Mismanagement of Costs

We incur costs when performing an activity, when expending energy.  Therefore a business enterprise that produces a product or service also produces costs, naturally.  Not only are costs unavoidable they are necessary! Moreover, there’s an optimal level of costs both below and above which an enterprise renders itself less viable.

So why is it that most managers or leaders want to minimize, not optimize, costs? The most logical answer, based on the formula profit = revenue – cost, is they see it as a means for maximizing profit.  After all, this is the business of business!

Having this mindset, what most seek to do is get the most out of the business.  That is, they view the business as a thing—an object—from which profit is extracted.   Moreover, every ‘thing’ in the economic equation (i.e. capital, labor, natural resources, suppliers, customers) is manipulated and even exploited for this purpose. This means spending as little as possible in order to get as much profit as possible out of the business.

Just look around, there are far more examples of this than a caring person could tolerate.  Examples where the total cost to society is enormous!  Most recent include the mining disaster in West Virginia and the tens of thousands of gallons of oil gushing into the Gulf of Mexico. In the long run this mindset is detrimental to society and to the business enterprise.

However, if the business of business is about serving the needs of people in society, then the purpose changes from extracting profit from the business to providing value through the business.  Correspondingly, the spending decision becomes an investment decision.  Thusly reframed, the decision requires a far wider perspective and a far deeper understanding of the role of business in the lives of people.  It becomes a decision about what best serves ‘We’, not merely a decision about what’s in it for ‘Me’.

But to manage and lead a business for this larger purpose requires a different kind of person.  One that is not narrowly fixated on profit or growth.  A person that understands that such a fixation is detrimental to progress.  The kind of person that makes a commitment to cultivating and developing the capabilities and ensuring the safety of people throughout the organization, and seeing this as an investment not an expense.   Why are such people so rare when doing otherwise increases the total cost of doing business?

7 thoughts on “Mismanagement of Costs

  1. The obsession with cutting costs isn’t just about economics. The truth is, I’ve heard many a manager puff about cost-cutting, only to find out that he or she doesn’t have the wherewithal to solve even simple “optimization” problems.

    Cost-cutting for its own sake is an unimaginative but safe way for someone with administrative authority to claim to be doing his or her job, and not having to think about it much. “If I cut costs, I must be making the company money.”

    Cutting costs, though, doesn’t necessarily equate to higher profit margins. Witness the decline of Circuit City as Best Buy was growing. Circuit City was all about cost cutting. Meanwhile, Best Buy was building brand equity around its “Geek Squad,” and spending money on that project. There’s a Best Buy around the corner from me, so to speak. Where is Circuit City?

  2. Dear Progressus

    Please forgive the long winded examples below I am not disagreeing with you, but perhaps qualifying what you say some what.

    The point I make is Optimising costs needs a much higher level of knowledge and experience, than cost cutting on its own.

    I agree very much with the notion cost cutting on its own can be and is a recipe for disaster.

    in the past I was fortunate to work for a couple of Plant directois who believed the fastest an easiest way of reducing cost was to improve quality. It eliminated one hell of a lot of waste and had a very positive effect on profit.

    Ill considered cost reductionIt is how many of the guys and gals involved in process mapping and business process improvemet come un stuck

    As a low level example cost cutting gone wrong. I used to attend a Gym which has a considerable brand name and precence worldwide.

    Last week my self and most of the membershio of my local branch gym canceled our membership, because of a move to new premises. The old premises were well planned and maintained and well equipped and well managed. The new premises are a total disaster and a severe step backwards. dangerously cramped and poorly laid out.

    We considered the old set up extremely good value for money, but not the new. It was clear some one was trying to save money, instead they have screwed the business into the ground.

    On a positive note

    I have been succesfully involved in cost downs where the intention was to give the customer better value and save adverse costs. (Adverse costs are costs that are not planned and should not occur)

    An example was for a plastic car part where we actually decided to use an alternative and slightly more expensive base polymer which allowed the deletion of an expensive and problematic coating process. The customer actually loved the quality improvement and my employer saved a load of money getting rid of the coating process.

    Two parties very happy

    I think you also need to dstingusih between waste reduction and cost cutting. By avoiding waste you do reduce cost.

    I believe every one wins with waste reduction and quality improvement.

    On a more critical level. In avaiation for aircraft maintenance the policy years ago used to strip the engine down and inspect every thousand or so hours. Today and they simply listen to the engine and make a recording and do not disassemble the enginer unless a problem is detected. I am a lot happier about flying because of this and the airlines have saved some money too, Imagine the potential for human error which has been removed.

    On a factory level I have been involved in sytematic cost cutting exercises, My experience has been fortunate, it was not about getting rid of people, no body lost there jobs and a few were created. I was about avoiding waste particularly of materials. For example we saved a fortune by using re-usablle packaging even after creating some jobs to manage the situation. Other examples were comonising materials. We reduced inventory by several millons dollars. Since most of our products had some form of coating. we saved futher large amounts of doller by simply reducing “over spray” I could quote many more examples

    The point I stress though is you have to know and understand what you are doing.

  3. Rick & John great examples! Good management/leadership does require knowledge which requires learning. Managing without the guidance of profound knowledge will send you and your business down the drain.

  4. Yet again, another very insightful article. The myopic focus on simple cost cutting doesn’t naturally equate to bottom line results should be taught to every manager in every business today. I have found multiple millions in cost avoidance – solving gaps, processes, errors – to avoid loosing money; millions in costs/loses that were not noticed, or given any importance before. All too often an organization looses sight of failures, or avoids solving them. In order to appear to improve margins, employees are let go to reduce costs – when millions would have been saved by simple improvements.

    It is the quarterly view, rather than the annual or multi year view which spawns the quick fix mentality. It is the lack of holistic understanding of business that causes the blind spots in cost optimization.

  5. Tamara, your parting statement is a gem and worth repeating: “the lack of holistic understanding of business” coupled with ignorance of statistical thinking is in large part the cause of so many of our difficulties.

  6. I agree that cutting costs for the simple reason of increasing short term profits is shortsighted and can damage the viability of the organization.

    Costs should be reduced by eliminating waste, rework and poor quality as well as investment in training and productivity aids. I just wrote a blog update on my website about the difference between Toyota and the U.S. auto manufacturers relative to planning, long term vision and execution. Toyota didn’t get where they are by cutting costs, they are doing the right things for the environment, the employees, and their customers. That focus results in better bottom line results. They invest in the future and look for profit over the long term.

  7. Martin, eliminating unnecessary activity–rework, non-value-added work, special cause variation–as you assert is a far better way for long term viability.

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