5 Reasons Why Many Cost Reduction Initiatives Fail

5 Reasons Why Many Cost Reduction Initiatives Fail

Most businesses are under extreme pressure to reduce costs while improving product quality and customer service. Developments in the global economy such as globalisation and advances in new technology have changed the traditional balance between customer and supplier.

Today, customers are spoiled with choices, meaning businesses need to be more customer-focused. They need to re-evaluate the value propositions they present to customers and find ways to capture value from providing new products and services.

Organisational support functions such as finance, procurement, information technology, sales, marketing and human resources need to collaborate to achieve organisational goals and objectives.

However, these support functions are often the focus of cost cutting. They usually have little contact with external customers and as such their contribution towards bottom line is viewed as indirect.

Support functions are critical for operating a successful business. For example, without an effective and efficient IT function, how would front-line workers be able to interact with customers, retailers and suppliers?

Companies need to be aware that cost cutting programs are not exercises where you randomly streamline services or headcount. If these cost reduction programs are not carried out properly, organisations risk damaging various stakeholder relationships.

This can ultimately lead to reduced employee morale, internal and external conflict.

So why do many cost reduction initiatives fail?

  1. When companies implement cost reduction exercises the cost savings are usually short term with higher costs reverting in the long term. Companies need to have a long-term perspective of their strategies and identify sustainable cost savings.
  2. Poor understanding of how staff and business functions to be made redundant support the business strategy. Frequently companies make the mistake of focusing only on reducing headcount as opposed to quality and product/service delivery.
  3. Lack of involvement of both senior and middle level managers. One of the conditions necessary for the successful implementation of cost reduction initiatives is executive sponsorship - otherwise managers and employees at lower levels will view the project as non-critical. There is also a need to have a “champion” to lead the cause and promote buy-in.
  4. Lack of ownership of the project because cuts are randomly applied without consultation. This often results in lack of commitment to sustain cost savings. Consultation and engagement is necessary to instill employees and other managers to a noble cause to which they are committed.
  5. Lack of performance measures to track implementation or reward systems linked to their delivery. Designing KPIs related to cost reduction initiatives provides a yardstick to measure and monitor current changes. Tying incentives to specific KPIs often motivates personnel and challenges them to go one step further and produce great results.

The goal should be to achieve cost reduction and improve margins without damaging service or damaging employee morale.

For cost reduction programs to be successful, companies should understand how each overhead area supports business strategy and contributes to the achievement of goals and objectives.

Assessing and evaluating the services provided by each support function and how they contribute towards the achievement of the entire business strategy is critical to a successful cost transformation journey.

Furthermore, companies must:

  • Understand their business environment and strategies. This is key to identifying areas that require improvement and evaluating the impact of suggested changes on long-term performance.
  • Conduct an activity analysis of their business support functions as this presents the cost-base for each department from an activity viewpoint.
  • Conduct customer reviews to identify areas of cost savings. This involves performing internal and external customer audits to establish how product/service offering can be improved. By doing so, companies are able to identify non-essential services or non-value adding activities. Customer reviews also provide a yardstick for comparing the cost of in-house services against equivalent third-party providers.

How else can an organisation strategically manage its costs and improve enterprise performance?

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