Today, cost cutting or cost rationalization has become a part of almost all corporate strategy. Fundamentally a reduction in cost increases bottom-line, hence it is desirable for any corporate. After all a corporate exist to make profits and there by appreciates shareholder’s value.
However I’m not sure how many of such cost cutting measure or initiatives do more good then harm to the organization?
Are you Penny wise Pound foolish?
Cost cutting is done to boost bottom-line, hence it needs a holistic view rather then just a change in cost variable. To give a clearer picture lets put a simple equation:
Top Line (T) – Cost (C) = Bottom Line (B) “or” T-C=B
In the equation, T is the positive variable (gives positive to B) and C (gives negative to B) is the negative variable. Fundamentally, C can never give positive addition to B because there can never be something called NGATIVE COST and the same way there can never be NEGATIVE TOPLINE. Hence at any point in time, for B to have positive figures there has to be some T which is bigger then C, meaning even if C is zero if there is no T your B doesn’t have any value.
What is Cost or C? It is the input for producing T. Hence any disturbance in C impact T.
I may be wrong, but what I think I observed in many cost cutting instances is that most often people goes with the assumption that a reduction in C directly increase B to that magnitude. But what they forget is that while reduction in C increases B but sadly it also disturbs T, and most of the time in an inverse proportionality. There can be four situations when C is reduced:
T remains constant
The reduction in T is lesser then the reduction in C
The reduction in T is the same as the reduction in C
The reduction in T is more then the reduction in C
It doesn’t need an IQ to tell that Option 3 and 4 is a cropper. Option 2 depends on the corporate strategy for that particular time, if you are looking for a market share then you might not want anything that reduces T. Option 1 is the ideal outcome, a result which is wanted at any point in time.
Therefore whenever any initiative for reduction in C is to be executed, we should look at the impact it had on all the variables. We should not assume that T will remain the same if C is changed.
Now, let’s look at few of the common cost cutting initiatives of different organizations:
Shifting office premises to lesser cost locations.
Organization that had undertaken this route might declare that they have achieved significant reduction in their rental cost, but at what cost?
Is there any drop in employee productivity – Impact on T?
Are employees as committed as they were – Impact on T?
What is the employee churn because of which new employees needs to be recruited and trained – Though C might be reduced but this will add an extra C1?
My gut is that unless it’s a consensus shifting, the impact of the above questions could be higher then the cost reduction achieved.
