SPECIAL GUEST BLOG By Sean Donnelly, Financial Management Mentor, Mentors.ie

The manner in which costs are reduced can either greatly help or seriously damage a business. Cutting the wrong costs or failing to reduce the appropriate

costs could endanger prospects for getting through the down-turn and the recovery prospects for a business. Irrespective of the organisation size the principles remain the same. The challenges for management are:

1. Not just about reducing costs in absolute terms but reducing unit operating costs.

2. Increasing efficiencies and competiveness.

3. Retaining the right staff and bringing the organisation with you.

4. Do it responsibly and with respect.

In summary there are at least 12 ways to reduce costs:

1. The simple approach: Cutting all discretionary spending on advertising, recruitment, training, delaying payments etc. This approach is simple, direct & effective at stemming cash outflow quickly.
2. "Bureaucratic" cost reduction: Centralised, imposed, rule-based cost control with strict budgetary controls.
3. "Equitable" cost reduction: Setting cost reduction targets e.g. 10% for every department. This approach frequently brings out the "departmental/functional" mentality.
4. "Stretch targets" – This is similar to the “equitable” approach but "stretch" targets means that the target varies by each functional area so that those areas where there is believed to be greater cost reduction opportunity can be asked to stretch towards a more demanding cost reduction target than other areas.
5. "Sweat the assets" approach: e.g.. cutting debtor days, reducing stocks, selling assets, delaying supplier payments.
6. Relocate: moving to a cheaper location.
7. "Changing the way we do things": Reviewing and re-engineering business processes, reviewing the way we service customers, reviewing overhead and IT effectiveness.
8. "Changing the mix of what we do": Trimming bad products/services, trimming poor customers, reviewing & changing routes to market & distribution channels, reviewing cost drivers. Activity analysis, data collection, challenging the way we do things are key steps of this process.
9. Simplify/rationalise the company structure: Review the organisational effectiveness including delegation, accountability, job specifications and performance targets.
10. Strategic purchasing – working with suppliers, buying smarter etc.
11. Outsourcing.
    
12. The strategic option – This incorporates all the proactive elements of the above including restructuring the company in line with a strategic plan to fulfil customers requirements.

Any approach focused taking only the first few steps alone will be unlikely to yield sufficient advantage over competitors taking a more strategic view. In summary, the most effective way to gain long-term advantage from a cost-reduction process is through squeezing all costs, eliminate all waste, changing strategic shape, playing to and building on strengths, maximising efficiencies from all necessary processes whilst eliminating unnecessary processes. A properly implemented cost-reduction programme offers a business a chance to re-position itself for a better future, re-focus on customer's real needs and to re-define how value is added.

The first step in increasing efficiencies is a thorough analysis of the role of all activities in the achievement of the strategic plan and of how value is created for the company & customer. Research suggests that c. 40% of operational expenses result from wasteful activities that add no value to the customer and therefore should be eliminated. There are 7 types of process waste that can be identified in virtually every organization: 1) Transportation. 2) Inventory. 3) Excess movement. 4) Waiting. 5) Over-production. 6) Over-processing and 7) Defects. Those activities that are not relevant can be eliminated or modified, thereby reducing costs, redirecting associated resources to more relevant tasks, and maintaining a high quality of service at the lowest unit and total operating cost.