Which Performance Metrics Should You Pay Attention To?

March 15, 2007
Companies need to develop a sustainable structural cost management capability.

Although U.S. manufacturers focus on cutting costs and removing excess spending, they struggle with profitability due to pressure from structurally imposed costs and lower cost foreign producers. Drivers such as corporate taxation, employee benefits, energy costs and regulatory compliance all place a significant burden on U.S. manufacturing companies:

  • Domestically imposed costs are damaging U.S. manufacturing by adding at least 31.7% to the cost of doing business from the U.S.*
  • U.S. external overhead costs are almost as large as total manufacturing costs in China.*

Given the above, the solution is for companies to develop a sustainable structural cost management capability. Unlike traditional, incremental cost reduction efforts, focusing on building a continuously improving, integrated cost management capability can contribute to increased shareholder value across the board.

A structural cost program can achieve results beyond those from traditional incremental methods:

Better than efficiency programs -- Traditional cost management tools which focus on operating cost lines are proving ineffective for long term cost reduction. These tools include budgets, variance analyses, continuous improvement programs (i.e., Lean, Six Sigma), hiring freezes, etc.

Sustained results -- A sustained, programmatic approach which combines efficiency programs with structural cost analysis provides the best benefits.

Next frontier -- Structural costs represent the next area for significant performance improvement and capability development, as traditional cost reduction efforts yield diminishing returns.

To hear more about this topic attend the IW Best Plants Conference, April 24-25, 2007 at the Indiana Convention Center & RCA Dome, Indianapolis, Indiana. The session Manufacturing Performance Metrics: Which Ones deserve Attention and Why will be held on Wednesday, April 25, 2007 at 10:20 a.m. To register for the conference and view the entire list of speakers visit www.iwbestplants.com.
Developing a sustainable structural cost management capability requires addressing four critical steps:

1. Acknowledge The Structural Cost Challenge

Acknowledging the problem is the first step in the transformation process. Several common business symptoms include:

  • Past cost reduction efforts have generated weak returns and are short lived
  • Programs focused in the functions or business units have stalled and captured the "low hanging fruit"
  • Performance enhancing programs have failed to address the "sacred cows" in the business
  • Acquisitions have created overly complex management structures and product portfolios
  • Rapid growth or the changing regulatory environment has paced the business
  • Competition is increasing from low cost producers requiring year-over-year reductions

2. Understand The Structural Cost Drivers

Evaluating the size and reach of the structural cost challenge is a critical first step. The nature and impact of these costs, and the impact on long-term performance, will focus management on where and what to "hunt." Common internal and external drivers include:

  • Internal (management controlled)
  • Business configuration (business model, geographic footprint, ownership strategies)
  • Complexity (products, channels, customers, processes, operational governance)
  • Organizational design/corporate structure (service delivery model, organization structure, spans and layers)
  • Employee related (compensation, benefits, health care, talent acquisition and management)
  • Infrastructure related (IT infrastructure, facilities design)
  • External (typically externally imposed)
  • Regulatory/Compliance (SOX compliance, tax regulations, environmental costs)
  • Environmental
  • Other (Energy, foreign exchange rates, trade/tariffs, legal, industry structure)

3. Develop And Prioritize Improvement Opportunities

Setting priorities for change is the critical next step. Management must balance the need for structural cost reduction with the demands of managing the ongoing business. This is challenging, however, several practices can help ensure success including:

  • Building a business case for change that values the cost reduction options in value-based terms
  • Defining key success targets and the needed time horizon
  • Developing a inventory of both transformational and operational programs critical to the business success
  • Preparing a comprehensive roadmap that defines the agenda, dependencies and critical commitments
  • Building management understanding and support for the agenda (guiding coalition)
  • Making it stick by aligning incentives

4. Execute Initiatives And Measure Progress

A plan is only a plan! Successful execution is the key to realizing value. Organizations usually stumble in the execution phase for a variety of reasons. Examples include unrealistic scope, lack of resources, unwillingness to accept change, lack of program management discipline and misalignment of incentives, to name a few.

A well-executed structural cost management plan, the most important part of realizing value, will result in:

  • Better understanding of the companies cost structure and the size and nature of the structural cost challenge
  • Greater organizational awareness of the challenge and value implications for the business
  • Clear priorities for management action
  • Improved allocation of limited capital and people resources to the right agenda
  • Greater management alignment and support for change
  • Better balance between short-term, tactical cost reduction programs and the long-term, structural cost improvements that can really change performance

By managing these important cost factors, you will ultimately transform your organization and improve performance.

*Source: The Escalating Cost Crisis: An Update on Structural Cost Pressures Facing U.S. Manufacturers (National Association of Manufacturers, MAPI; 2006)

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