June 5, 2008

Keeping Company Costs Cut

 

Looking beyond traditional approaches to a company’s DNA will avoid frequent cost-cutting.

Dubai, UAE, June 2008 - “Corporations must understand why costs escalated in the first place, to therefore avoid the need for frequent cost cutting,” explained Bahjat El-Darwiche, a Principal with Booz & Company. Going after structural issues alone while ignoring the three other critical strands of every organization’s DNA — decision rights, information, and motivators — will not help to cut costs and keep them cut.

Transparency of information and costs at all levels is central to any sustainable cost-cutting effort, in addition to the metrics required to monitor these costs. “Business units and departments without access to such information act as though they have a blank check, which can lead to an explosion of IT costs,” commented Rabih Abouchakra, a Principal with Booz & Company.

With transparency on costs - companies can allocate services by forcing departments to make decisions on the basis of fixed prices, or by open, competitive bidding between service providers. Once information on the real costs is available, companies can use this to make better, more sustainable cost-cutting decisions - as long as the governance structure is clearly defined, logical, and consistent.

Decision rights involves identifying who is responsible, authorized and accountable for making various decisions. If these rights are at a high, centralized level, companies will lose time waiting for top executives to make key decisions, and if decision-making authority is too decentralized, redundancies and inefficiencies result as divisions and departments replicate one another’s efforts. Worst of all is a company that hasn’t defined these rights, meaning decisions are made by everyone - or by no one at all.

“Senior managers should push decision rights further down the org chart while monitoring the decisions their direct reports make,” commented El-Darwiche. That expands the senior manager’s control and with good information, decision makers become more efficient, lowering the cost of the decision-making process.

Giving managers more responsibility can save money by slowing the increase in organizational layers. That effort must be accompanied by a system of motivating incentives; “It means creating a bonus system that rewards managers who meet specific cost targets, not just business targets, as well as developing a promotion strategy that goes beyond standard vertical promotion schemes,” Abouchakra stated.

Companies should develop strategies for top performers that emphasize lateral promotions - conferring more responsibility and higher salaries without a move up the management ladder. Such moves open up the channels of communication with the increased movement of managers between departments.

Combining structural changes, better managed decision rights, a new approach to incentives and motivators, and the access to cost information, involves taking an integrated approach to a sustainable cost management program. In one company, distribution costs were a considerable expense, as they were treated as fixed costs and charged back to sales teams as a percentage of sales. Executives knew that expenditures on distribution varied widely, due to special requests for services such as more frequent delivery and expedited shipping.

Top managers decided the answer was to fix the problem beginning at the level of information transparency. Introducing a “rate card” that defined specific charges for added services — at prices competitive with outside distribution services — forced the customer teams to make decisions within a true supply-and-demand regime. Lower-level managers were also given rights to make decisions on the basis of the information on the rate card, and their incentive structure was changed to reflect not just their sales gains but also their ability to keep costs low.

“Costs came down even more than the company expected and stayed down, and newly empowered managers took the rate-card mantra with them. These changes allowed each division to maintain its lean structure, given team managers expanded spans of control and greater flexibility in making decisions,” concluded Abouchakra.

Costs, once cut, have to stay cut. The only way to do so is to reach deeper into a company’s makeup, to put in place an integrated program that takes into account all four of its DNA strands.