cost out - sternstewart.com · cost out how to successfully cut costs stern stewart research //...

cost out HoW to succEssFuLLY cut costs

cost out HoW to succEssFuLLY cut costs

stern stewart Research // Volume 61

Gerhard Nenning, Dimitri Belobokov, Milan Manduch, christian sparrevohn

FIVE PINCIPLES

1. "10 -100 -1000": Quickly define where you want to go 2. "Efficient, but ef-fective": Base your approach on well-founded hypotheses 3. "Single source of truth": Quickly ascertain the numbers 4. "Everybody follows the rules": Strictly apply the methods and tools 5. "Get lean and stay leaner": Institutionalize cost awareness

Management Summary

Global competition forces companies to optimize their cost structures – even those companies that

did not have to worry about price-oriented competitors in the past due to their superior technologies

and outstanding product characteristics. Enterprises that combine innovativeness and product qua-

lity with low costs are becoming ever more common, causing repeating impacts on the own company

and cultural change with regard to its relationship to the outside world. this in turn has the corre-

sponding implications for the company's self perception and internal interactions. this transition is

particularly difficult for companies, for which costs had previously "never been an issue", and it also

comes with its share of risks.

cost-reduction programs are often poorly designed: they take too long and are insufficiently co-

ordinated, which paralyzes the organization; they are too tentative, so that the people within the

company, who fight to retain the status quo prevail; or they depend too much on benchmarks, which

reduces their internal acceptance and diverts the focus from the actual sources of potential.

temporary initiatives for a specifically targeted "cost out" are often a more effective way of freeing

up cash, capital and resources. What matters is the way a cost out program is structured and exe-

cuted. Five principles help make a success of a cost out ...

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stERN stEWARt REsE ARcH # 61 // c o s t o u t – H o W t o s u c c E s s F u L LY c u t c o s t s

"10-100-1000": Quickly define where you want to go

Many cost initiatives generate short-term successes for an organization, but fail over the long term,

leaving in their wake a culture of resistance and mistrust. Bottom-line successes can often be seen

early on, but after a while these savings are eaten up by a lack of efficiency in critical areas of the

company.

the root of the problem is most often that top employees leave or that those who remain, at all levels

of the hierarchy, are preoccupied with protecting their own destinies, crippling the organization.

Program must be strategically logical and understandable cost-reduction measures are always accompanied by uncertainty. the management has to explain

why the cost cuts are necessary. Whether it is because there is an acute need to act ("burning plat-

form"), the enterprise's competitiveness has to be improved or more growth is desired in the low-cost

divisions; the planned actions have to be made understandable to the staff. the entire management

must advocate the program, without exception or reservation, and the line managers have to moti-

vate and support as good as they can.

Quickly define where you want to go and minimize the phase of uncertainty in practice we see it time and time again: A program is announced, followed by a year of procrastina-

tion, during which the resistance becomes hardened on all fronts; the social partners feel left out and

block any proposal that comes up, the top employees leave the company for safer pastures.

Performance indicators essential to success collapse and any savings achieved are insufficient to

compensate.

the reason for this is that poor process management and an inefficient procedure coincide. Either

critical stakeholders are not integrated until it is too late and don't consider themselves to be truly

participating, or they are brought in too early and the initiative gets lost in contradictions, misinter-

pretations and the chaos of the irreconcilability of different standpoints.

the solution that experience tells us works best is having a sufficiently well defined target picture

that is determined early on in the piece together with the key stakeholders. this makes a structured,

efficient and participative discussion possible. A taskforce – a small group (10) of central decision-

makers – sketches a rough but tangible target picture for the organization after the cost out, quanti-

fies and allocates the savings and says what levers are expected to bring improvements, how the

changes are to be made as socially acceptable as possible and when and how social partners are to

be met with.

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this target picture is communicated, challenged and refined together with the most important stake-

holders (100). only then can a larger group of decision-makers be actively integrated (1000), who are

responsible for working out the details and implementation. the 10 -100 -1000 principle has arisen

from a broad base of experience with global company groups – of course the actual number of stake-

holders used in this equation depends on the size of the company and scope of the project.

"Efficient, but effective": Base your approach on well-founded hypotheses

throughout the history of cost-cutting programs, three essential approaches or variations on them

have predominated, taking turns at being more popular than the others:

the benchmark approach

the "Activity Value Analysis (AVA)" approach

the hypothesis-based approach

they fell in and out of favor, because experience brought the weaknesses of the previously popular

approach to light, and the belief in the future was channeled into a new concept.


FIG. 1:

The 10-100-1000 meThod

W H o

Core team representing top decision makers

Most important managerse.g. Lead country heads, Heads of functions etc.

