How to Cut Costs--Strategically (Harvard Business)

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Paul Michaelman: Hello, I’m Paul Michaelman from Harvard Business Publishing, and I’m delighted to be joined today by Cesare Mainardi. Cesare is managing director of Booz and Company’s North American business, and is the co-author, along with Shueme Benergy and Paul Linewand, of Cut Costs, Grow Stronger: A strategic approach to what to cut and to keep. Cesare, thanks for making the time to talk today.

Cesare Mainardi: Pleasure to be here Paul.

Paul: Cesare, implicit in your decision to write this book, I think is an important, kind of profound idea, especially considering the economic times we’re living in, and that’s that most companies, and particularly their leaders, don’t know the most effective way to take their costs out of their organizations. So before we get into the solution, what’s the problem? What are companies doing wrong?

Cesare: Well, we have found that most companies, when confronting cost reduction, tend to make cuts across the board. Umm, I believe most executives know that that’s not quite right, but they resort to that. They’ve come to the conclusion that they need to act fast, and then they pull the trigger in that way. And we have come to realize that it, the activity of expense reduction is really a strategic choice, and in fact there’s, no time like that to make some very sharp decisions about what’s important, what is strategic, and to make decisions around costs in that context.

Paul: So that sounds great in theory. I take it we need some kind of framework or limbs to do this effectively, so where do we go next?

Cesare: Ah, well we’ve come to learn that, ah, that the best way to define, umm, activity, is around capabilities. And we have found that, if a firm is able to concentrate it’s expense around the capabilities that make a real difference in terms of winning in the market, then great things happen. And, not only are they able to cut costs where things matter less, but they are able to invest in the areas in business that will cause them to thrive and to grow, even as an economy returns, for instance.

Paul: Dumb question, what’s a capability?

Cesare: A capability is a combination of know how, people, ah, expertise, processes, all that happens in a business that allows that business to out execute competition in the markets that they serve. It’s not, many, many different capabilities, but it’s a few, two, three, four, five, six things that make all the difference in terms of winning in the market.

Paul: Does the average CEO or senior leadership team know what their capabilities are? Can they, can they freely list them when asked?

Cesare: Ah, in a moment, ah, of reflection, ah, sort of away from the day to day, ah, if you were to an executive what three, five things might really make the difference in the business, the majority can in fact tell you. Ah, I think many times in the day to day it gets lost in all the different things that happen in the big corporation, all the functions and all the activities, and then at times it’s hard to see the forest through the trees.

Paul: Is there an example of a company, maybe quickly you could, you could talk about what their capabilities are just to cement this?

Cesare: Sure. Frito-Lay comes to mind, a division of Pepsi, and they built a tremendous capability to, ah, market up and down the street, as they call it, and it was a combination of trucks, and highly motivated sales people, and the tools and techniques to know what product to place in those stores and direct store delivery, umm, decisions about pricing, umm, everything that goes, umm, in terms of, everything that is required to serve that market in that channel extremely well. They built a tremendous capability in that regard, and it caused them to secure leadership for quite some time in terms of salty snacks.

Paul: OK. So we have an understanding of, of what our capabilities are, maybe we could use Frito-Lay as an example here. How do we transfer that knowledge to a strategy for taking cost out of a company?

Cesare: Well, umm, take Frito-Lay as the example, umm, if, ah, if, clear-minded that that is the capability that they’re building over time, what is it that they do that is then, umm, not essential to that activity? Umm, and any corporation has many, many activities in it, and the key is to figure out what is essential to the success, and then what is just required to keep the lights on. And what’s important is to triage the two, and invest in the activities that cause success relative to competition, and then to be as lean as possible in everything else.

Paul: So does this mean we’re looking for things that we might classify as non-strategic, to focus on them, or are there things that might actually seem to be strategic that we should be also looking to cut.

Cesare: It’s a, a combination of all the above. We think about, umm, three kinds of costs to an extent. There’s a minimum that’s required to keep the lights on. It’s not very strategic, but if you’re a public company you have to report, you have to, you have an accounting department, and the like. The rest of it we think about as investment. It is, in fact, expense investment in the business, umm, as opposed to the capital investment that drives growth, and expansion, and, ah, new decisions, new markets, innovation, whatever it might be. Umm, and when you look at expense investment, there are a number of things that really are essential to success, and we call those the core capabilities of the business. And then the rest of it might be an investment step too far. And so, what management does, is a triage between what I need to keep the lights on, where is it that I’m spending that’ll make a difference in terms of spending over time, and then, how is it that I keep the rest as lean as possible?

Paul: Who’s involved in making these decisions?

