cost case study

Case Study 06 - Costs

The project proposal and the project log

Keep a cool head in times of rising costs

By Anthony Hopwood, 21 August 2003

Costs are a strategic consideration for most companies. With pressure mounting on prices, volumes and margins, business leaders have to give renewed consideration to their cost management strategies. With low-cost outsourcing becoming more widespread, concerns about costs are more intense than ever.

In times of slowing growth, increasing competition and the risk of deflation, costs take on a new significance in the management of profitability. As control of price starts to slip away, retailers and distributors demand an ever greater share of margins. Companies that are ill-prepared for the consequences can slip into crisis.

However, immediate cost-cutting in practice tends to be a crude and simplistic exercise. Redundancies and the elimination of overheads usually take priority. Investment in marketing and research and development is sacrificed for immediate gains. Goodwill can be lost both inside and outside the company to save short-term cash flow. In times of crisis, there is usually little investment in analysis and reflection. The meat-cleaver approach takes priority over putting the brain to work.

But in such difficult times it pays to be analytical. Even in the short term, cost management should never be merely an accountant's exercise. Accountants only record costs: they do not incur them. All functions — operations, distribution, marketing, human resources and finance — have a role to play in identifying targets for saving, and managers should establish interdisciplinary teams to co-ordinate their actions.

Managers tend to be inward-looking when thinking about costs, yet ideas for reducing costs are as likely to come from outside the company as inside. It is vital to benchmark against competitors and study developments in the wider economy. Germs of imaginative ideas that challenge the status quo should be welcomed. What is being done elsewhere? Can it be done here, or modified for application here?

Reducing costs requires them to become what they were not. In the process of transforming its supply chain systems, for example, a retail organisation is likely to reduce its costs of inventory. If managers have to conceive costs differently, this can be as much an act of imagination as a crude process of elimination. `Can this be done without that?' ought to be the daily refrain.

Cost management should not be an isolated exercise but should sit alongside the disciplines of value creation and revenue management. Knowing when to incur additional costs for additional return is as important as knowing how to eliminate them when necessary. In the longer term, companies should be more interested in spending money to create profitable products — premium, high-quality products — than in cutting costs now.

Consider the example of Wedgwood, manufacturer of fine pottery. The company has been in the news this year for drastic cost-cutting, redundancies and — the ultimate irony - outsourcing manufacturing to Asia, where the techniques for producing its wares originated centuries ago. Its approach is strikingly different from that of the 18th-century founder, Josiah Wedgwood. He invested heavily in research and development, in management and in design. He was at pains to understand the emerging culture of eating and entertainment. As a result, he was able to create a range of high-quality products at premium prices that attracted attention — and profits.

How different has been the Wedgwood of recent years. No longer noted for its commitment to technical innovation or management expertise, it now trades largely on tradition, thus denying itself real possibilities for branding and product differentiation. Without that, prices are in turn under pressure and costs become more vital.

In the company's defence, it faces strong foreign competition and is one of many UK industries that have struggled with overcapacity inherited from the glory days. Wedgwood has started to rediscover the value of investing in design, with a new range by Jasper Conran, the British designer. Yet this may be too little, too late.

Companies that lose control of their market see the importance of costs rise and the possibility of dealing with them in clever ways eliminated. Any significant change in a company's cost structure needs to be accompanied by a change in strategy, so that it can compete more effectively on the basis of its product.

Should Wedgwood expand further and promote its contemporary range alongside the classic Wedgwood of old? Should it invest in design, by creating a range that recalls the highlights of the Art Deco period, the 1950s and so on? Would such a strategy allow it to transform the production process using smaller-scale technologies? And how could the latest research on materials science and ceramics production enable it to restructure its costs more radically?

Such questions make it apparent that cost control cannot be considered outside the context of product, marketing and distribution strategies. Cost management is a knowledge-intensive pursuit. It requires much more information than current cost, which are only the benchmark for radical change. Wedgwood needs the stimulus that knowledge of radical alternative production techniques and modes of operations management could bring.

The latest thinking on ceramic materials would enable it to gauge whether niche product innovations could attract higher prices and bring in different production technologies. An informed decision on this requires the involvement of scientists, operations specialists, marketing experts and designers, as well as accountants. A successful cost management company, it follows, requires a strategy for bringing in fresh knowledge that includes a process for efficiently capturing the results and distributing them around the business. This cannot be achieved overnight. There is no doubt that the Josiah Wedgwood of old would be comfortable in such an enterprise. He used his links with such bodies as the Royal Society and the Lunar Society to contact the top applied scientists of the late 18th century, and also to the artistic elite of his time — Stubbs, Flaxman and others. How would the Wedgwood of today attempt to replicate such a dense circle of knowledge and understanding?

First, he would be cautious of consultants. The knowledge they offer is often second-hand and sometimes dated. What is needed is the contextual understanding of people who know a sector and can see what it might become. When there is a need to be at the forefront of ideas it is best to look directly at internal talent and the centres of new expertise — companies in other industries, universities, research institutions and design schools. Use student project teams; they are cheap. Invite in a wider range of contacts and open the enterprise to new ideas. Travel, visit, read and reflect. Then act.

Today's most innovative companies are doing just that. Intel has set up a series of mini 'lablets' next to universities to draw in ideas. Eli Lilly continues to refine InnoCentive, its online knowledge broker, posting problems and inviting solutions from individuals and companies around the world.

Drastic though some of today's cost-cutting may need to become, its real pay-off can only come from a deeply informed strategic examination of the cost management that is intertwined with a careful review of other vital aspects of the business. Cost management is not an isolated art or one that should be confined to the accountant's floor. It should involve the whole business. It has the potential to change the whole business

The writer is Peter Moores dean of management studies at Said Business School, University of Oxford.

Q1. Imagine that you have been offered the Wedgwood project. Review the article and make a series of key points in your log for discussion a meeting with the client.

Q2. What challenges and objections might the client raise about a consulting project? Detail about four in your log and plan responses.

Q3. What is the general learning from this article about your consulting future? Detail about four key points in the log.