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This article was first published in the September 2008 edition of Accounting and Business magazine.
The cost structure of an organisation is defined in this article as the distribution of costs among the processes an organisation uses to deliver its products or services. An outcome is the result and benefit of achieving an objective, a desired future state.
Research within 500 organisations has found that few ever rethink their cost structures, though all frequently look for cost reductions. So what is to be gained from rethinking cost structures, and what is lost by restricting attention to cost reduction?
Drawbacks to current cost reduction strategies
The conventional approach to cost management is to start with the costs and find ways to prevent or reduce them. Well of course, what else could you do? Seems obvious doesn't it?
Current cost reduction strategies include outsourcing, category management, process standardisation, leverage of purchasing power, low cost market procurement and some Internet sales models.
These strategies work and are very successful in reducing costs.
However, they have defects in common:
- They don't help you to rethink your cost structure - they reduce costs within the existing structure.
- They don't tell you which cost reduction strategy should be applied to which area of the business and when.
- They don't tell you why you're spending what you're spending on what.
- They threaten product / service quality.
- They don't deliver value for money and the outcomes you need to deliver.
- They potentially deprive strategy of the resources required for implementation.
- They don't make optimum use of resources.
Looking at cost from a different perspective
Here's a different perspective. Instead of letting your cost structure determine your outcomes, let your outcomes determine your cost structure. Instead of starting with cost reduction strategies, start with an outcome delivery strategy.
Such an approach lets you have your cake and eat it. You get all the benefits of conventional cost reduction strategies but also:
- rethink your cost structure
- find out which cost reduction strategy should be applied to which area of the business when
- discover why you're spending what you're spending on what
- increase product / service quality
- deliver value for money and the outcomes you need to deliver
- align resources with the strategy
- make optimum use of resources.
Consider an analogy
The Titanic had a double-bottomed hull that was divided into 16 watertight compartments. Because four of these could be flooded without endangering the liner's buoyancy, it was assumed unsinkable. Shortly before midnight on 14 April 1912, the ship collided with an iceberg; five of its watertight compartments were ruptured, causing the ship to sink at 2:20 AM 14 April.
What lessons can be applied from the Titanic to rethinking cost structures?
Firstly, take a unified approach. Instead of relying on watertight compartments, treat the organisation as a whole. Instead of operating like a ship, whose purpose is to resist its environment, operate like a fish which lives in and co-operates with its environment.
Secondly, look ahead - get radar. The pace of change continually increases and so does the need to rethink cost structures. Thinking ahead to what the future outcomes will and should be, gives you the ability to define the required cost structure.
Thirdly, use your picture of the future to challenge assumptions and convention. Starting with outcomes gives you a cost structure from which to challenge existing practices, procedures, processes, programmes and even products.
A unified and flexible approach
The unified and flexible approach to rethinking cost structures proposed here has five steps:
- Develop a future-proofing benchmark to define what needs to be produced
- Extrapolate what needs to be done, employed and spent from the required outcomes
- Use this cost structure to challenge and change what exists
- Create self-managing teams to achieve the outcomes with minimal overheads
- Install the Business Management System to maximise productivity
Define what needs to be produced
Start from the future - where you want to be - rather than trying to improve the present - where you can't stay. Starting from the future stimulates radical and objective thinking about what needs to be done and employed.
Most organisations have given thought to the future, but sometimes this thinking is vague and has little effect on what people do and produce. Consequently, the biggest dangers to most organisations are the ones they don't see coming. Understanding these threats - and anticipating opportunities - requires strong peripheral vision.
The future-proofing template is a set of questions about the future from the perspectives of the natural and economic environment, the customer segments and value propositions, the core business processes and value chain, and the learning and growth enablers. Its use improves your organisation's peripheral vision and increases the completeness, consistency and probability of its strategy.
The future-proofing benchmark is developed by determining, for each question in the template:
- what the world will be like in future, in general
- what the consequences of this scenario will be for your organisation, and
- how your organisation should prepare for this world.
