Strategic Cost Reduction
WestchesterCounty and FairfieldCountyBusiness Journal - December 30, 2002
Dan Delmar
For many if not most companies, 2002 was the year of the cost-reduction strategy. Unfortunately, strategic cost reduction was rare. They sound similar, but are miles apart.
Cost reduction has been a common theme in many companies in order to deal with the recession and slowdown of the past couple of years. Layoffs were announced daily. Despite stagnant sales, some corporations achieved increased profits through cost reduction.
The most common approach to cost reduction is to make cuts across-the-board in all areas or in those functions deemed less essential to current results. While providing short-term profit improvement, this approach often undermines growth or even sustainable profit. Fewer people are asked to do the same total amount of work. This overstrains a work force that is demoralized by seeing their co-workers getting pink slips and distracted by insecurity about their own future.
Our economy is increasingly service oriented. Even manufacturing companies, (e.g., GE) are increasing their service component. Delivering services is people intensive, and cuffing people leads to poor service, which stunts demand and future growth potential.
Far more effective, in a strong economy as well as a weak one, is Strategic Cost Reduction (SCR). Strategy is frequently defined as the major resource allocation decisions of an organization: which product/market/geographic segments to invest in for. growth and which to use to generate current profits and cash flow. Thus, SCR involves making the tough choices about which product/market/geographic segments should have investment and/or expenses reduced or eliminated. The flip side is to decide which segments should have continued or increased investment for growth.
SCR is about focus. It requires focusing limited resources on fewer segments that are determined to be good opportunities and not pursuing other opportunities that are determined to be less attractive. SCR reduces expenses in a focused way, improving short-term profits by reducing some major expenses and investments. It also frees up some resources to invest in the best opportunities to increase the odds of success, future growth and profits.
SCR can be applied to a company that is losing a lot of money and in deep need of a turnaround. An example is a pharmaceutical company that was hemorrhaging money. A team of consultants that I led identified the client's root problem: their large number of ethical and over-the-counter products relative to their small sales force and limited marketing resources. By eliminating some products and focusing on their best product opportunities, they reduced selling costs 25%, increased revenue and achieved operating profitability within a year, with profits projected to double in the following two years.
SCR can be applied to a very successful business. A very profitable insurance client was comfortable with its strategy but was required by its parent company to undertake a strategic review. Over three intense months, my team performed an in-depth analysis of their customers, markets, competitors and costs. Through significant interaction and review with the management team, we convinced them to adopt SCR; to stop investing in a business segment in which they had been investing for several years, because we predicted that it would never be very profitable for them.
Complete strategy has at least two sides; both SCR and strategic investment. In the case of the insurance client, we also focused resources on their strongest business, convincing them that the business had continued growth potential. Two years later the client's profits were 23% higher than the previous high level, and the president was enthusiastic about how the strategic focus that we had brought them had been instrumental in their success.
A well publicized example of SCR was IBM's sale to Hitachi of its disk drive business. The operation was losing money, so selling it reduced costs significantly and improved profitability. At the same time, IBM was focused on its best opportunities and purchased PriceWaterhouseCoopers Consulting and Rational Software.
Why do companies use a blunt instrument such as across-the-board or functional cost cuts when they could use the surgical instrument of SCR, with less blood and a faster, healthier recovery? 1) Internal politics within a corporation leads to vested interests, creating a requirement for significant political fortitude and courage to shut down or sell a business. 2) The ethic of teamwork and shared objectives sometimes results in a desire to share the pain equally, undermining the need for focus. 3) Some management teams have not internalized the key strategic imperative; achieving market share leadership with a competitive advantage leads to higher profit -- therefore focus enough resources on a business for it to achieve leadership, or else exercise SCR. 4) Sometimes inadequate analysis undermines the perspective necessary to see where continued investment has low probability of providing attractive returns. These four drivers of organizational politics and limited strategic perspective by operating managemen t usually result in unfocused, broad cost cutting.
Some executives associate strategy solely with strategic investment for growth and long-term profits. SCR for short-term profit is the other side of the strategic coin. In today's economic environment, SCR needs to be elevated to be the top priority. It is the successful adopters of Strategic Cost Reduction who will outperform their peers to attain both short term profitability and higher long term growth and profits.
Dan Delmar, can be contacted at (203) 247-5777 or .
Citation Details
Title: Strategic cost reduction. (ViewPoint).(recession demands cutbacks)
Author: Dan Delmar
Publication:Westchester County Business Journal (Magazine/Journal)
Date: December 30, 2002
Publisher: Westfair Communications, Inc.
Volume: 41 Issue: 52 Page: 38(1)