Effective, Win-Win Cost-Reduction Management
Executives commonly focus on cost-reduction as a primary goal, especially in commodity, service, retail, wholesale, and technology- and marketing-driven businesses. Very few, however, actually reduce their costs faster than competitors do and faster than the rate at which prices they charge fall when business conditions are weak. Many of those who do succeed do so, however, by favoring the interests of one stakeholder group, such as shareholders, at the expense of another, such as many laid-off employees (Al Dunlap's success at Scott Paper may fit this description). Is that a good idea for the long run? Our research and experience show that cost-reduction (as hard as that is to do) is not enough, you must also have a plan to effectively use the savings -- one that all stakeholders enthusiastically support.
If we accept that executives are truly seeking to achieve meaningful results from cost reduction, we must conclude that there are problems with the methods being used. How then can we make cost-reduction management a core competency that creates a lasting competitive advantage for the company?
My suspicion has always been that even though executives may have the best intentions in this area, they suffer from a serious lack of effective tools and training to diagnose, prescribe, and implement the best cost-reduction opportunities. This belief was first confirmed during our now-famous study in 1991 for SHARE PRICE GROWTH 100 (as reported in Time, Newsweek, U.S. News and World Report, The Economist, and Harvard Business Review by Hamel and Prahalad) where those who restructured to achieve large cost savings usually saw their stock prices underperform the market and their industry over the subsequent three years. What went wrong in most cases was that the cost reductions were too modest to overtake competitors' normal rate of progress, or the changes hurt the company in other ways that were not intended, such as lost sales due to reduced customer satisfaction as well as a lack of employee knowledge necessary to operate the business well. Watching cost-cutters since then has reinforced what we saw, that large cost reductions are usually ineffective (with a few exceptions).
We want you to retain the benefits you have been receiving from cost-reducing efforts and activities like TQM and Reengineering, but now we want to move you to the next generation of easier, more valuable cost-reduction changes. To do that, a new management process, Effective, Win-Win Cost-Reduction Management, has been designed for your use.
Our purpose is to create a process for which you can be quickly and effectively trained that will be complementary to everything you do now, but will achieve differentially greater results by focusing on more productive areas for improvement (that are typically being ignored now) and better ways to change. For example, most companies almost totally ignore reducing cost of capital when focusing on cost reductions (except for interest-rate reducing), yet for most companies this will be the highest payoff area. Also, by using a new type of financial instrument developed by Mitchell and Company, many average and below-average return cyclical businesses can eliminate the likelihood of losing money on the downside of their cycle and double the profit enjoyed when times are good. Few cost-reduction, TQM, and reengineering efforts can yield such a powerful outcome, mostly because their focus is too narrow.
Let's look at another benefit of a wider focus -- developing more ways to reduce operating and capital costs. Reengineering is a valid way to reduce costs of a business process. If, in addition, you double your stock-price multiple permanently compared to competitors, by comparison, you will always be able to use your stock to buy resources at half the cost of the competitor. You can then add the reengineering benefit onto that purchasing advantage, and enjoy the improvements that both provide to you. In all cases, however, you will have a large edge over those who only reengineer.
Most companies assume that the bulk of their costs cannot be changed. For example, for many years juice manufacturers believed that they had only three options for what they could sell people: all juice (either fresh or shelf-stable), juice mixed with soft drinks (like Slice) or frozen concentrates. To the great surprise of the industry, Welch's recently developed a fourth alternative: partially concentrated nonfrozen juice which has the consumer benefits of greater convenience, lower cost, and lighter weight. Also, the juice-maker's costs are enormously lower because no freezing or shipping of a lot of extra water is required.
As Pareto's Law reminds us, 80% or more of our economic benefit comes from less than 20% of what we do. Doing more of that 20% and less of the 80% will make a profound change in most costs. That reallocation can potentially improve our profits and reduce our costs by a large multiple of what just cost reduction can do. For example, Intel once made both commodity memory chips and microprocessors. The company's growth and profitability only began to really take off when they exited the memory business where they had focused a lot of unsuccessful attention on cost reduction. By focusing on microprocessors, they vastly reduced their costs and increased their effectiveness in the high potential area, and built the enormous success they have since enjoyed. They used the savings to build something better, as you should.
Another important insight comes from where you decide to redeploy the resources you generate through cost reductions. You will free up enormous amounts of people's time, talents, capital, equipment, and other resources. If you quickly make them useful in a higher payoff area, that will do much more for you than just eliminating the costs. In a sense, the largest cost you have is the opportunity cost of not using your resources in the most effective areas. Effective, Win-Win Cost Reduction Management is the first management process that addresses both cost reduction and application of the benefits of cost reduction simultaneously.
