Cost cutting in action

Till 2008, when the world economy was booming, “growth” was the favoured strategy in C-suites. After Lehman Brothers collapsed and global growth contracted, “cost-cutting” became the mantra, and it has stayed that way since. The takeaway for corporations in this long slowdown has been that a cost-cutting exercise is much more than a sum of sharp cutbacks. How can cost-cutting be made a constructive exercise? Here are some lessons from the field as experienced by leaders, entrepreneurs and experts. Many of these may appear obvious, yet executives and experts say they are often overlooked in the urgency of the mission.

From the ‘PMO’
The most apparent of these is the close involvement of the company’s top leadership. As Subroto Bagchi, chairman of Mindtree, one of India’s pioneer IT services firms, points out, “Irrespective of how necessary cost-cutting may be, and how mindful the decision maker, it causes collateral damage. These need to be understood and, if inevitable, budgeted for.”

And budgeting entails close monitoring. “As Deming said, what’s measured gets done and an effective cost-cutting exercise involves day-to-day, week-by-week monitoring. This requires sustained energy and organisational time and that only happens if the top management is fully on board,” says Devinder Chawla, partner, advisory services in consultancy firm EY.

Full involvement entails what Bagchi calls the “programmatic approach with a ‘PMO’ in place. This is what Pune-based Deepak Fertilisers and Petrochemicals, maker of industrial chemicals and fertilisers, did when it went in for a massive cost-cutting programme in 2012.

The exercise began when profits shrank in FY13 to Rs 147 crore from Rs 213 crore the year before for multiple reasons (drought, higher raw material costs and so on) even as the top line grew steadily. Lower profits suggested a need to relook cost structures so that the company became more resilient. One of the first things chairman and managing director Sailesh C. Mehta did was set up a team under him to monitor the exercise.

“We have a strong Internal Board that takes all decisions so there was a buy-in for the big vision from day one,” explains Sanjay Gupta, associate vice-president, who headed the monitoring team. The importance of this was evident when, as he points out, “the drilling into each area starts” so a “very healthy discussion at each level ensured we had very high degree of commitment”.

The top-down approach also sets the agenda. In Deepak Fertilisers’ case, the vision was to sustain the best of the last three years’ performance and ensure full capacity utilisation of all assets.  “This helped us identify the areas we needed to tackle,” Gupta explains. “We had a feeling that we needed structural changes in both management staff and workers to align to the new strategy, so we took help of external consultants in many of these areas which brought in an outsider’s perspective and industry benchmarking.” To implement these broad goals, the company put cross-functional teams in charge of each project and these were monitored on an almost daily and sometimes weekly frequency.

By the next financial year, the company saw profits rise to Rs 244 crore — a caveat: Deepak Fertilisers is suffering losses now owing to a specific problem with supplies of gas, the basic feedstock for its products, which is administered by the government.

Though metrics and measurement lie at the heart of a successful cost-cutting exercise, communication is vital for executives down the line to participate and come up with the critical “small ideas” that accumulate into big gains. As Bagchi puts it, “The war must be a people’s war and not a CEO war.” Indeed, consultants say teams often know the problem 60 to 70 per cent of the time, so involving them in the exercise rather than making them defensive helps.  

To minimise the defensive mind-set, recognition is important. This was something Deepak Fertilisers’ Internal Board instituted from the start. “While each success was celebrated, we made sure no failure was criticised,” Gupta says. Rewards and incentivisation matter too, since organisations are essentially asking people to do something outside their regular work description. Some consultants link their fees to the benefits that accrue (the “success fee”), to create “positive energy” and companies often do the same for their executives.

This strategy can backfire. The CEO of a diversified company that was looking to save Rs 100 crore announced a reward for executives that matched the consultant’s success fee. Although the CEO attained his target, he did so in an atmosphere vitiated by “us versus them” competition between internal staff and the consultants.

This mindset is often a product of organisational resentment to consultants, who are associated with job cuts. This is less of a problem in manufacturing firms where manpower costs tend to be lower than raw material costs (even well-run firms can have 15-18 per cent of poor quality). But what about firms in the service industry? Mindtree showed how creatively involving executives in hard decisions can help.

When 9/11 hit and business dried up, the company was barely a year old and cutbacks were inevitable. Bagchi recalls, “We huddled with our middle management and asked them to let go of poor performers. The entire team came back and told then chairman Ashok Soota that a crisis is the worst time to let go of the bottom 5 per cent because, unlike high performers, they wouldn’t land on their feet.” Accordingly, the middle management said they would take an additional cut themselves but keep the bottom performers for another six months.

