How to cut costs not simply to survive but to thrive

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.