Strategic Planning Analogy #459: Strategic Toss-Outs

THE STORY
When its time to clean out the junk which accumulates at my house, my wife and I have different opinions.  She seems very willing to toss out my stuff, but more reluctant to toss out her own stuff.  I, on the other hand am very willing to toss out her stuff while hanging on to my own.  As a result, we often disagree about what should be tossed out.

Sometimes, I’ll come home from a business trip and find out that my wife used the time I was away to get rid of the junk in the house.  Apparently, she finds it a lot easier to make those decisions about what to toss when I’m not around.   The disagreements go away (along with a lot of stuff I would have wanted to keep).

THE ANALOGY
Houses aren’t the only things which collect junk over time.  So do businesses.  Business junk that accumulates over time includes:

   1) Old Products and Services which are no longer relevant.

   2) Formalized Processes and Procedures which are out of date.
   3) Informal ways that things get done which are out of date.
   4) People and positions which no longer accurately reflect best practices.
   5) Ways of thinking about the business.
   6) Unprofitable customers.
   7) Old capital investments.

Although nobody would argue with the abstract concept of eliminating the obsolete and irrelevant, the problem arises in that not everyone agrees about what is obsolete and irrelevant.  This is particularly true if someone else believes that what you yourself do for the business is obsolete and irrelevant.  Like the situation with my wife, someone else’s area in the business may appear less relevant than one’s own, so you fight to toss their junk while keeping your own.

Worse yet, sometimes businesses are in a position like a couple who is downsizing from a large house to a small apartment.  In order to fit into the smaller dwelling, they not only have to get rid of junk, but also get rid of some stuff that has reasonable value.  Similarly, businesses often find a need to downsize and are faced with the tough task of getting rid of seemingly good things in order to fit the budgeted shrinkage.

The problem, of course, is in deciding what seemingly valuable aspects of the business to toss out.  This can be difficult, because it may require getting rid of long-time employees or heritage products associated with the founding of the company.  And, as in the story, there can be differences of opinion as to what is or is not valuable. 

And, if some people are left out of the decision (as I was during a business trip), some highly valuable things could get tossed out because the one doing the tossing did not appreciate the value.

THE PRINCIPLE
The principle here is that strategic planning is about more than just how to grow a business.  Yes, it may be more fun to talk about growth strategies.  However, often times a lot more value can be unlocked from a business by tossing out a lot of the accumulated junk already choking the business.

There can be all sorts of processes, people, products, and factories embedded in the business which are gigantic cash drains.  Getting rid of this junk can create a far greater return on investment than investing in completely new stuff.  (Remember all those statistics about how most acquisitions and new product introductions fail?—it is not a given that every growth move is a winner.) 

Unfortunately, if you get rid of the wrong stuff, like core competencies, key aspects of your competitive advantage, and investments in the future, you can end up destroying the future of the business. (Wrong cutting moves can be as dangerous as wrong growth moves).

Therefore, decisions about what to toss out can be just as strategic as decisions about what to add.  Yet, I’ve seen many examples where cost cutting programs totally bypass any strategic scrutiny.  Perhaps every department is told to cut out 10% of their expenses and they can use their own judgment about what they can toss.  This could end up being a strategic nightmare, because it may not cut out enough junk in some areas while choking off the best potential in other areas.

Without a coordinated, strategic approach to tossing out, you can end up tossing away your best chance at success.  Here are some strategic issues to consider when embarking on a cutting/fixing program.

1) Know what is the Foundation of Success

Nobody would intentionally sabotage the underpinnings of their success.  Yet it happens all the time.  There are two causes.  First a company may not know what is the basis of their success, or they may have a mistaken understanding of what strategic elements created their success.  Unless you first know what is critical to your business model, you will not know how cuts or fixes are going to affect those critical elements.  So before embarking on a cutting/fixing program, make sure everyone is in agreement as to what is important for future success.  Know what your key points of differentiation are and what parts of the business model cause them.

Second, all cutting/fixing suggestions need to be viewed in the context of their impact on the core business model.  If the cuts or fixes critically hurt the core elements of success, then don’t do them.  Remember, these are not isolated decisions.  They impact the overall business model.  Keep that in mind when making each decision.

2) Consider Cross-Linkages

Actions in one part of the business can impact many other parts of the business.  For example, the operations department might cut back on labor to make their department’s costs lower.  They might even get a big bonus for this action.  However, the resulting drop in quality could ruin the budget for the service/repair department and make the selling force much less productive due to the problems in trying to sell lower quality goods.

Therefore, one needs to look at the big picture and all the cross-departmental implications.  Reward people on the total impact of their decision, not just on their individual area.  Otherwise, you can end up with a single individual maximizing their area while destroying everyone else (sort of like when my wife cleans out when I’m not around).

3) Flexibility and Backup is Important

Getting rid of excess fat in your supply chain is usually a good idea.  However, like most good ideas, it can turn into a bad idea if taken to an extreme.  If the 2011 tsunami in Japan taught us anything, it was that an extreme approach to lean supply chains is a disaster if a link in the chain gets broken. 

