Strategic Cost Management | How to Take a Structured Approach to Reducing Operating Costs
Have you ever gotten an order to reduce costs within your structure? Or have you ever been affected by such an order?
Occasionally, in times of crisis, companies encourage corporate-level cost cutting, in which each area has a goal, and the most common example is to reduce staff.
This happens because companies do not practice Strategic Cost Management which consists of a systematic, continuous approach to constantly review corporate cost centers, using methods that offer visibility of expenses, establishing a change strategy, and taking action to cut costs in alignment with the company’s strategic objectives, as well as methods to measure the results.
Strategic Cost Management begins with the idea that just as every dollar of revenue contributes a bit to profit, every dollar saved contributes directly to profit. In other words, when a company actively manages costs, it is making a direct contribution to its own profitability.
In this mindset, back office areas normally seen as cost centers (and therefore the areas most impacted by cost cutting efforts) become profit centers that make a direct contribution to increasing profitability.
It begins with gathering information on the costs associated with the company’s structure. In doing so, studying not just salary costs, but also costs related to suppliers, software, facilities, and others is important. If some costs are apportioned, try to direct them, to create a clear picture of all costs (direct and indirect) associated with your structure.
The data should cover at least 24 months, which offers a broad view of real expenditures.
With these data in hand, it is possible to conduct diverse statistical analyses to understand their composition, behavior and trends. Possible analyses include descriptive analyses, cluster analyses, and classification models such as decision trees.
Analysis provides greater understanding of current costs. For example, a cluster analysis could identify cost centers with similar behavior, despite being different.
Once analysis is complete, an integrated dashboard of the data and analysis is created, allowing a unified view of the cost structure. This allows everyone involved to make their own analysis and derive insights.
With the current cost structure as a basis, the process of defining a cost change strategy begins. This is a vital moment, and must involve the entire formal and informal leadership team. This differs from a top-down approach in which decisions are made at a high level and other leaders must simply comply.
By involving the entire leadership team in defining the cost change strategy, stakeholders are better engaged and empowered, strengthening a sense of ownership, and making decision-making and later execution, more efficient.
The cost change strategy is based on three guidelines:
· Revert costs that harm the operation and should be reduced/eliminated.
· Transform costs that should be streamlined, using new approaches.
· Invest in costs that should be maintained or increased.
These three guidelines break a paradigm. When we talk about cost management, it is natural to think only of ways to cut costs. But when we work only with reducing and eliminating costs, although we may solve the problem at hand, we compromise the future productive capacity of the business.
To define the strategy, in addition to the guidelines, you can use different methods and tools to support discussions, such as trends in the sector and correlates, internal and external benchmarks, analysis of operational indicators, correlating them with the cost centers analyzed and co-creation techniques.
These methods should help answer questions such as: is the business more oriented to value or costs? Which costs are fundamentally derived from the business/strategy? Which key activities represent a significant expense to the business?
Once the cost change strategy has been built, you will know which costs should be reverted, transformed, and should receive investment based on a definition created by all stakeholders and on qualitative and quantitative objectives for each cost center, aligned with defined guidelines.
But to achieve the strategy, an action plan must be created. To quote Napoleon Bonaparte: “In strategy, application is decisive.” The plan must take as a starting point the defined objectives, from which initiatives are derived, with a focus establishing an action plan to turn the strategy into reality.
Activities related to the “transform” and “invest” guidelines are the most challenging, because they can involve renegotiating supplier contracts, changing the use of certain platforms (for example, from user licenses to service models), or seeking out new partners, among others.
To support the design and implementation of action plans, you can work with startups that offer services and solutions that enable companies to reach their objectives. One way to search for startups is to begin with the startup ecosystem, such as accelerators, universities, co-working spaces, hubs, among others.
Each initiative should have a lead: a staff member with authority to establish deadlines and execute the plan. The lead should be a person who participated in creating the cost transformation strategy, because he or she will be engaged in the change and must have the autonomy to create a plan, define deadlines, and execute activities.