The answers are used to define the outcomes your organisation will need to deliver to its governors and customers in future, the processes it will therefore need to excel at, and what it needs to learn and develop in order to excel at these processes.
Nothing is an island, and organisational divisions inhibit delivery.
Defining the causal relationships between outcomes will:
- demonstrate inter-dependence
- prioritise activities
- predict delivery, and
- mitigate risks.
Objective measurement is essential to rethinking cost structures because it tells you whether your cost structure is having the desired effect. You are recommended to design ways of measuring both the achievement of each outcome and the likelihood of its achievement.
Finally, you should determine the key risk to each outcome so that mitigating activities can be identified.
The next step in rethinking the cost structure is to define the activities required to deliver the outcomes, the facilities, skills, information needed to carry out the activities, and money required to employ these resources.
In so doing, temporarily disregard the current processes, initiatives and cost structure to allow yourselves to imagine creatively 'what could be'. This process defines the organisation's cost drivers and causes and its ideal cost structure, i.e. the minimum expenditure required to deliver its outcomes.
Challenge and change what exists
The cost structure created by the previous step is used to identify unnecessary deliverables, and redundant activities and information by assessing existing jobs, skills, deliverables, processes, behaviours, initiatives, systems, information, resources and costs against the cost structure, using that model as a benchmark.
The information is then used to stop those current activities that don't help to deliver the outcomes of the future, redeploy resources to deliver the required outcomes, and restructure costs.
Change and align the current jobs, products, processes, initiatives, resources and costs to increase productivity and improve service
In order to use the cost structure for this purpose, you need to make an inventory of existing jobs, products, processes, initiatives and costs.
Achieve the outcomes
The re-thought cost structure is implemented by working through the organisational hierarchy, allowing and requiring everyone to state the contribution they will make to the corporate outcomes, and how they will do so.
Such an approach lets people do what they want to do and makes what they want to do deliver what the organisation needs. It applies to the organisation's governors, customers, partners and suppliers as well as its employees.
It avoids the need for reorganisation and overcomes the silo effect by creating virtual teams and networks. By making these networks explicit, you give them recognition, which increases their effectiveness.
Next, allocate rewards to the achievement of outcomes in proportion to the contribution made by the team. Since what's rewarded gets done, this aligns everyone and everything around the corporate goals - internally and externally - and encourages joined-up working without challenging the traditional functional organisational units and power bases.
The final step is to use the Business Management System to raise productivity.
The Business Management System is unique web-based software which captures and displays the cost structure on the intranet and the extranet. Everything the organisation needs to do and employ to deliver its required outcomes is linked and displayed at all levels across the whole value chain, from customers through people within the organisation to suppliers.
The causes of success are known, and the probability of the required outcomes being delivered is objectively predicted.
Being able to see what the organisation intends to employ, do and deliver, as well as the progress being made and the expected outcomes, motivates people to deliver their outcomes. It encourages joined-up working and predicts the probability of achieving the required outcomes, mitigating risk and reassuring the organisation's governors. The transparency and comprehensiveness of the information reduces the need for meetings, reports and e-mails.
Sustainable cost reduction
Quick fixes rarely deliver large or lasting savings. A diet helps you lose weight for a while, but it often takes a change in lifestyle to deliver long-term health.
The process described in this article explicitly aligns everyone and everything inside and outside the organisation around a single set of corporate goals, resulting in the quick and effective delivery of these goals at a sustainably lower cost.
It moves resourcing and budgeting issues to their rightful place at the end of the value chain, focusing attention on outcomes rather than money. And because the causes of success are explicitly defined, people have the confidence to act and time to put things right before the opportunity passes or the budget has been spent.
Peter Bebb is director of Perendie, authors of Business Alignment, an interdisciplinary approach to the development and operation of organisations which makes working lives more fulfilling and productive.