A lot of automotive manufacturing parts had only a single source of supply and that source was wiped out by the tsunami.  And because of a just-in-time system, there were no excess parts on hand. As a result, the entire global automobile supply chain ground to a halt waiting for the single source for one product to be replaced.  This created great financial losses for many months.

You can prevent these great losses by building a little bit more flexibility and backup into the system. Have backup sources or alternative manufacturing options.

Also keep in mind that needs and desires can change over time.  This can require you to make frequent tweaks to your offering.  If you get so specialized in your process (to save money) that you cannot quickly adapt to minor tweaks, you have really made yourself less efficient. 

4) Consider Fewer, But Larger Cuts

A lot of strategy has to do with making trade-offs (see prior blogs here and here).  The idea is that if your strategy requires you to excel in a certain area, it may require you to put more money in the area to excel in and less in areas which do not add (or even take away from) from your competitive edge.

In other words, instead of cutting back a little bit everywhere, perhaps you need to invest more in some places and completely eliminate other areas.  For example, Wal-Mart invests more in areas where cost savings can be realized (like IT systems) and completely eliminates services which only serve to raise costs (and prices).  When you consider fixed and variable costs, the only way to get big improvements in some non-essential activities is to eliminate the whole thing (to cut out the fixed cost).   

So, before making your decisions on what to toss out or fix, first understand the trade-offs which underpin your strategy.  Then consider becoming more extreme in your approach to those trade-offs.

5) Think Longer-Term

To prosper long term, you need a full product development pipeline.  You need something to sell today, something to sell in the near term and something to sell in the long term.  If you cut off R&D and product development to help near-term profits, you may be destroying long term profits because you let the pipeline get empty.

This is like saving a little money today by not changing the oil in your car and ending up eventually having to replace the entire engine because of the damage caused by improper lubrication.  Those near-term savings pale when compared to the long-term consequences.  So make sure our near-term cuts aren’t crippling your long-term strategy.

SUMMARY
Strategy isn’t just about plans for how to grow and expand.  It should also include plans for how to fix/improve/eliminate the messes in the current business.  If you do not take a strategic approach to these cuts and fixes, you can end up destroying the key elements of distinction which created your basis for existence.  In other words, strategists can’t just dream about a blue sky future; they need to get their hands dirty helping keep the current businesses on a balanced path between cost efficiency and strategic effectiveness.

FINAL THOUGHTS
A lot of companies focus on “best practices” in order to increase efficiency.  But if all you do is focus on industry best practices, then you are not doing anything to distinguish yourself in the marketplace.  To win, you have to do things differently, and you don’t get different by following industry norms.  Strategies help you understand how to be different, and this can open up greater efficiencies through trade-offs than you can find in best practices. So power your cuts and fixes with strategic insight.

Strategic Planning Analogy #282: Wonderful Weeds

THE STORY
As much as I hate being on committees, there’s one committee I think I’d like to be on. That would be the committee that determines which plants are good plants and which plants are weeds.

Why would I want to be on that committee? Because I hate having to pull up weeds. If I were on the weed naming committee, I’d see to it that nothing would be called a weed. That way, there wouldn’t be any weeds to pull (since nothing would be classified a weed anymore).

Take the dandelion, for example. Why is that considered a weed? I think it is a pretty flower. I’ve eaten dandelion leaves in tasty salads. A friend of mine made dandelion wine. Why is such a nice and useful plant considered a weed?

And how about switchgrass? It’s called a weed, yet many think it holds great promise as a source of biofuel.

I think I’d like to be the Will Rogers of plant life. Will Rogers said he never met a man he didn’t like. I’d like to be the guy who says he never met a plant he didn’t like. That way, I’d have an excuse not to have to pull any so-called weeds, since they would all be my friends.

THE ANALOGY
At some point in the past, plants were placed into one of two categories: good plants and bad plants (which we call weeds). It seems a bit arbitrary to me why some are called weeds and others are not.

The same thing happens in the business world. Certain practices, costs or outputs were long ago automatically labeled as bad, while others were automatically labeled as good. Who made up those labels and why should I automatically agree with them?

So-called “bad” plants, like dandelions and switchgrass, have some beneficial qualities. Similarly, some business practices or outputs considered bad may also have some benefits if we look at them differently.

If you want some breakthrough innovations, you may need to reconsider the things you label as “weeds” in your business. Just take off the “weed” label and look at them as potential opportunities. It could lead to some remarkable new business ventures.

THE PRINCIPLE
The principle here is that old labels can be wrong. Labeling something a business weed can bias you against it and cause you to want to automatically pull it out of your business. If you take off the label, you may find that it could be valuable source of new profits.

We’ve talked about labeling in prior blogs. For example, back in October of 2008, we talked about lost business potential by how one labels the rest of the value chain. For example, if we label someone as just a customer, we only expect them to consume. By doing so, we can miss out on the opportunities to also use that person to help us develop products, market products, critique products and provide all osrt of other inputs.