Being human
Mindtree’s middle management highlighted a basic truth: that it is vital for the management not to lose its humanity. This was something Bagchi learnt from a near-death experience when the company had to pull out of the R&D unit of a smartphone company it had acquired. “Acquiring it was a big mistake because the business plans of the leaders of the acquired business were off the mark and there were unfolding culture and value issues. A time came when we had to make a tough call and close that business and that meant 500 people had to be let go of.”

In doing so, Bagchi says the management made a “clear mental difference between shutting a business and shutting out people. We shut the business rapidly but we made sure we provided as much safe passage as we could and staggered the separations.” Importantly, the company exhausted all other forms of intervention before doing so.

Attitudes begin from the manner in which the message is conveyed. Thus, tonality and transparency are critical. Says Bagchi, “Executive bravado and e-mail urgency are a no-no. If there is a rapid environmental downside that calls for urgent intervention and tactical cost-cutting is a must, the top team must show up at ground zero and speak and answer hard questions — however hurtful.”

Salami tactics    
The latest global slowdown has demonstrated that the era of “plain vanilla cost-cutting” is over. “Many companies now talk about ‘end-to-end transformation’,” says EY’s Chawla in which process improvements are essentially funded by cost reductions.

This is especially true of companies in acutely competitive businesses like fast moving consumer goods. “Cost-cutting is a “365-day, 24×7 concern for finance,” says R Subramanian, vice president, Finance, India sub continent, GlaxoSmithKline Consumer Healthcare (GSKCH), “and we approach it from two ends of the value-chain — the shareholder and the consumer”. In practice this means “the finance guys are involved in each of the five or six buckets — marketing, sales, supply chain, administration and so on.” Each of these departments meet once a month on a fixed day and scrutinise ideas and innovations to enhance value.

The critical issue is to examine ways of value engineering, or what Subramanian calls “salami tactics”. This, drawing from his vast experience across many organisations, could range from changing the way, say, tea sachets are transported to the distributor — it is possible to replace space-occupying cardboard boxes with gunny bags to minimise transport and packaging costs. Or by focusing on a creative, it is possible to reduce the length of a TV commercial from 30 to 20 seconds, with concomitant savings.

No one understands “salami tactics” better than car makers. For them, as Jagdish Khattar, former managing director of Suzuki’s India subsidiary Maruti puts it, “the selling price is determined by the market but costs are in our control”. This is a lesson Maruti Suzuki imbibed after its strike in 2001, when it introduced the Baleno, WagonR and the Alto.

Recalls Khattar, “We were in a hurry to introduce these models after the strike but the import content was very high, and we were losing money, sometimes by as much Rs 1.5 lakh per car. So we launched a vigorous localisation programme, setting out an engineering plan monitored by the management committee.” Eventually, the differential between Maruti’s Alto and its best-selling 800, for example, was reduced from about Rs  1 lakh to Rs 10,000 over a year and a half.

The exercise began, Khattar says, with a target price from which they worked backwards, disaggregating the major systems — engine, transmission, and so on. The next step was to assign it a weight in the total cost. This, then, became the target price of each component which was conveyed to the vendor who had to sign an MoU with a specific localisation schedule.

How are vendors motivated to comply? Messaging, Khattar says. “We didn’t go for cost reduction by the danda; we never told the vendor to reduce price but cost”. Second, the benefits of the cost cut were calibrated so that vendors received a larger share of revenue for every reduction with each year. “That way, it’s a win-win for both — we were able to sell more so they got more business and our credibility went up”.

‘Good expenditure’
Not all costs are wasteful, however. Indeed, one common error companies make when markets are growing but profits are under pressure is to cut costs that are considered “discretionary”: advertising and promotion or the sales function.  “Cutting back on anything connected with growth is like putting a rope around your neck,” says GSKCH’s Subramanian.

The same rule would apply to companies that cut back on quality parameters in such circumstances. One example is when Hindustan Unilever cut the total fatty matter (TFM) in its soaps some years ago. TFM determines the softness and lather of a soap and when it was cut in several popular brands like Lifebuoy market shares dipped.

Not postponing critical investments that create efficiencies is another counter-intuitive lesson. For instance, a fast-growing chemicals company needed larger trucks to transport its products but could not deploy them for lack of sufficient space to turn such large vehicles in the factory.  Although the company was in the middle of a cost-cutting programme, it invested in widening the roads and other infrastructure to accommodate bigger trucks so that it was in a position to ship greater volumes in the future.

Similarly, a fertiliser company was advised to replace the manual loading of fertiliser bags with a boom conveyor; although contract manual labour is cheaper, they are unlikely to be able to handle the volumes envisaged in the company’s growth plans in the long run. “It’s a question of considering what is strategic and what is non-strategic, says Chawla of EY, “so not all cost-cutting exercises involve spending reductions — there’s also a case for ‘good expenditure’.”