Cost cutting, cost reduction, consolidation or cost management have become central planning topics in all competitive markets. An established company in a maturing market is likely to see the best return from investments in cost cutting – but this has to be balanced with investments that will grow the top line – typically a mixture of selling more to existing clients (market penetration) finding new clients both locally and internationally (market development) and creating new profitable products and services (product development). This mix of strategies has been referred to as the golden circle:
Consolidation improving cash flows which can be used to invest in building profitable sales in existing markets (market penetration);
More profitable home market sales enabling investment in the existing product/ service mix in new markets (market development);
More profitable sales in home and new markets enabling investment in new products and services which can then be transferred to existing distribution channels (product development).
The temptation is often to look for major, single solutions – with the obvious “nuclear” option of outsourcing, and/or dramatic cuts in personnel. This has surface advantages, but often creates crucial competitive problems. The main areas of concern are:
The impact on core competence;
The decreased speed of response to market demands;
Increased problems of quality control;
Vulnerability to supplier default.
Often companies by attempting to make big changes miss the advantages of applying a continuous cost management discipline. Such a continuous cost management programme is a key component of risk management as it provides a mechanism for improving high risk components. It is also an important driver of competitive advantage.
Research suggests that those companies that integrate a cost cutting program into the DNA of the enterprise by insisting on a continuous stream of mini-projects in each operational area are those that succeed – it appears to be the total number of initiatives that is the most important element.
Continuous cost management as part of planning
An understanding of what potential cost savings exist is a limited part of the problem; the major barriers (at least 75% are organizational). Individuals initiate change and organizations prevent it from happening.
A step by step approach will create an environment where cost management is continuously incorporated in company decision making. The most important elements can be summarized below:
Leadership. Commitment from the top for cost management is essential, with personal example counting most. There is little incentive to chase a fairly significant but not large item when the CEO is being driven in a diamond encrusted luxury car.
Senior management responsibility. Supervision of cost management initiatives is essential and should be a rotational responsibility within the senior management team. The added advantage of this supervision is the identification of potential within the enterprise for succession planning.
Temporary staff. High temporary staff ratios reduce the potential for effective cost management and overall productivity.
Labour turnover. High rates of labour turnover reduce the ability of the organization to plan long term and effectively manage projects, with a considerable impact on cost management programmes.
Outsourcing dependency. Outsourcing may have a contrarian effect on cost management. Where there is a wealth of suppliers and the goods or services are low down on the value chain, outsourcing will have a beneficial effect on cost management (subject of course to quality considerations). Where the number of suppliers is limited, and the goods and services are high up the value chain, the ability of the enterprise to control costs will be correspondingly limited.
Recruitment. Diverse groups have been shown to accept change more readily; be more objective, and bring wider experience to decision making. Recruitment policy will therefore have a substantial impact on cost management programmes.
MBWA/Random inspection. Inefficient practices grow and prosper with time. Regular reviews by senior management identify those aspects of the enterprise that require attention, many of which will lead to significant savings.
MBO. All cost saving programmes (apart from the most minor) should be considered as projects with risks and returns identified through project management and investment appraisal techniques. This will enhance the ability to deliver on time, on budget and on specification.
FCF emphasis. A strategy that generates free cash flow will enable the enterprise to take advantage of cost cutting initiatives when and where they become available.
Internal competition. The existence of a system of internal competition through which individual knowledge centres or SBU’s can pitch for additional finance for specific projects will further drive the potential for intrapreneurial activity aimed at cost reduction.
Bonus systems. Bonus systems linked to gross profit, return on capital employed and at a knowledge centre level the achievement of fixed cost budgetary targets will provide additional assistance in driving cost improvements.
Deferred compensation. Cost management programmes pay off over long periods. Emphasising equity and deferred payment within bonus arrangements ensures that long term commitment to cost management programmes are improved.
Fringe benefits. Certain elements of fringe benefits such as the provision of a canteen and the encouragement of informal groups have been demonstrated to encourage the discussion of inefficiencies in working practices.