We also touched on this subject in a blog in February of 2008. In that blog, we saw how the so-called useless byproducts of business can become new sources of income. We saw how Australian breweries turned their waste byproduct into popular Vegemite. We saw how McDonalds turned real estate (normally a nasty weed of a cost to be minimized) into cell tower income. We saw how Wendy’s took useless overcooked meat scraps and turned it into chili. We saw how HEB turned a costly overhead expertise into a consulting business. And we saw how Tyson is turning their (formerly useless) fatty byproducts into a bio-energy profit center.

I was reminded of the latter idea in a recent issue of Fortune magazine, which talked about a company named Darling. This company specializes in collecting the so-called useless fat byproducts from restaurants and slaughterhouses. Darling then takes these “weeds” from the restaurants and renders it into saleable products. In 2008, Darling had sales of $807 million and profits of $55 million. Darling was ranked #13 on Fortune’s 2009 Fastest Growing Companies List. Not a bad way to earn money off of someone else’s weeds.

In addition to byproducts, another area of business often looked at like weeds is the cost of labor—a nasty expense to be pulled out of the organization whenever possible. However, as we discussed in a blog last March, labor costs can also be seen as an investment. As long as one is getting a great return on that investment, one should actually add labor to the business.

In general, any cost-cutting is a form of weed pulling. The idea is that costs are bad, and the more you pull them out, the better your “business garden” will be. Yes, cost cutting is often a good and necessary thing. But not all costs are weeds. They may just be underutilized assets that can be redeployed for greater profit. For example, the write-offs from shutting down weak businesses and underutilized assets can be huge. If you can discover a new use for these assets, you are far better off.

Some costs have delayed benefits. For example, one can cut out maintenance costs for awhile and look great. But eventually, things will start breaking down, because the equipment was no longer well maintained. That cost of maintenance starts looking pretty small compared to the cost of repairing broken machinery.

Similarly, Chrysler saved money for awhile by cutting back on product development. Now, Chrysler is hurting, because there are no new products in the pipeline.

In yet another prior blog, we talked about how profits can be temporarily improved if you cut out advertising expenses. However, without advertising today, future sales can eventually stagnate and decline. As a result, if you cut the advertising expense today, you may seriously damage future profits. So even if the cost looks like a pull-able weed now, consider the long-term ramifications before pulling it. You may regret pulling it later.

SUMMARY
We tend to view the world through labels. If you label something as a worthless weed, you will no longer look for any worth in it. However, many so-called worthless weeds can be new sources of revenue if we just think about them differently. Therefore, before starting to pull the weeds out of your business, reconsider them as untapped resources. Look for ways to tap into them for innovative new sources of profits.

FINAL THOUGHTS
It takes a lot of effort and pain to pull weeds. It can also take a lot of effort and expense to get rid of business “weeds.” It is so much better if you can avoid the pain of pulling by finding the profits hidden in the weeds.

Analogy #237: Take It Off

The Story
A lot of people have trouble losing weight. Well here are two sure-fire ways to lose weight.

Method #1: Get Very, Very Sick
There’s nothing like a severe case of food poisoning, flu or diarrhea to take off pounds quickly. The weight just goes down the toilet. In addition, you’ll feel so weak and nauseous that you won’t want to eat for awhile after that.

Method #2: Amputation
Now some would complain that with method #1, the weight eventually comes back. So if you really want to make sure your weight loss doesn’t come back, try amputation. Once you cut off a leg or two, that weight is never coming back. It’s quickly gone FOREVER.

THE ANALOGY
The two methods above that were recommended for weight reduction are impractical and stupid. What good does it do to lose weight if you have to spend all your time weak and sickly, either in bed or near a toilet? There’s nothing beautiful about seeing someone in such a sickly condition. In addition, there are the long-term negative health considerations from depleting your vital fluids.

Amputation may cause weight reduction, but it also eliminates key functioning parts of your body. Chopping off vitally important pieces of your body is extremely short-sited. Eventually, you’re going to want those pieces back, and by then it is too late. Not only that, you still haven’t eliminated the ugly fat in the rest of your body. You’re still fat, but without a leg.

As silly as these methods sound for human weight reduction, I have seen similar approaches taken by companies in the name of cost reduction. On the one hand, some companies cut out their “vital fluids” to the point where the company is too weak and sick to effectively function in the marketplace. They may be lean, but they are not mean. They are bedridden and on their way to oblivion.

This is often the result when companies indiscriminately announce 20% cost reductions across the board. Not every area has 20% waste, so some areas will lose vital fluids needed to be effective in the marketplace. Purging yourself of vital energy to compete makes a company sicker, not healthier.

Second, some companies will lop off entire sectors of their business. At first, they may think that they can get away without these major pieces of their business, but eventually they want them back and it is too late. For example, amputating R&D or maintenance from your company may save money today, but without R&D, you won’t have a pipeline to grow future profits, and without maintenance, your current profit machine will break down and go into disrepair, shutting you down.

During these current economic times, many strategies are focusing on cost reductions. Please don’t use either of these methods.

