Long but most profitable road to cost reduction

A while back I was reading an article in the magazine 'outlook business' that touched on the need to be prudent when it comes monetary policy. When an economy surges ahead it gives some scope to tighten interest rates. But rarely central banks do that as that is seen as anti growth by corporates and even politicians. If tightening the belt makes one sit upright, it will only help in sensible and safe driving. However we do see rate cuts to further fuel growth. When the tide turns it leaves central banks gasping for breath with already low rates. Rates can't go below '0'. Similarly businesses get carried away when times are good and don't look around much for cost cutting opportunities.

Cost cutting and cost reduction may have hardly troubled the corporate minds when the picture was rosy. But today everybody wants to cut costs. Nothing wrong with it just that people turn cost conscious only when pushed to a corner. If companies constantly work on reducing / eliminating unwanted costs, they will find it easier to navigate through rough waters. Unwanted costs present greater opportunity to achieve substantial recurring cost savings. However they also pose greater challenge and prove harder to crack.

Operational issues and problems

Unwanted costs happen due to operational problems and issues (OIPs). They are not something that can be easily and immediately done away with. They (OIPs) require a systemic solution. For a systemic solution we need better understanding and clarity of what they are and where to look at. In this post I am presenting a broader picture of operational issues and problems. It is an attempt to understand various factors that contribute to operational issues and problems and what causes each of these factors to thrive at work. The diagram given below captures two different sides of OIPs. On one side it has 'causes' and on the other side 'outcome' of operational issues and problems. By no means causes listed in the diagram are exclusive. There could also be some that may not find a place on the left side of this diagram but can impact one of the outcomes listed on the right side, directly. Click on the diagram to expand it and give me your feedback and suggestions.


I have broken it down to the next level, for example, expanding 'myopic view of the organisaiton' under 'Cooperation'. Currently going through them to filter and identify high impact causes. It's too huge a picture currently and there are some 128 causes with 39 duplications. In any case we are looking at not less than 89 different causes that when unattended infects and negatively impacts a business with the business virus called OIPs.

I will take up major causes of OIPs and discuss them one by one in future posts.

Link to earlier post on cost reduction

Cost cutting - The way forward

Cost is something that a business must incur to create and deliver value for its customers. However it is far from the reality. Businesses do incur costs that do not create value or costs that add little value to its customers. 'So what's the big fuss? Just remove costs that add no value and your job is over'. well it's not as simple and easy as that. Each cost, rather each expense item that figures in the financial statements of a company conceals both 'wanted' and 'unwanted' costs. Chaff should be carefully separated from wheat as otherwise wheat could be mistakenly thrown out.

Operational issues and problems (OIPs), a business virus, cause unwanted costs and to ward off against this virus a company needs to take a systematic approach that may require changes at various levels and things, in-depth training and a change in attitude. OIPs and guarding against them is a big topic that could fill many blog posts. But for the moment we will focus on a n approach to cost reduction.

If you are on a cost cutting mission then I would recommend you to consider the following approach to cost reduction.

Reducing cost

We can classify costs (not in the cost accounting way) into four different categories viz., essential, necessary, optional and unwanted costs.

Essential costs are those that are incurred to create and deliver value for customers. If by any chance these costs are reduced then a company will be compromising on the value it offers. To distinguish essential cost from the rest, ask the question what if this cost is removed or reduced? If the answer casts a shadow on quality, customer satisfaction, or sales capability then stay clear of it.

Necessary costs are those incurred to keep the business running. Certain employee related expenses, statutory costs and the like do not add much value to the customer but are necessary. It's hard to reduce these costs but they can at best be monitored and kept as tight as possible with some rules and tinkering.

When a company can afford luxury it incurs optional costs. They also help boost the image of the company among employees, customers, industry, analysts and the lot. It may not be possible for a company to entirely root out optional costs as some of it, when reduced, can damage the image of the company. But with effective PR and communication most of the negative impact of reducing optional costs can be avoided. For each expenditure falling under optional cost ask, what would happen if this is removed? If the answer is not damaging and the company can afford to remove it go ahead.

click the picture to enlarge

If there is one cost that requires most attention and effort to deal with then it's got to be unwanted costs. Generally six sigma and lean management interventions help companies achieve significant cost reductions as they attack unwanted costs head-on. There are case studies that claim 40 - 60% cost savings. But one thing can be said with confidence that operational issues and problems (OIPs) present huge opportunity for companies to achieve greater and recurring cost savings.

The picture given alongside captures some of the factors that contribute to unwanted cost. They reside in every process and activity right from the top to bottom. Many a times they may not be obvious and would require lot of questioning to identify. To identify and attack unwanted cost, scan each process, raise questions, scrutinise decisions and actions. A picture will emerge out of this exercise and that act as the basis for eliminating unwanted cost.

Final words

Form a team to handle the whole cost reduction exercise. Start from understanding what is essential, necessary and optional from companies' point of view. It would also be a good idea to explore people's mind on what these could be. Once this picture emerges and is clear then straight away attack optional costs by questioning each item under that. Form a separate team with a clear mandate to attack unwanted cost.

Good luck.