MIS. Performance needs to be monitored and reviewed, data needs to be collected and organized so that these reviews can take place.
Planning/monitoring. A comprehensive business plan will link all the divergent elements of the business together and provide the essential overview of where management and staff should be concentrating their activities to improve overall performance. Creating a knowledge centre system with devolved responsibility for cost management and regularly reviewing successes, failures, lessons learnt as part of the plan will significantly improve cost management.
Key projects. Within the overall plan, the identification and management of key projects by each knowledge centre will incorporate cost management programmes.
Key costs. Within the overall plan, the identification and management of key costs by each knowledge centre will incorporate cost management programmes.
Prioritization. Within the overall plan, the identification and management of key priorities will focus the enterprise on the most important activities for the next planning period, which will often include cost control.
SBU orientation. Small self sufficient units provide the best framework for managing costs and delivering enhanced performance.
Vertical tribe. Grouping the SBU together will improve potential performance and smooth cost cutting initiatives.
Knowledge centres. Focusing cost control on individual knowledge centres within the enterprise supports the wide application of cost management concepts and projects.
KPI/Benchmarks. The inclusion of key performance indicators and benchmarks within the monitoring system on a knowledge centre by knowledge centre basis will identify those operating criteria most in need of attention.
Trade-offs. Focusing the knowledge centre on trade-offs within their operational areas will improve awareness of potential improvements in operating efficiencies.
Budget. The budget methodology used by the enterprise will have a substantial impact on the effectiveness of cost management programmes. Experience suggests that rigid budgeting is counter-productive while the concept of “beyond budgeting” is too lax. The middle ground of fixed cost budgeting by knowledge centres appears to be the best option, especially as fixed costs make up the bulk of the cost environment in the majority of organizations.
Quality circles. The formation and maintenance of quality circles within each knowledge centre will drive the identification of improved cost management.
Training. Structured induction, maintenance and development training can all incorporate cost management components as part of personal development programmes (PDP) and succession planning. The more highly skilled the team, the greater the ability to manage complex and longer term cost management programmes.
Creativity. Improved problem solving abilities within the enterprise will generate greater numbers of alternatives to a range of problems including cost management.
Mentoring. Well organized mentoring improves links within the enterprise and the transfer of ideas.
Standard operating procedures. Standard operating procedures in themselves often provide major cost management solutions. They also provide a usual framework to continually review cost and the impact of decisions on cost.
Digitization. Once the standard operating procedure has been successfully used for a period of time, full scale digitization of the system will further drive cost savings.
Ideas day. A regular ideas day will provide external validation of company operating procedures and the ability to review whether other company initiatives (whether a direct competitor or not) have value for cost management initiatives.
Employee suggestion scheme. Research indicates that an employee suggestion scheme, when properly administered can provide the most cost effective route for the generation of cost management concepts.
Exhibitions. Innovative companies attend more exhibitions than their less innovative competitors, suggesting that exhibitions provide a valuable external view of current enterprise operations.
News circles. The creation and maintenance of a news circle listing ideas, maintains a data bank of cost cutting ideas for immediate or future implementation.
Zero based budgeting. An extreme cost management solution is to start from a zero position in the analysis of costs and revenue.
Integrating cost management into the knowledge centre
Planning and control should be focused on the knowledge centre within the strategic business unit as the prime driver of bottom up planning.
Integrating five cost related components into the development of the plan encourages members of the knowledge centre team to be more entrepreneurial in their management of cost:
The identification of trade-offs as part of the plan encourages an understanding of investment return and options within the cost environment;
Key cost base management within the knowledge centre demands that the team understand how to manage large (normally fixed) cost lines;
Budget control (and budget ratio as a KPI within monitoring of knowledge centre performance) linked to part of the knowledge centre bonus system has a further impact on how specific costs are managed at an operational level;
KISS (keep it short, simple) and SCORE (simplify, cut, operational excesses and redundancies) is reviewed as part of the development by the knowledge centre of their departmental plan);
Project control (and project ratio as a KPI) ensures that significant variable expenditure is also identified and properly managed.