THE PRINCIPLE
In the end, the real goal is not absolute lowest weight, but absolute best health. If you go to a health club, the trainers will tell you that some people are so weak that they need to gain some muscle weight in order to function at their peak. Likewise, strategies should be designed to focus on health, rather than just cost reduction, since, as we have seen, not all loss is healthy.

Experts will tell you that the sensible way to lose weight is also the healthy way. The idea to do a combination of two things: Change to healthier eating habits, and increase your exercise. In other words, it’s all about managing caloric inputs and outputs: fewer, but more nutritious calories in, and burn more calories out. In today’s blog we will apply this principle to business cost reductions.

1. Cut Back on Bad Calories
The goal is not to cut out all calories. That leads to unhealthy bulimia. Instead, eliminate the empty calories that provide no nutrition. In a business sense, that means cost cutting which takes out the things that have no bearing on your positioning, things that will not be missed and do not hurt your image or competitive strengths. In fact, some cuts can actually improve your strengths (just like cutting out an excess of cabs and sweets can eliminate energy crash cycles).

My current favorite example of this is Revol Wireless. In the United States, cell phone usage is fairly mature. Just about everyone who wants a cell phone already has one. Now the typical cell phone model in the US is to sell a phone well below cost and then charge a higher phone rate over a set period of time (in a contract) in order to recover the cost of the phone.

Well, what if a cellular company were to treat the phone as empty calories? If you eliminate the phone, the usage fees no longer have to cover a phone subsidy. In addition, you do not need to lock people into a long-term contract, since you don’t need to stretch usage out until subsidy is paid for. That’s basically what Revol Wireless has done. By treating the cell phone as empty calories, it can eliminate the undesirable contract and charge much lower phone rates than the competitors who have to factor in a subsidy.

Now not everyone wants to stick with their old phone, but if that market is big enough, someone like Revol can make out.

A simpler example is Kellogg. In the past, cereal companies have tried to cut back by putting less cereal in the box. Over the long haul, that can hurt, because you have reduced the value of the box without a comparable reduction in price. This is not just eliminating fat, it is eliminating muscle. People are buying cereal, and you’ve reduced that very thing they are trying to buy.

Recently, however, Kellogg has tried a different approach. Instead of reducing the contents of the box, they have changed the shape of the box so that it takes less cardboard to house the same contents. When you multiply a small savings on cardboard times all the boxes they sell, that adds up to a large cost reduction. This reduction, however, did not reduce in any way the quality or quantity of the contents. As a side benefit, Kellogg contends that the new shape fits better on a customer’s shelf, so the value may have actually increased, even though costs decreased.

Many of the green marketing programs also work in this way. They eliminate wasteful excess packaging (empty calories), which not only reduces costs, but can increase one’s image as caring about the environment.

2. Increase Exercise
One can lose weight not only by cutting out food, but by keeping food intake constant and increasing exercise. So when one feels pressured to improve productivity, don’t blindly rush to cut. Perhaps all you need to do is improve your exercise.

In a business sense, you can see that in ratios. Most productivity measures are ratios, like Labor $ per Unit Made, Costs per Unit Sold, Overhead per Dollars Sold, and so on. The cutting reflex wants to quickly cut the numerator of these ratios—the labor, the costs, the overhead. The exerciser realizes that productivity can also be gained by keeping these inputs flat and increase the denominator outputs, like units or sales.

For example, in this current economic recession, P&G has resisted cutting inputs like advertising. If anything, they are putting added emphasis on advertising. Why? Strong advertising (flexing their advertising muscles) can increase the denominator of sales, thereby increasing productivity.

Recently P&G has announced that they are taking their Mr. Clean Car Washes out of test mode and rolling them out. This will cause an increase in expenditures, but it is a productive exercise of their money, so they will be better off. In addition, it will provide another avenue of sales so that overhead as a % of sales will go down even if overhead costs stay the same.

SUMMARY
In tough economic times, there can be a lot of pressure to cut costs. However, the best strategy is not one that cuts the most costs, but one that creates the healthiest company. So if you have to cut, look for cutting the empty calories out of your business diet—things that won’t be missed or hurt your image if they are cut (both near term and long term). Otherwise you may be cutting out something vital that you will need later (weight loss through amputation). In addition, look for ways to increase your exercise, so that you can grow the denominator (sales, units) faster than the inputs (costs). If an investment is highly productive, you can increase productivity by actually spending more.

FINAL THOUGHTS
The tough times will not last forever. More prosperous times will return. Unfortunately, if you amputate your leg, it is never coming back. Think twice before placing the saw on a piece of your corporate body.

Cutting Your Way to Prosperity? (part 3)

THE STORY
Once there was a farmer who thought he had come up with the secret formula for living the good life. When he was young, this farmer had noticed how so many other farmers were struggling to make ends meet. Not wanting to live that way, this young farmer’s goal was to live well by farming differently.

