LEADING THROUGH CRISIS
How to cut costs not simply to survive but to thrive
APRIL 23, 2020 | BRENDA VAN CAMP
In times like these, you frequently hear leaders talk about right-sizing their company in response to the economic downturn. Perhaps you have already received an email from the c-suite with the missive that “the company as a whole needs to find 30% in savings across the board to keep costs in line with the projected lower revenues.” But making cuts “across the board” is a dangerous knee-jerk approach. While it may feel more “fair,” that is not the goal?
The goal is to realign the company’s cost base in a way that better enables it to weather the storm and position itself to rebuild afterward. So, the aim is to be strategic, and in this week’s post, we will discuss a two-part framework to ensure you cut costs in a way that will enable your organization to thrive again in the future ? not just survive.
Part 1: Re-validate your direction
Following such a significant shift in the overall business environment, each company needs to first conduct a quick strategic review of their business portfolio because the route to future success isn’t necessarily “the same strategy but at 30% less cost.”After a crisis, the route to future success is most likely not ‘the same strategy but at 30% less cost.’Hence, one needs to answer the following five questions to identify which aspects of the business portfolio strategy need to be revised in response to the new business environment.
What are the resulting shifts in the needs and overall demand for our products & services?
Note: We wrote this article in early 2020, so we used examples of the shifts caused by the onset of the pandemic at that time.
Example: As all live sports around the world are on hiatus until further notice, attention has turned to e-sports. This provides previously unthinkable opportunities to e-sports companies such as Take-Two Interactive Software, the makers of NBA 2K and Electronics Arts, the makers of American football video game Madden NFL 20, and Psyonix’ Rocket League, the car racing game.
How does this shift affect how we differentiate ourselves from other players?
Example: Fitness is moving online en masse, rapidly commoditizing the “on-demand” aspect of existing online fitness offerings such as Peloton and Mirror, and requiring them to rethink how to differentiate their value proposition to remain competitive.
How does this shift affect our customer segments?
Example: Previously, Zoom focused on providing video conferencing services to business customers. Now, due to personal distancing, it has been adopted by new segments of customers, including personal users and schools. This has resulted in unexpected revenue growth for Zoom, yet it also required the company to make changes to address the differing needs of personal users and schools.
How does this shift affect how we produce & deliver our products or services?
Example: The shelter-in-place order closed down cinemas around the world, throwing a wrench in the wheels for the release of several new movies. While some have decided to wait until the fall, like Universal Pictures with the new James Bond movie, other film studios are rethinking their distribution strategies now and selling their films directly to online streaming services such as AmazonPrime and NetFlix.
How does this shift impact our various sales channels?
Example: Before the current health crisis, 79% of wine was sold through grocery stores and wine shops, 19% was sold through restaurants and bars, and just 2% was sold directly to consumers. However, in light of the new normal, winemakers will have to increase their focus on developing their D2C sales channel to replace the projected sales decline through restaurants and bars.
Part 2: Cut with surgical precision
Not all costs are created equal. Some expenses are critical to your organization’s ability to differentiate itself. At the same time, other costs are necessary to pay for basic operational activities to operate in your industry and yet other costs are not strategically required but nice to have’s. So, rather than cutting across the board, you need to safeguard the alignment between your expenses and your strategy. I.e., you need to carefully weigh which costs to cut and which to keep based on what you need to do to execute your plan going forward successfully.
So what’s needed?
Get specific about which exact capabilities underpin your company’s ability to deliver a differentiated value proposition.
Companies frequently get this part wrong by defining this too broadly. This is not about saying, “Marketing is a core capability.” Instead, this is about getting specific. For example, one of Apple’s distinctive capabilities is its exceptional supply chain management, which is a capability that includes a variety of activities, such as supplier management, warehousing operations, demand management, inventory control, production planning, and sourcing.
Note, how we did not say that “operations” is one of Apple’s distinctive capabilities, but that we got specific around which set of activities creates that unique supply chain management capability. When you’re this specific about which activities help deliver a company’s differentiated value add, then you can also, during a cost-cutting exercise, protect the particular expenditure on people, technology, tools, and processes that are required to maintain those capabilities that underpin a company’s competitive edge.
During a cost-cutting exercise, your need to protect the particular expenditure on people, technology, tools, and processes that are required to deliver your company’s competitive edge.
Distinctive capabilities don’t tend to fit neatly into budget lines.
Once you have a detailed definition of what your differentiating capabilities are, then you need to unravel your budgets to isolate the activities and resulting costs across functions that support these capabilities. If you don’t do this and just cut your budget by a certain % across the board, you risk cutting the very expenditure that you need to maintain your company’s competitive edge.
To do this, you first have to categorize each cost into one of four cost categories, based on the Fit for Growth cost-optimization model developed by Vinay Couto, John Plansky, and Deniz Caglar.
- Differentiating capabilities: Expenditure for activities to develop and maintain distinctive capabilities
- Table-stakes:Costs to enable activities to be a viable player in your industry.
- Lights-on:Expenses incurred to operate your organization day-to-day, such as legal and facilities costs.
- Not required: Any expense that’s not needed, including executives frills, nice-to-have employee perks, non-strategic initiatives, and pet projects.
Once you have categorized all your costs, the next step is to re-evaluate the optimal level of expenditure for each cost. Given that we want to protect our distinctive capabilities, the aim should be to find opportunities to save in the other three categories. However, when doing so, be aware that our own bias can get in the way of making the tougher calls.
For example, when considering cutting initiatives that are no longer deemed strategic, leaders often struggle to pull the trigger because of what economists call the sunk cost fallacy. This is our tendency to continue investing in a losing proposition because of what it has already cost thus far. Instead, the only real question should be, “knowing what I know now, would I still make this investment.” The answer is generally no.
When considering cutting initiatives that are no longer deemed strategic, leaders often struggle to pull the trigger because of what economists call the sunk cost fallacy.Also, businesses tend to over-invest in table stake activities ? those technologies, processes, and tools that are part of the “cost of entry” into an industry. Instead, when reviewing what we spend on those activities, we would do well to remember that they do NOT differentiate us because EVERYONE has to undertake these activities to play in this industry. That’s why it would be much wiser to try and find ways to spend as little as possible on them.
Lastly, don’t overlook the many crimes that are hidden in your “lights on activities.” Lights-on costs include costs such as utilities, office supplies, and legal fees. The reason why they often are overlooked is that, when allocated by department, they look like small-fry budget lines. However, when aggregated across departments, lights-on costs can be significant and provide fertile ground for cost savings.
Taking an across the board approach to your cost-cutting may sound fair, but tends to gloss over the need to review whether a company’s long-term strategy is still valid in the new environment. It can also ultimately end up doing more harm than good by cutting in areas that are critical to your company’s ability to regenerate growth. Instead, taking a more strategic approach will help your company not just emerge with savings but also with clarity about your revised strategy and distinctive capabilities to succeed in the new normal.
Taking an across the board approach to your cost-cutting may sound fair, but can ultimately end up doing more harm than good by cutting in areas that are critical to your company’s ability to regenerate growth.
Fit for Growth: A Guide to Strategic Cost Cutting, Restructuring, and Renewal, by Vinay Couto, John Plansky, Deniz Caglar