HBR co-writers share their findings and insights with us about how to cut costs strategically.
We’ve all been through it — the looming cost project. And for many of us, it’s not a fond memory.
How many cost-cutting initiatives have our companies gone through in the last dozen years? More important, do we look back on those initiatives as transformative in helping us build success and leading us to growth?
For executives at most large organizations, the answer to the first question is probably “too many,” and the answer to the second is “no.” Call it cost management fatigue. When doing research for our book, we found that the main reasons most companies suffer from this syndrome are that they make across-the-board cuts that are unconnected to their strategy, and fail to make the cuts sustainable. Most organizations wait to act until they have a problem, at which point they don’t have the time to make the right trade-offs for the long term.
The best-run companies, in contrast, think of cost management as a way to support their strategy, and of cost as precious investment that will fuel their growth. They put their money where their strategy is and continually cut bad costs and redirect resources toward good costs. After all, if we aren’t directing spending to the right places, what chance do we have to grow?
Management teams at such companies spend a lot of effort separating out the costs that truly fuel their distinct advantage from the ones that don’t. They base their decisions about where to cut and where to invest on the need to support their greatest strengths: the capabilities that enable them to create unique value for customers. This important distinction is a way of life at leading companies we have studied, like Amazon, CEMEX, Frito-Lay, Ikea, Lego, and Starbucks. They cut costs to grow stronger. You can see this different approach to cost allocation at work in the way winning companies behave in times of adversity.
The writers then tell the story of Roger Enrico when he took the helm as CEO of Frito-Lay, in 1991. In summary, under his leadership, the company could cut $100 million, equal to 40% in general and administrative costs by removing layers of management and many unnecessary practices, leading to a much higher level of responsiveness and effectiveness, and freed up money to invest in Frito-Lay’s distinctive capabilities — in direct store delivery capability, product and manufacturing innovation, and consumer marketing. Today, Frito-Lay “owns the streets” in its markets, as well as several $1 billion brands.
Proposed minset shifts
Five big mindset shifts can help you and your organization manage costs in the right way.
First, connect costs and strategy. Look at every opportunity to cut costs as an opportunity to channel investments toward strengthening your value proposition. Connect your budget directly to your strategic priorities; if your budget doesn’t reflect your priorities, you have very little chance of executing your vision. This entails viewing costs not merely as an in-year expense but also as a multiyear investment in differentiating capabilities designed to help your company execute its strategy.
Second, rethink costs in terms of capabilities. In many companies, the investments you make in capabilities are hidden within an array of functional budgets. Unravel these budgets and sort out the strategic implications of your current spending patterns. It’s not easy to do, since most conventional expense-tracking systems don’t assign costs to capabilities. It will likely ruffle some cultural and operational feathers, but it can lead to great success because it creates a meaningful discussion among executives about what you really need in order to win in the market.
Third, list all the expenses related to the activities of the enterprise, move them into a metaphorical “parking lot,” and then, one by one, decide whether to let them back in. Distinctive capabilities will get the resources they need to realize their full potential. You’ll pay for them by cutting everything else. We call this “zero basing”; it enables you to break free of the budgetary practices of the past, which at many companies amount to variations on the theme of “last year plus X percent.”
Fourth, make your cost-management plan sustainable. Build financial systems that create more transparency around “good” costs, those associated with differentiating capabilities, and dispensable “bad” costs, leveraging your culture to increase awareness of the difference. Closely link your budgeting process with your strategic planning process to ensure that differentiating capabilities continue to receive disproportionate investment, while other expenses are tightly managed. In a true “ownership culture,” cost-consciousness becomes an organizational capability and a shared mindset, rather than a bunch of rules that are resented and resisted. Even when no one is watching, employees treat every spending decision as if the money comes from their own pocket.
Last, be proactive. Fix the roof while the sun is shining. Once you’re in trouble, you may not have the luxury of making the right kinds of decisions. Creating a continuous cost-management mindset that connects costs to strategy is the best way to ensure that your company never gets out of shape.
Managing cost in this way will give your organization the freedom to make the right choices over the long term, choices that are required to close the gap between strategy and execution — and the rewards are immense.
*Source: Harvard Business Review by Paul Leinwand and Vinay Couto, dated: 10.March.2017
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