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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 under perform 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 non-frozen 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 re-deploy 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
non-moveable 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:
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. |