Therefore, the young farmer spent time investigating what other farmer’s were doing, to find out why they were having trouble making ends meet. After a thorough analysis, he came to his conclusion: Farmer’s do not live well, because they foolishly waste their money. He saw many ways in which farmers were wasting their money:

1) They would let portions of their land lay fallow each year rather than plant something they could make money off of.

2) They put all kinds of money into fertilization and irrigation. Why spend all that money on something Mother Nature supplies for free? (rainwater and fertile soil)

3) They would waste money buying expensive seeds when they could just get seeds for free off of part of the prior year’s crop.

So the young farmer put his plan into action. He planted his entire land every year. He would use “free” seeds from what was produced in last year’s crop. He cut way back on irrigation and fertilization, relying on the “free” resources of Mother Nature.

At first, this plan seemed to work quite well. The money he saved on irrigation, fertilization, and seeds was used to live the good life—a nice home, nice car, luxury lifestyle. He was proud that he had “beaten the system” and could live well on the farm. Over time, however, the plan seemed less successful—every year the fields supplied less and less produce. Eventually, it got so bad that eventually the farmer had to declare bankruptcy.

THE ANALOGY
The farmer in the story failed because he had a tragic flaw in his logic. He assumed that the farmland would continue to produce at peak performance forever without replenishing the soil. Yes, Mother Nature may have gotten him started out with good soil, but if you do not replenish the soil through fertilizer, irrigation, and letting it lay fallow, it will eventually become depleted—unable to produce crops. Weak crops do not produce the kinds of seeds which create healthy crops the following year—and are nowhere near as effective as specially grown hybrid seeds.

The farmer’s success was an illusion. What he thought was high profits from current operations was actually stealing the profits from future crops by failing to reinvest in the soil. These were not extra profits—they were the costs of doing business which he was refusing to pay. By not paying the price of reinvestment into the soil, he was destroying his own future.

Does it sound silly that a farmer would not be smart enough to take care of his soil? Well, I’ve seen otherwise smart business people destroy their future by not reinvesting in their businesses. Yes, it is wise to not be extravagant in your business spending. Keeping costs low can be a good thing, especially during the tough times. But a continual effort to starve a business of investment, even during the good times, can cause a business to have the same fate as this farmer.

THE PRINCIPLE
This is the third and final blog in a series on the pitfalls of cost-cutting. In the first blog, “part 1”, we looked at how some cuts are really not cuts at all, but are rather just shifting of costs from one location in the company to another. In “part 2” we looked at the problems that can occur when cost-cutting is done without being connected to strategy. In this third blog, we will look at what happens when extreme cost-cutting becomes the norm, even in good times.

Extreme cost-cutting means not reinvesting into the future cash flow streams of the company and instead taking the money out as today’s extra profits. It may make you look like a genius today, but in the long run it depletes the business of what it needs to produce future profits. Businesses are like soil, they need to be replenished.

The temptation to take the money out rather than reinvest seems greater today, with top executives spending ever less time in their position. If the leaders only expect to be hold the position for a couple of years, why worry so much about the long term? In the world of marketing, the average CMO lasts less than two years in a job. Often times, as in the recent case at Macy’s, the rapid change in CMOs is a result of a conflict between near-term sales promotion and long-term brand building. The CMOs trying to invest in the long-term strength of the brand are losing favor to leaders trying to take the profits out now.

There are three main reasons why reinvestment is crucial to long-term success:

1) Things Wear Out
2) Customers are Fickle
3) Technology Improves

These are discussed below.

1) Things Wear Out
Cutting back on repairs and maintenance may work for a short period of time, but eventually, lack of repairs and maintenance will cause thinks to break down. There is an old Fram auto parts advertising campaign where a mechanic would say “Pay me now or pay me later.” The implication was that you could spend a few dollars now on a Fram oil filter or put it off until your engine breaks down and then pay hundreds and hundreds of dollars on engine repair.

This principle may seem obvious for equipment and machinery. However, other things can also wear out if money is not put into them. For example, in retailing, shopping centers and entire neighborhoods can wear out and become tired. It may become necessary to spend the money to move a store a few miles to a more vibrant neighborhood, even though the store itself may still be in relatively good condition.

Strategies themselves can wear out overtime and become less relevant in a changing environment. With the current movement to green environmentalism, an old formerly successful strategy viewed now as environmentally wasteful could severely damage a company. It is better to invest time and money in strategic thinking on a continual basis to stay in front of these changes, rather than waiting until it is too late to efficiently react.

2) Customers Are Fickle
Even if everything in your business is in fine working order, it does not mean that there is no need to reinvest. Customers are fickle. Loyalty is weak. Just being in fine working order may not be enough if competition is investing in the latest and the newest gizmos and gadgets. Shiny new things from the competition can catch the eye of your consumers and make you look dull and drab by comparison, even if there is nothing inherently wrong or broken in your process.

The goal is not to be serviceable. The goal is to be superior (in some way versus competition). Superiority is a relative term. Today’s exciting superiority can fall behind competition if they invest at a faster rate than you do.

