Executive Briefings

The Riddle of Supply Chain Cost Reduction: Here's a Hint--Cut, Cut, Cut is Not a Strategy

Unless you are a hermit who has been stranded on a deserted island for the past 12 months, you get it. The global economy is in a recession. The credit markets are a disaster. The real estate mess is unprecedented. The automotive industry is on the ropes. The retail industry is in upheaval. Unemployment is a major problem. You get it. Yes, you really get it!

If you are like me, you have read countless articles on the deepening economic crisis and the reality that it will get worse before it gets better. But, at the same time, if you are like me, you only read about 10% of most articles because they are all the same: They tell us about the mess, but not what to do about it. So, instead of reading more and more about the problem, what do you do?

Well, let's see what all the "smart" companies are doing. Many are cutting payroll, cutting advertising, cutting consulting, cutting strategic initiatives--cutting, cutting, cutting.
But what should you do? Follow along and also cut, cut, cut? No, in fact, you should not, 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" really applies in these volatile times.

Sam Palmisano, CEO of IBM, gets it. In a December 8 interview with Fortune magazine, he strongly says, "In the face of an economic meltdown, you can retrench, pull in your horns, protect your balance sheet, and preserve cash. Or you can realize that this is about humanity screaming for change."

Model of Success Comes First:
Let me take a step back and lay a little groundwork. First, I strongly believe that a company's success begins by having everyone in the organization aligned with a Model of Success. A clear, effective Model of Success consists of:
Vision: Where we are going
Mission: How we will achieve the vision
Requirements of Success: The things we must do well to accomplish the vision
Guiding Principles: The values we will practice in pursuit of the vision

Measures of Success: The key performance indicators we will measure as we pursue the vision.
Once an organization is aligned with its Model of Success, move to what I call the Big 7:
1. Strategic Plan
2. Action Plan
3. Budget
4. Risk Mitigation
5. Contingency Plans
6. Execution
7. Accountability

So where does cut, cut, cut fit into this equation? To be clear:
Vision precedes Strategy. Strategy precedes Action. Cut, cut, cut is an Action, not a Vision or a Strategy. Cut, cut, cut is wrong unless it is consistent with the Vision and Strategy.

The Difference Between Cut and Reduce:
But, now you may ask, "Wait a minute, isn't this article supposed to be about Supply Chain Cost Reduction? What is the difference between cut, cut, cut and cost reduction?" Okay, this is the question. Thank you, now we have the table set for some real understanding.

The answer to the question, "What is the difference between cut, cut, cut and cost reduction?" depends upon the type of organization that is doing the cost reduction. Unfortunately, in this terrible economy, the difference between the two approaches is zero in most organizations.

Today, cut, cut, cut and cost reduction are 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. Yes, haphazard, across the board, uniform, indiscriminate cost reduction will beget the unintended result of less profits, not more.

However, in an organization that is aligned with its Model of Success and is pursuing the Big 7, the difference between cut, cut, cut and cost reduction is huge! In these Visionary/Strategic firms, costs are broken into three categories:

Category 1:
Capital and operating costs: Traditional ongoing expenditures
Category 2: Talent costs: Expenditures for key resources that are required to operate the business profitably
Category 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 deeply 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 save millions of dollars via a consulting project costing 20% of the savings, stymied by a mandate to cut, cut, cut all consulting costs. It takes talent to reduce costs, and without it, you can cut, cut, cut, 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 allow you 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

Now, the question you may ask me: "How about the firm whose very existence is at risk?" My response: "That is a major issue, but not what this article is about." If your organization is on the verge of going out of business, it is because you have cut, cut, cut your Category 2 and 3 expenditures in the past. The fact is you are probably out of business already but just do not know it yet. An indiscriminate "slash and burn" action plan is not a strategy that results in winners.

Particularly in these very tough times, prudence, not panic, is the order of the day. Yes, you need to be sure your Category 2 and 3 expenditures are aligned with your vision. And given that you know where you are going and how to get there, it is wise to protect your talent and guard your strategic plans. Most of all, yes, you need to aggressively, intelligently go after Category 1.

Aggressively and Intelligently:
By now you are probably thinking, "Great, I get it, but why emphasize "aggressively and intelligently" when talking about going after Category 1? I get 'aggressively' as these are bad times, but what is your meaning of 'intelligently'?" Wonderful, great question, and in fact a great segue into Supply Chain Cost Reduction.

You see, there are many organizations that reduce the cost of certain supply chain elements, yet fail to increase the profitability of the firm. Consider these real-world examples:
1. A company eliminates all overtime in its distribution centers, and the result is a loss of customers from the West Coast.
2. A company cuts transportation costs in its distribution center by receiving product floor loaded, but the cost of palletizing upon receipt at the distribution center is greater.
3. A company shifts production to an offshore location to reduce purchase price, but the result is an increase in the Total Delivered Cost.
4. A company sources a product line to reduce Total Delivered Cost, but does not consider sourcing clusters, and thus its costs are higher than its competitors' costs.
5. A company fails to include the margin from lost sales in its supply chain cost model, and therefore, makes bad buying decisions.

