Brief

The Right Way to Cut Costs

Make cost reduction a core competency, and growth won't be far behind.

By Vernon Altman, Marty Kaplan and Alistair Corbett

Published on March 28, 2003
min read


For most managers, cost discipline holds as much appeal as a cold shower. The prevailing attitude, even in harsh economic conditions, is that costs must be cut from time to time. Usually, the grueling work of taking out costs is a reaction to events, a periodic program rather than an operating principle and an ongoing way of life. But the most competitive companies have embedded cost discipline in the way they do business. Consider how Kroger, the US grocery retailer, used the technology of customer self-service to cut costs—and discovered an avenue towards growth. With 300,000 employees, $9 billion in operating expenses (most of it labor), and the razor-thin margins typical of the grocery industry, Kroger began experimenting with self-service checkout aisles in the mid-1990s. Fewer cashiers meant lower costs, but self-service quickly became its own draw. Customers enjoyed the speed, privacy and convenience so much that 33% said they were more likely to visit a Kroger's store because of the self-serve checkout. The self-serve aisles were saving money, and bringing in more business—potentially generating as much as $100 million a year in additional profits (according to early estimates) if the company rolls out the money-saving convenience to all of its stores. The groundwork for such a breakthrough is continuous cost reduction. Companies that perform well, in good times and bad, develop a capacity to recognize downturns early, to take action quickly, and to relentlessly drive out costs—even when their businesses start regaining momentum. According to Bain research, top-performing companies achieve about half of their total profit improvement directly from cost reduction. Companies that instinctively take out costs create unexpected opportunities, as Kroger learned. In a deep downturn, those instincts, coupled with a disciplined process, can help stabilize a business and lay the groundwork for the next phase of growth. Tie Cost Discipline to Growth Strategy The broad categories of cost reduction are fairly basic: eliminating waste and duplication, implementing best practices, introducing technology where it's effective and creating virtual operations through use of 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'll create more. What is the urgent situation that requires reducing cost? How will the company use cost discipline to build momentum? It's critically important for a company's leaders to make clear these reasons and to create a collective will to tackle the issues Empower the Advocates The problem is, most managers aren't wired for cost reduction. It's more fun to concentrate on generating revenue and growing the business. For that reason, companies need champions who see it as their purpose in life to keep the organization focused on the cost side of the business. When a downturn or sudden market shift makes the need for cost reduction more acute, companies that have already located and empowered champions of cost discipline have the processes and instincts of cost reduction in place. Benchmarking—internally and against competitors—helps managers to locate the cost centers throughout the company where cuts will yield the biggest improvements in profitability. That focus proved crucial for PacBell. In 1993, the telco recognized that operating constraints and increasing competition were causing revenues to flatten despite growing product volume. Managers realized that ongoing cost discipline wasn't enough; another layer of costs had to come out. A systematic cost-reduction program driven from the top boosted PacBell's revenue per employee by 25% and produced more than $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 critical moment for the cost-discipline champions to exercise strong oversight, by assigning specific goals to the various teams that are on point to accomplish results. If teams are formed primarily from line organizations to develop the specific cost-reduction plans, buy-in is higher and familiarity with targets of opportunity is greater. Time after time, the largest cost improvements and synergies come from optimizing information technology systems and tightening supply chains to take out procurement costs. A simple example is Bell Canada—which found $65 million of savings in its billings and receivables in part by automating its response to frequently asked questions. Lead From A Strong Center Once targets have been identified and the strategy is firmly fixed throughout the company, execution becomes the priority. Sustaining an organization's energy through any major cost-reduction program ranks among the thorniest challenges managers will ever confront. When everyone in the company thinks you've gone too far, there's always one more layer of cost to take out. That may be the most important lesson we've learned. Make cost reduction a core competency, and growth won't 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. Alistair Corbett is a Bain director based in Toronto.

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

Consider how Kroger, the US grocery retailer, used the technology of customer self-service to cut costs—and discovered an avenue towards growth. With 300,000 employees, $9 billion in operating expenses (most of it labor), and the razor-thin margins typical of the grocery industry, Kroger began experimenting with self-service checkout aisles in the mid-1990s. Fewer cashiers meant lower costs, but self-service quickly became its own draw. Customers enjoyed the speed, privacy and convenience so much that 33% said they were more likely to visit a Kroger's store because of the self-serve checkout. The self-serve aisles were saving money, and bringing in more business—potentially generating as much as $100 million a year in additional profits (according to early estimates) if the company rolls out the money-saving convenience to all of its stores.

The groundwork for such a breakthrough is continuous cost reduction. Companies that perform well, in good times and bad, develop a capacity to recognize downturns early, to take action quickly, and to relentlessly drive out costs—even when their businesses start regaining momentum. According to Bain research, top-performing companies achieve about half of their total profit improvement directly from cost reduction. Companies that instinctively take out costs create unexpected opportunities, as Kroger learned. In a deep downturn, those instincts, coupled with a disciplined process, can help stabilize a business and lay the groundwork for the next phase of growth.

Tie Cost Discipline to Growth Strategy

The broad categories of cost reduction are fairly basic: eliminating waste and duplication, implementing best practices, introducing technology where it's effective and creating virtual operations through use of 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'll create more. What is the urgent situation that requires reducing cost? How will the company use cost discipline to build momentum? It's critically important for a company's leaders to make clear these reasons and to create a collective will to tackle the issues

Empower the Advocates

The problem is, most managers aren't wired for cost reduction. It's more fun to concentrate on generating revenue and growing the business. For that reason, companies need champions who see it as their purpose in life to keep the organization focused on the cost side of the business. When a downturn or sudden market shift makes the need for cost reduction more acute, companies that have already located and empowered champions of cost discipline have the processes and instincts of cost reduction in place. Benchmarking—internally and against competitors—helps managers to locate the cost centers throughout the company where cuts will yield the biggest improvements in profitability.

That focus proved crucial for PacBell. In 1993, the telco recognized that operating constraints and increasing competition were causing revenues to flatten despite growing product volume. Managers realized that ongoing cost discipline wasn't enough; another layer of costs had to come out. A systematic cost-reduction program driven from the top boosted PacBell's revenue per employee by 25% and produced more than $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 critical moment for the cost-discipline champions to exercise strong oversight, by assigning specific goals to the various teams that are on point to accomplish results. If teams are formed primarily from line organizations to develop the specific cost-reduction plans, buy-in is higher and familiarity with targets of opportunity is greater.

Time after time, the largest cost improvements and synergies come from optimizing information technology systems and tightening supply chains to take out procurement costs. A simple example is Bell Canada—which found $65 million of savings in its billings and receivables in part by automating its response to frequently asked questions.

Lead From A Strong Center

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

When everyone in the company thinks you've gone too far, there's always one more layer of cost to take out. That may be the most important lesson we've learned. Make cost reduction a core competency, and growth won't 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. Alistair Corbett is a Bain director based in Toronto.