how to reduce costs rather than slash budgets
Turning inflation challenges into a strategic opportunity
“Smooth seas do not make skilful sailors” – African proverb
Navigating yet another challenge
The pandemic, supply chain disruptions, war in Europe, rampant inflation – there is no shortage of challenges facing businesses. Executives navigating this volatile environment are riding one tidal wave after another. And just as the ship sails into calmer waters, another wave rolls in, seemingly from nowhere.
One potential tsunami impacting businesses is inflation. As a result of high prices, the average UK household is expected to lose 8.3% of its total spending power in 2022. From the perspective of businesses, the rising cost of a broad range of inputs – notably energy – is putting pressure on profitability. Companies are squeezed between reduced consumer spending power and increased input costs. Their dilemma: the need to reduce costs while staying operationally resilient, retaining their workforce, and finding new revenue sources.
Traditional cost cutting focuses on target-driven percentage reductions across budget lines. That’s like repeating the same diet every year without acknowledging and exploring the reasons behind the diet. Setting targets without addressing root causes is not only unsustainable, it misses an opportunity for change. Often, an organisation needs to simplify, review what works and what doesn’t, and address longstanding issues in order to be more effective and efficient. The need for cost reduction provides the burning platform to do this.
By focusing on cost drivers it is possible to turn the challenges of inflation into positive, sustainable changes. In this article we explore how simplification, reductions in the costs of failure, and operating model alignment can free up capacity to be redirected to other areas or removed entirely. There should then be no need for next year’s diet.
Cost driver 1: the noise
Noise, aka the sheer volume and complexity of everything the organisation has to deal with, drives costs, often with negative impacts on employee and customer satisfaction.
Consider these examples:
A utility company had around 100 priority initiatives, resulting in a crunch on resourcing, overlapping meetings and, ultimately, poor return on investment.
A network control centre received a high volume of alarms, of which less than 10% required investigation or action. The 90% added effort and cognitive load that could be prevented by different processes or elimination of root causes.
A telecom provider had an overly-complex product set, leading to high costs in technology and fulfilment.
Modern organisations inevitably accumulate complexity over time across customers, processes, initiatives and many other factors. Reducing this complexity directly reduces costs and creates capacity to deal with broader opportunities. Sometimes, it’s hard to see the path when you’re stuck in the wood. It pays to take a step back and notice where the noise is coming from. Ask yourself, ‘What if we did/didn’t do x?’
The well-known 80/20 Pareto principle is a simple starting point to understand which products or customers generate effort or cost above and beyond the contribution they make. Typically, a large share of revenue or costs is driven by a smaller share of products, customers or processes. Differentiating how you deliver to each customer group, automating processes or streamlining the offering, are ways to manage costs.
Another simple tool is to assess initiatives by effort and possible value. This will put the spotlight on activities that are not likely to make a material difference but nevertheless consume resources. Low-value and high-effort initiatives should be stopped or restructured to reduce noise.
In both cases, decisions need to be informed by the data on the ground, and taken at the most senior level. Otherwise, personal and functional preferences might get in the way.
The prize can be significant. In our network control centre above we identified an opportunity to reduce costs by 35% without additional capital investment by simplifying processes, data flows and ways of working.
Cost driver 2: cost of failure
By cost of failure, we mean the excess cost incurred as a result of unplanned and unscheduled work. Breakdowns and issues are inevitable, customers must be served, and people kept safe. Many companies excel at resolving customer issues as they occur, and these behaviours are rewarded and therefore reinforced.
However, when the root causes are not addressed, costs of failure escalate to include, in the worst instance, repeated emergency activities and expensive mitigation actions such as compensation. At the very least, sloppy work or lack of accountability upstream that is never addressed causes repeat fixes downstream, adding not only effort but also resentment between teams.
For utilities, incidents typically occur due to issues in the networks that require emergency repairs. One water company estimated that around 20% of all operational spend was related to unplanned events and incidents. For retailers, costs around product shortages or failed online deliveries can quickly rise. For service providers, the otherwise efficient call routings may exacerbate some issues and lead to high levels of customer defections. While some incidents – like cyber attacks, server outages or freak storms – are unpredictable, many failures can be avoided, and most failures can be managed better.
The first step is to operate according to agreed specifications and processes, in particular when machinery, data and technology are concerned. Introducing variability whether it’s local or customer specific because ‘this is how we’ve always done it’ is the enemy of standardisation and growth, and will cause issues over time – for example when teams or systems change.
