Industrial companies such as Caterpillar or DuPont, with their strong manufacturing capabilities, are expanding their decision-making rights deep down the supply chain, where resource decisions directly impact 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 confident that resource decisions made every day at all levels of the organization will increase the company’s differentiating capabilities and create real competitive advantages. Difficult times in the economy are a good reason to start working on long-term benefits. It’s 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 earlier. And the more so, it does not come down to just 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