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Strategic Cost Reduction Primer: A Systematic Approach to Transforming Costs

Editor's Note: Take a look at our featured best practice, Cost Reduction Opportunities (across Value Chain) (24-slide PowerPoint presentation). Though there are multiple levers to maximizing an organization's profitability, costs are the most directly controllable by any organization. Profitability is being challenged by increased costs, stagnated revenue growth, and increased capital costs in today's economic climate. Therefore, a [read more]

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Cost Optimization Programs are hard to manage, sustain, and often tend to fall short of delivering the promised value.  The failure could be attributed to many reasons—including lack of clearly delineated objectives, failure to account for operational difficulties, internal resistance to change, trying to cut corners from everywhere, not paying attention to planning optimal utilization of resources; lack of direction, accountability, and management agreement.

However, the tremendous pace of technological disruption, today, offers new opportunities to transform enterprises by eliminating complexities, transforming the strategy and cost disciplines, streamlining operational capabilities, and consistently innovating.

Alongside transformation of organizational cost bases, leadership should focus on value rather than costs.  Cost optimization plans need to consider achieving the more strategic, long-term options.  These long-term options include pulling out from unworkable markets, business model innovation, robotic automation, or streamlining processes.  These cost initiatives necessitate revisiting the strategy, costs, and, the way they align.

A robust 5-phased cost optimization framework helps businesses sustain competitive relevance and maximize their potential.  These steps provide a more informed, systematic, and sustainable approach to Strategic Cost Reduction:

  1. Start with the Corporate Strategy
  2. Align Costs to Strategy
  3. Be Transformational and Aspirational
  4. Demonstrate Leadership Support
  5. Create a Culture of Cost Management

Let’s talk 3 of the phases in detail.

Start with the Corporate Strategy

The first phase emphasizes on having a clear view of the Corporate Strategy and ensure that it is consistently understood across the organization.  The commencement of strategic cost reduction endeavor demands developing a thorough understanding of the business strategy, operating model, and the investment on and revenues from the operations.

The phase encompasses examining the expenditures and revenues of the business, evaluating the sustainability of the existing ventures; and contemplating the effects of disruption, changing customer needs, and competition from startups.  There is also a need to comprehend the interfaces between different units and their associated costs, instead of merely utilizing industry benchmarks to gauge the viability of costs.

Align Costs to Strategy

The second phase signifies differentiating the strategically critical good costs from the non-essential bad costs.  It involves segregating the good costs from the bad costs (avoidable expenditures), making informed decisions to improve the good costs, clearly articulating the current skill inventory and knowing the few critical competencies crucial to meet customer expectations and remain profitable.

The phase demands distinguishing high-value priorities for investments, directing investments on creating winning capabilities, and developing plans to minimize bad costs.  This can be done by undertaking organization-wide cost analysis to understand the type of projects being executed, their value, the expenditure critical to run the business, the transformation and automation opportunities, and how to realize the potential for improved savings.

Demonstrate Leadership Support

The next phase of the strategic cost reduction approach requires from the senior management to set the strategic direction and demonstrate Leadership support and buy-in.  Leaders should treat the cost optimization program as a strategic business transformation initiative.  They need to assign dedicated resources to the endeavor, guide teams, devote time, set governance and oversight mechanisms, and engage employees across the organization.  It is critical for the leaders to develop ways to encourage organization-wide sense of ownership and partnership.

Interested in learning more about how to implement Strategic Cost Reduction?  You can download an editable PowerPoint on Strategic Cost Reduction Primer here on the Flevy documents marketplace.

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This document discusses various cost reduction methodologies and concepts, including the following: Process Optimization, Strategic Sourcing, Shared Services, Business Process Outsourcing.

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About Mark Bridges

Mark Bridges is a Senior Director of Strategy at Flevy. Flevy is your go-to resource for best practices in business management, covering management topics from Strategic Planning to Operational Excellence to Digital Transformation (view full list here). Learn how the Fortune 100 and global consulting firms do it. Improve the growth and efficiency of your organization by leveraging Flevy's library of best practice methodologies and templates. Prior to Flevy, Mark worked as an Associate at McKinsey & Co. and holds an MBA from the Booth School of Business at the University of Chicago. You can connect with Mark on LinkedIn here.

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