Simple Formulas Are Nice But They Don't Work

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American business loves quick and easy answers.  In fact, the best way to get people to pick up a book or read an article (and I admit, I’ve done it myself) is to provide an easy-to-follow formula that solves a difficult business problem.   While this approach can help sell magazines, it really doesn’t do much to help drive actual improvement.  Organizations are too complex to assume there is a quick answer to any of the significant problems they face.  Although formulas do appear to provide easy steps to follow, they do not provide the knowledge necessary to effectively address the big issues.

Fortune Magazine recently published a one-page article entitled 5 Ways to Stay Ahead of Rising Costs.  The article presents five easy steps to address out-of-control costs in an organization, including a two or three sentence description of how to apply the step.  Although each step appears to make sense on the surface, accepting and blindly following recommendations like this can easily backfire and result in causing more harm than good.

The article’s focus is on imposing accountability for spending in order to drive responsible management of costs.  Although it’s hard to argue with the need for accountability, it is very easy to misapply this type of effort and distract people from their main responsibilities – including serving customers.

Below are the five ideas presented in the article, along with my thoughts about each.

1. Share the Responsibility:  This involves making someone in the company accountable for every line in the financial statements.  By the time the numbers make it to the financial statements, however, it is too late to do anything about them.  While I have no problem with making people accountable for understanding and monitoring spending within their areas of responsibility, it needs to be done real-time, and through a process of comparing actual costs against expected costs.  Also, it is unrealistic to think that one person can be responsible for an item – like a line on a financial statement – that is comprised of so many elements.  This type of approach often clouds the idea that cost is an element of a target condition, which includes safety, quality, and delivery of product or service, rather than an isolated objective.
    
2. Reveal the Price:  Making sure people know what actions cost is important and can lead to improvements as long as the focus does not become solely on reducing the price.  As presented above, the target condition of applying this practice needs to be something like reducing cost while maintaining or improving quality.  I agree with the article, however, that most organizations really have poor cost information systems.  In far too many companies, information on costs is often inaccurate and provided far too late to drive any real improvement.
    
3. Monitor the Use of Items:  Of all the ideas presented in the article, this is the one that’s probably applied the most and resulted in the least amount of improvement in organizations.  Although it’s the easiest step to take, shifting into a counting paperclip mode of operation is one of the most frustrating and distracting actions companies take when costs are out-of-control.  In my first job out of college, I asked for a set of folders to organize the projects I was working on.  A couple days later, the office manager came to my office with an expandable folder that was taped, written on, and worn, explaining that the company was focusing on reducing the costs of office supplies.  After she left, I threw it in the garbage and bought my own folders.  Although that was many years ago, I still remember how demotivating that was, and how it made me feel about my decision to join the company.
    
4. Spend Wisely to Win:  I completely agree with focusing spending on the efforts that are most likely to result in business for the company.  The problem with this suggestion is the difficulty of applying it in real situations.  This is a perfect example of an idea that requires significant knowledge to effectively apply.  A lot of thought, clarity, and planning is needed before attempting to blindly implement this type of thinking within the organization.  It’s just not that simple
    
5. Raise Your Prices:  As with the idea of spending wisely, raising prices can be very dangerous if not done correctly.  Determining what your products or services are worth lies with your customers – not you.  If you can’t make money by selling at the price the market is willing to pay, you’ve got to find ways of lowering costs without lowering quality.

I’ve seen many organizations over the years go through periods where costs became the focus, and each time people would respond by lowering spending.  More often than not, though, while short-term costs dropped, longer-term problems increased significantly because of the lack of knowledge and planning behind the approach.

Although controlling costs is obviously important, companies are not in business to save costs.  If your approach to managing costs is not backed by knowledge, you can wind up saving your way into oblivion. 

Formulas for success – like the one in the Fortune article – make running a business seem easy, and although the elements of leadership are simple, they are anything but easy.  You still need to be able to communicate the purpose, develop and deploy an effective strategy, and continually adjust along the way to be successful, and an overly simple formula will not make it any easier to do.

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.