These are just a few of the many unique features of this approach to cost reduction, making it truly the next generation in cost reduction management that everyone needs.
Effective, Win-Win Cost-Reduction Management is based on Mitchell and Company's more than twenty years of experience in helping our clients obtain and improve cost advantages over their competitors in both operations and cost of capital. Our information is supplemented by many special studies of best practices used by others for achieving great cost-reduction results. This learning has been expanded to look at the Theoretical Best Practice (the most that anyone could ever do in light of unmoveable limitations) of how to reduce costs. The result is a process that far exceeds the breadth of any one company's highly successful cost-reduction program, to create enormously more cost reduction from the same amount of time and effort.
Mention cost-reduction, and many people will develop a pained expression on their faces. They may be imaging the layoffs, the long hours, the frustration, and the missed opportunities that often accompany such efforts. By comparison, Effective, Win-Win Cost Reduction Management can be less work, and is certainly a lot of fun. Why? You are focusing on areas where there is lots of low-hanging fruit, so it is not hard to achieve large gains. The thought process is an innovating and exciting one. All stakeholder groups will benefit. It is unlikely, for example, that layoffs will follow because those people will be directed, rather, into high payoff activities so that the company can grow. Just the opposite, job satisfaction and compensation will probably grow faster because of the accomplishment that will follow. We want you to profit from easier, more fun ways to improve because that will encourage you to want to do more of this.
Potential Benefits from Effective, Win-Win Cost-Reduction Management
For a manufacturing company with at least $2 billion in revenues, using the process we have designed should yield cost-cutting benefits for operations and capital in excess of 100 times the cost to learn and implement the process within the first year. On-going benefits should be larger. I have described the benefits as being much smaller than I usually have seen happen because I want to be more credible to you. Let's look at the results of these gains in some well-known, best practice companies
Few skills are more highly valued among CEOs, CFOs, and other senior executives than the ability to reduce costs rapidly. One of the best-known, effective cost-reducing CEOs in the country is Herb Kelleher of Southwest Airlines. He is simultaneously beloved by his fellow employees at the airline, the company's customers receive great (and sometimes humorous) service, and shareholders have enjoyed top rewards. Those who reduce costs faster than others in new areas on a sustained basis, like Ken Iverson at Nucor (see below), achieve high esteem in the business community. CFOs who have been highly effective in this area often go on to become admired CEOs, such as Steve Bollenbach (formerly CFO with Marriott, the Trump Organization and Disney), now CEO of Hilton Hotels. Cost reduction is an area where achieving good results can be good for those who remain with the organization, its shareholders, and the people involved in directing the change.
Nucor is an example of a company that took advantage of the huge potential benefits of effective cost reductions. Nucor became a technology pioneer by manufacturing steel using melted-down scrap in electric furnaces, rather than the prior state-of-the-art, steel-making facilities using iron ore and coke in blast furnaces. Nucor's approach was not only cheaper in operating costs, it was also much cheaper in capital needed per ton of steel produced. Over time, the company was able to extend its technology into making higher and higher quality steel as a result of its superior focus and skill, and is expected to expand into the stainless steel market in the next few years.
In the last ten years, Nucor has grown from being a small producer to one of the leaders . . . and Value Line has recently estimated that it will be the market leader in North America within 3 years. Because costs were so low, the expansion was paid for primarily out of retained earnings and cash flow, so the cost-cutting allowed enormous market share gains from internal growth with little financial risk. At the same time, shareholders profited. During the best period (from the 1987 lows to the 1994 highs), the gain was over 900%, while the S&P 500 grew by less than 125% -- and remember that this is the normally staid steel industry, where few earned their cost of capital.
Key Problems With Traditional Ways of Reducing Costs
To help you decide how your organization might benefit from this process, I have put together a list for you to test yourself and your organization against.
(1) Are your cost-reduction goals significant enough to improve your cost position much faster than all competitors on a sustained basis? Semiconductor manufacturers reduce costs all of the time, and often fail to keep up with the industry leaders and have to drop out. As I mentioned earlier, that happened to Intel in the DRAM semiconductor memory business during the 1980s while the company was establishing its dominance in microprocessors.
(2) Are you developing cost-reduction capabilities adequately to offset the cost and performance advantages of major new ways of performing your base business? For example, are you a steel company using blast furnaces competing with Nucor, or are you Nucor?
(3) Are you responding carefully to serving future customer needs, as the requirements of being an effective supplier change? Are you Dell Computer building Personal Computers to order via the Internet, or are you IBM making high-priced PCs to build wholesale inventory?
(4) Are you using cost-reduction to energize and excite your people such as occurs at Wal-Mart through incentives, training, and a great sense of pride, or is this a cause of concern and discouragement like at Kodak?
