Sustainable Cost Reduction: A Diet Plan for the Organization

Article excerpt

With cost-cutting high on managers' to-do lists, companies are looking for ways to trim expenses without sacrificing customer value and quality. Here's a look at there common approaches to cutting away the fat - and at the role of management accountants in ensuring that the fat stays off.

Cost reduction has suddenly moved near the top of management's priority list. Whether they sell computers, cars or air travel, companies find themselves in an endless spiral of price competition and cost-cutting. Some of this competition is destructive: below-cost pricing in the airline industry has caused huge losses during the last three years. Elsewhere, companies have been able to reduce prices without sacrificing customer values. How does the intensifying cost reduction war affect management accountants, who carry much of the responsibility for cost management?

During the last year, I had the opportunity to study cost reduction strategies and programs in various organizations in order to determine whether one "right" way exists to carry out cost reduction, or whether best practices vary with different situations. I found three distinct approaches to reducing costs: attacking costs directly; modifying organizational structures; and improving executional competencies.

Attacking costs directly

The most common way to reduce costs has been to carry out a direct assault: just stop spending money. This is the easiest approach and the one with the most readily visible effects, especially for discretionary overhead costs. Recent examples of organizations attacking discretionary costs directly are not difficult to find: Procter & Gamble has slashed its marketing budget; IBM has reduced its research and development costs; Toyota has reduced travel budgets; Apple has frozen senior managers' salaries. Many companies have announced across-the-board staff cuts.

Organizations also attack costs directly by adopting technology, replacing the ever-higher costs associated with retaining employees with relatively stable capital costs. Another form of direct attack is delocalization, or moving core production operations to a less costly location. Much of the North American apparel industry, for example, has relocated to Asia and Africa. Mercedes-Benz and BMW both plan to move much of their production to the United States from Germany. Much of the Japanese electronics industry has moved production to other Asian nations in order to reduce costs.

At times, a direct assault on costs is justified. Some companies - particularly those with few competitors - cannot be globally competitive because their organizational structure is too expensive. So, bureaucracies can often be trimmed, and technology can be employed to reduce costs and increase efficiency.

However, a direct attack on costs can actually disguise cost problems rather than offer solutions. The approach will often reduce the organization's long-term ability to add value. Research and practical experience show that, within months of instituting a direct cost reduction program, organizations often see higher absenteeism and turnover, loss of confidence in senior management, lower quality, and loss of customer confidence. Yet some organizations still conduct one round of budget-cutting after another.

Budgets cannot be slashed indefinitely. Employees are supposedly there to add value above and beyond their cost. Simply sweeping them out the door provides no guarantee that the work levels will be reduced. Nor will job cuts fundamentally change the way in which work is done. Delocalization sacrifices the chance to develop and retain competencies; employees replaced by technology are obviously unable to help the organization improve.

Lower costs are never the only important strategic variable to consider; cutting budgets is hardly the only way to reduce costs. Instead, organizations can seek out sustainable cost reductions by attacking cost drivers rather than costs. …

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