These are just a few scenarios of how organizations can miss opportunities to increase profitability by not making "intelligent" cost reduction decisions.

Holistic Cost Reduction:
To capture immediate cost reduction opportunities, take a holistic view of your supply chain and focus on Buy-Make-Move-Store-Sell. Here is a good outline to begin this process:

Buy:
Sourcing
1. Source strategically to find the right partners
2. Reduce material cost
3. Reduce transactional cost
4. Customs and Trade Management

Make:
Lean Manufacturing -- Waste Reduction
1. Increase operation throughput
2. Improve labor productivity
3. Reduce lead-time
4. Product Quality
5. Improve production process
6. Implement Supplier Relationship Management
7. Measure KPIs and performance

Move:
International and Domestic Transportation
1. Find hidden costs in practices
2. Use analytical tools to shrink cost drivers
3. Use best practices to plan, procure and manage freight

Store:
Distribution Centers
1. Leverage best practices to eliminate unproductive labor
2. Reduce material usage and waste
3. Reduce energy costs
4. Improve space utilization and reduce off-site storage
5. Material Handling Systems
6. Find extra throughput capacity via improved equipment and software controls
7. Increase labor efficiency and optimize operational practices

Sell:
Inventory Management
1. Reduce days of supply
2. Minimize non-performing inventory
3. Improve stock-outs and order fill rates

Overall:
IT Systems
1. Identify obstacles such as data accuracy, timeliness, completeness
2. Configure systems to maximize full potential
3. Integrate with other internal systems
4. Integrate with trading partners

Outsourcing: Identify operations that will save money when outsourced
1. Select and implement service providers
2. Audit current service providers and develop improvement initiatives
3. Toward this end, explore this Web site's information on reducing costs for in-depth discussion on aggressive, intelligent Supply Chain Cost Reduction on specific elements of Buy-Make-Move-Store-Sell.

The Riddle is Solved:
Today's marketplace is full of folks who want to help reduce your Category 1 costs (capital and operating) 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. 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?

About the Author: Jim Tompkins has a unique perspective that prepares corporations and executives for the future. He is an internationally known authority on leadership, business planning, logistics, warehousing, manufacturing, material handling, outsourcing, and supply chain best practices. As an innovator who has consulted with numerous Fortune 500 companies around the world, he has an insider's view into what makes great companies even better.
Tompkins Associates

Unless you are a hermit who has been stranded on a deserted island for the past 12 months, you get it. The global economy is in a recession. The credit markets are a disaster. The real estate mess is unprecedented. The automotive industry is on the ropes. The retail industry is in upheaval. Unemployment is a major problem. You get it. Yes, you really get it!

If you are like me, you have read countless articles on the deepening economic crisis and the reality that it will get worse before it gets better. But, at the same time, if you are like me, you only read about 10% of most articles because they are all the same: They tell us about the mess, but not what to do about it. So, instead of reading more and more about the problem, what do you do?

Well, let's see what all the "smart" companies are doing. Many are cutting payroll, cutting advertising, cutting consulting, cutting strategic initiatives--cutting, cutting, cutting.
But what should you do? Follow along and also cut, cut, cut? No, in fact, you should not, 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" really applies in these volatile times.

Sam Palmisano, CEO of IBM, gets it. In a December 8 interview with Fortune magazine, he strongly says, "In the face of an economic meltdown, you can retrench, pull in your horns, protect your balance sheet, and preserve cash. Or you can realize that this is about humanity screaming for change."

Model of Success Comes First:
Let me take a step back and lay a little groundwork. First, I strongly believe that a company's success begins by having everyone in the organization aligned with a Model of Success. A clear, effective Model of Success consists of:
Vision: Where we are going
Mission: How we will achieve the vision
Requirements of Success: The things we must do well to accomplish the vision
Guiding Principles: The values we will practice in pursuit of the vision

Measures of Success: The key performance indicators we will measure as we pursue the vision.
Once an organization is aligned with its Model of Success, move to what I call the Big 7:
1. Strategic Plan
2. Action Plan
3. Budget
4. Risk Mitigation
5. Contingency Plans
6. Execution
7. Accountability

So where does cut, cut, cut fit into this equation? To be clear:
Vision precedes Strategy. Strategy precedes Action. Cut, cut, cut is an Action, not a Vision or a Strategy. Cut, cut, cut is wrong unless it is consistent with the Vision and Strategy.

The Difference Between Cut and Reduce:
But, now you may ask, "Wait a minute, isn't this article supposed to be about Supply Chain Cost Reduction? What is the difference between cut, cut, cut and cost reduction?" Okay, this is the question. Thank you, now we have the table set for some real understanding.