Local heads of functions, country manager, team leaders, etc.

W H At

Development of target picture defining key elements of program

Concretization of program, final evaluation and

development of measures

Implementation lead, feedback, reporting, fine tuning

1 0

1 0 0

1 0 0 0

s t R At E G Y & t o P M A N A G E M E N t o P i N i o N

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Finding the right balanceso which approach is the best? the answer is as simple as it is inconclusive: All three have their justi-

fication in a well-structured cost out project – when used at the right time and with a clear understan-

ding of their possibilities and limitations.

At the heart of successful cost out projects are well-founded potential hypotheses that are then

refined during the course of the project.

Benchmarking highlights possible directions for the development of optimization hypotheses. it also

helps developing a basis for the dimensioning or individual organizational areas and checking the

plausibility of the measures. its limitations lie clearly in the comparability of organizational units and

the risk of methodical differences, when gathering data for comparison.

Another, best-practice-oriented view takes cultural aspects, the specific company situation, the opti-

mization history and experience from similar initiatives into account and together with the benchmar-

king creates a solid hypothesis framework. the plausibility of these hypotheses is then reviewed in

structured workshops through figures estimated for them. typical levers are systematically checked.

the areas for optimization are then prioritized on this basis and subjected to further detailed investiga-

tions. Here, Activity Value Analysis is a commonly used tool for assessing the optimization options in

an area previously defined.

Hence, by combining the approaches, a good balance of efficiency and effectiveness can be found for

the cost initiative.

FIG. 2:

BeNChmARKING AS A

BASIS FoR dImeNSIoNING

SUPPoRT FUNCTIoNSFinance 25 23 32 48

Functions All companies

StrategicHolding

Mgmt.Holding

ParentCompany C.

Audit 19 23 21 15

Tax 12 10 13 13

IT 17 3 13 58

Accounting / Controlling 72 43 73 114

Communications 14 9 15 21

General corporate mgmt. 27 23 29 31

Sales planning 24 4 14 54

Purchasing 28 13 25 43

Legal / Compliance 27 15 30 53

Corporate development 20 9 21 46

HR 35 22 38 57

Other functions 62 13 51 197

All functions 382 210 375 750

tARGEt DiMENsioNiNG (estimate of required FtE)

# FtE

Low Quartile Median top Quartile

All companies

239 380 604

Management Holding

268 375 524

Strategic Holding

152 212 297

Parent Company Concept

537 751 1050

Target range Status quo

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take all optimization levers into account when forming the hypothesesA set of optimization levers became apparent, gleaned from numerous observation points. Depending

on the specific company situation, the pertinence of these levers varies, but they arise time and time

again in a similar pattern. While the companies generally understand the levers in the operative units

quite well, and these levers typically center around throughput speed, quality, footprint efficiency,

factor costs and factor efficiency on the production side, and around portfolio decisions on the custo-

mer side, administrative levers are usually much more difficult for decision-makers to grasp, and it is

hard to estimate a realistic extent of the possible optimization.

the internal service relationships are often very complex, have developed over time and are rigidified

in organizational structures that make it difficult to take drastic measures. typical levers here are:

stop Doing or Waste Away, in/outsourcing, structural optimization, process improvement/automa-

tion, wage-cost arbitration, de-layering, standardization and bundling.

it quite obviously cannot be efficient to test all levers across all internal products. Benchmark and

experience-based hypotheses and historical values are essential here for an efficient approach.

FIG. 3:

TYPICAL LeVeRS WheN

oPTImIZING PURChASING

AT A STeeL PRodUCeR

typical spend breakdown steel manufacturer (%, sum = 100) typical levers

FOCUS

∑ 2bn EUR

typical impact (%)

70 – 7525 – 30

35 – 45

15 – 25

10 – 15

5 – 10

3 – 5

3 – 7

2 – 3

2 – 3

2 – 3

insurance & consulting

MRO

energy

distribution

rental fees

operating resources / supplies

hired labor

raw materials

others3rd party spendPersonnel

Forward spot buying / strategic stock mgmt.Volume consolidationCustomer-lead price reductionClean sheet costing

Forward spot buying (direct or broker)CHP / trigeneration (owned or leased)Peak load managementUtilities self-generation

Volume consolidationCustomer-lead price reductionDemand management / consumption reduction

In- / OutsourcingSupplier substitution towards white labelFramework contracts / catalogues

1 – 3

1 – 3

4 – 7

5 – 10

7 – 14

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Waste Away is often a very powerful lever in the field of support. one proven procedure is integrating

internal clients into the prioritization of the services received. Alongside prioritization, simulating

relinquishment scenarios is a common method: "What services would you forego, if you could only

use 20, 30 or 50% of the current products?" the internal clients themselves provide the answer to the

question of which services have priority. these results are then compared with the cost of providing

the service. Experience shows that with support functions, typically 20% of the internal and particu-

larly complex products can be done away with – depending on the extent of the optimization, without

the performance of the organization suffering tangibly.