3) Technology Improves
Even if your investment is in fine working order, that does not ensure top performance. For example, you may have the absolute best computer operating system available in the 1980s (which is when you purchased it) and you may have kept it in fine working order all these years. However, there have been so many technological advances since the 1980s that you would be woefully uncompetitive in the marketplace versus significantly more efficient competitors who are using the power of more up-to-date computer technology.

It could even be more subtle than this. In retailing, one could have perfectly serviceable cash registers which do a good job of scanning the price tag and letting the customer pay you. However, modern cash registers (which are now called Point of Sale computer terminals), can do so much more—capture customer data, process credit cards faster, allow more sophisticated pricing programs, suggest add-on selling opportunities, handle customer loyalty programs, and so on. By not investing in the new terminals, one is missing out on opportunities and falling behind those that do make those investments.

SUMMARY
Continual aggressive cost cutting may be seen by some as being efficient, but it does not necessarily mean that you are effective. By not reinvesting in your business on a regular basis, you can deplete it of its ability to produce revenue in the future.

FINAL THOUGHTS
The biggest problem with chronic underinvestment is that by the time one can see the problem, it is often too late to fix it. The soil of the business is too depleted. Too much time and money would be needed to bring it back to life. And you don’t have the money, because you took it out in extra profits. And without new income coming in, you do not have the time to wait until the soil is brought back to life.

Cutting Your Way to Prosperity? (part 2)

THE STORY
One of my favorite comic strips of all time was Pogo, by the late Walt Kelly. In one of his comic strips, Albert the Alligator was running as fast as he could through the swamp. Pogo the ‘possum was desparately trying to keep up with the pace. While they were still running, Pogo asked Albert where he was going. Albert answered something to the effect that he didn’t really have a particular destination in mind. In response, Pogo replied, “If you don’t know where you are going, then why are you running so fast to get there?”

This story is not that dissimilar to what happened to Alice in Wonderland. Alice was confused, so she asked the Cheshire cat which way she should go. The Cheshire cat asked Alice where she was trying to get to. Alice said that she didn’t know. In response, the Cheshire cat said that if you don’t know where you are going, then it really doesn’t matter which path you take.

THE ANALOGY
Strategic planning is all about finding the right destination for your business and the right path (journey) to get you to your destination. Both are necessary ingredients to success. A goal without a means to get there is worthless. Similarly, tactics which lead nowhere are also worthless.

Sometimes, we can fall into the trap that captured both Albert the Alligator and Alice in Wonderland—disconnecting the journey from the destination. Albert was so intent on making progress on the path that he failed to take the time to choose a destination. A lot of activity and movement was enough to make him happy. And as Pogo pointed out, if the journey has no purpose, striving to do it faster or more efficiently does little, if any good.

Alice had a similar problem. She was so intent on leaving her current situation that she failed to take time to determine a better location. She was seeking guidance on which path to take to move away from a position she did not like. And as the wise cat responded, if you have not planned your destination, then it really doesn’t matter what you do or where you go.

Although it may seem silly to think that a business would be as foolish as Albert or Alice, it does happen. During the dot com boom, people were saying that choosing a destination is obsolete. All you need to do is race like Albert to get to the next “killer application” before someone else. Some of those dot com “geniuses” don’t look so smart anymore.

Another time when leaders are tempted to disconnect action from destination is during tough times. When tough times hit, there is pressure to make a lot of cuts in order to make it through until good times return. These cuts can be across the board, regardless of any strategic concern. Like Alice they are looking at avoiding the current bad situation rather than seeking out a better situation. The analogy I hear often goes something like this:

“I don’t have time to worry about fancy things like strategy and positioning. My patient is dying. I’ll worry about that luxury later. Right now I have to focus on stopping the bleeding.” And, of course, stopping the bleeding means stopping the flow of red ink by cutting costs as much as one can (and without thought as to how it will impact the strategy). However, if you do not know what is wrong with the patient and how to cure the underlying problem, stopping the bleeding will not ultimately solve the problem.

THE PRINCIPLE
This blog is the second in a series on avoiding pitfalls when in a cost-cutting mode. In the prior blog (see “Cutting Your Way to Prosperity (part 1)”), we looked at the pitfall of when cuts are really not cuts, but rather just a shifting of costs from one location to another. In today’s blog, we are looking at what happens when cost cutting is done without concern for its impact on reaching a strategic destination.

Three principles should be considered when making cuts to ensure that it doesn’t get disconnected from strategy:

1) Prioritization
2) Process
3) Preemption

These are covered in more detail below.

1) Prioritization
Across the board cuts can not only cut the fat in your business, but also the meat. I recall two discount store chains that cut their merchandise buying across the board. Unfortunately, not all merchandise sells at the same rate. Fast turning items like health & beauty care, household chemicals or candy sell through much faster than clothing. In one store, the only thing consumable item left in stock after inventory cuts was 2001 flushes, so that’s what an entire aisle was filled with. In another store, I saw more than three aisles filled with just one item—red licorice rope. I doubt if this left a good impression on the customer who was looking for the items which used to be on those shelves. Sometimes, you have to cut things differently, due to their different characteristics.

