Article

The Challenge of Cutting Costs

For most managers, cost discipline holds as much appeal as a cold shower.

By Vernon Altman, Marty Kaplan and Ravi Vijayaraghavan

Published on May 01, 2003
min read


For most managers, cost discipline holds as much appeal as a cold shower. The prevailing attitude is that costs must be cut from time to time. Usually, the gruelling work of taking out costs is a periodic program rather than an ongoing way of life. But the most competitive companies have embedded cost discipline in the way they do business. One-off cost-reduction efforts are common, especially during economic slowdowns and headcount reduction, capital expense elimination, and project deferral are common tools. Companies thinking beyond short-term cost containment now adopt practices that provide structural (and therefore not easily replicated) cost advantages. Actions by Hong Kong's PCCW to outsource network services to a 'spun-off' entity called Cascade, and recent announcements on off-shoring of business processes to India, Malaysia, and the Philippines are examples of this trend. Even so, the groundwork for breakthrough cost positions—the kind that are sustainable, self-reinforcing and enable top-line growth—is continuous cost reduction. Companies that perform well develop a capacity to recognise downturns early, to act quickly, and to drive out costs relentlessly. Bain research indicates top-performing companies achieve about half of their total profit improvement directly from cost reduction. Companies that instinctively take out costs create unexpected opportunities. In a deep downturn, such instinct, coupled with a disciplined process, can help stabilise a business and lay the groundwork for future growth. Tie cost discipline to growth strategy. The categories of cost reduction are basic: eliminating waste and duplication, implementing best practices, introducing technology where it is effective and creating virtual operations via the Internet. Engaging in cost reduction without a clearly defined growth strategy, however, is like driving into a car wash with the convertible top down: you may clean up some problems, but you will create more. What is the urgent situation that requires reducing cost? How will the company use cost discipline to build momentum? Empower the advocates. The problem is, most managers are not wired for cost reduction. For that reason, companies need champions who see it as their mandate to keep the organisation focused on the cost side of the business. When a downturn or market shift escalates the need for cost reduction, companies that have located and empowered such champions have the required processes and instincts already in place. Benchmarking-internally and against competitors—helps managers locate cost centres throughout the company where cuts will yield the biggest impact. That focus proved crucial for PacBell. In 1993, the telco recognised that operating constraints and competition were flattening revenues despite growing product volume. A systematic cost-reduction programme boosted PacBell's revenue per employee by 25% and produced more than US$1 billion in cost savings. The performance improvement was reflected in the premium paid by SBC Communications when it acquired Pacbell in 1997. Act quickly on analysis. Diagnostic work should shape a company's agenda and its cost-reduction goals—generated not from the bottom up, but from the top down. This is a moment for cost-discipline champions to exercise strong oversight, by assigning specific goals to the various teams. Usually, the largest cost improvements come from optimising information technology systems and tightening supply chains to take out procurement costs. Lead from a strong centre. Once targets have been identified and the strategy is firmly fixed throughout the company, execution becomes the priority. Sustaining an organisation's energy through any major cost-reduction programme ranks among the thorniest challenges managers will ever confront. When everyone in the company thinks you have gone too far, there is always one more layer of cost to take out. That may be the most important lesson we have learned. Make cost reduction a core competency, and growth will not be far behind. Vernon Altman is a director of Bain & Company and co-leader of Bain's Technology & Telecom practice. Marty Kaplan is chairman of JDS Uniphase and former executive vice-president of PacBell. Ravi Vijayaraghavan is vice-president with Bain & Company in Singapore, and a key member of Bain's Asian Technology & Telecom practice.

For most managers, cost discipline holds as much appeal as a cold shower. The prevailing attitude is that costs must be cut from time to time. Usually, the gruelling work of taking out costs is a periodic program rather than an ongoing way of life. But the most competitive companies have embedded cost discipline in the way they do business.

One-off cost-reduction efforts are common, especially during economic slowdowns and headcount reduction, capital expense elimination, and project deferral are common tools. Companies thinking beyond short-term cost containment now adopt practices that provide structural (and therefore not easily replicated) cost advantages. Actions by Hong Kong's PCCW to outsource network services to a 'spun-off' entity called Cascade, and recent announcements on off-shoring of business processes to India, Malaysia, and the Philippines are examples of this trend.

Even so, the groundwork for breakthrough cost positions—the kind that are sustainable, self-reinforcing and enable top-line growth—is continuous cost reduction. Companies that perform well develop a capacity to recognise downturns early, to act quickly, and to drive out costs relentlessly.

Bain research indicates top-performing companies achieve about half of their total profit improvement directly from cost reduction. Companies that instinctively take out costs create unexpected opportunities. In a deep downturn, such instinct, coupled with a disciplined process, can help stabilise a business and lay the groundwork for future growth.

Tie cost discipline to growth strategy. The categories of cost reduction are basic: eliminating waste and duplication, implementing best practices, introducing technology where it is effective and creating virtual operations via the Internet. Engaging in cost reduction without a clearly defined growth strategy, however, is like driving into a car wash with the convertible top down: you may clean up some problems, but you will create more. What is the urgent situation that requires reducing cost? How will the company use cost discipline to build momentum?

Empower the advocates. The problem is, most managers are not wired for cost reduction. For that reason, companies need champions who see it as their mandate to keep the organisation focused on the cost side of the business. When a downturn or market shift escalates the need for cost reduction, companies that have located and empowered such champions have the required processes and instincts already in place.

Benchmarking-internally and against competitors—helps managers locate cost centres throughout the company where cuts will yield the biggest impact.

That focus proved crucial for PacBell. In 1993, the telco recognised that operating constraints and competition were flattening revenues despite growing product volume. A systematic cost-reduction programme boosted PacBell's revenue per employee by 25% and produced more than US$1 billion in cost savings. The performance improvement was reflected in the premium paid by SBC Communications when it acquired Pacbell in 1997.

Act quickly on analysis. Diagnostic work should shape a company's agenda and its cost-reduction goals—generated not from the bottom up, but from the top down. This is a moment for cost-discipline champions to exercise strong oversight, by assigning specific goals to the various teams. Usually, the largest cost improvements come from optimising information technology systems and tightening supply chains to take out procurement costs.

Lead from a strong centre. Once targets have been identified and the strategy is firmly fixed throughout the company, execution becomes the priority. Sustaining an organisation's energy through any major cost-reduction programme ranks among the thorniest challenges managers will ever confront.

When everyone in the company thinks you have gone too far, there is always one more layer of cost to take out. That may be the most important lesson we have learned. Make cost reduction a core competency, and growth will not be far behind.

Vernon Altman is a director of Bain & Company and co-leader of Bain's Technology & Telecom practice. Marty Kaplan is chairman of JDS Uniphase and former executive vice-president of PacBell. Ravi Vijayaraghavan is vice-president with Bain & Company in Singapore, and a key member of Bain's Asian Technology & Telecom practice.