By: Ignacio Barros
It’s possible to reduce costs while promoting growth. The key is to assess the influence each cost has in driving the company toward its objectives and reduce or eliminate those that don’t assist the company in reaching them. But to be successful in a cost transformation, a company must start with a blank page and ignore sunk costs. This is the mindset underlying zero-based budgeting, as well as Peter Drucker’s famous question: “If I weren’t already in this business, would I enter it today?” Applying this lens to each project, each critical decision, and each role allows leaders to view the cost structure strategically, which is imperative because there likely isn’t a more strategic decision in a company than where to invest its money.
Simply challenging each line of expenditure is not enough for analysis, and on its own may seem like a disjointed and endless effort. Therefore, we believe that in parallel to account-by-account analysis, companies need to take four critical steps.
As much as possible, simplify.-
Companies often take their activities for granted and make incremental adjustments rather than having a bold and holistic view of which businesses, product lines, SKUs, or operations should be part of their future. Most also underestimate the cost of complexity, measuring only direct costs instead of the costs of the system as a whole. One way to gain better perspective is to imagine a new competitor arriving in your segment without the burden of all your past decisions. How would they compete? What products, activities, solutions, and services would they create? How would they simplify the offer to the customer?
The Dutch company Philips, for example, had a long history in lighting products and personal electronics, but in the mid-2010s, it decided to focus on healthcare and divest, spin off, or sell any other type of business. Philips knew that to succeed, it needed to center the management’s attention solely on healthcare. With this tremendous simplification came new investments in capabilities that backed a much bolder healthcare strategy, which led to significant innovations in health products and services.
Connect costs with outcomes.-
Consider every dollar spent as an investment in creating the value you provide to your customers and in the specific multifunctional capabilities necessary to deliver that value. Costs should no longer be locked within organizational silos disconnected from growth. Budgets should be deeply discussed at the management committee and prioritized to focus on what truly supports your strategic objectives and the internal capabilities that will help to achieve them.
A great example is IKEA. The company has historically been guided by a very specific principle that is also a promise to its customers: “We do our part. You do yours. Together we save money.” After opening its first retail store in 1958, the company’s founder, Ingvar Kamprad (responsible for the letters I and K in IKEA), encouraged his employees to seek any saving opportunity that wouldn’t affect the product’s quality, the customer’s experience, or operational efficiency, a practice that continues to this day. IKEA designers, for example, continuously work on packaging to reduce materials and sizes so the company can put more pieces in a container, save money, and offer lower prices. That consistency between strategy and execution is rare in product design. In many companies, products are designed by people who are not responsible for managing costs. But IKEA connects its design with all outcomes for the customer, including cost. If you visit the company, its cost-consciousness is evident. For example, company executives typically take their guests, even VIPs, to IKEA cafeterias instead of fancy restaurants to avoid any unnecessary expense that might impact customers.
Digitize value chains to the max.-
Yes, automation offers great potential, but not when held hostage by intricate networks of programs and technological applications. Companies can realize the benefits of digitization by rethinking entire processes from beginning to end, but they will achieve much greater short-term gains when they place automation above or rather in place of existing tools. To manage such efforts, some companies build “digital factories”, teams that are responsible for the rapid and continuous (sprints) deployment of automation throughout the organization. These factories can dramatically streamline one or several processes in parallel. They also allow companies to evaluate all automation investments comprehensively.
When the executives of a global food and beverage company embarked on an ERP implementation scheduled to last several years, they quickly realized the projected cost improvements were so significant that the company couldn’t afford to wait that long to capitalize on them. So, they created a digital factory that brought together people with experience in automation design, development, and maintenance, and assigned them the task of reinventing manual, costly, and slow processes (such as the macro-process from purchasing to accounts payable, or the human resources process that goes from hiring to employee retirement). The team’s solutions captured savings within the platform of their current ERP while remodeling the processes in preparation for the enhanced automation and insights the new ERP would allow.
Create a management system focused on efficiency.-
The smartest companies don’t think of cost reduction as a natural reaction to a slowing economy; they believe, instead, that it’s a manager’s duty to constantly stay alert to costs. But this approach isn’t as common. Many companies downsize during periods of economic stress, only to increase sales, general, and administrative expenses in the following years of economic boom, seemingly without learning the lesson. Budgets are a real test of how your company thinks about costs. If yours tend to adjust gradually, you’re probably not managing them actively or strategically. But if your budgets are zero-based and allocated and evaluated across functions, focusing on the most critical and differentiated capabilities, you’re creating a culture and a process to manage costs.
The global situation is putting cost management at the center of discussion in boardrooms and leadership teams. When addressing this issue, executives face a choice. They can cut costs in the traditional way and run the risk of weakening their organizations, or they can take the trouble to rethink the basics of their business: identify the bold actions that will differentiate them, simplify every part of their operations, generate savings through automation, and build the foundations of cost management in everything they do.
- Cost cutting that makes you stronger (Harvard Business Review, Jul-Ago 2023)
- Making cost engineering count (Mc Kinsey Quarterly Review, Jul 2019
- Cost-Efficient Growth: Cutting Expenses While Boosting Revenue (www.adp.com, Jun 2018)
- SYNERGOS Internal cases