I. Recession and Cost-Saving

Earnings of major companies at home and abroad have declined dramatically since the second half of 2008, aggravated by a deepening global recession. Many have declared bankruptcy, while others are struggling for their survival. Due to the worsening business environment - declining revenue, rising unit costs, fierce price competition and a credit squeeze - protecting profitability and maintaining cash reserves have become paramount management concerns.

Under such circumstances, companies have mounted an array of familiar cost-cutting steps: selling off businesses, downsizing their workforce and reducing operations, postponing investments and cutting salaries and benefits. However, traditional cost-saving methods, while having their intended short-term cost-reducing effects, tend to bring other longer-term problems into play. This is because some measures are not implemented in the context of a longer-term corporate strategy, but rather tend to focus on the short term or on specific parts of the company. Sometimes, measures are taken just to demonstrate to shareholders that cost-saving efforts are being made. Ultimately, a short-term approach cannot lead to improvements in the fundamentals underlying a company’s competitiveness and may in fact damage its long-term growth potential.

A prime example would be the case of the three major US automakers. They were able to get through the 2001-2003 recession through payroll reductions, but they failed to bring about a fundamental improvement in their competitiveness, so that they again face closure in today’s recessionary environment. There are many other examples where short-term-oriented cost-saving efforts have been inconsistent with a company’s overall strategy or underlying causes of loss in competitiveness have not been properly addressed.

There is therefore a clear need to put together cost-cutting measures with a firm strategic perspective. Indeed, it will be important to resist the strong temptation, in times of recession, to adopt quick-fix types of cost-cutting measures. Rather, a more strategic and systematic approach will be needed.

“Strategic cost-saving” refers to the reduction or control of costs while at the same time strengthening the longer-term competitiveness of the company. An example of this is the “4-4-2” approach (closing down four, maintaining four and increasing two investment projects) introduced by Harvard professors Ranjay Gulati and Nitin Nohria as a “strategic” way to lower R&D costs during a recession. The point is that it is not good enough to just reduce inputs/costs; inputs and outputs must be considered together so that productivity and competitiveness can be enhanced at the same time. Prior to implementation, companies must analyze how proposed cost-saving measures affect the products and services they provide and ultimately how they affect their longer-run competitiveness. The choice must depend on whether the measures (1) are consistent with the company’s overall strategy, (2) can be sustained over the longer-term and (3) help costs for the company as a whole.

II. Strategic Cost-Saving

Strategic cost-saving covers a much broader area than what is normally considered in cost-cutting. Importantly, it covers the business model itself, manpower and departmental organization, and business processes. In some circumstances, reconfiguring the business model may be necessary to adopt cost-cutting measures that are consistent with the overall company strategy. Of course, it is very difficult to implement changes to something as fundamental as a company’s “cost-profit structure,” but such changes will also bring the biggest benefits and be sustainable over the longer term. With regard to manpower and departmental organization, recessions can provide an opportunity for the company to carry out radical reorganizations to bring things more in line with the overall strategy - a very difficult task during normal times. Once established, a low-cost, high-efficiency business model/process will prove to be profitable on a sustained basis, irrespective of one’s place in the business cycle.

1. Business Model/Method

There are many ways in which a company can both save costs and enhance its longer-term viability by changing its business model or the way business is conducted. One way is for a company to reinforce its core competencies through cooperation or strategic alliances with other companies. Such cooperation may be with companies that are either in the same or different business areas. An example would be the recent strategic alliance between Chrysler and Fiat, where an exchange of technology and capital was made to allow greater cost saving and improve the longer-term competitiveness of both parties.

A second way would be for a company to recycle used equipment and products to reduce costs and even develop new businesses. Caterpillar, a major global manufacturer of heavy equipment and engines, has adopted “remanufacturing” to both reduce its own costs and at the same time sell its “remanufactured” products to generate additional annual revenue of over US$1 billion.

A third way would be to get a better handle on what is required by a company’s core clients and concentrate on meeting those requirements. In a recessionary environment, where resources are more limited than usual, such a narrowing of focus may be the way to cut costs while maximizing not only near-term profitability but also maximizing longer-term viability. This point is illustrated by Curves, a fitness franchise that opened in 1992 amid a recession in the US. First, it identified the core needs of female clients, its key target group: namely safety, convenience, affordability and social networking. Then it offered an exercise program called “Quick Fit,” dedicated to women and designed to service each of these needs. For example, by arranging 10 running machines in a circle rather than the usual single row, Curves provided an opportunity for female clients to exercise, while carrying on conversations and socializing with other female clients. At the same time, bathrooms and other facilities were fu rnished without unnecessary trimmings to minimize cost, both for the company and its clients. Curves’ innovative way of doing business caught on fast and the franchise expanded rapidly.

A fourth way to improve a company’s cost structure and enhance longer-term competitiveness is through rationalizing and streamlining the value chain. For example, SPA (Specialty retailer Private label Apparel) companies such as H&M and Zara were able to achieve both objectives by shortening the distribution chain and operating directly-operated retail stores. At the same time, they improved communications between stores and planning/production departments to enable a quicker response to changing demands.

