Cost Reduction By Mandate

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Seven out of eight companies openly admit to be looking for ways to optimize their costs, either by the means of integration of newer technology, enhancements to their core processes, capital investments to upgrade both technology and processes, by divesting out of non-core or non-profitable business units, by identifying and eliminating sources of waste and redundancies, or by consolidating back office structures; Some do nothing, and some others just do it by mandate.

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SG&A as well as operating costs are on the rise and cost of money is also going up while competition for most industries is at a peak, no one is safe from the increasing costs of goods and services, and the longer you wait to react and see the implications, the longer you are either going to be losing money or passing on those costs to your customers, both of these scenarios are non-sustainable and can put you out of business.

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Needless to say, an intention to always keep your costs under control should be a recurring theme for discussion at the Executive and all other levels in the organization. Talking about it doesn’t do any good, unless there is true action attached. Once a strategic path has been set and targets are defined it is time to come into action, the worst scenario comes when there are no solid basis to work from and a flat number is thrown out, after all, it is the number that will meet the plan drafted in paper.

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In situations like this we see head of divisions being informed that each one of them are expected to deliver a 25% cost reduction for the next fiscal year, most of them will have no background information about where those reductions are expected nor the logic behind it. So, as head of divisions, they start drafting their own plan to come to the expected number and  list of actions to what might not necessarily be in line with the strategy discussed at the Executive table, other than “there is a number to meet” and they will go for that number as they are expected to deliver results, later sharing with their area managers and repeating the story itself, as the mandate cascades down all the way through the organizational structure.

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There are a number of issues with this way of doing things, the most critical issue is that cost reductions executed by mandate have a bouncing effect which means that in no more than three years the eliminated costs will be back on the books disguised as something else while some of them will become outsourced, services costs will increase resource allocation to ‘transition costs’ and among others, the generation of new areas or positions.

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Also there are the ‘softer’ implications that you won’t be able to immediately see on the books in a specific line. Item such as increased pressure on people lead on to longer days and weeks which will result in some of them leaving the company and finally, the activities that stop happening without major implications in the first few months that will end up requiring a special task force assigned to get things back on track and up to speed.

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A large financial institution in North America has a procedure to mandate a 15 to 20% cost reduction in every area every single year, this practice distracts management from their daily duties for six calendar weeks. Decisions and the natural flow of business come to a halt, business suffer, and anxiety takes over the entire company until the number is met. However, there is a budget account greater than the overall cost reduction target, this account is destined to manage the issues generated by this practice, which is usually not enough to cover for everything that ends up being required. When the CFO was asked the reasoning behind this practice, he said that it was a board decision to keep it working like that as they thought it made them look good on the street, something he disagreed with as he had clear visibility of the overall numbers.

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Other companies stop spending on critical items such as scheduled maintenance and by doing so they are generating a potentially more expensive corrective fix down the road, which implies not only the costs associated with the repair itself but also the disruption in the production flow and impact on service to customers as well as damage to their market reputation.

In some cases, approvals for all and any disbursement begins being questioned and challenged, even if it is a contractual agreement. This, in some instances becomes a good reason to start building up inventory of parts, raw material and even finish goods. In one particular case, we saw inventory buildup equal to 10 times the savings initiative had reported.

To avoid falling into these type of situations, always make sure that there is a detailed plan that will bring in the cost savings you are looking for. When you have clear visibility of the roadmap it is just a matter of tracking through the execution, never jeopardize the operation by asking for a reduction in cost that is unsustained, as tempting as it might be. If you are getting rid of a function a thorough analysis of all work done should be made beforehand so you don’t get caught up in a trap where something that is non critical in the short term becomes a liability for the business in the long run.

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The worst I have heard is when an organization is ready to execute a massive reduction in their fix cost without any substantiation under the argument that dealing with the consequences will be easier done at a later time, such advice was given to a major natural resources company in South America causing them a major issue that forced them to revert their decision in only 6 months.

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It is always a good advice to first have a solid assessment of what the opportunities are, then, draw the most convenient roadmap for the organization. Prioritize based on the strategy of the business, keeping one eye on the top line and the other on the bottom line, seek help from a third party that is not involved in the everyday business of your organization as the most analytical advice will come from them and most importantly never underestimate the need to effectively manage the change and keep an open communication with your stakeholders.

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By: Cristopher Del Angel, CEO at To The Top Management Consulting