Joseph A Hopper

Joseph A Hopper is Principal Consultant at the Theory of Constraints Institute (www.tocinstitute.org) and Executive Director at Sunstone Business School (www.sunstone.in). Prior to this, he headed Corporate Development at NIIT Ltd. where he oversaw the strategy, budgeting & review processes for 13 independent business units.

How Cost-Cutting Might Be Destroying Your Organisation

Joseph A Hopper


“In today’s competitive environment, controlling costs has become even more mission-critical than ever.” The silence that followed was deafening; no one dared to question the CFO! After all, ‘cutting costs’ and ‘increasing efficiency’ had been their mantra longer than anyone could remember. And yet…

The company had finished their third major round of belt-tightening. With each new day, the situation seemed to grow worse and worse:

– Ever since the L1 purchasing policy came into effect, the quality of inputs from vendors suffered, causing high inventory and major production delays for key customers. The organisation recently lost their largest customer.

– Ever since HR started measuring ‘People Productivity’, chronic labor shortages emerged across the organisation (especially for critical skill sets).

– Since the time the CEO vetoed critical maintenance expenditure, downtime and firefighting had become an almost daily occurrence, and physical injuries had been sustained.

– Ever since the finance team set out to reduce interest expense, they stopped paying vendors on time. The organisation was blacklisted by key suppliers and was facing stockouts across a wide variety of items.

– When the ERP upgrade got deferred, data inaccuracies and reporting delays transformed budgeting into little more than a game of dumb charades.

The allure of cost-cutting is seductive indeed…just find a cost and eliminate it. Showcase your efforts to the senior management and take all the credit. Then move on. Nothing could be easier or more instantly gratifying.

But wait, what about the harmful side effects? These are rarely captured, reported or even widely understood. As the examples above illustrate, negative side effects from cost-cutting can be severe and at times, debilitating for the entire organisation.

Negative side effects are often difficult to attribute, much less quantify in hard numerical terms. Just think back to the last round of layoffs that shattered morale and team loyalty. The best and the brightest were overloaded with work and no longer felt secure; so they started looking  for new jobs elsewhere. They left gradually over a period of time, not on the same day when layoffs were originally announced. Try placing a number on such a loss as that!

Or take the infighting and blame throwing — typically, the cost-cutting enthusiast has been promoted or has left the organisation for greener pastures by the time anyone gets around to cleaning up the mess. The ones who remain are left holding the baby, and often get criticised for things that are no fault of theirs.

Cutting costs holds surprisingly little scope for actually improving profitability. While it may be possible to trim an individual head by five to 10 per cent or even more, it is rarely possible to achieve this kind of result across the overall cost base. In general, cutting more than three to four per cent from overall costs picture without bankrupting the organisation is an extraordinary accomplishment indeed.

And what then? Next quarter, has the job become any easier? Like do-it-yourself liposuction, each new layer of fat removed makes it trickier and trickier to remove the next. In our zeal to trim fat, we often wind up cutting muscle or even bone. Taking this process to it’s logical extreme, all costs can ultimately be eliminated and we could just shut down the organisation once and for all! Imagine how much THAT would improve profits! But like it or not, cost cutting remains subject to the harsh reality of diminishing returns, greatly limiting its usefulness over any meaningful horizon.

By comparison, what if the same organisation devoted similar energy and zeal towards profitable growth? A mere 20 per cent increase in sales volume (at similar price levels) is enough to nearly double the profit of many organisations, if fixed costs are not unnecessarily increased. Hence, a similar amount of effort can yield an order of greater magnitude with far fewer harmful side effects.

How does this focus on growth affect future efforts to grow? Curiously, true success tends to compound on itself. Creating one blockbuster product (iPod) makes it easier to create the next one (iPhone). Increasing sales by providing reliable delivery builds customer trust, and makes it far easier to grow wallet share with those customers in the future. The ability to eliminate stockouts in a retail environment might increase sales today, but it also makes it possible to increase the product range in the future.

Here it is important to note that we are not referring to shortcuts. Short-term tactics such as deep discounting or overpromising by aggressive salespeople can produce growth in the short term. But these behaviours obviously backfire as the organisation moves ahead.

Ongoing growth, on the other hand, requires dedicated effort, cooperation and business acumen:

– Solving your customer’s toughest problems (and charging for it)Taking calculated risks

– Operational / technological excellence

– Growth such as this has no finite limits other than your organisation’s imagination and ability to work together.

Let’s take an example from the IT industry, whose very foundation is built on the principle of cost-arbitrage. Could such a blatant disregard for cost-cutting ever survive in the IT industry, ruled as it is by the cost-conscious sword of the customers? Cognizant’s basic strategy in this industry has been to ‘enlarge the mine’. For instance, Cognizant stations extra people at the customer site to sense future needs and build relationships. And when they open a new ‘mine’, they assign people who already know the customer, rather than random outsiders.

 Neither of these moves helps cut Cognizant’s costs. Sudin Apte of Offshore Insights, who has been tracking Cognizant for the last 16 years, said, “As compared to its competitors such as Infosys, Wipro and TCS, Cognizant’s expenditure in sales and marketing is 50 per cent higher. The lower operating margins show up in higher S&A (sales and administrative) expenses, which drive Cognizant’s faster growth.”

Yet, Cognizant has consistently outperformed its penny-wise, pound-foolish competitors. According to their CEO, Francisco D’Souza, “Our consistent revenue and earnings growth is a testament to our long-term strategy of reinvesting in our business to stay relevant to our clients’ changing needs and provide increasing value, as we grow each of those trusted relationships.”

In summary, cutting costs is not just a ‘necessary evil’ that we all need to learn to live with. Rather, it is a destructive management approach rooted in a win-loose way of thinking. By contrast, any organisation which learns to merely control its costs (prevent them from galloping), while devoting most of its energy and bandwidth to profitable growth, is laying the groundwork for success now, and in the future.

Joseph A Hopper is Principal Consultant at the Theory of Constraints Institute and Executive Director at Sunstone Business School.

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