2. Manpower and Departments

Even during a recession, it is important to maintain worker loyalty to the company. Accordingly, personnel downsizing should be avoided as much as possible to maintain the loyalty and trust of workers. For example, IQ Consulting, a personnel consulting firm in the US, recently conducted a survey of 4,172 people who had survived corporate restructurings. The survey found that productivity levels, quality of customer service and employee loyalty all fell substantially in these instances. The implication is that, even in times of recession, lay-offs must be carried out with the greatest of care with a firm eye on a company’s longer-term competitiveness. This is especially true given that it costs more to hire and train personnel than to retain valued, competent employees. For example, Eastman Kodak carried out a large lay-off of long-serving skilled workers in 1995, reflecting its need to cut costs at that time. However, changing circumstances dictated that it replace such workers only a year later - at much higher cost.

In a similar vein, it is risky to adopt a “me too” approach to cutting costs. When Circuit City, a US retailer of consumer electronics, decided to cut 7% of its skilled workers in 2007 and replace them with low-cost labor in a move to copy its rival Best Buy, it found that the service it provided to customers fell significantly and ended up filing for bankruptcy in 2008.

Clearly, it is risky to take a non-discriminatory approach to company downsizing, such as all departments reducing the headcount by a given percentage. A more selective approach that takes into account the company’s overall competitiveness and longer-term viability is needed to avoid unnecessary loss of worker morale, an exodus of core talent and a fall in productivity. The aim of this selective approach should be to cut where value added is low, or where there is a surplus or duplication of labor. For example, integrating units that perform simple but similar functions in their respective departments/businesses into a central, “shared service” department can help to cut costs and also to release employees to focus on core tasks, thereby enhancing efficiency and competitiveness.

3. Process

It is possible to achieve sustainable cost savings via redesigning business processes that do not add much value or are duplicative. In normal times, such redesigning activity is often carried out separately by various departments. However, a recessionary environment provides an opportunity to take a fresh look and redesign them from a company-wide perspective, under the umbrella of the company’s longer-term strategy. It may be the case that process redesigns, when conducted independently by different departments, end up harming overall process efficiency. Renowned management guru Peter Drucker highlighted the need to approach cost-cutting from a company-wide perspective. Unless done in this way, the cost reduced may just turn up elsewhere in another form. The company’s core activities may be damaged and in any case the cost-reduction measures may lose their effectiveness in just a few months.

Improving the supply chain can contribute to cost-saving and enhancing longer-term competitiveness. Rather than myopically aiming for the lowest-cost input component, “strategic sourcing” requires more carefully managing the supply chain so as to achieve the lowest-cost supply on a sustainable basis. In this regard, Samsung Electronics succeeded in standardizing components for common use (from 594,000 in 2000 to 223,000 in 2005) across its vast product lineup. As a result, material costs vis-a-vis revenues were cut by 6%, totaling savings of 4.7 trillion won from 2000 to 2005.

4. Management and Operation

There is a need to take a broader approach to cost cutting in the area of management and operation as well. This point is illustrated by the recent aggressive adoption of more efficient energy-use technologies. Companies can install systems that enable the reuse of energy waste from factories or install facilities that run on low-priced fuel. Everland, designated an Energy Service Company (ESCO), saved 35.5 billion won in 2005 by setting up a system that distributes surplus steam from a factory to two adjacent factories at a low price.

Also, companies can install systems that curtail the unnecessary use of power when operating electronics equipment. Cisco Systems introduced “Energywise” in January 2009, a system that automatically controls power usage of computers, telephones and access point devices.

It is also important to avoid inefficient use of office/factory space and avoid unnecessary real estate costs by taking a more company-wide approach. In turn, this will allow savings in other related costs, such as furnishings and equipment. IBM, for instance, saved US$1.4 billion by reflecting rental costs of each department in its performance appraisal and strengthening the monitoring of unnecessary space.

Companies also need to keep a close eye on, and take full advantage of, the business-friendly tax incentives that are being provided by governments worldwide in their effort to fight the global recession. For example, to support voluntary corporate restructuring, the Korean government is planning to offer incentives via investment tax credit, a postponement of taxation on capital gains from asset transfers and a reduction in double taxation on non-commercial land.

III. Implications

The business environment appears to be getting worse by the day - it certainly looks worse now than just a few months ago. Nevertheless, the temptation to focus on the near term, as strong as this may be, must be resisted so that a more strategic and systemic approach can be taken to cost-cutting. Recessionary times, like now, can provide a valuable opportunity to retool and reorganize the company to not simply cut costs, but also to put it in a stronger position for the longer run.

Pursuing cost saving in a strategic and company-wide manner allows one to avoid a “balloon effect,” where pushing down costs in one area of the company simply means that costs rise in another area. Such a systematic approach requires (1) keeping a firm eye on the company’s longer-term strategy, (2) a detailed review and analysis of the company’s entire cost structure, (3) setting targets for cost-saving, (4) selecting which cost savings are practical and prioritizing them, and (5) making sure they are implemented via strengthened monitoring.

It is important to make sure that the core values and competencies of the company are not damaged in the cost-cutting process. According to Donald Sull, author of “Revival of the Fittest,” ignoring the core values of a company is one of the main obstacles to its successful restructuring and innovation. It goes without saying that one of those core values needs to be the minimization of waste.

Finally, a successful cost-cutting effort requires a strong consensus among the company’s workers about what are the aims and how it will be achieved. Moreover, each must know what his/her role is in this effort. This, in turn, requires good internal communication from management to the staff. Indeed, active communication of cost-related information and cost-saving policies, employee training and improving access to cost-cutting information are likely to trigger a strong and favorable employee response.

Result :   0 Ratings

Report as inappropriate