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Making cost cutting work

Posted 25/10/2010 by KatieJ

In today’s environment of cost cutting, by everyone from governments to individual household budgets, it is timely that consultancy firm McKinsey has recently been looking at how to ‘make cost cuts stick’. Although its advice is directed at chief financial officers, today everyone must now consider themselves as the cfo of their own company.

McKinsey believes that successes in cost cutting can erode over time and action is needed to maintain the momentum. Indeed, many executives questioned by McKinsey expect some proportion of the costs cut during the recession to return within 12-18 months, and earlier research found that only 10% of cost reduction programmes show sustained results after three years.

The consultant also points out that while manufacturing efficiencies have reduced costs consistently over the last decade, sales, general and administrative costs have proved difficult to reduce.

The key factors are that cost reduction programmes sometimes don’t address the true drivers of cost or are simply too difficult to maintain over time.

And sometimes the executives concerned do not have sufficient depth in their insight into their own operations and are therefore unable to set suitable cost reduction targets. In the absence of sufficient insight, they look for easily available benchmarks, similar to those achieved by comparative companies, rather than taking the time to conduct a bottom-up examination of which costs can, and should, be cut.

In other instances draconian measures are adopted that are successful in the short term but unrealistic in the longer term, and indeed rather than adding value actually destroy it. Finally, the use of inaccurate data to track costs can result in missed opportunities and a lack of accountability.

And accountability is a key aspect, according to McKinsey, and it needs to be assigned at the right level. Buy-in from top executives is essential but they have other areas of responsibility that clamour for their attention. Additionally, McKinsey emphasises that most cost innovation occurs at a very small and practical level. Breaking down the costs into smaller business activities enables the managers directly concerned to ‘see the wood for the trees’ and identify potential areas for cost reduction.

There also needs to be a focus on how to cut and not just how much to cut, says McKinsey. In many cases, ‘Managing to a number has resulted in flawed decisions’, and the resulting cost cutting is likely to be short-lived and even illusory or damaging in the longer term. Executives need to set new policies and procedures and then demonstrate the required behaviour themselves, setting an example that signals real and enduring change, which is not reversed when things get better.

And tracking the changing cost situation needs careful monitoring that is much deeper than just the profit and loss data. The expenses behind the data need to be carefully tracked. Cost management, not just cost reduction, needs to be seen as an ongoing exercise not just a reaction to a difficult situation, if the benefits are to be sustained.

And finally, strategy must lead cost-cutting efforts: ‘The goal cannot merely be to meet a bottom-line target’. There has to be a targeted approach that is based on a thorough and ongoing examination of every aspect of the business.

As McKinsey expresses it: ‘Once these practices are baked into the company’s standard operating practices, cost reductions will become a more enduring part of its strategy for long-term health.’

So how do your efforts measure up?

Neil Eisberg - Editor

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  • Anonymous said:
    18/11/2010 02:58

    I thought this was an unusally useful article from a major consulting firm. If we focus on long term, sustainable cost management with the right example from the top then we have a chance of embedding this into the culture of the organisation along the lines of continuous process improvement. We're certainly working on this at SCI! Joanne