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.
- Reduction in travel by slapping a quota or limit
There will be an immediate reduction in cost as travel expense will go down, but at what cost? This is more specific to departments (sales, business development) whose jobs require meeting people/client in different locations. There are many cracker deals or important leads which happens because you were at the right place at the right time. To hit the right place at the right time, you have to ramble a bit which will not happen when you have a cap in your travelling quota.
- Cutting down infrastructure cost – e.g. switching off glow signs, removing security guard from ATM
This are customer facing hence it can creates dissonance. Moreover, these actions generally have more impact on you’re existing customers rather then potential customers. So one needs to be careful and look at the potential impact on T which might not be as explicit as the reduction in C.
Hence we need to ensure that whenever we undertake any cost cutting project or measure we should not trade our pound for a penny (Here, pound is the T and penny is the C)
Are you Crash Dieting?
Cost cutting is like dieting habits. If you do a crash diet you might cut those unwanted flab in the short run. But at the same time, the chances of those flabs coming back again are equally high. Crash dieting also disturbs you’re body system/balance, that’s why you’ve heard upcoming models passing out in green rooms or becoming anorexic. To get clearer picture, let’s look at few initiatives undertaken:
- Employees are invited to take up sabbatical
The following questions needs to be answered:
- What if the more productive ones opt for it while the lesser contributors stay on? My gut is that the more productive employees will have hihger probability of going in for a sabbatical.
- What is the cost of training the replacement and what is the cost of re-training once the person comes back?
My take is that sabbatical should be a human resource management tool rather then cost cutting tool.
- An organization has recently launched an initiative asking all its employees to go in for a one-time cost savings of $10 each.
The easiest way I can think of it is to forgo a conveyance claim of Rs 500 or maybe to forgo a mobile bill of Rs 500 or maybe consume lesser electricity. If it’s an ad hoc requirement then it might serve the purpose. But what after hitting the $10 mark…are you then saying that there is no cost pressure anymore?
- Overhead reduction – disposable cups, napkins, AC, etc. etc.
This to me sounds like, the ship is sinking hence the captain has requested all passengers to offload all heavy objects in the ship. It sounds like the organization is pressing the panic button, which can hurt employee morale. Then what about non-panic days, isn’t cost optimization non-relevant in those days?
If you follow a crash diet approach, by taking up cost cutting as a project, it’ll hunt back again once the project is completed. Also this approach can imbalance the system by de-boosting employee morale.
Just as the best way to control your weight is to develop a dieting discipline in your day-to-day life by inculcating a healthy habit of eating on time, eating the right food in right quantity and doing regular exercise, cost cutting also has to be inculcated in the habit of all employees in their normal course of work. Cost cutting should not be a project or an initiative which ends with the end of the project or the initiative, it has to be a discipline and should be part of the corporate DNA/culture.