Rather than cut everything equally, one needs to make priorities. In general, areas that are most near and dear to one’s competitive advantage need to be cut the least. You’ve worked hard to build that reputation. Don’t give it all away at the first sign of panic.

Areas that are least crucial to your strategy should take the brunt of the cuts. Of course, this assumes that:

A. The people doing the cutting understand the strategic priorities of the company and what is most crucial to success; and
B. They understand how various cuts might impact the ability to continue down the path to one’s strategic goal.

Before making a cut, first ask yourself:

- Will there be a noticeable difference to my customers, enough to turn them away?

- Will this cut change the nature of who I am, to the point that I have inadvertently changed my strategy without knowing it? For example, if your historical strategy hinges on being known for superior service, and you cut the life out of your people providing the service, then you have really changed your strategy to no longer be about service.

2) Process
It takes a certain amount of input (people, money, equipment) to get a job done in a particular way. If you cut back on one or more of these inputs and do not change the expectations of the way a process gets done, you may be courting disaster by guaranteeing failure, since the same process cannot be done with the lower input. Decisions about cuts in inputs should not be divorced from decisions about the process creating the outputs.

Two types of process decisions can be made. First one can look at the various tradeoffs involved in cutting the inputs. For example, it you need to cut back on your service one can choose a tradeoff between speed and quality—either keep the quality and make it take longer to get the service, or keep the speed, but lower the quality. Depending on your strategy, one tradeoff may be better than the other. Hence, you alter your process based on which tradeoff you want to make. Making such a tradeoff is usually better than cutting back both quality and speed.

The second type of process decision may be to change the process to best fit the cut in inputs. For example, let’s say that the advertising budget gets cut. Since the original process cannot be achieved on the lower budget, maybe it’s time to do things differently, like maybe switch from TV advertising to radio, or move from mass-oriented advertising to just advertising to a narrow niche…or cluster fewer ad dollars into less frequent, but bigger bursts, instead of dribbling it evenly throughout the year.

Again, it is easier to know how to alter the process if you know your strategic direction, because it will help direct which alternative processes are most in tune with your strategic direction and destination.

Preemption:
Sometimes tough times are caused more by our own lack of strategic direction than by any outside forces. To quote from Pogo again, you may be in a situation where, “We have met the enemy, and he is us.” If your strategy is weak, you are more vulnerable to competitive onslaughts and economic downturns. Conversely, if your strategy is strong, you may be able to weather an economic downturn without much difficulty. You may not even have to cut much at all, because the strength of your strategy will carry you through.

The plummet in prices on digital TVs is hurting all the consumer electronics retailers with weak positions. Circuit City has been furiously trying to cut costs. Tweeter this week filed chapter 11. Best Buy, however, is still going strong due to its years of building a strong strategic position.

In other words, the best way to deal with price cuts is to avoid them completely by creating such a strong strategy that you are less vulnerable to downturns. This would be preempting cuts via strategic forethought.

SUMMARY
During tough times or economic downturns, there can be a tendency to forget strategy and just rush to cut costs. Spending a little time first thinking about strategic implications can make cost cutting far more productive, and may even eliminate the need to make the cuts in the first place.

FINAL THOUGHTS
The best time to prepare for the tough times is when you are still in the good times. During the good times, you have the luxury of time to figure out your strategy and what is really critical to its success (the destination and the path). As a result, instead of acting irrationally or emotionally in panic when the bad times come, you can calmly go back to what you learned in the good times and do what makes sense both near term and long term.

Cutting Your Way to Prosperity? (part 1)

THE STORY
A long time ago, I was in charge of creating the advertising media budget for a retail company. I turned in what I thought was a reasonable budget.

A couple of weeks after I turned in my budget, I got a call from the budget department. They said that when the budgets of all the departments were rolled up, the expenses were too high. They asked me if it would be okay for them to cut the advertising budget by 25%.

I said, “Before I answer that, let me ask you a question. If the advertising budget is cut by 25%, are you planning on cutting sales by any amount?”

They replied, “No, the sales budget would stay the same.”

In response, I said, “Well in that case, why don’t you make advertising $0? Obviously, you do not think that advertising has any impact on sales, so I suppose we shouldn’t do any advertising at all.”

THE ANALOGY
One of the hardest times to execute a strategy is when times get tough, such as in an economic downturn. To get through the tough times, there is often a need to cut expenses deeper than normal. There can be many problems if the cutting is done improperly. This is the first of a series of blogs on some of the pitfalls to avoid when cutting costs.

The first pitfall to avoid is in ignoring the interconnectivity of cost reduction decisions. If you cut costs in one area, it can make that area look good. However, due to interconnectivity, the impact of that reduction impacts other parts of the business. It may cause damage to other parts of your business which are worse than the benefits gained in the inital cuts, causing you to actually lose ground in your quest for profitability.

You may end up congratulating someone for their cuts, even though it is ruining the profit structure elsewhere. Take, for example, the story above. One could look like a hero for cutting advertising by 25%. It might cause the people in the advertising department to get a big bonus. However, if the reduction in advertising causes sales to drop too far, then you have rewarded people for destroying value.

