Cost Reduction v. Cost Optimisation

Do you have a strategic approach to cost optimisation that balances effectiveness with efficiency for greater customer value?

The Real Cost Of Mistakes

You see the headlines time and time again where a prominent company announces mass redundancies and major cost reductions to return to profitability. And, every time, I wonder whether anyone ever dares to account for the real cost of the error.

The great cost of having built the capability that is now being dismantled and will likely be rebuilt again in a few years’ time when the past has been forgotten. And the enduring impact on the competitive performance of that business as corporate memory stores away the trauma and distrust that was likely created through the cost reduction programme.

Allowing costs to get out of hand to a level where significant cost reduction programmes must be initiated is a clear failure on the part of leadership. There are two reasons for this view:

  1. It is leadership’s role to look to the future and steer the course of the business so that it may sustain its competitiveness. If something occurs that causes a sharp change in that direction and cost reductions to accompany it, you must ask ‘who was steering the ship and why did they not see this iceberg on the horizon?’
  2. What is best described as ‘cost optimisation’, should be a part of every business’s DNA. And therefore, the process of continually keeping a tight hand on the drivers of costs, making strategic decisions as to where costs are invested, developing a culture of cost saving and building cost structures to be adaptable for change are a part of this process. Every leadership team should be investing in cost optimisation in their business.

It is also important to recognise that one-off cost reduction programmes typically do not create sustainable cost reductions. There is a sharp knee-jerk reaction where every department must shed costs to spread the burden evenly, and the easiest and simplest targets are hit. And then, when the pressure is off, everything creeps back to, and beyond, where it was.

If you needed one simple compelling reason to justify cost optimisation, then consider its impact on competitiveness. If your business has achieved a sustainable cost advantage over its competitors, it will allow your business to deliver greater value to its customers on a continuing basis underpinning its ability to outcompete everyone else.

Conditions Precedent For Cost Optimisation

Cost optimisation is spending the right amount of money in the right places so as to build and sustain the competitiveness of a business. It’s about increasing expenditure in some areas and reducing expenditure in other areas, while always having an eye to cost drivers, adaptability and the competitive posture of the business.

A business that has perfected cost optimisation will gain the maximum competitive value from every dollar it spends every day. Bear in mind, businesses today compete around the customer value delivered.

For a business to make cost optimisation a part of their DNA, there are a range of conditions that must first be met. These conditions reflect key elements of cost optimisation and if they do not exist or are weak, any efforts to create cost optimisation will falter.

These key elements are:

1. Worthy Leadership

Worthy leadership reflects a leadership team who possess the necessary character traits to place the business before themselves. These are character traits and not technical competencies, leadership experience or compatibility. It is ‘who’ these leaders are as people and what drives them.

Some would say that it is their values and motives but I would say it goes even deeper than that and it is who they are at their core. And it is this core character that gives birth to their values and motives.

Worthy leadership is the cornerstone to the success of your business and is integral to any attempts to establish cost optimisation as a DNA trait. Leadership will need to not only give authority to this effort but they will need to live it. They will need to ‘walk the talk’ and adopt cost optimisation in all that they do also.

Self-interest, politics and bureaucracy will always be barriers to optimising performance in any business and, therefore, efforts must start with leadership to ensure these barriers are removed.

2. A Clear Business Purpose

Optimisation requires a focus and that focus cannot be profiteering, in other words, it cannot be just driving costs down to increase profit.

For a business to truly become a great business, it must have a purpose for its existence that is aligned with the needs of the community that it seeks to serve, that is its customers. The purpose must be clearly articulated and provide direction for the business so everything that the business does can be aligned with it.

For example, ‘At IKEA our vision is to create a better everyday life for the many people’. That purpose statement should allow them to ask, are these cost reductions we’re considering going to add to or take away from ‘creating a better everyday life for many people’ we seek to serve?

3. A Defined Competitive Posture

A business’s competitive posture is created through its strategic planning process. This posture reflects the way the business intends to compete to win as it draws its strengths to the surface each and every day, and allows it to outcompete everyone in its chosen marketplace.

The competitive posture articulates how the business will deliver on its purpose in the competitive marketplace. It states what is important and what needs to be focused on.

