As a management consultant working with top management worldwide for many years, I constantly meet management teams that are immersed with the quest of reducing cost. It is common for top management to have a yearly goal of cost reduction and for all levels of management to be investing effort in finding ways for meeting these targets.
When I ask the top management why is it that they invest so much management attention on this matter, I usually get two types of answers:
- We are constantly under pressure (from the market) to reduce our prices
- We are constantly under pressure (from our share holders) to increase our profits and profitability.
I usually follow with another question – why is it that the major way for satisfying the above two needs is through cost reduction? I am not suggesting that cost savings opportunities are to be ignored, however I am wondering if there are no better ways of fighting the price pressure and increasing profits and profitability?
My personal overwhelming sensation is that focusing on cost reduction has many negatives, that outweigh dramatically the potential benefits:
- Management attention is limited. Successful cost reduction initiative can at best reduce cost by no more than 100% of the organization’s cost. So, the potential benefit is limited. On the other hand growth is unlimited. So, where do you invest limited attention – at something that, at best, can deliver limited results, or at something that at best, can deliver unlimited results?
- Cost reduction programs are usually planned and executed locally (meaning at a function level) and often times are blind to the dependency between the function where the cost reduction takes place and the overall performance of the organization. As a result too often the local cost reduction achievements do not result with a global performance improvement.
- Cost reduction programs tend to lead to lay-offs, salary reductions, benefits trimming etc. This type of changes cannot be expected to be well accepted by employees. Thus, they provoke resistance not only to the cost cutting initiatives but to any initiative as all of them seem to be different names to the same objective.
- Cost reduction programs often times call for cutting prices payed to suppliers, changing suppliers or splitting what is being purchased between a few suppliers. This type of changes cannot be expected to be well accepted by suppliers. Thus, supplier loyalty and commitment cannot be expected and as a result suppliers tend to believe that any approach to them is done with one purpose, and other type of improvement initiatives with then are treated with huge disbelief.
The evidence shows clearly that in spite of the immense effort invested in cost reduction, rarely do organization succeed in reducing their overall costs. The explanation is always – “external circumstances’ and “if we had not made this investment in cost reduction, we would not pass through these external circumstances”.
However, these are intuitive arguments and not fact driven arguments. The truth is that the cost cutting initiatives are rarely delivering bottom line results (in spite of the fact that they may deliver local results). Their biggest attributes that enables the continuous investment in this futile effort are that it is measurable and seems to be totally under control.
On the other hand building a competitive advantage that will clearly lead to the ability to continuously increase revenues, profits and profitability is much less measurable and more than that, seems to be much less under control. It is even perceived to be impossible (why do we think cost reduction is possible?). So, yes organizations do invest effort in growth but with disbelief that they stand a meaningful chance of outperforming their markets. And hence, we are back to the cost cutting initiative. If we cannot outperform our market, we must make sure our costs are as low as possible.
If we invest the same amount of effort and attention that we invest in cost cutting in the creation of a meaningful differentiation in the market I am certain (and there are a few excellent examples) companies can find ways to outperform their competition to the extent they can be confident that profits and profitability are exceptional. And now, if there are clear cost saving opportunities we “bump” into, by all means we should exploit them. But, we do not need to waste precious management attention in active pursuit of them and then business performance excellence can become a reality.