FIG. 4:

TYPICAL AdmINISTRATIVe

LeVeRS

tYPicAL MEtHoD sEt oPtiMizAtioN LEVERssHARED sERVicE

oPtiMizAtioN ExAMPLEs

transactional Know-howOPTIMIzE SERVICE PORTFOLIO / DEMAND

MAkE OR BUy

OPTIMIzE SERVICE GENERATION

Stop Doing / volume optimizationElimination of internal products / services

In- / Outsourcing of servicesActive management of external providers

Cost structure optimization potentialLimit variety of working hour models

Internationalizationtask relocation to low-wage locations

Scoping / Processes improvementstandardization & automation

Multi-Tower bundlingcross-functional bundling of tasks

Review service level & volume with “80 / 20” cost analysis approach

Eliminate local “shadow organization”

improve management of external spend

Avoid exceptions such as various working hour models

Reduce overlaps and redundancy across organization

outsourcing of activities not strongly connected to business

optimize personnel cost structure by moving jobs to different pay grades

use proven criteria catalogue for in- / outsourcing to determine “Make or Buy”

optimize processes based on degree of maturities with proven framework

challenge levers feasibility based on analysis and define cost-cutting measures

Determine synergies in services & compare local vs. international effects

identify integration potential based on analysis of typical service clusters

ø-savings of 20 – 30% ø-savings of 15 – 25%

transactional services Expert tasks

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"Single source of truth": Quickly ascertain the numbers

if controllers are asked how much turnover a unit has, they generally answer the question with a que-

stion: "Which turnover do you mean?" in complex organizations, key figures are often not defined in a

standard way, which makes it difficult to properly analyze the cost structure, evaluate possible optimi-

zation levers and control the degree of their implementation. this often leads to confusion and contra-

dictory information – especially when figures come into play that had previously been less central,

allowing more leeway for interpretation.

Define measurement standards for the initiativeit has to be determined how all key elements of performance and efficiency measurement are to be

defined in an initiative. For instance, are supplier-related delays to be taken into account when measu-

ring throughput times? the answer is yes and no – it depends on what exactly you want to measure.

there are numerous of such differences. it has to be considered, where what makes sense and is

possible, and clear standards have to be defined on this basis.

institutionalize a clear understanding of the figures clear standards particularly help achieving a unified understanding of the issue as it pertains to the

object being measured. in larger cost out projects, however, it is extremely important to keep control

over the assessments. unrest often arises, because parallel analyses of a decentral division generate

contradictory results, and in the process that follows, it becomes clear that things were understood

differently, that varying and unclear assumptions were made, or that quite simply, logical errors found

their way into the assessment. But once information is in circulation, it is difficult to gain control over

them.

the more sensitive the situation is, the more important it is that all flows of information are consistent

with one another. A proven method for achieving this is giving a certain unit the central responsibility

for all analyses and evaluations. this unit then gathers input from outside when required, while taking

into account that differences in the data are accounted for and made transparent.

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this demands communication by the management that clearly shows which analytical fields of re-

sponsibility are located where, and how precisely the inquiry process is structured. in complex

projects, a data management group is generally set up in the project management office. in most

cases, the cost of centralized handling is more than compensated for by preventing internal frictional

losses in the decentralized data management.

FIG. 5:

PRoVeN oRGANIZATIoN

FoR STAYING IN CoNTRoL

oF The NUmBeRS IN

The PRoJeCT

team repres.

CORE TEAM

team

repr

es. team

repres.

team repres.

tEAM DAtA QuALitY & REPoRtiNG

Data aggregation, consolidation, coherence and

reporting

FINANCE

HR

tEAM iMPRoVEMENt

tracking and challenging of measures

ExPERTS / CHALLENGER

TRACkING

PMo

overall project coordination

SCHEDULE

COORDINATION

REPORTING / MEETINGS

tEAM LEADERsHiP

Facilitate organizational readiness and support Executive

team in their leadership

CHANGE MGMT.

GOVERNANCE

COMMUNICATION

TRANSFORMATION OFFICE

ExECUTIVE COMMITTEE

Bi-weekly reporting and escalationKey decisions and issues resolution

FINANCE

MEASURES & ACTIONS

HR

HR COMM.

