Achieving True Cost Transformation
Suppose your business is facing significant competition from traditional and non-traditional competitors. Demand for your company’s products and services is tepid and customers are deserting you. Revenues are in sharp decline and the impact is beginning to show in shrinking margins.
To increase revenues and alleviate shrinking margins you try to cross-sell and up-sell your products and services, but all your efforts are in vain. You ultimately decide to embark on a company-wide cost transformation initiative.
Do you cut back on equipment investments, reduce marketing and IT spend, sell some of your business assets, lower inventory levels, lay off certain employees, freeze salaries, shrink transactional administrative costs or eliminate all cosmetic travel and training?
Although the above cost reduction measures are all necessary, they are basically short-term wins which are difficult to sustain in the face of new technologies, changing customer expectations and increasing competition from new entrants and other disruptors.
Cutting costs for the sake of it
Many organizational cost transformation initiatives fail to deliver lasting gains because they are often implemented in isolation without the context of the broader strategy of the business. You need to understand that cost transformation is not simply a matter of cutting costs randomly.
Rather, gainful cost transformation is linked to strategy and drives the effective execution of that strategy. In my experience, I have realized that majority of cost initiatives are more inward focused and less outward focused.
It’s all about increasing the bottom line as opposed to making sure the business remains competitive. More backward-looking and less forward-looking.
Because cost management is misaligned with business strategy, there is little focus on generating capital to fund strategic growth initiatives or diverting resources from low performing business units or unviable markets towards higher value and return opportunities.
Partly to blame for this misalignment is lack of understanding of strategy by employees across the organization. As a result, employees are unable to distinguish necessary costs (essential to meet customer expectations and deliver the organization’s value proposition) from unnecessary costs.
That is why it is important employees across the organization have a clear understanding of the strategy of the business, its objectives and how these will be achieved, including the costs.
The devil is in the detail
Given that there are necessary and unnecessary costs, implementing across the board cuts will only yield marginal gains. Ultimately, high performing business areas or markets end up badly impacted because of such mediocre management decisions.
Instead of channeling resources towards investments, projects and markets which matter, or customers who matter, lackluster business performance areas may receive more than their fair share of limited resources.
To obtain customer, product or channel profit visibility and optimize costs, it’s important to understand the key drivers of each. Implementing activity-based costing principles and techniques (Beware of Misguided Accountants – A Case for Improving Your Costing System) can help you answer any cost transparency and visibility questions you might have.
For instance, basing cost reduction decisions on consolidated gross margin alone obscures the reality that your business is actually making losses on particular products, customers or in certain markets.
You therefore need to drill down and understand the costs-to-serve each customer, service line or product and their drivers. This will in turn help you explain why costs are unnecessarily higher in certain business areas and make informed decisions.
Thanks to advances in technologies, companies are now able to leverage advanced analytics to analyze customer, product, market and channel data and generate insights into costs and where savings opportunities exist.
Use it or you will lose it
The “Cut first, then plan” culture is prevalent in organizations that are yet to break free from the shackles of the traditional annual budgeting process. For example, during the financial year, business unit managers underspend their budget allocations. However, towards the end of the year, to avoid losing the unused budget allocation in the forthcoming year, they willy-nilly spend the funds resulting in unnecessary costs. These funds could have been deployed somewhere for profitable return.
Unfortunately, such scenarios do little to transform the cost structure of the business and transition to a value-based model.
To avoid the culture of “use it or you will lose it” spreading over, leaders need to foster a culture of accountability, performance reporting and continuous improvement.
Hence the need to align cost transformation initiatives with strategy. Cost reduction targets must clearly be defined, both at enterprise and business unit levels, then hold leaders accountable for achieving performance improvement goals.
It’s therefore imperative to educate employees on the future financial needs of the business. They need to understand the costs that really add value in your business, and those that don’t.
Cost transformation is not a one-time initiative. Instead, it is a continuous improvement approach for leaders seeking to transform the cost structure of their companies and deliver a sustainable business advantage.
This does not mean leaders should focus entirely on cost reduction efforts. You need to maintain an appropriate balance between achieving cost reduction targets and supporting necessary innovation and process improvements that drive effective execution of strategy and the ultimate success of your business.
Prioritizing cost optimization initiatives with only short-term goals in mind can cause unanticipated problems.
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