Can Cost Cutting Uncover Value?

In ordinary times, these were difficult enough tasks. But today's managers also sense that the combination of globalization forces and technology are often reshaping their business beneath their feet. The dilemma they face is unenviable. At the very moment they are pulling in the reins on cost they have to keep an eye on building out their proven strengths into new territory. Are such management pressures compatible? Yes—provided that managers are willing to rethink their approach to cost cutting so that efficiency becomes a pathway to uncover value.

The Limits of Old School Cost Cutting

At this point in the economic cycle, most firms have already attacked cost using the traditional means. CFO have driven efforts to reduce staffing, inventory levels, extend A/P and shrink A/R. Operating unit heads have been given across-the-board cost reduction targets and are forced to "make due" with what remains. In many firms, these types of efforts in and of themselves produce real returns. They are proven, predicable, and easy to communicate to employees and investors. Moreover, most firms pursuing this path have likely already invested in several years of "leaning" their organizations, developing in-house leaders who can drive down costs. Managers, predictably and reasonably, conclude that they have done all that is possible without cutting into bone.

Alas, as most managers reluctantly recognize (but rarely say out loud) that these efforts aren't enough. To be competitive today, winning firms need to make significant, even radical, adjustments to their cost structure—and in some cases, to the operating model themselves. Reducing costs 10, 15, and even 20 percent has become a competitive requirement, not a long-term aspiration. With commoditization of many inputs (e.g., raw materials, energy, labor costs, etc…) the only way firms can outpace competition is by refining their operating capability. In practice, that means fundamentally changing how they create value.

What is Still Left On the Table?

The truth is that, even after most rigorous but traditional cost cutting exercises, most companies are still leaving a lot on the table. These are significant opportunities to alter a companies cost structure and performance. But they often overlooked simply because they don't easily fit into the categories that can be lopped off with mandates to "cut 10 percent more."

The real issue for most complex organizations is that they have lost sight of where their cost bottlenecks are and, consequently, where in their processes they actually create value. Most companies would benefit from stepping back and taking a broader, system-wide look at how value flows through their system. This exercise, by itself, can often reveal huge areas to advance performance at every level.

Companies that start looking at cost by looking at their process for creating value invariably make at least three critical discoveries.

1. Cross Silo Waste Continues To Destroy Value.
Since Alfred Sloan developed the modern corporate management structure, firms have perfected the management of top-down, divisional operations. Then in the 1990s, cross functional inefficiencies were attacked by restructuring into matrix organizations. But both models have challenges. Top-down organizations ignore the interrelationship of different functions.

Matrix structures often became bloated and slow with unclear decision-making. In both models, cross silo waste is developed—between sales and marketing, marketing and delivery, delivery and cash receipt. This occurs even in organizations that claim to be flat and de-layered. The problem is that each silo rarely focuses on how value flows through the organization. Do they, for example, ask how many days it takes to ship a product from the date an order is received? How many people must touch that order? How much of this is high-value added time?

2. The Wrong Data Makes the Right Decisions Impossible.
Managers today have more and more data, but less and less of the right information to make the decisions that create the most value. Many retailers see vast amounts of data surrounding the purchasing and merchandising process—largely around forecasts, variance to forecasts and fill-rates. Yet, very little of it is used by merchandisers to measure returns or net margins.

As a result, those in charge of purchasing inventory only see half the story—how good they were at filling shelves and at generating gross revenue. The other half of the story—the net profit of the items they sold—is lost. The impact to the bottom-line of this lack of transparency is huge, in some cases 5 to 10 percent of total gross margin.

The same problem persists in manufacturing. One manufacturer, after mapping their entire process, discovered that over 30 percent of the company's cost structure was energy costs. However, none of the key managers who controlled the equipment that consumed the largest percent of this energy had any knowledge of how to run their equipment efficiently. Think about that—the largest single cost of the plant was being managed by professionals that had no data about the consequences of their decisions. How many key cost centers are managed with a similar lack of data to steer action?

3. Engagement and Action at the Ground Level.
Oftentimes those closest to the "action" are the ones who have the answers—or at least insights that hadn't occurred to senior managers. "Listening to front-line employees is a favorite old chestnut of management consultants." But the truth is that very few organizations leverage their employees for information on how value is lost to inefficiencies.

In thousands of cases, these employees who see unhappy customers (or delighted customers who would be happy to pay more), delays in process, inefficient labor schedules, slow moving inventory. By creating a transparent, widely distributed map of where value comes from, these employees are suddenly engaged at a new level of rethinking a company's cost structure and operating model. When companies pursue these steps simultaneously they begin to see their organization and its processes in a new light.

Instead of simply trying to meet an arbitrary budget goal, they now see where the process itself can drain time, costs, innovation, and opportunities for cooperation. Reforming these dysfunctions becomes not just a way to reduce costs, but the beginning of a more nimble organization.

Three Steps to a New View of Costs and Value

Where does an organization begin rethinking its costs and value? How can it move beyond the well-trod path of conventional cost cutting. Here are three avenues that are open to any manager.

• Understand your key activities: What is it that your organization actually does every day? Such an obvious question can actually open up a much richer dialogue with mangers and employees. It stars by taking a system-wide view of the enterprise, ignoring top-down, function-by-function charts that have often been embedded into a company's operating culture. Instead, managers ought to break down each of its operations by the key activities they engage in at the highest level: How do we acquire a customer? How to we create a product/service of value? How do we deliver it? How do we get paid? By evaluating the economics of each key step in those activities—looking at cost, quality and time of each—a different map of the organization's process emerges.

• Think global, act local: Businesses today are too complex and disperse to run cost programs totally from corporate or a single division. Broad corporate strategy must be combined with local efforts to maximize the efficiency of effort. Successful firms are able to coordinate hundreds, if not thousands, of discrete local
efforts, to move the needle on key initiatives.

• Engage employees: Finally, few transformational efforts can occur without constant input and activity with employees throughout the enterprise. The employees have to be exposed to and understand the new value map of the organization as well as the managers. They have to be shown that many of the traditional processes are part of the problem. A firm that keeps motives and metrics transparent will find it easy to encourage employees to come up with new ways to wring out costs and discover value.

Preparing for the New Normal

These steps are just the beginning of allowing a company to reposition itself during the economic downturn. It also allows an organization to build up its strengths and even expand them. As industries are going through fundamental changes, the value equation with customers is changing, too. The parts of a manufacturing service that was once thought to be of the highest value may no longer be so important to customers. Aviation, retail, real estate, and financial services are all seeing the underpinnings of their business model change.

Most other industries ought to take note. What seems certain is that, like the problem of legacy computer systems, companies that are entangled by their own, encrusted and aging processes won't be able to move swiftly to take advantage of new cost models, new sales methodologies and new arenas for customers.

That's why the current round of efficiency pressures ought to be focused not simply on reeling in monthly spending, however critical that may be, but also on revealing a the organizations basic process map so that decisions about efficiency, growth, and evolution can be made across the company. Companies that start to understand how they create value will be better positioned to understand how they can interact with their customers of the future.

David Niles is president of SSA & Company, a process improvement firm founded as Six Sigma Academy in 1994.