Dukh mein sumiran sab kare
Sukh mein kare na koi
Jo sukh mein sumiran kare
To dukh kahe ka hoi.
Kabir
We all remember God when we are beset by grief,
none of us remember Him in our good times.
Had we remembered Him in our good times,
why should the days of grief have come!
With due apologies Kabir if I may rewrite the Doha for the business -
Loss mein Cost Cutting sab kare,
Growth mein kare na koi
Jo growth mein Cost Management kare,
to loss kahe ka hoi…
Normal practice, if the company is not doing well, is to demand every employee to cut cost by 15%. It is akin to telling each employee, “take 15% lesser food”, or “Restrict the number of words in your report to 85% of the intended length”. What many of us call as cost control is nothing more than expense control. We list the expenses appearing in the Profit and Loss Account, take percentage of the expenses on Sales and set “aspirational” targets to reduce the expenses. Expenses appearing in the Profit and Loss accounts are only the symptoms of the management decisions we take. The impact of our decisions impact Revenue, Cost and Investment.
Addressing Costs calls for addressing the causes of cost. Addressing Expenses is to cut the expenses without understanding the impacting factor of the cost. For example, we take material cost as a percentage of sales and compare across periods. Then we attempt to reduce the material cost in isolation by forcing the purchase in-charge to look for alternative sources. Without any concern for the impact on the delayed material delivery, adverse impact on conversion cost and material losses and adverse impact on the post sales utilisation by the customer, the purchase in-charge end up cutting the material purchase price. Material cost might have changed from the previous accounting period due to myriad reasons, which includes, change in material prices, change in product mix, change in input mix, changes in material wastages and operating practices. If an increase happens, we tend to put the blame on factors beyond our influence and control (global meltdown); otherwise, we take the credit for our superior operating practices. Either way, we sweep the reasons for variation under a singular major cause.
Addressing Costs call for an uncluttered thinking process of understanding the root cause of the cost and focus on that. Uncluttered thinking can happen if we have a clarity on the sources of causes.
Four sources of causes:
In my opinion there are four sources of causes for cost. I classify them as Economic factors, Design, Operational and Attitudinal.
“Economic factors” are price level changes, Government policies and social issues and are generally factors beyond our control and influence.
“Design” includes, design of product, process, supply chain structure and organisation structure. These factors are normally within our influence and control.
“Operational” is fulfilment of design. It is influenced by the Economic factors and design. These factors are normally within influence and control.
“Attitudinal” is the way people react to a situation and the culture of the organisation. It is also influenced by the design of organisation structure. These factors may or may not be within influence.
Economic Factors:
This is the favourite “Pass-The-Buck” for any cost increase. “Why have the costs gone up?” “Input prices have gone up”; “Our suppliers are in a monopoly market”. “Wages have gone up”. “Government has changed the rules”. “The Green Lobby is creating lot of problems”. We need to isolate the Economic Factors first. Addressing these factors call for a more strategic focus than by a simplistic operational focus.
The following is an inclusive list of economic factors:
1) Changes in price level Prices are influenced by many factors, both and macro and micro economic. Macro economic factors are like demand supply gaps, speculation of commodity prices, cost of living index going up leading to labour cost changes. The impact of these on the bottom line is to be isolated before doing any comparison of costs across periods. Otherwise, this will vitiate the sense of direction. Addressing these causes is to be at a strategic level of freezing the sources for longer duration. However, the flip side is when the prices fall. Micro economic factors of an individual firm impacting the prices due to their monopoly position in the market, Union level wage agreements, normal trend being followed within the company for salary increase (this drives the attitude) are again to be addressed at a strategic level. Developing alternative sources (design), relook at the practices within the organisation for salary hikes, relook at the agreements are some ways of influencing these causes. Costs going up due this factor are normally not a worry, if it impacts all the players and the product we deal is a necessity for the customer. We palm off the cost impact to the customers. However, if it impacts only our firm, then we are in trouble. Design plays a crucial role here, if we can create a modular design to change the dependence on any one input and thereby minimise the impact. Or Design of our supply chain, where we integrate with the upstream sources (Holding the mining rights and thereby minimise the price level changes)
2) Government policies: Changes to tax structures, money market policies, restrictions and removal of restrictions on import play a huge role in causing our costs. For example, our design of supply chain is influenced not only distances and nearness to sources, but also speculation on introduction of GST. These again, in the ultimate analysis, will impact the whole industry and not only a specific firm. However, it will certainly impact differently, if the different players are in different impact zones like an SEZ or FTZ. Even if competing within the domestic competition may not impact differently, if a firm has to compete globally or with global competition internally, then it plays a huge role on the cost structure.
3) Triple Bottom Line Requirement: Global concern for measuring firm’s performance based on People, Planet and Profit makes the environment and society a non-negotiable necessary condition for survival of the business. Firms are expected to avoid exploitation and spend on creating a carbon credit as they grow. It certainly impacts the costs internally for the firm. However, over a period of time, it hopefully, will impact all the firms. So long as a few vested interests get away with exploitation, this will only be a lip service. What ever may be, the impact of focusing on TBL will certainly impact the internal cost, mostly adverse. But, I think it is worth it.
Design:
Design can create or destroy. More than 90% of the costs are committed by the time we go for the detailed design (of the product, process, and supply chain or organisation structure). Trying to reduce the cost after the “damage” is done is more like catching the bull by the tail. Once committed, you have to address the design to achieve significant cost impact.
