Thursday, June 02, 2005

The Cost Cutting Ritual

Does anyone recognise this????

The Cost Cutting Ritual (non-crisis)
(NB In a crisis this ritual can be bypassed and usually is)

Having been through this (painful) experience a few times it is apparent that there is a 3 step ritual that must be completed in sequence if one is to achieve real significant costs savings.

I describe the three steps as
1. Count the paper clips
2. Point the finger
3. Face reality

In "Count the paper clips" management attempts to save money by making what are essentially petty and ultimately ineffective gestures. Examples are move to recycled paper, use cheaper pens, cut out business class travel, stop company phones, etc.. These are picked because they are seen as easy, painless(?) changes, that do not threaten any significant power base.
These are ineffective for a number of reasons. The first is that when you look at the overall cost base they represent only a small percentage of total costs and even if major inroads can be made to them (and this is rarely the case) it will have only a small effect on the bottom line. Short term there may appear to be gains but these are usually quickly eroded. For example cutting out business class travel may well result in more overnight stays or higher costs for changing travel arrangements.

The second reason they are ineffective is because they alienate the core of the company, its staff. They see small things being taken from them and as a result often withdraw their goodwill, with a negative cost impact.

So having "Counted the paperclips" and not achieved the objective the stakes get raised and we move to "Pointing the finger". This phase is usually looking at what are seen as overheads and cross charges. In essence management looks to someone else to make the saving and thus charge the business less. Examples are looking at the cost of a Finance Department and deciding that something like expense processing is too high. So the central team is cut to a minimum and the work, that still needs doing, is distributed to team secretaries. This may mean some staff cuts but usually among junior, relatively inexpensive staff. The cost of Finance drops as to the allocated charges, but a business unit overtime will need more secretarial support, control of expenses is likely to be slacker and probably staff unhappier with the process.
There is often a stage where the basis of allocation is examined closely and changed, but in the end the same total cost has to be allocated across the set of business units, just maybe allocated differently.

There are many possible examples, but they all have they all have similar impact, a reduction in central costs and this allocated charges with a compensating increase in "local" costs. Net impact over the medium term is usually minimal and less than desired.

Finally we get to the crux of the matter and "Face reality". In this, having tried the easy(?) options and failed the business faces up to cutting the drivers of significant costs which constitute the key power bases of the company. In business like financial services with high human capital this means cutting big jobs, front office jobs, the roles that require support. Having worked in such environments there is often a multiplier effect and that is that the total cost of a business is some near-constant multiplier of front office salaries, albeit the multiplier is specific to that company. For example with a 2.5 multiplier cutting a £100k job will lead to £250k saving.

Other businesses will have other key drivers for example plant and property and it is these that need to be tackled at this stage.

These are not easy savings but are possible and sustainable and management only reaches this point by having tackled the previous two steps. in anything other than a crisis, when drastic steps are required, trying to jump straight to "Facing reality" is extremely hard as the other ineffective savings will be offered as a smoke screen in order to protect key power bases.

In summary

Count the Paper Clips

Typified by: Use of cheaper supplies/services

Results: Minimal saving after initial impact
Loss of goodwill and thus increased costs

Point the Finger

Typified by: Some reduction in central functions
Some reduction in allocated cost

Results : More local resource needed
Compensating local cost
Reduced service(?)

Face Reality

Typified by: Cuts in key drivers

Results: Reduction in local and associated costs
Attacks key power bases
Is sustainable