When Cost Cutting Becomes the Focus

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The recent media coverage regarding the Gulf oil spill has reminded me of countless industrial accident and product recall news stories over the years that point in some way to misplaced cost-cutting as a fundamental cause of the problems.  The scrutiny that results from a major incident, however, tends to highlight the companies involved as if they are the exception when, in fact, arbitrary and misaligned cost-cutting is much more common in business than many realize.

It Happens Everyday

I have seen many examples throughout my career where attention was focused much more on cost-cutting than providing value.  In one instance, I was contracted by an energy company to help improve their processes for project planning and execution.  After spending time with some of the people involved in projects, however, it became obvious that the problems were not related to the skills of the employees or the processes and systems used for projects.  The problem was directly caused by an excessive focus on costs.

There had been so much emphasis throughout the company on cost-cutting that people worked as if the company's purpose was to control costs instead of producing oil and gas.  When conflicts arose between cost and production, cost won out every time.  There was virtually no analysis regarding the benefit of getting a well operational ahead of (or even on) schedule.

In another example, a plastic products manufacturer regularly missed its deadlines for new product introduction due to cost overruns.  The company had strict earnings targets and had gotten into the mode of, what many in the organization referred to as counting paperclips.  High-level meetings, as well as measures and rewards for managers, were heavily focused on meeting cost targets.  Because of this, whenever a product development project fell behind schedule for any reason, no consideration would be given to providing additional resources to get back on track.

Value as the Driver

Several years ago, study published by McKinsey & Company showed that a new product introduced on-time but with a 50% cost overrun negatively impacted profitability from the development by 3.5% as compared to a 33% loss in profits for a product introduced six months late but within budget.  There are obviously a lot of assumptions associated with the study, but the point is that getting investments - whether in new products or operations - to produce more quickly is beneficial to the company, even if it involves additional expenditures.  I believe the same philosophy applies to oil and gas producers as it does to product manufacturers.

The most successful companies focus on improving the value their processes provide rather than cutting costs.  Improving in this context does not mean finding shortcuts.  If value is the driver, improvement refers to reducing waste (i.e., anything that does not add value).  If only cost is emphasized, there will be a tendency to cut corners and implement changes that reduce costs without consideration as to the effect on quality, safety, or cycle time.

Value, Value, Value

Getting into a cost-cutting mode most likely occurs because it is much easier to focus on cost reduction than it is on increasing value.  Business leaders need to remember, though, that increasing value is what leads to success.  When the company focuses on continually improving the value it provides, it becomes much easier to keep costs under control.