1) Design of the Product: Product Design plays a huge role in the life cycle cost of the product and the process. Any attempt to reduce the cost after the design is complete can have only a limited impact. For example, in the case of material costs, after prices, design has the greatest impact on the cost. If I can design a component out, then the resultant effect on the cost is significant. Methodologies like Target Costing (in conjunction with Value Engineering and QFD) can help the firm to design out tomorrow’s cost through today’s design.
2) Design of the Process: Design of the product plays a significant role in the design of the process as well. Still Process design independent of the product design, impacts the operations cost significantly. Out dated technology, unreliable process due to faulty process design, inappropriate processes are capable of playing havoc with the cost structure.
3) Design of the Supply Chain: My customer wants directly online delivery. Therefore, I need to keep stock nearer to the customer. This is essentially a supply chain design driving the cost structure. Creating Supplier clusters, cross docking, milk run design, choice of the channel of distribution and sourcing, etc., all play a major role in the cost structure.
4) Design of the Organisation Structure: For men may come and men may go, But I go on for ever. (The Brook by Tennyson) Similarly, men may come and men may go, but the Organisation Structure goes on for ever. Many firms still follow the pyramidal organisation structure created by DuPont plc in early 20th century. Organisations may be divided as functional or SBU or matrix or flat as it is called for minimal levels of hierarchy. The structure drives the communication channel, drives the decision making process and ultimately the cost as well.
Operational:
This is the favourite “Scapegoat” for any cost increase. “Guys! Cut the cost everywhere; we need to tighten our belt”. Operations can only control cost can’t reduce or manage cost beyond the boundaries given by Economic factors and Design. Operations can fulfil and destroy can’t create. Design can create a far greater damage. But, operation’s inconsistencies, strains and penchant for creating waste all make a heady cocktail of cost increase. The three Ms – Muda, Mura and Muri emerge out of operation’s inefficiencies.
1) Wastes – Muda Defects, Overproduction, Waiting, Transportation, Inventory, Movement and Extra-processing, the seven wastes identified by Taichi Ohno, who propounded the Toyota Production System are essentially triggered at the operations level. Though the structure of the supply chain, process and product do influence this, these seven wastes can emerge independent of the design. Lean thinking principle of aligning the process to the purpose (customer value) and thereby focusing on the Six out of Seven zeros (Zero Defect, Zero Lot size, Zero Lead Time, Zero Breakdown, Zero Handling and Zero Setups) can minimse the Mudas.
2) Inconsistency – Mura Variability in processes, surges and inconsistencies force us to have capacity more than what is actually required. We need to commit resources, men, machine and inventory to minimise the shock of the variability. Hence the cost has a tendency to increase. Focusing on the Seventh Zero (Zero Surging) and thereby improving the process capability is critical for minimising Mura. Six Sigma focuses on this.
3) Strain - Muri Strenuous processes, postures, movements, strain on machines, men and other resources are the third M of the infamous three Ms of Muda, Mura and Muri. Many of the quality initiatives focus primarily on the operational stability. Operation’s major role is to ensure stability.
Attitudinal:
After all organisations are so called as they are made up of people. People behave in the way their performance is measured. For example, I believe that selling price is not driven by the competition or customer or cost; it is driven by the month end pressures of the sales man to achieve the target. We incur costs because there are budgets. We stretch our project completion time to accommodate the padding we have done during planning.
1) Outdated Performance Measures
Purpose of a performance measure is to implement strategy and validate strategy. Strategy has to be in sync with the changed environment. If there is a change in environment, we tend to believe it to be temporary. This leads to a delay in formulating a strategy to meet the changing needs. We need to adapt our performance measure to fulfil the Strategy. Strategy is for the future, but delayed with reference to the changing environment; where as performance measurement is for the past delaying to adapt to the strategy. There is an in-built anachronism among change in environment, change in strategy and change in performance measure.
2) Short term focus
Performance measures tend to focus on short term achievement of targets. Even a CEO’s shelf life is not more than three years. “Who cares what’ll happen to my successor; I need to cover my back (called as CYA syndrome)” (We follow the same attitude with our environment as well).”Let me focus on reducing the purchase price; cycle time reduction is not my area of concern (called as Not In My Back Yard Syndrome NIMBY). This leads to locally optimising the cost but the overall cost may tend to increase.
3) Fulfilling a budget through reprimand
“I have the budget; I need to exhaust the budget.” This is especially true in the case of Discretionary cost – A cost triggered at the discretion of the management, like Research, Sales Promotion, Training, CSR, etc. In these cases, a budget based on a percentage of sales target is given to the functional heads. If the budget is not exhausted, they may get a cut in the next year. We often find a high surge in these expenses in the last three months of the year.
Conclusion
Profit is a mind relaxant. We tend to splurge when we do well, but get to stingy levels when we do badly. To consistently address cost a cost aware culture is critical. We need to realise that cost is an effect and not a cause. Addressing the effect, by taking one-off initiatives rarely deliver, sustainable and significant cost advantage. We need to address the sources of the causes of costs. We find that in many firms Cost Ownership is unclear. Sustainable cost advantage emerges out of Tackling, Taming, Tracking and Trapping the cost. This can be done only by scientifically addressing the causes.
