Taming the Cost Dragon

[Also posted on LinkedIn]

(Sustainable Cost Reduction in good times and bad times)

In his book, “The Goal,” Shigeo Shingo emphasized cost reduction as one of the three primary goals of the firm. The other two are increasing throughput or sales and improving cash flow. As economic times become increasingly challenging, however, reducing cost is no longer just a goal but a necessity. Even as many firms continually post revenue growth, just as many are getting saddled with increasing costs that pull down profit margins and frustrate desired returns in investment.

Cost can be likened to a mythical dragon. It may seem invincible and impossible to defeat. Firms that employ brute-force solutions do not succeed in the long run. For instance, factory managers can crank up production to spread the expense over a larger volume, thus decreasing unit cost or the cost of every manufactured item. Factories, however, can’t keep production on high-gear forever without compromising inventories. Executives may resort to hiring freezes, downsizing, and/or outsourcing to reduce costs of labour-intensive operations. But labour costs continue to grow and any loss of talent from downsizing eventually bites the firm back in the long run. The dragon eventually returns with a fiery vengeance that burns the bottom line.

Any cost reduction effort thus has to be systematic and sustainable in order for it to succeed. Reducing cost therefore needs to be built into a firm’s strategic plan. Majority of executives would assert that they have been doing just that for years but yet a good number of managers would complain that they couldn’t keep costs from going up as they would cite uncontrollable factors such as inflation, government-mandated wage increases, spiralling prices of commodities, and added electricity and water charges.

Management strategy formulation towards cost reduction requires careful assessment and deliberate innovative change management even as external uncontrollable cost factors may seem formidable. A strategy that incorporates assessment and deliberate innovative change would manifest itself via the following:

  • Employee Involvement. As executive leadership provides the resources and the enabling structure and systems, employees, who know more about their work than anyone else, would provide the innovative ideas to reduce cost;

  • Organization Structure. An organizational structure toward cost reduction would include technical support from departments such as information systems, finance and engineering to assess proposed ideas and get the feasible ones running;

  • Executive Commitment. Some companies appoint “cost czars” to lead cost reduction efforts. The best cost czars are those from the c-suite such as the chief financial officer or the chief supply chain officer. Cost czars should clearly lead and show it via performance reviews and critiques of results;

  • Planning & Accountability. The most visible manifestation of the cost reduction strategy is when firms plan and execute budgets. Firms should get away from simply adding inflation to previous years’ numbers and hoping for the best. A firm serious on cost reduction would ask managers to commit challenging targets and action plans. Managers would be asked to show how their proposed plans will translate to savings and lower costs and correspondingly be accountable for such plans. The finance budget would then show all of these and become the documented commitment of all concerned;

  • Education & Dissemination. People should be educated on the nature of cost and given the tools to target what they can innovate. Cost reduction should be disseminated into the organizational culture not only via a firm’s mission statement but in the everyday communications of the company.

The cost dragon comes in different forms that seem impervious to any solution. It comes in fixed and variable. It attaches itself to how much are delivered or produced. As much as the cost dragon may seem impervious, it would always have a weakness and if we cannot slay it, we can at least tame it. The trick is to find its weaknesses and exploit them. Transport costs, for instance, seem untouchable because as much as one cannot control the number of deliveries without compromising service or one cannot dictate fuel prices, one can still determine the best optimal loads and best suited vehicles for the best delivery routes.

Cost reduction will succeed with a strategy that considers proper assessment and deliberate change management. It manifests itself with an involved organization, a fully-supportive structure, top-level leadership commitment, the right planning with respective accountabilities, and education with dissemination. There is always a better way.

Mr. Jovy Jader is a Supply Chain Advisor and Regional Speaker on Supply Chain Management. He has directed and implemented Business Improvement projects both local and international which have resulted to company-wide improvements in revenue, working capital, total cost, and customer service levels. Mr. Jader is the author of the book Speed Kills … your Competition: Driving Growth Through Supply Chain Excellence – a book on Supply Chain Insights and Best Practices. Should you have questions or comments, please e-mail them to jjjader@prosultsconsulting.com.

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