The Right Way and the Wrong Way to Cut Costs

The good news is that companies these days treat cost containment as a discipline and an ongoing process rather than reactively. The not-so-good news is that they tend to focus on minor, low-yield initiatives and on squeezing expense out of their processes. And that may not be enough, according to Omar Aguilar, partner with Deloitte Consulting.

The typical company's approach is "a perfect storm in this environment," says Aguilar, "because it can lead to a complacent view that a company engaged in ongoing cost reduction has adequate cost management capabilities, when in fact the type of cost management you need in a downturn or a situation like we're in right now may need to be more than incremental."

Deloitte studied cost-management initiatives at 70 of the Fortune 500 and found that about two-thirds of executives at those organizations expect their current efforts to provide only single-digit savings. The other third are aiming at bigger savings through what Deloitte describes as "transformational" improvements to their cost structure.

Transformational cost management projects "tend to be multifunctional; you try to attack multiple functions or significant parts of the business at the same time, and that leads to higher savings and more impact to the business," says Aguillar. Of course, they're more difficult to undertake than, say, cutting back on telecom costs or T&E expenses. But in the current environment some companies may have little choice. "Ten, fifteen, twenty percent of companies may indicate that they don't expect a downturn or are not in one, but the vast majority are in one or are expecting one," Aguilar points out.

Deloitte offers five tips for doing cost reduction right:

1. Start with the obvious. That generally means trimming general and administrative expenses (see The Hackett Group's analysis of G&A savings opportunities, which we reported here) and pruning external spend. Surprisingly, though, "some organizations are highly reluctant even to take a broad view of G&A," says Aguilar. "There's a lot of opportunity there, but many companies are not taking it."

2. Take an enterprise view. G&A and procurement are only pieces of the puzzle, and the potential cost improvements in these areas may not be big enough. It's worth making the effort to develop an enterprisewide view of all expenses that are within the company's control over the next 12 months, including sales and marketing, manufacturing, and supply chain costs.

3. Protect strategic investments. A whole-company view of expenditures shouldn't be the blueprint for an indiscriminate, across-the-board cost-cutting campaign. Areas that are essential to the company's future prosperity, such as R&D and marketing, need careful treatment. But they can still yield savings, says Aguilar: "I hear too many times that everything is a strategic investment. It isn't. You need to be fact-based and understand what drives value and revenue and then protect that or invest in that. But the rest is not strategic." In some sales and marketing programs, for example, 50 percent to 70 percent of the work performed is transactional, "not the value-added work you might expect."

4. Balance short- and long-term improvements. In a downturn, companies tend to default into near-term, low-yield projects. A better approach is to develop tiers of initiatives spanning short-, mid-, and long-term opportunities. Savings from the "low-hanging fruit" can fund more ambitious structural improvements in the mid- and long-term.

5. Choose the right business model. Centralized, integrated companies have a cost advantage over those that allow individual business units more independence. For businesses that are highly diversified or experiencing rapid growth, a decentralized model makes sense. But for a surprising number of companies, including many in the Fortune 500, it's an unnecessary burden. "Many, many companies -- notwithstanding they're mature, they're not growing -- still follow decentralized models. And then they become challenged," says Aguilar. "So there's still lots of opportunity relative to rethinking your model and how you become more scalable and more efficient."

Download the complete report "In Fighting Shape? 2008 Survey of Cost-Improvement Trends in the Fortune 500" from Deloitte.