Keeping company costs cut

Bahjat El Darwiche and Rabih Abouc, principals with Booz & Company, look beyond traditional approaches to a company's DNA will avoid frequent cost-cutting.

Bahjat El Darwiche
Bahjat El Darwiche

Corporations must understand why costs escalate in the first place to avoid the need for frequent cost cutting.

Going after structural issues alone while ignoring the three other critical strands of every organisation's DNA - decision rights, information, and motivators - will not help to cut costs and keep them cut.

Transparency of information and costs at all levels is central to any sustainable cost-cutting effort, in addition to the metrics required to monitor these costs. Business units and departments without access to such information act as though they have a blank check, which can lead to an explosion of IT costs.

With transparency on costs, companies can allocate services by forcing departments to make decisions on the basis of fixed prices or by open competitive bidding between service providers. Once data on the real costs is available, companies can use this to make better, more sustainable cost-cutting decisions - as long as the governance structure is clearly defined, logical, and consistent.

Decision rights involve identifying who is responsible, authorised and accountable for making various decisions.

If these rights are at a high, centralised level, companies will lose time waiting for top executives to make key decisions, and if decision-making authority is too decentralised, redundancies and inefficiencies occur as divisions and departments replicate efforts.

Worst of all is a company that hasn't defined these rights, meaning decisions are made by everyone, or by no one at all. Imagine everyone at a large meeting thinking she/he has the right to decide on project issues or, just as easily, thinking that she/he is off the hook and his colleague is pushing the project further. Those are unclear decision rights.

Senior managers should push decision rights further down the organisational chart while monitoring the decisions their direct reports make. That expands the senior manager's control and with good information, decision makers become more efficient, lowering the cost of the decision-making process.

Giving managers more responsibility can save money by slowing the increase in organisational layers. That effort must be accompanied by a system of motivating incentives.

It means creating a bonus system that rewards managers who meet specific cost targets, not just business targets, as well as developing a promotion strategy that goes beyond standard vertical promotion schemes.

Moreover, the lack of significant differentiation in performance bonuses discourages the stars and overcompensates the underperformers. While costs rise, the talent pool suffers.

Companies should therefore develop strategies for top performers that emphasise lateral promotions conferring more responsibility and higher salaries without a move up the management ladder. Such moves open up the channels of communication with the increased movement of managers between departments.

Combining structural changes, better managed decision rights, a new approach to incentives and motivators, and the access to cost information, involves taking an integrated approach to a sustainable cost management program.

In one company, distribution costs were a considerable expense, as they were treated as fixed costs and charged back to sales teams as a percentage of sales. Executives knew that expenditures on distribution varied widely, due to special requests for services such as more frequent delivery and expedited shipping.

Top managers decided the answer was to fix the problem beginning at the level of information transparency. Introducing a "rate card" that defined specific charges for added services - at prices competitive with outside distribution services - forced the customer teams to make decisions within a true demand-and-supply regime.

Lower-level managers were also given rights to make decisions on the basis of the information on the rate card, and their incentive structure was changed to reflect not just their sales gains but also their ability to keep costs low.

Costs come down even more than the company would expect and will stay down, and newly empowered managers take the rate-card mantra with them. These changes allow each division to maintain its lean structure, given team managers expanded spans of control and greater flexibility in making decisions..

Costs, once cut, have to stay cut. The only way to do so is to reach deeper into a company's makeup, to put in place an integrated program that goes beyond standard structure-based measures and takes into account the other three DNA strands.

This enables senior managers to effectively diagnose the root causes of organizational obesity and institutionalize continuous cost-efficient practices and behaviors.

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