Cost Reduction Strategies for Manufacturers
What is Cost Reduction?
Cost reduction, as related to any business, is just as it sounds. The definition of cost reduction, according to Wikipedia is:
“The process used by companies to reduce their costs and increase their profits. Depending on a company’s services or product, the strategies can vary.” (Wikipedia)
While the Wikipedia definition is straightforward, the path to cost reduction for manufacturers is actually the exact opposite. For many businesses and organizations, cost reduction programs are focused on cost-cutting. However, this approach can backfire and lead to reduced service, reduced quality and ultimately reduced profits. In order for cost reduction to help enterprise growth, it is critical for a business or organization to take a strategic approach to their initiatives. In fact, “Big Four” auditing, accounting and professional services firm Pricewaterhouse Coopers (PwC), asserts:
“The crucial priority isn’t the costs you take out, but where you focus resources to stimulate growth and differentiation – strategic cost reduction. And while technology opens up opportunities to improve operational capabilities and strengthen return on investment, the real keys to successful strategic cost reduction are the ambition and underlying culture of innovation within the organization.” (PwC)
Why Employ a Cost Reduction Strategy?
There are a number of reasons why manufacturers and organizations develop cost reduction strategies. The obvious one is that they want to reduce costs to improve their numbers. Employers usually look to cut benefits and staffing, vendor and administrative costs. They also often investigate adding technology to improve efficiency. But, without real thought about how those costs will affect growth and profit, organizations frequently find that cost reduction can actually reduce profits. Why?
- Cutting benefits and staffing costs can lead to employee frustration and dissatisfaction. Furthermore, hiring the cheapest employee may not lead to the best possible results for that position, ultimately leading to reduced quality and customer satisfaction.
- Cutting vendor costs can lead to lower quality, incorrect orders, and employee frustration because of the extra time spent dealing with vendor mistakes.
- Cutting administrative costs can reduce the quality of customer service for tasks such as billing, payments and other administrative duties that affect customer satisfaction.
No business wants to be seen as a frustrating place to work with bad customer service. That’s why strategic cost reduction is critical. It gives any business enterprise or organization the ability to look at specific business areas where cost reduction won’t negatively affect employee and/or customer satisfaction. In fact, if done properly, it can improve growth and profits by allowing organizations to reduce costs in areas of the business that can be controlled, while also freeing-up resources to focus on transformation and innovation.
How many cost-cutting initiatives have our companies gone through in the last dozen years? More important, do we look back on those initiatives as transformative in helping us build success and leading us to growth?
For executives at most large organizations, the answer to the first question is probably “too many,” and the answer to the second is “no.”
Tips for Getting Started with Strategic Cost Reduction
It’s interesting that if you google ‘strategic cost reduction strategies,’ numerous key industry and national articles say basically the same thing. Hire less expensive labor, replace open positions with less expensive employees, hold down pay increases, control miscellaneous spending, and the list goes on. As explained above, this is exactly the wrong way to approach strategic cost reduction, because it can lead to the opposite of what a business wants and needs. So what to do instead? We have a few suggestions, as follows:
Define your costs. According to Forbes, companies implementing cost reduction should first define their costs as good, bad and best. The ability to understand and rank a cost helps provide a framework for determining what makes sense to cut. Bad costs are expenses that don’t align with the overall company strategy. Good costs drive initiatives and align to the customer and company strategies. Best costs create differentiation from competitors.
“Once a company’s costs are classified, strategic cost cutting becomes a process of minimizing exposure to bad costs and maximizing investment in the best ones. The practice helps create a more resilient growth model, particularly important during times of uncertainty.” (Forbes)
Connect costs and strategy. Harvard Business Review asks readers to think of cost cutting as an opportunity to channel investments toward strengthening their value proposition.
“Connect your budget directly to your strategic priorities; if your budget doesn’t reflect your priorities, you have very little chance of executing your vision. This entails viewing costs not merely as an in-year expense but also as a multiyear investment in differentiating capabilities designed to help your company execute its strategy.” (HBR)
Make cost reduction everyone’s responsibility. While executive support is important for cost reduction strategies, the right company-wide accountability ensures its success. McKinsey states:
“Few would dispute that the support of top executives is necessary for cost-management efforts to succeed. Involved CEOs and CFOs, in particular, can help mediate the inherently political nature of such exercises and provide critical energy and motivation. Yet in our experience, the involvement of top managers is not by itself sufficient—especially in a period of growth, when they naturally turn their attention to other initiatives.” (McKinsey)
Think of cost reduction as an ongoing program. Typically, during difficult economic times companies look at cutting costs. However, if the goal of cost reduction is to strategically free up capital and resources for innovation and differentiation, this mindset does not make good sense. Instead, companies should consider cost reduction an ongoing strategic program, through both good and bad economies. Much like continuous improvement, Lean, and workforce development programs, it work best as an integrated part of a company strategy that includes measuring and adjusting for optimal effectiveness over time.
Measuring Cost Reduction Program Effectiveness
Once you have a program in place, it is very important to measure its impact on the organization. Review each initiative and decide:
- Was it a success? If so, how big?
- If not, was it worth the trade off?
- If not, is it worth improving or should it be removed?
- Were any of the cost reduction programs damaging to the company’s reputation?
Companies that take the time to align their cost reduction programs to their strategy see real benefits.
- They have a framework for reducing costs and improving growth BEFORE it is needed. This removes the damaging reactive cost reduction measures that create unhappy customers and employees.
- They understand what makes the most impact, not just what’s most efficient.
- They can have historical data and can report on successes and failures in order to adjust to industry changes and optimize the program.
VMEC can help your Vermont manufacturing enterprise or organization make informed decisions about strategic cost reduction programs, and we can also help you implement them. To learn more, Contact VMEC Today!