In most cases, it is illogical to believe that one can just cut 25% of advertising and expect it to not impact sales at all. The overriding purpose for practically all advertising is to influence people to buy more from you. Advertising and sales are interconnected. To budget a huge drop in advertising without any drop in sales is to either admit that you are incompetent in your advertising or admit that your sales budget is an unrealistic lie.

THE PRINCIPLE
The principle of interconnectivity needs to be considered when implementing cost reduction programs. There are three main areas where interconnectivity can hurt you:

1) Vertical Connections
2) Horizontal Connections
3) Customer Connections

These are discussed more fully below:

1) Vertical Connections
An income statement has many lines on it. If you focus on just one line on the income statement, you can achieve huge cuts on that particular line. However, it may just serve to move those costs up or down the income statement to a different line. The lines on an income statement are interconnected.

For example, let’s say one is focused on cutting a department’s payroll expenses. There are many ways to achieve this. For example, one can outsource work which used to be done internally to an outside third party. The payroll line goes down, but the outside services line goes up. It may even go up faster than payroll goes down.

Another way to reduce payroll is to increase the use of temporary services. The work didn’t go away…it just went to a different line item. If the focus is on cutting headcount, it may result in increased overtime for the remaining workers.

If the focus is on cutting capital investments, there may be an increase in repairs and maintenance in order to keep the old capital running. Or if the repairs and maintenance are cut too far, as appears to have been the case at some BP refineries, you may end up with serious disasters of entire businesses going out of commission for a long period of time. That raises costs on all sorts of other lines.

The moral of the story: When looking at a department’s cost cutting efforts, do not focus too narrowly. Look at the impacts that a cut on one line could do the increasing a different line on that department’s income statement. Cuts on one line rarely fall 100% to the bottom line. Some of it leaks back to other lines. Capture the leakage in your estimates.

2) Horizontal Connections
Vertical connections tend to be easier to address, because the income statement can be contained within a single department. For example, if you tell the legal department to reduce their total costs, then they do not gain much when shifting internal legal personnel costs to outside legal counsel. Since they have responsibility for both lines, they do not shift their total expense much in shifting the burden from one line on their income statement to the other. Hence, there is not much incentive for making the shift.

The more difficult problem is when the connectivity is horizontal—between departments. If one can improve their department’s expenses by pushing costs to another department, it can make that department manager look good, because his or her area has permanently reduced their costs. Even though the total company expenses did not go down, the department that shift costs to another department can get undeservingly rewarded.

Let’s look at how this might play out in a retail company. The merchants might be able to lower their cost on the good they buy by requiring less of the vendors. They could ask the vendor to stop doing certain tasks in return for a lower price. Those tasks could include:

A) No longer having the vendor put price tags on the goods.
B) No longer having the vendor sort the goods by store before shipping them.
C) Shipping the goods all at once, rather than holding onto the inventory and shipping it in more manageable quantities.

While this takes costs off the merchandiser’s books, it adds a ton of costs to the retailer’s distribution center, because now they have to do what the vendor used to do. They have to do the sorting and the tagging. At the same time, the warehouse gets clogged with extra goods, making processing at the distribution center less efficient.

Now the distribution center may want to escape some of this problem by shifting the burden to the stores. They could send the goods to the stores untagged. They could clog the stores with more inventory than they need. So now, someone at the stores has to do more work than before.

Moral of the story: Don’t just accept a department giving a commitment that they will reduce their costs. Ask them how they are cutting their costs, so that you can determine if their method of cutting is just shifting the burden to another department.

3) Customer Connections
Some cuts in cost are noticeable to the potential customers. If your cost cuts make your firm less desirable to customers, they could end up going somewhere else. It does little good to cut costs if it results in alienating customers and eliminating sales. Long after the tough times are over, customers will remember how you treated them in the tough times and may not come back when the times are good.

Using a retail example again, one can cut labor in the stores in a way that:

1) Makes the store visually less desirable, because there is less cleaning and straightening up.
2) Make the checkout lines longer due to fewer people operating the cash registers.
3) Create more out-of-stocks, because there are fewer people restocking shelves.

These outcomes can cause customers to no longer want to shop your store. The drop in sales could be greater than the drop in costs.

Moral of the story: Don’t forget the customer perspective when cutting costs. Do the reductions in expenses exceed their impact on reducing sales?

SUMMARY
Just because one has a “successful” cost cutting plan put in place does not necessarily mean that total costs really went down all that much or that profitability of the entire company is better off. To really have success in tough times, one needs to check the interconnectivity of cost cutting actions, to make sure that costs were not merely shifted up and down a department’s income statement, or shifted to another department, or caused customers to stop patronizing your business.

FINAL THOUGHTS
I am not trying to imply that cost cutting is bad or unnecessary. Cost cutting is often necessary and good. We just cannot go around blindly believing that all cuts are good cuts. The next blog will address some of these issues around deciding what are good cuts.