Cut If You Must, But Do it Credibly

I was reading the Harvard Business Review’s Daily Stat and discovered that a mere 10 percent of cost-reduction programs sustain their results after three years, according to research from McKinsey.

Sometimes there’s no accounting for cost-accounting when it doesn’t really account for all the costs involved in an enterprise. That can really stress complex supply chain and outsourcing relationships, where cost and financial information is often not very transparent or willingly shared and when costs need to be examined and reduced.

A recent article from McKinsey Group’s Corporate Finance Practice says that even apparently successful cost-cutting exercises can erode over time. But the group outlines ways – five to be exact – to make cuts stick.

According to the article, while there is optimism that a “solid economic recovery is taking hold around the world,” don’t expect the cost cutting that was so prevalent during the recession to soon go away as a strategic priority. In fact “the number of executives reporting steps to reduce operating costs in the next 12 months increased significantly between February and April, even as confidence in the economy grew,” McKinsey says.

But even as they plan new cost cuts these same executives know that “any successes companies have at cutting costs during the downturn will erode with time. Many executives expect some proportion of the costs cut during the recent recession to return within 12 to 18 months — and prior research found that only 10 percent of cost reduction programs show sustained results three years later.”

Programs started in the early months of the downturn “are already beginning to fail,” McKinsey continues.

Why is it so hard to make cost cut stick? Several factors come into play: “In most cases, it’s because reduction programs don’t address the true drivers of costs or are simply too difficult to maintain over time.

“Sometimes, managers lack deep enough insight into their own operations to set useful cost reduction targets.”

In other cases, business unit leaders try to meet targets “with draconian measures that are unrealistic over the long term, such as across-the-board cuts that don’t differentiate between those that add value or destroy it.” Or, the article continues, managers use inaccurate or incomplete data to track costs, thus missing important opportunities and confounding efforts to ensure accountability.

McKinsey describes methods to make cuts stick:

–          Assign accountability at the right level

–          Focus on how to cut, not just how much

–          Don’t let P&L accounting data get in the way of cost reduction

–          Clearly articulate the link between cost management and strategy

–          Treat cost management as an ongoing exercise

As I read these it occurred to me that implementing Vested Outsourcing model, along with the Five Rules would be a great service in providing the insights required for executives to know what is driving costs in the first place and then to understand their operations more clearly when setting their cutting goals. That’s right out of Rule 5 – establishing a governance structure that provides insight, not just oversight.

In fact those “sticking points” that McKinsey mentions merge well with the Rules. For example, ‘assigning accountability’ tracks focusing on outcomes not transactions (Rule 1) while focusing on ‘how to cut, not just how much’ naturally leads into the vested tenet to focus on the what (Rule 2). And ‘articulating the link between cost management and strategy’ is helped along by agreeing on clearly defined and measurable outcomes in the first place (Rule 3) and by optimizing pricing model incentives (Rule 4).

Of course Vested Outsourcing is about collaborating for mutual success and the win-win rather than achieving cost cuts, but isn’t it easier to save money and avoid the need for cuts in the long run when collaborating, measuring and reviewing for mutually beneficial outcomes, rather than just arbitrarily deciding to lop people or services one fine day?

The point is that draconian cutting would not be credible or even needed in a vested relationship.

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