Cost reduction : a false good idea for organizations in tough times ?

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Summary : In tough times, businesses have one major concern : reduce costs. A saving attitude provided it’s not mixed up with its far relative : the reduction of spending and investment. Spending reduction may be the logical consequence of a cost reduction program but does not replace it. Reducing costs means pondering one’s operational efficiency and the organization of work. Spending less does not always mean producing better and when this issue is overlooked the only result of cost reduction is that the enterprise is thrown in a negative spiral

It’s been the motto of nearly since the economy collapsed : costs have to be reduced. Any possible solution is leveraged : people are laid-off, projects prozen, the smallest expense questioned… Nothing but logic (except for the concerned people).

At the beginning it inspired me some very basic thoughts : after all, if these people and spending were useless why having keep them for so long ? Then I tried to digg a little further : for what I can remember, costs and spending have never been synonymous, either in the common or financial vocabulary.

So I reminded of a years old anecdote, that dates from the time when I was a student. We had to work on the case of a company that was loosing money again and again. Basic reflex : I started to examine all items of expenditure and start to cut all unnecessary ones before having a deeper look. By luck, the company started to make money again. The miracle happened and I did not need to go further. All the other students, of course, did the same.

Then came the debriefing session with the professor. It can be summed-up in one sentence. “Sirs, while you had to focus on costs you cut many expenditure items to make the bottom line become “green” again. Let me tell you that you could have followed you logic till the end : sell machines, stocks, all the assets and then close the business. You would have achieved what seemed to be you goal : a zero expenditure company. Let me tell you that this kind of organization won’t create any kind of value but, at least, won’t lose any money !”.

In fact the production tool, the organization and the business model well so irrelevant that the enterprise could not make money. So short-term cheating was possible by cutting expenditure but the situation could not last and cuts had to happen again and again until there was nothing left. Not even mentioning the fact that at each expenditure reduction phase, the potential that would have helped the organization to recover in the future was destroyed.

“Of course, rethinking organization, strategy and production takes a long time and it’s a tough work so you did what was the simplest. In the “real life” you would even have been rewarded for that and got a bonus. But if such a situation happens in your future, take the bonus and run because it would mean that you have put your organization on a path that will lead it to its end.”

Reduce costs does not mean expenditure reduction. It’s reducing the cost of obtention of the product of service that’s sold to the customer. It means organizing resources differently to get the same with a lower cost. In the case in question, it would have meant investing in more modern machines, increase the budget of R&D and rethink work organization to increase collective efficiency.

But I have to admit that this reasoning has limits : it only works in a growing economy. In a stable or collapsing market, producing “smarter” means than less resources are needed what leads to expenditure reduction.

Hence my first conclusion : reducing expenditures is relevant if it’s the consequence of a more efficient organization of work. If reducing expenditures means “avoid a global approach to the way we work”, that’s the beginning of the end because it starts a trend that leads to the “zero spending company” that has no resource to reinvent itself or create any value.

But it’s also possible to reduce costs without impacting expenditure. It implies that new markets are found. Impossible in times of crisis ? No, if the interactions between the organization and its ecosystem are more dynamic, if there’s a focus on value co-creation, on internal agility that allow ongoing business models design and refinement. Have a look at Cisco’s numbers these last years ? Isn’t it the result of Chamber’s obsession that turned Cisco into a “market transition focused organization ?”. In a different style, could we think that the success of Apple at the same period is the consequence of its capacity to create new markets ? Anyway none of these companies reduced anything during these hard times while some others were becoming fossilized, waiting for better days to come. Operational efficiency + ability to understand the market and anticipate are key for success…provided all the people that make it people have not been laid-off (in fact they are often those who are forced to leave first because they’re impact is more on middle/long term than short term).

By the way…what about cost reduction ? It’s relevant and even essential when it’s not confused with spending reduction. The solution is not in a local approach to production factors but in a systemic understanding of value creation. Kind of “work smarter”…