(5) Do your cost reductions create immediate advantages for customers as happens at Solectron (lower prices and more reliable products from custom manufacturing) or disarray and hardship for customers as occurred at Apple in recent years?
(6) Do your cost reductions simplify the task of running your company or organization like at Sears recently, or do they create complexity that makes good performance harder to produce, like the way CIGNA's efforts to cut HMO invoice processing costs following an acquisition caused them to lose track of the cost trends for their patients by delaying timely reports?
(7) Do you get the cost reductions, but just too late to do any good? Consider how many companies have become marginal suppliers or left the business of making semiconductors used for computer memory over the years because they made great, but late, cost reductions such as most U.S. memory manufacturers.
(8) How much does cost reduction cost you? In some industries, cost reduction also decreases capital expenditures and therefore the cost of capital (such as Coca-Cola's restructuring of bottling operations), while in others, increased capital intensity hurts returns (such as happens with paper companies).
(9) Are you focusing on all large classes of costs? Many companies emphasize replacing labor costs and head counts, and ignore what can be larger costs like the cost of capital and the amount of capital required to run the company. This limited focus is especially prevalent in labor-intensive businesses like the insurance and airlines (which is also very capital intensive). In the gaming industry, Circus Circus has been outstanding in working on both lowering operating costs and capital costs to become the preeminent player in its segment of the market.
(10) Are you using the savings from cost reductions to accelerate your profitable growth? For many companies (like faltering computer manufacturers), cost reduction is more like an amputation of key limbs that slow down future progress, while companies like Southwest Airlines use the cost reductions as a key element in their ability to grow without losing any muscle, limbs or capability in the process.
How Does Effective, Win-Win Cost-Reduction Management Work?
First, we make sure that you address the questions that so many ignore, such as:
(a) What amount of cost reduction is needed in order to reach an improved position over competitors that cannot be easily duplicated, and in this way achieve a strategic advantage?
(b) Looking at current and evolving customer's needs and the needs of their customers, can the entire business model be changed to provide more value at lower cost?
(c) How can shifting the mix of customers and products provided create a more effective and lower-cost way of doing business in light of evolving needs?
(d) How can capital be removed from the processes you use?
(e) What have been the experiences of similar companies making the same kind of changes in the past, so that you draw on their best practices and understand the risks that have tripped people up in the past?
(f) What is the theoretical potential to create much lower costs by using the discipline of investigating Theoretical Best Practices?
(g) How can the changes be done to excite both employees and customers?
Second, this process uses improved ways to answer the questions. Mitchell and Company has developed many proprietary ways of asking questions and listening to the answers that make more valuable options become apparent. For example, customer segmentation studies are based on whether you will earn a higher, the same, or a lower margin by serving a customer better than any competitor can. This provides a much more effective profit-based focus to the analysis.
Third, more classes of large costs are considered. For example, there may be ways to access lower-cost capital to fund the cost reductions (such as an acquisition allowing overheads to be eliminated or better equipment operating with faster speeds and less waste) that will boost earnings and cash flow, yet few consider these as ways to develop an advantage. Most people focus on head count, materials, and overhead costs only.
Fourth, we have had successful experience in developing large cost advantages for companies starting from cost-disadvantaged positions in many different industries. This experience provides a unique perspective on how to make successful change in this area. In one case, a client went from the weakest in the industry to the highest margin competitor in less than 18 months. In no case did a turnaround of cost position versus competitors take more than 3 years to accomplish. All saw their stock prices soar, as a result.
This process can be applied through:
- training of those who will use the process,
- training of trainers who will train those who will use the process,
- selected work to develop data or analyses, to supplement your internal efforts, to be conducted by Mitchell and Company, and/or
- through full diagnostic and implementation assistance by Mitchell and Company with minimum involvement by your people.
We are unusually good at training and prefer to either train trainers or train directly. You achieve benefits must faster that way, and the benefits are a larger multiple of the time, money and effort you put into the learning and using the process. This approach also frees us up to work with more companies and to work on new management processes to help you even more in different areas.
You can experiment with this in a small area first, or jump right in to attack your largest issues. The process is equally applicable, and can be used by any level of the organization. The minimum cost to receive training will normally be several hundred thousand dollars, except for pilot projects to test the process. We have seen the process provide enormous advantages to operations as small as $30 million in revenues. There is no upper limit to the size of operation that can benefit.
Receiving additional assistance beyond training will cost a multiple of the training-only expense. Specific, fixed prices can be quoted to reflect your precise needs.
Next Steps
If you would like to learn more about Effective, Win-Win Cost-Reduction Management, please contact Don Mitchell by e-mail at askdonmitchell@yahoo.com, and he will send you a series of questions tailored for your use on existing operations to help you test your potential to benefit from this exciting and valuable process.
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