Building a data bank of cost cutting ideas
Each industry will have different cost structures and opportunities, but there are many common ideas that work across sectors and countries. Ibis had identified over 500 possibilities for reducing cost and improving productivity by the end of 2015.
Some examples of this long list illustrate the opportunities that companies have to cut costs and reduce the requirement for major surgery.
Voice over Internet Protocol (VOIP). The growing penetration of broadband availability within most organizations, has made VOIP an obvious method for cost management. Companies that have implemented this technology have seen telephone costs dive – savings of 40-60% are common – especially in those companies with heavy long distance voice traffic.
Open source software. The increasing sophistication of open source software has made this a more and more viable option. Research suggests that IT costs can be significantly reduced by adopting this approach – with savings through licence costs, but also through a major reduction in maintenance – more than offsetting the higher initial training costs. One survey suggested a 50% reduction in such costs – though experience suggests that it is lower in most organisations.
Improving meeting management. Surveys suggest that supervisors and managers spend an average of 10% of their working life in meetings – where many spend their time thinking of holidays and leisure. Introducing a SOP to improve meeting management has a dramatic effect on productivity – not only at least halving the time spent in meetings, but also making meetings themselves more effective.
Recruitment appraisal. Treating recruitment as an investment appraisal technique can dramatically reduce labour overhead costs. With an average 7% annual staff turnover, enterprises can improve productivity on a step by step basis using this methodology.
Bonus systems. Focusing the bonus system on the overall company objectives defined within the balanced scorecard has been shown to significantly increase long run profitability.
Service provider contracts. There are often significant advantages in entering into medium term contracts with service providers for power, water, waste management, insurance, cleaning, security, telecommunications, or facilities management. First they focus the enterprise on defining exactly what level of service is required. Secondly they enable competitive quotes to be gained from a variety of potential providers.
Special units. Many centralised organisations or enterprises create more and more special units as a solution to specific problems. Their effectiveness is often limited; they are resource intensive; they cause major monitoring problems, reduce personnel flexibility, and they often are a source of major conflict within the rest of the enterprise. Transferring all the functions of the special unit(s) back into the strategic business units and their constituent knowledge centers will enable the enterprise to focus its service at the operational level and to achieve major cost savings. Specific and major problems can then be addressed by the creation of teams from several strategic business units, which also has the advantage of management development for the team leaders.
Web usage management. The growth of social media has led to an increase in web misuse during office hours. Incorporating acceptable web usage practice within the code of conduct (best suggestion is to limit private use to mid day break period) and monitoring web usage with relevant software has been shown to significantly reduce misuse and improve productivity.
Ideas day. A regular ideas day, when both ideas from suppliers (existing or potential) and from within the company will add to the existing employee suggestion scheme (itself one of the most valuable cost cutting tools any company can introduce) can be combined. Short presentations (twenty minutes at most) allow for 12-15 ideas to be presented to company management in a morning session. Returns from such sessions are impressive – as well as providing a training ground for presentation skills for company employees.
Standardization review. A regular company-wide review of standardisation options will provide valuable cost saving ideas – from components, raw materials, vehicles, to operating procedures.
White floor tiles. White floor tiles reduce lighting requirements and reduce cleaning costs.
Diesel/hydrogen mix. For large fixed diesel units, the incorporation of low levels of hydrogen into the fuel feed through electrolysis systems has been shown to improve fuel efficiency.
Car park conversion. Roofing car parks with solar panels and water collection pipes will provide substantial returns.
Reverse engineering. Identifying in detail how competitive products and services are delivered can yield valuable ideas for future development.
Flight booking. Research suggests that the cheapest flights are available on a Tuesday and that prices are lowest overall 53 days before flying.
A worked example of how the Ibis approach is applied is available as part of a model business plan download.