"Everybody follows the rules": Strictly apply the methods and tools

two key reasons why potentials cannot be adequately gathered in projects are a lack of specialist

leadership and the special treatment of individual divisions. Because a situation is special or of parti-

cularly high/low importance, some divisions are given freedoms that lead to target conflicts in several

dimensions: objectives are not ambitious enough, potentials are not (sufficiently) identified, measures

collide with other important initiatives or are not integrated adequately or in sufficient quality into the

regular implementation reports.

Definition of methods and tools it is important to determine, which units are to be included in the project, how measures are identified,

defined in detail and consolidated, and how they are to be included in the tracking of the implementa-

tion.

Here, structural tools are used such as the integration into the regular communication and standar-

dized project structures, as are methods-related elements for identifying and specifically defining

areas of potential. All divisions are included in the benchmarking, if there are comparative values

available, optimization hypotheses are conceived and consolidated for all divisions, and measures are

recorded centrally for all divisions and subjected to the same substantiation standards. this is the only

way, potentials can be properly exploited.



FIG. 6:

deFINITIoN oF

dImeNSIoNS oF

meASUReS

ASSeSSmeNT

2. COST TyPE

4. INTER-

SECTION

1. O

RGA

NIz

ATIO

NA

L LE

VEL

3. P

ROD

UCT

/ PR

OjE

CT

Business unit

coGspersonnelnon-personnelother

sG&Apersonnelnon-personnelother

R&Dpersonnelnon-personnelother

otHER

Division

sector function

REsP

oN

siBi

LitY

P&L EFFEcts

MARKEt DYNAMics

total measure effects split by organizational level

transparency about measure effects on specific organizational level, on cost type and on product-group

total measure effects split by product / project groups to incorporate market fluctuations (indicative)

total measure effects split by cost types

1

1

2

3

4

2

34


the example of a global company underlines the importance of strict methods: After several unsuc-

cessful attempts at reducing costs, a program was installed, in which all administrative divisions were

analyzed using the same principle. the procedure was based on the standardized division of responsi-

bilities into expertise-oriented and administrative tasks. this was the first method to expose that a

large share of the administrative tasks were carried out by internal experts. A clear separation enabled

the existing potential to be estimated on the basis of past experience (approx. 25% cost reduction in

administrative tasks) and facilitated a specific assessment of a broad base of possible and relevant

improvement levers. Examples such as this repeatedly confirm the need for a strict method without

any exceptions that are not clearly justified within the framework of the method.


FIG. 7:

eXAmPLe oF PReSCRIBed

meThod FoR TRACKING

PRoJeCT PRoGReSS

suBPRojEct

iNDiViDuAL REsPoNsiBLE

1 suBPRojEct LEADER2 DEPutY3 tEAM MEMBERs4 stRuctuRiNG5 tARGEts, scHEDuLE6 iMPLEMENtAtioN

25%

50%

75%

100%

7 stAtus

1. R

emod

elin

g

2. R

ange

tran

sfer

food

3. R

ange

tran

sfer

NF

4. iM

inte

grat

ion

5. P

erso

nnel

and

soci

al

6. P

erso

nnel

dev

elop

men

t

7. c

omm

unic

atio

n / ad

verti

sing

8. P

roce

dure

s mar

ket

9 Au

ditin

g / m

arke

t tra

nsiti

on

10. L

ogis

tics s

truct

ure

11. s

yner

gy co

ntro

lling

12. P

rocu

rem

ent

13. c

oord

inat

ion

adm

inis

tratio

n

14. A

dver

tisin

g

15. u

tiliza

tion

16. Q

ualit

y ass

uran

ce

... ... ... ... ... ... ... ... ... ... ... ... ... ... ... ...

"Get lean and stay leaner": Institutionalize cost awareness

Experience shows that the difference between cost out and a mere cost reduction lies in particular in

the desire to keep the costs at an adequate level over the long term instead of merely cutting them

once to meet immediate financial goals. if adjustments are not also made in the service culture and

efficiency-evaluation processes, reduced costs are simply rebuilt elsewhere, or even worse in the

same place, and this time with buffers, in order to be prepared for the next cost reduction.

