when cost cutting doesn't pay

when cost cutting doesn’t pay

February 25, 2011  |  knowledge, leadership, main blog, management

We’re finding it harder to compete in Australia! Higher costs (particularly for labour) and a strong currency are providing serious challenges in manufacturing, primary industries, tourism, and retail. A typical response to the problem is to start cost cutting, rather than seeking higher prices – because a strong and well marketed value proposition with a point of difference generally takes longer, and is harder, to achieve.

The entry of James Hardie into the US market is a great example where cost reduction made the difference between market skimming and market penetration. Working with Australian researchers, the US operators and engineers halved the cost of production of “Hardiplank” (fibre cement siding that looks like wood) to levels that had previously been seen to be impossible. Not only did they achieve a penetration strategy, but they “saw off” four new entrants – all with deep pockets who lusted after the market that had been created.

The pursuit of lean manufacturing and smarter ways of doing things in business, like the Hardie example, is widely accepted. However, cost cutting across the board can be a problem. Some CEO’s (often with accounting backgrounds), adopt unfocussed slashing across the board. Handled inappropriately and insensitively, cost cutting can trash morale and stifle creativity, as well as negate the strategies that drive top line revenue. The key to sensible cost cutting is to make decisions based on contributions to profitability, rather than total cost as such. It’s a bit like sorting out the good cholesterol and the bad cholesterol.

Under short term pressure, I’ve seen how some managers and owners have shot themselves in the foot with ill-advised cost cutting:

  • A tourism business where cost cutting in food and beverage diminished the overall customer value proposition. Total savings were relatively small in the context of the resulting loss of word of mouth and customer satisfaction – both critical mid to long term business drivers.
  • A public sector organisation where all the perceived “nice to haves” were cut – things like green plants, art work, fruit and Christmas parties. Losses in productivity from low morale outweighed any cost savings. I also found out the other day that studies have shown a 17% productivity improvement from greening an office!
  • A manufacturing business which had reduced operating costs as well as sales and marketing capacity. While the new business model was sustainable operationally, the sales pipeline dried up due to insufficient customer interface and new business development.

Some of these comments may appear obvious, particularly with the benefit of hindsight. However, too often, management teams and boards get so caught up in the short term pressures for outcomes and quick fixes, that they take actions like the three examples above. It happens!

It’s not too long ago that the four big Australian banks, in a cost cutting frenzy, lost touch with the human element, closing branches and increasing call centres. These same banks are now falling over each other to restore relationships with customers.

My advice then is to chase lower operating costs, but not at the expense of our most valuable asset – people (actually good cost reduction programs make positive motivation an integral part of the process). Nurture, develop and reward talent, and if there are pay cuts, make sure the executives take the medicine as well. Ensure that the drivers of profit and revenue (like relevant R&D and marketing) are not impacted to the extent that they will damage sustainability.

 The objective should to achieve what Catherine de Vrye advocates in her excellent book “Paperclips don’t grow on trees” and add value, not cost, to the bottom line. In tandem with this, ensure that you read how the customer is reacting at every point along the journey.


5 Comments


  1. Ken,

    I look forward to reading Catherine de Vrye’s book “Paperclips don’t grow on trees” which I hadn’t heard of prior to your blog.

    I would however like to make a point about labour costs, particularly given my experience in the Industrial Automation sector. Few people in the general community, including pollies, are aware of industrial automation and control and the associated technologies such as Manufacturing Execution Systems (MES).

    It is certainly true that in those industry sectors, such as clothing and footwear (but I would add not necessarily textiles), where the manufacturing processes are labour intensive, it is very difficult for Australia to compete with countries like India and China due to labour costs.

    That is not the case a many other industry sectors though. Let me provide a couple of examples.

    Pharmaceutical manufacturing need (should) not be particularly labour intensive. It is however subject to very strict regulatory requirements. We don’t want people to receive contaminated medicines or the wrong doses etc and should things go wrong, it is essential we can recall any contaminated batches very quickly. This requires manufacturing processes to be very closely monitored, production processes to be validated and ingredients and product batches to be tracked through the process. This is regulated by the TGA in Australia, the FDA in the US and similar bodies in Europe. Whilst there are a number of very sophisticated systems to do this, many of our major pharmaceutical companies still “validate, track and trace” manually using dozens of people paid at Australian labour rates. If I wanted to set up a pharmaceutical company I would do so in India. Not because of any desire to hire hordes of cheap labourers to do this validating and tracking work. I would do so because I could probably find and/or build a suitable facility within 3-6 months and then implement a state of the art MES system, which would allow me to meet the FDA and TGA regulatory requirements and then export products globally.

    A few years ago I visited a manufacturing site which made components for the automotive industry. They ran 3 shifts over 24 hours. About 30-45 minutes prior to the end of each shift they ran the production line dry. They did this on order to count the number of units that been manufactured, check them for any problems and assign the production to a particular shift. All things that could have been performed by some imaging technology and a simple Manufacturing Execution System (MES) driven off the plants control system. An MES costing no more than $150k together with an imaging system would have saved this plant maybe 2 hours of production time each day, yet the company was not prepared to make such an investment. My understanding is that some of these particular automotive components are now imported from China.

    Many of our manufacturers don’t seem to have the vision to improve their current manufacturing technologies or to strive to make themselves competitive in the world markets. Having said that it is not always the manufacturers fault since they have often been constrained by short sighted unions who put whole industries at risk to save a few jobs now rather than allowing companies to build world competitive businesses.

    Our pollies have neither the vision or political will to create planning approval processes that would allow startups manufactures to establish themselves within financially viable timeframes.

    It’s all to easy to blame cheap labour, our small marketplace and the tyranny of distance to world markets. These are simply excuses for ignorance, inaction and a lack of vision.

  2. I think Paras 6,7 and 8 have diluted considerably the intended message.

    • Thanks Graham. Value your comments as you are my mentor in relevant cost reduction. I guess there really are two messages here. I will never walk away from the fact that across the board cost reduction can have devastating impacts at customer level, and in the mid term, the business. I think we are aligned but welcome the ongoing debate if we are not.
      Ken

  3. Ken I completely agree with you. We are on the same page. My impolite comment(on Bill Ellerton’s comments) reflected the blurring of the essential point that to achieve intelligent cost cutting we must study and change the process first. Get rid of unnecessary work. Automating the counting process ,albeit good, will prevent the silly stockpiling and counting I agree, but the inference in that example did not identify the fact that the management who were perpetrating that silly practice were poor management and buying a counting machine that will institutionalize those stupid managers.
    Also pollies do not understand productivity. How can we blame them this time! Pollies should be identifying all the reasons why manufacturing is essential in this country and spend less time on some of their current” social ” pursuits. Manufacturing well done, gives work ,gives dignity.gives social cohesion
    Management must understand it is management’s responsibility to learn what is productivity and how to implement it, and train and nurture employees whether they are unionized or not.
    Lack of productivity is always management’s fault . Sometimes unions make the job a little more difficult. That calls for more nurturing . Graham S

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