The second step is to analyse the failure demand, in particular issues that repeat themselves. Increased visibility of the repeat failure enables the next step: (re)design of processes to fix the root causes and development of contingency plans when things go wrong. The initial effort to source better data, develop new metrics and create cross-functional collaboration is relatively small compared to the significant benefits of fewer failures and a less frustrated workforce.
The third and final step introduces analytics to identify potential issues before they turn into failures. Intelligent combination of data sources, supported by analytics and visual representation, enables early warnings for the centre and operational teams who can make changes to prevent issues, or to prepare in advance. Technology including advanced analytics and AI plays a big role here, but improving foresight can be achieved with simple tools and by bringing together data from different sources.
A common denominator of all three steps is a commitment to remedying the root causes. This puts the spotlight on company culture, and how much pre-emptive action is valued over heroic actions to fix issues as they emerge.
The reduction in costs typically manifests as time or materials saved. Improved customer service and better product availability are additional benefits. In a recent engagement with a large field force, we delivered annual cost reductions of 10 to 13% through significant decreases in ‘bad demand’, where the same issues kept recurring. In a climate where the focus is on employee retention, the need to improve collaboration and relationships between teams and functions should also not be underestimated.
Cost driver 3: operating model
Operating model is the combination of activities that turns strategy into outputs. The activities are enabled (or hindered) by processes, roles, technology, data and other components that make up the live operation of an organisation. The critical question is, which parts of the operating model are causing interference and not adding value? For example, planning and scheduling team members at a large utility recently estimated that around a third of their time was spent on non-value adding activities due to poor information flows. And as much as 50% of scheduled field service repair capacity wasn’t fully utilised due to organisational complexities.
Operating model choices range from tactical to strategic. Tactical improvements – through clarification of roles, upskilling or better availability of information – will drive efficiencies and reduce frustration. For example, a high street retailer we worked with needed to ensure better insight upfront to reduce inefficiencies downstream.
But in the current environment, tactical opportunities may not go far enough. The pandemic has changed customer behaviours and ways of working in fundamental ways. At the same time, an abundance of data and an urgent need to move towards Net Zero require organisations to take a fresh look at operating models.
In our signature operating model methodology, we start from the customer and work back through design principles and strategic choices and trade-offs to develop the best possible new model – co-created and resilience-tested with key stakeholders. For more on this, take a look at our recent operating model article. The key takeaway here is that your operating model can either be your friend or your enemy. If you’re fighting to achieve your strategic goals, then you need to address the enemy.
One client who had experienced fast growth as a new market entrant described themselves as ‘coping despite the system’. Before they reviewed and redesigned their operating model, sales were down and company and staff satisfaction metrics were at an all-time low. By putting the customer rather than their technology first, breaking down silos and clearly linking strategy to action throughout the business, all metrics rapidly began to rise. The prize, if you have the vision and capacity to go for it, can be huge.
Laying the foundations for the future
“Difficulties mastered are opportunities won” – Winston Churchill
Driving cost reduction with targets for budget lines may be the most straightforward approach. However, without attending to the three cost drivers outlined above, unintended consequences could include starving of resources in critical areas. Reviewing the three cost drivers gives you concrete cost reduction opportunities while engaging employees and maintaining the interests of customers.
So where do you start? As regular readers of Egremont articles know, we are fans of asking questions like Socrates once did. Here are a few:
What consumes the day-to-day energy of the organisation? Where do we spend time on initiatives and issues that feel noisy rather than productive?
What are the pain points that consume a lot of time and resurface regularly?
If I could redesign my processes or products from scratch for optimum efficiency, which steps, data or interventions are not needed and which need reinventing?
What are the legacy ways of working and operating that, if we’re honest, are holding us back? What are the sacred cows?
How does the underlying culture impact the way we work, for example by adding complexity?
The current operating environment is challenging. It is also an opportunity to re-set and re-design the way a company operates. Executives need courage to embark on this journey. But those who do, know that staying still is not an option. They also understand that knowing the right questions to ask is better than assuming you have the right answers. So, if you could turn inflation challenges into a strategic opportunity, what would you do differently?
Sources: International Monetary Fund
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More about the author
Ari Iso-Rautio
Ari’s 20+ years as a management consultant has given him insight and access to multiple industries and business challenges. His calm strategic approach has helped many clients to see the wood from the trees and focus on what really matters to drive growth