Achieve operative excellence and institutionalize continuous improvement.From blue collar to white collar: Also anchor excellence in the administrative divisi-ons

in particular, manufacturing organizations have already internalized Lean and six-sigma principles in

their operations, and they are usually in the process of consolidating them within the company. Kaizen,

Genda, Bushido, Hoshin and Poka-Yoke are different expressions and results of the "toyotism" that

is already part of the everyday workings of many efficiency-oriented industrial companies. But most

of them find it difficult to transfer these principles to the administrative or service fields. the product

portfolio is highly complex, customer satisfaction is difficult to distil into just a few core elements,

costs and benefits of individual elements are often difficult to grasp and it is almost impossible for the

staff involved to optimize them internally, as the internal need is often not questioned and the product

quality or efficiency of its creation is difficult to assess.



that is why the anchoring of principles like Lean and six sigma in companies marks most of all a

cultural change. the employees are asked and trained to always ask, whether complex perfor-

mances are really necessary, whether the side demanding them is aware of the cost-benefit ratio,

and whether and how one could possibly provide necessary performances better and more quickly,

and how they can be continuously improved upon.

in essence, the extension of the Lean method to encompass white-collar areas is based on avoiding

six sources of waste. these are displayed in Figure 9.



FIG. 8:

LeAN mANAGemeNT

deVeLoPmeNT TReNdS

TOyOTA PRODUCTION SySTEM

LEANMANAGEMENT

MAstERiNG coMPLExitY

increasing flexibility

synchronous flow production

Dynamic, value-added structures

standardized plants

Lean and healthy / Lean and flexible

Quality in volatile, flexible processes

increasing penetration rates

Lean logistics

Lean development

Lean services

siMPLiFYiNG coMPLExitY

opening in the direction of individual production / customer variability

opening to the entire value-added chain / supporting functions / services

Digitalization Networking



in practice, every organization decides what elements suit its management model and culture best.

ultimately, the goal is always the same – to establish a process of constant self-optimization in all

functions. these principles are embedded in the daily work through workshops, seminars and by crea-

ting applicable institutions and incentive systems. the objectives are often to obtain clarity and perva-

siveness in the management process, efficiency and organizational and process transparency.

clarity and consistency are the marks of a stringent structure, from the overall strategy down to the

individual processes, and they demand lean management from the bottom up.

Efficiency aims at achieving a clearly defined self-adjustment mechanism at each level of manage-

ment. Here, clear escalation management is set up for exceptional cases, and the compression of the

relevant information is managed.

transparency enables the standardizing of information, communication and procedures, helping to re-

duce errors and improve efficiency. An adequate KPi system secures continuous monitoring and hence

supports continued improvement.

3. wAITING FOR UP- / DOwN-

STREAM INFO

Are all information accurate and just in time available?

2. OVER "PRODUCTION"

Every deliverable along the process really needed?

1. OVER PROCESSING

Elimination of process steps possible?

6. INFORMATION OVERLOAD

separation between relevant / irrelevant information possible?

5. NUMBER OF ITERATIONS

Which arbitration loops to avoid?

4. UNNECESSARy INVOLVEMENTS

Which interfaces or # of stakeholders during process to reduce?

T yPICAL SOURCES OF

" wASTE"

ELiMiNAtE "oBVious" WAstE MiNiMizE "HiDDEN" WAstEFIG. 9:

SIX SoURCeS oF WASTe



suMMARY

irrespective of their causes, cost reduction programs are often an inherently unpleasant topic. While

they are a strategic necessity for the institution or company, they have negative consequences for

many staff members. Paradoxically, this uncomfortable truth leads to the situation that many top

managers shy away from concentrating their resources to ensure the best possible planning and exe-

cution of these processes. they hide the responsibility in a budgeting process or delegate it as far

down the hierarchy as possible, sometimes even underpinning it with ambitious benchmarks. All too

often, savings achieved are only of a temporary nature, or falsely designed from the outset, leading to

the cost reductions hitting the enterprise at its core.

But there are also managers, who see the savings efforts as an opportunity to reshape the way their

company thinks and acts. they consider them to be a chance to strengthen leadership competencies or

a tool for more growth. Here, approaches are used that are precisely tailored to the customer, in line

with the company's strategy and culture, and the upshot is generally lasting results and considerably

higher cost awareness levels throughout the organization.

if done correctly, cost-reduction programs can improve the productivity of a company with just a few

staff, thus reducing the need to repeat them again and again every year.



stern stewart & co.

stern stewart & co. is an independent strategy consulting boutique. our advisory

focus is on the core issues of management. these include strategy, corporate

finance, organization and performance management. We see company managers

as strategic investors in the business, and support them to increase the value of

their company.

The authors

Gerhard Nenning, [email protected]

Dimitri Belobokov, [email protected]

Milan Manduch, [email protected]

christian sparrevohn, [email protected]

Stern Stewart & Co.

MunichSalvatorplatz 4D-80333 MünchenT +49.89.242071.0F +49.89.242071.11

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