Solving the Riddle of Supply Chain Cost Reduction

Feb. 11, 2009
Across-the-board cuts decrease, not increase, profitability

Unless you are a hermit who has been stranded on a deserted island for the past 12 months, you get it -- we are in a recession.

Let's see what all the "smart" companies are doing, in manufacturing and in other industries. Many are cutting payroll, cutting advertising, cutting consulting, and cutting strategic initiatives.

So should you follow along and also cut, cut, cut? No, because this is not a strategy that leads to success. Across the board cuts, without understanding where your company's real profitability lies, results in average performance at best and leaves your organization wide open to failure at worst. That old saying, "When you do average, you get average" applies more than ever in these volatile times.

The Difference Between Cut and Reduce

But wait a minute, isn't this column supposed to be about Supply Chain Cost Reduction? Yes, and there really is a difference between cut, cut, cut and cost reduction.

Unfortunately, in this terrible economy, the difference shown between the two approaches is zero in most organizations. Today, cut, cut, cut and cost reduction are wrongly considered the same thing. This is a disaster, as cut, cut, cut done across the board without more definition will not result in greater organizational success. On the contrary, it will lead to stagnation and declining profits. Haphazard, across the board, uniform, indiscriminate cost reduction will beget the unintended result of less profit -- not more.

However, in an organization that is aligned with its Model of Success, which defines vision, mission, requirements of success, guiding principles, and measures of success, and is doing the BIG 7 -- strategic planning, action plan, budget, risk mitigation, contingency plans, execution and accountability -- the difference between cut, cut, cut and cost reduction is huge! In these visionary/strategic firms, costs are separated into three categories:

  • Category 1. Capital and operating costs: Traditional ongoing expenditures
  • Category 2. Talent costs: Expenditures for key resources that are required to reduce costs and increase profitability
  • Cateorgy 3. Strategic costs: Expenditures for strategic profit improvement initiatives

Category 1 is wide open for cost reduction and should always be pursued, but pursued even harder during difficult times. Today is clearly a difficult time, and I strongly believe, support, and encourage cut, cut, cut in Category 1.

Category 2 must be carefully analyzed. I see companies cut so deep in Category 1 that the people left do not have the capacity to bring about the cost savings. I see organizations that are running so thin that they cannot accomplish a million dollar cost savings because they do not have on board the $100,000/year employee needed to realize the savings. In a similar way, I see organizations that can achieve millions of dollar savings via a consulting project costing 20% of the savings, but a mandate comes down from above to cut, cut, cut all consulting costs. It takes talent to reduce costs. Without it, you can keep cutting, but your costs will not go down, only up.

Category 3 expenditures must be segregated and protected. Let me be clear -- Category 3 cost cutting is dumb. Especially in a bad economy, it is more important then ever to pursue the strategic things that will result in long-term competitive advantage.

By correctly focusing on Category 1 cost reduction, you will generate sufficient profits, even in this terrible market, to maintain your Category 2 and 3 expenditures. This will position your organization for greater success after the economy improves. So, yes, times are difficult, but gain a competitive advantage by focusing on:

  1. Segregating Category 1, 2 and 3 expenditures
  2. Aggressively and intelligently going after Category 1 cost reduction
  3. Protecting and pursuing Category 2 and 3 expenditures

Prudence NOT panic should be the order of the day. Yes, we need to be sure our Category 2 and 3 expenditures are aligned with our vision. And given that we know where we are going and how to get there, it is wise to protect our talent and guard our strategic plans. Most of all, we need to aggressively, intelligently go after Category 1.

The Riddle is Solved

Today's marketplace is full of folks who want to help reduce your Category 1 costs in a piecemeal fashion. Transportation costs, purchase costs, customs and duty costs, inventory carrying costs and distribution center costs are all very, very important expenses that in these difficult times need to be reduced, and you should do so aggressively and intelligently!

Now you know the answer to the Supply Chain Cost Reduction riddle. It is not about piecemeal cut, cut, cut, and it never will be so. The answer to the riddle is an integrated, holistic approach that increases profitability and puts your company in a stronger competitive position.

Consider this recent insight from Timothy E. Sweet, Director at OEM Capital: "In times like these, there are those who hide and those who 'seize the moment' to secure a much stronger market share after the upturn. Now is the time for relatively healthy companies to take advantage of weaker competition, profit from falling valuations, and begin to build added enterprise value." Yes, he certainly gets it.

Times are definitely tough. But why not turn adversity into an advantage that will give you an even stronger organization once the smoke clears from this economic crisis?

Jim Tompkins is President & CEO, Tompkins Associates. Tompkins provides global supply chain services, distribution operations consulting, technology implementation, material handling integration, and benchmarking and best practices. Jim also writes a blog on supply chain issues

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