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//Why Cost Reduction Initiatives are Killing You

Why Cost Reduction Initiatives are Killing You

Cost optimization and cost reduction are not the same thing, and the former should not be used as a fancy way of saying the latter. As defined by Gartner, “Cost optimization is a business-focused, continuous discipline to drive spending and cost reduction, while maximizing business value.” I’m going to focus on cost reduction in this article and will address cost optimization in a different article.

Cost reduction is a component of cost optimization and is an effort to reduce expenses without changing your operating model, vendors, or services levels. Effective cost reduction involves renegotiating with current vendors, eliminating unused products or services, and addressing both one-off and recurring billing errors. Properly done, it should not disrupt or negatively impact your business at all.

Please note that I am not going to address people here – workforce changes and changes to compensation and benefits should not be part of a cost reduction initiative as defined above and need to be considered and managed very carefully. If your main cost reduction strategy is to cut your workforce or cut compensation and benefits without first doing what I’m suggesting below, that is why cost reduction is going to kill you, and unless you can’t make payroll, you better pump the brakes.

Any people changes would be considered in a cost optimization initiative and you need to have a solid organizational change management strategy in place with the means to execute it. And if you don’t have an ongoing employee engagement program, you’d better do something about that if you want to weather economic storms and excel in times of economic prosperity.

Cost Reduction Is a System

In order for your cost reduction effort to be effective, it must be approached systematically; look at all of your expenses and engage the right people, or the outcome will be that you’ve completed a high-effort, low-value activity that costs more than it saves, especially in the short-term.

First, define the scope of your cost reduction by identifying all your recurring expenses. While it’s tempting to only look at the biggest spend areas, try to capture everything. Experienced backpackers and thru-hikers carefully consider the weight of every item they carry (including their pack); they know that replacing only the heaviest items with lighter ones won’t help much. Why? Because the lightest version of a backpack, tent, and sleeping bag that still meets their needs is likely not going to yield a weight reduction of more than 25% per item, which may yield a total of 2 kg on a 15 kg load – a 13% savings. However, taking all the items into consideration may yield another 2 kg, resulting in a 27% total savings. Though this would be a more accurate analogy for optimization (as would eliminating items), the principle is the same.

Second, understand that a cost reduction initiative is not free, no matter how you do it. A comprehensive in-house cost reduction initiative is a high-effort activity resulting in an outcome that is anywhere from low-to-high value. As the size of the organization or the complexity and number of recurring expenses increases, so does the risk of low-value outcomes. Factoring in both the direct costs of your staff and opportunity costs will demonstrate this clearly and will also show that as the size or complexity increases, so does the cost.

For these reasons, the best option is to transfer that effort to someone else, which will also increase the likelihood of a high-value outcome. Engaging cost reduction specialists who are paid a percentage of the realized savings (not forecast or theoretical savings) transfers the financial risk away from the organization, allows it to maintain focus on income generating activities and core business operations, and allows it to benefit from the specialists’ expertise across a wide range of industries. Further, they know what your neighbors and competitors are paying, enabling them to negotiate more effectively. The result for you is a low-effort activity with a high-value outcome.

Cost Reduction Matrix

So unless you’ve got a team of volunteers standing by who are cost and billing experts in waste management, telecommunications, employee benefits, facilities maintenance, information technology, public utilities, shipping and logistics, taxes, insurance, etcetera, engaging cost reduction specialists results in the optimal outcome and will prevent you from getting killed by your cost reduction initiative.

As usual, I’d love to hear your thoughts below and appreciate your likes and shares.

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