Every company has to control costs in order to survive and prosper. Therefore, many firms on regular basis perform cost reduction projects. Cost reduction projects may be part of a wider Performance Improvement Project or be a standalone project carried out only in one of the business units. Those projects are extremely interesting because you will be able to make a real change, create a new reality, and improve part of the business or even the whole business. There are also very difficult as you have to not only analyze areas but also find ways to cut costs, improve the current situation as well as, on some occasions, implement the changes.
Today I will show you briefly how you can do that in practice. This will be a short introduction to cost reduction. This is a part of our course Cost Reduction for Managers & Management Consultants that I recommend checking.
We will go briefly through the main stages of cost reduction projects and I will try to provide some practical tips that should help you with projects.
So, let’s see how you can reduce, cut costs in practice.
Generate potential ideas for improvements / cost reductions
The first thing you should do before even the project starts is to create a simple framework that will help you quickly identify costs that should be eliminated or reduced.
Below a short overview of our framework for cost reduction:
As you can see we have divided the potential actions into 4 areas: Reduce usage, Automation, Process Optimization, and Renegotiation of contracts. I recommend using this framework to generate a list of potential improvements that you believe could be crucial in the business that you are optimizing.
Before the project starts you can try to guess where you can expect the biggest savings. After you get initial data you can verify your guesses with some rough estimation.
Apart from the cost reduction framework use also an issue tree. This will help you generate fast potential ideas for cost-cutting. Have a look at an example of an issue tree showing potential savings in distribution / logistics.
Identify quick wins
In the first week of the project or even before the project starts, if you have data, you should try to identify quick wins using rough estimations. This will help you prioritize analyses and find fast potential improvements with the biggest potential. This sort of analysis will also help you greatly to talk with managers, directors, and the owners of the firm. Usually, they are positively surprised once you show them potential quick wins in the first or second week of the project. This greatly increases your credibility.
In order to identify quick wins, you have to divide all potential improvements into groups. We will use the ideas for potential reductions that we have generated in the previous stage. A lot of ideas will also be generating during the first meetings with the customer. For identifying the quick wins we are using the following framework:
As you can see we use 2 dimensions to prioritize potential improvements: potential savings that we can achieve by implementing the potential improvement and difficulty level. Our quick wins are the Cow Savings – easy to implement and big improvements. As a second priority, we would consider Elephants (difficult projects that still can have a big impact on the costs).
Below an examples of a quick-wins analysis done in Excel for a drugstore chain:
As you can see, with this framework, you can find out what you should concentrate on within 1-2 days.
In some cases, you will need additional data to estimate potential savings, but they can be easily obtained via benchmarks, 1-day audits, auctions, sampling, and conversations with experts or suppliers.
Detailed Analyses Phase
Once we have clarity on what to concentrate on, we can finally get down to detailed analyses. Depending on the size of the firm and complexity of the business this will take from 1 to 6 months. In the end we should have confirmed the potential savings from the Quick-win Analyses Phase. In some cases, you will discover that you were initially too optimistic. In other cases, you may find out that you have underestimated the true potential of a cost reduction project. I would recommend having every analysis in a separate Excel file. Below examples of such analyses:
- Make or buy analysis example
- Estimating the benefits of M&A including cost reductions and synergies
- Improving the efficiency of salesforce
- Process optimization – an example from Retail – Price change
- Analysis of cost reduction Capex – ceramic tiles
On the basis of such analyses during consulting projects, you prepare a list of potential cost reductions, improvements that can now be considered for implementation. The analyses are bases for the final presentation in which you show by how much the customer can increase EBITDA by cutting costs. The best way to show the potential savings is to do it through a waterfall chart.
When it comes to how the teams are organized, usually, you would have the responsibility for identifying and analyzing potential cost reduction spread over the whole team. The team can be organized either by areas (Sales, Supply Chain, Production, Head office), or by business units / sites.
Usually, you would have 1-2 Business Analysts analyzing 1 area or 1 business unit / site. With bigger firms you may be forced to a have mix of both methods. In this case, you would have a team of 3-4 people per site / business unit. Every person would be responsible for 1 area within 1 site.
In most cases, the project ends at the Detailed Analyses Phase. However, some customers can need support for the implementation phase. During the Implementation Phase, consultants have to switch from analytical work to project management. Below a few examples of how the support during the implementation phase can be organized
- Provide full analytical and project management resources for the Implementation Phase. In this set-up, you provide Project Managers and Business Analysts that help implement the cost reductions. Usually, it would mean that around 50-70% of the initial team stays on the projects and continue the work. This obviously is extremely expensive. The consulting firm is responsible for delivering the promised cost reduction. It usually is an important part of their fee. Such projects tend to be rather long: 12-24 months.
- Provide some analytical and project management resources for the Implementation Phase. In this set-up, you provide mainly Project Managers that help implement the cost reductions. Usually, it would mean that around 20-30% of the initial team stays on the projects and continue the work. The involvement is quite often also limited not only in scope but also in time. In most cases, the involvement of the consulting firm would finish after 6-9 months.
- Set-up and run PMO. In some cases, you may be asked to set up a Project Management Office that will supervise the implementation of cost reduction projects. In this case, you provide the know-how, you train the people, create templates as well as procedures. However, usually, you are not responsible for delivering specific savings. In the initial phase, you may be providing 1-2 Project Managers and 2-3 Business Analysts. This tends to be much cheaper than Option 1 and Option 2. Such projects are a great source of new projects and can last years. Once you built the PMO, the benefit may be so big that they will not remove it after the cost reduction project is done.
- Supervision.The most often involvement of consulting firms boils down to the supervision of the implementation. Usually, 1 Project Manager and 1 Business Analyst spend 1-2 days a week (or every second week) in the firm and check the progress. They may help with certain issues implementation teams, however, their involvement will be limited by the time that was paid by the customer.
That’s in short. Below a more extensive presentation on Cost Reduction.
I strongly recommend checking my course Cost Reduction for Managers & Management Consultants where you can find a lot of examples of analyses done during cost reduction projects along with calculation in Excel.