The answer to the question, "What is the difference between cut, cut, cut and cost reduction?" depends upon the type of organization that is doing the cost reduction. Unfortunately, in this terrible economy, the difference between the two approaches is zero in most organizations.

Today, cut, cut, cut and cost reduction are 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. Yes, haphazard, across the board, uniform, indiscriminate cost reduction will beget the unintended result of less profits, not more.

However, in an organization that is aligned with its Model of Success and is pursuing the Big 7, the difference between cut, cut, cut and cost reduction is huge! In these Visionary/Strategic firms, costs are broken into three categories:

Category 1:
Capital and operating costs: Traditional ongoing expenditures
Category 2: Talent costs: Expenditures for key resources that are required to operate the business profitably
Category 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 deeply 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 save millions of dollars via a consulting project costing 20% of the savings, stymied by a mandate to cut, cut, cut all consulting costs. It takes talent to reduce costs, and without it, you can cut, cut, cut, 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 allow you 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

Now, the question you may ask me: "How about the firm whose very existence is at risk?" My response: "That is a major issue, but not what this article is about." If your organization is on the verge of going out of business, it is because you have cut, cut, cut your Category 2 and 3 expenditures in the past. The fact is you are probably out of business already but just do not know it yet. An indiscriminate "slash and burn" action plan is not a strategy that results in winners.

Particularly in these very tough times, prudence, not panic, is the order of the day. Yes, you need to be sure your Category 2 and 3 expenditures are aligned with your vision. And given that you know where you are going and how to get there, it is wise to protect your talent and guard your strategic plans. Most of all, yes, you need to aggressively, intelligently go after Category 1.

Aggressively and Intelligently:
By now you are probably thinking, "Great, I get it, but why emphasize "aggressively and intelligently" when talking about going after Category 1? I get 'aggressively' as these are bad times, but what is your meaning of 'intelligently'?" Wonderful, great question, and in fact a great segue into Supply Chain Cost Reduction.

You see, there are many organizations that reduce the cost of certain supply chain elements, yet fail to increase the profitability of the firm. Consider these real-world examples:
1. A company eliminates all overtime in its distribution centers, and the result is a loss of customers from the West Coast.
2. A company cuts transportation costs in its distribution center by receiving product floor loaded, but the cost of palletizing upon receipt at the distribution center is greater.
3. A company shifts production to an offshore location to reduce purchase price, but the result is an increase in the Total Delivered Cost.
4. A company sources a product line to reduce Total Delivered Cost, but does not consider sourcing clusters, and thus its costs are higher than its competitors' costs.
5. A company fails to include the margin from lost sales in its supply chain cost model, and therefore, makes bad buying decisions.

These are just a few scenarios of how organizations can miss opportunities to increase profitability by not making "intelligent" cost reduction decisions.

Holistic Cost Reduction:
To capture immediate cost reduction opportunities, take a holistic view of your supply chain and focus on Buy-Make-Move-Store-Sell. Here is a good outline to begin this process:

Buy:
Sourcing
1. Source strategically to find the right partners
2. Reduce material cost
3. Reduce transactional cost
4. Customs and Trade Management

Make:
Lean Manufacturing -- Waste Reduction
1. Increase operation throughput
2. Improve labor productivity
3. Reduce lead-time
4. Product Quality
5. Improve production process
6. Implement Supplier Relationship Management
7. Measure KPIs and performance

Move:
International and Domestic Transportation
1. Find hidden costs in practices
2. Use analytical tools to shrink cost drivers
3. Use best practices to plan, procure and manage freight

Store:
Distribution Centers
1. Leverage best practices to eliminate unproductive labor
2. Reduce material usage and waste
3. Reduce energy costs
4. Improve space utilization and reduce off-site storage
5. Material Handling Systems
6. Find extra throughput capacity via improved equipment and software controls
7. Increase labor efficiency and optimize operational practices

Sell:
Inventory Management
1. Reduce days of supply
2. Minimize non-performing inventory
3. Improve stock-outs and order fill rates

Overall:
IT Systems
1. Identify obstacles such as data accuracy, timeliness, completeness
2. Configure systems to maximize full potential
3. Integrate with other internal systems
4. Integrate with trading partners

Outsourcing: Identify operations that will save money when outsourced
1. Select and implement service providers
2. Audit current service providers and develop improvement initiatives
3. Toward this end, explore this Web site's information on reducing costs for in-depth discussion on aggressive, intelligent Supply Chain Cost Reduction on specific elements of Buy-Make-Move-Store-Sell.

The Riddle is Solved:
Today's marketplace is full of folks who want to help reduce your Category 1 costs (capital and operating) 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. 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?

About the Author: Jim Tompkins has a unique perspective that prepares corporations and executives for the future. He is an internationally known authority on leadership, business planning, logistics, warehousing, manufacturing, material handling, outsourcing, and supply chain best practices. As an innovator who has consulted with numerous Fortune 500 companies around the world, he has an insider's view into what makes great companies even better.
Tompkins Associates