Without a clear understanding of a business’s competitive posture, it is impossible to know what impact cost reductions will have on the ability of the business to compete.

Essentially, where you decide to invest for growth (to spend money) must be guided by your capability to compete effectively in that market.

4. The Correct Organisational Design

The way your business functions as an organisation should be designed to your unique needs. There will be elements to the design of your business that are common to all great businesses.

But there are also elements that will be unique to your business and the customer value you intend to deliver. These elements must be carefully crafted and continually reviewed to ensure they are still relevant as your competitive posture evolves to stay effective in your marketplace.

Knowing the perfect design for your business and how to bring the greatest focus and strength to your competitive posture will allow you to clearly identify where costs should be invested and where costs can be reduced.

5. A Culture Of Saving

The culture of your business will underpin, or undermine, its level of success in the marketplace. We often only think about culture when something goes wrong, whereas it should be invested in every day as it reflects the business’s ability to compete.

There is a culture that is right for your business. And it may have some elements in common with other businesses. But it is tailored and designed to lift your competitive posture to the forefront. And in the instance of cost optimisation, it is about developing a culture of saving in the business at all levels.

Culture starts and finishes with leadership. It starts and finishes with the way they act and the culture they allow to exist. In addition, the way you design your business determines the culture that will thrive within that design. Culture is determined by leadership but it is also all the subtle — and sometimes not so subtle — systems and processes that are put in place that mould that culture.

A culture of thrift and prudence, or what I simply call a culture of saving, is difficult to establish and maintain in any business but it is essential to underpin a DNA of cost optimisation.

6. Continuous Improvement

A final element is that of innovation, or perhaps better expressed as continuous improvement. It is a cultural trait but also a process and organisational design trait. Costs will only be optimised if there exists a continuing focus on improving efficiency and effectiveness throughout the business that is focused on lifting customer value.

There are two aspects to continuous improvement, they are imagination and delivery. Both are necessary for innovation to be effective.

Required Mechanics

There are a range of practical matters that must be addressed to allow any business the information and controls that are required for costs to be optimised:

  • Cost data must be correctly captured, classified and attributed. Profit and loss charts of account can often be too general to allow a proper analysis of costs. A detailed level of analysis to support optimisation must be implemented by your finance team. The integrity of cost data is also critical so time is not wasted arguing over its accuracy.
  • Responsibility for cost optimisation must be passed to those closest to those costs, that is, the people spending the money. For example, if you want to reduce travel costs incurred by your sales team by encouraging video conferencing, then the sales managers and their team members must be the ones optimising those costs. Which sales meeting critically require an in-person presence and which can be dealt with by video conferencing is a call that can only be made at the coal-face.
  • Where responsibility is assigned, so to must authority and accountability. Accountability should preferably be on an ROI basis rather than some arbitrary budget figure.
  • Benchmarking of costs must be approached with caution. External benchmarks are often vague and do not provide good measures as the transparency of what makes up that cost is simply not available and/or not comparable.
  • Cost drivers must be identified, measured and managed by their responsible managers to allow proper control and measurement of results.

These are the key practical aspects of the systems and processes required to equip cost optimisation efforts.

The Path To Cost Optimisation

Rather than pursuing a single cost reduction program, the investment should be made in building the competencies in cost management so that cost optimisation can become part of your business’s DNA.

It starts with leadership making the commitment to optimisation as a cultural trait and holding themselves accountable to this goal.

The next critical foundation stone is developing a strategic business plan based upon purpose, clearly setting your competitive posture, and designing the organisation to deliver on it.

Building the systems and processes to mechanically allow optimisation to become possible should occur quickly and decisively.

The final step is committing the business to the journey of making optimisation real. This will require optimisation being used to drive customer value and competitiveness to win business-wide support. If more profit is the motive then the effort will likely fail.

Cost optimisation can deliver significant competitive benefits to any business and, through that, additional value to customers. It should be pursued by every leadership team that wants to build a great business.

Act Now To Grow Your Business:

Are you facing challenges in your business that you are struggling to overcome?

Are you looking for opportunities and new ideas on how to take your business to the next level?

If so, then join the Entrepreneurs+ community. Sign up for my eNewsletter and join the conversation by sending your questions to Ask Richard.

All the best in the success of your business,

Richard Shrapnel

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