Cesare: Well, because we believe cost reduction is in fact strategy, and some of the most important strategic choices that are made, we believe that top management has to be in the lead on, on significant cost reduction. It begins with top management, umm, coming to a clear determination about what the big target to reach, and in fact the greater the aspiration, the greater the result always. Ah, so they set a big hairy target, and then have a discussion about what might be different about the markets today, and where could we be more clear-minded about the capabilities that make a difference to win over time. So, the distillation of the three, five things that are so terribly important to the future and to growth in the future, they set the stage, ah, they build their hypotheses then about what is important and less important. And then they launch teams, ah, into doing their work, and the teams have to come back and, umm, inform management as to were the hypotheses right or wrong? Were the risk tradeoffs entailed with, ah, going down the path of reducing costs, and some places versus, versus investing in others, ah, and it’s an iterative process where management debates with working teams throughout the organization in terms of making the best decisions and the best risk, return tradeoffs around that expense investment.

Paul: This sounds like a very rational approach, but in the face of, say, of surprisingly dismal results, umm, an unexpected to take costs out, out of an organization, sadly an experience that many companies have had over the past, ah, twelve months or so. Can a process like this be implemented quickly for short-term savings, or is this really just a longer term approach?

Cesare: Umm, we have found, ah, that the majority of executives don’t believe that this can be done quickly. In our experience it can be done very quickly. Umm, we have found that it doesn’t take very long time to distill the three, five things that are most important in a corporation, and that, in fact, if you mobilize everybody around those concepts, umm, there’s a positive upside around thinking about the future and growth. But more importantly, it really frees up thinking that it, ah, eliminated the barriers to what has caused expense to be what it has been before, and it causes people to really engage on making tradeoffs that are far different and far more aggressive in terms of cost over time. And those decisions made, can be made quite rapidly.

Paul: By quite rapidly you mean?

Cesare: Ah, we’ve been in situations where the bottom was falling out fast, and we were able to, ah, turn around, ah, for instance, a, ah, the battery division of Johnson Controls working with management there. Together they were able to, ah, take out dramatic costs in the span, they started with four weeks of, ah, of activity, and costs already was starting to come out, and completely transformed over a half year timeframe. Ah, and we have found you can move very, very quickly with this approach.

Paul: Can this approach only be applied, umm, from the very top of the organization down? In other words, there was, if I’m a general manager of a division of a company, can I implement this approach just within my group, or is it by definition, really an organization-wide approach?

Cesare: Umm, within a division, umm, it is, you can implement elements of the approach. Umm, one can be clear-minded about what is most important in terms of activities and the capabilities in that division, and then make decisions within that context as to where to invest an expense, ah, how they think about how their product line, for instance, matches against those capabilities. That can be done, certainly within a division. Work capabilities are shared across divisions, then obviously there’s an interplay with the organization, ah, the much larger organization.

Paul: So there are some hard decisions here. Can you tell us about a company that has made these decisions and followed this approach effectively?

Cesare: Be glad to. Umm, Pfizer comes to mind, in a particular consumer healthcare part of that business. Umm, years ago, ah, they acquired Warner-Lambert, and frankly the acquisition was all about Lipitor and the, ah, pharmaceutical side. But with Lipitor came a large consumer products business, ah, within Warner-Lambert. Umm, and historically, the presumption within Warner-Lambert was that they were, ah, consumer businesses. And so, ah, some consumer insights and some excellent marketing, and those kinds of activities would cause all those businesses to thrive over time. Ah, as new Visor-Warner-Lambert management start to consider the portfolio, they realize that in fact that have four very different businesses in the portfolio. They had a confectionary business, and that is all about rapid innovation, new flavors, owning the front end of the store. Ah, that was different from a personal care business, ah, like a body lotion, ah, where you are making things claims about beauty and, ah, maybe new scents, and whatever might be a different part of the store served. Two, umm, two other areas of the business that lent themself more to a medicinal approach, consumer healthcare, like mouthwash, and then traditional over the counter, ah, medications. And in those last two businesses, we realized that the capabilities required to win were very, very different. They had everything to do with, ah, ah, pharmaceutical like research, and health claims based marketing, and regulatory management, ah, and owning, ah, channels that were different from general trade channels. And so we realized that they were trying to do too much in the portfolio. With management they pared down the aspects of the portfolio that didn’t match the way that they were going to play in the market, their sweet spot, and then they invested in building the capabilities to really accelerate growth in over the counter and in consumer healthcare. They built the capabilities that I describe, and the outcome was paring of the portfolio, significant cost reduction within what was left over, but then a real focus on what made the difference in terms of winning and what conferred upon them, umm, the right to win, and in fact the ability to out compete everybody else. By choosing to focus the portfolio on the capabilities that mattered, by choosing to invest in the capabilities that mattered, they were able to drive industry leading growth coming out of that significant restructuring. Tremendous success to the point where Pfizer at some point decided to focus on pharmaceutical. They had a jewel in the crown with the consumer healthcare business and was able to, ah, sell that business to Johnson and Johnson, terribly interested in the kind of capability, ah, for over twenty times ????.

Paul: Great. Cesare Mainardi, thank you very much.

Cesare: My pleasure, thank you Paul.

Paul: To learn more about this approach, ah, you can read Cut Costs, Grow Stronger: A strategic approach to what to cut and to keep, which is available in digital form for the Kindle, umm, and as a downloadable PDF from harvardbusiness.org. Thank you very much.