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McKinsey_A Better Way to Cut Costs

McKinsey_A Better Way to Cut Costs

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05/03/2011

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OCTOBER 2009
 A better way to cut costs
Cutting all parts of a company equally may seem fair, but it doesn’tmake sense. Targeted cuts and efforts to build capabilities do.
Suzanne Heywood, Dennis Layton, and Risto Penttinen
 
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 According to
a recent
 McKinsey Quarterly
survey, 79 percent of all companies have cutcosts in response to the global economic crisis—but only 53 percent of executives think that doing so has helped their companies weather it. Yet organizations continue to cut.Cost reductions often go wrong, we believe, and our experience suggests that they can bedone in a better way.
In the heat of a nancial crisis, companies must focus on their nancial viability, but
they tend to cut about equally everywhere—without considering their strategic needs— because that seems more straightforward, and in some senses more fair, to all executivesconcerned. A second problem, with longer-term consequences, is that quick head countreductions often come at a price: missing the opportunities that crises can create toimprove business systems or to strengthen parts of an organization selectively.Here’s an example of how things can go wrong. An international energy company that
needed to save money fast started by simply dening the amount of savings it needed and
then required each department to cut costs by a similar amount, primarily through headcount reductions, which varied from 17 to 22 percent. The reality, however, was that thecompany needed to invest more in certain technological areas that were changing quickly,as well as in operations, where performance was far below industry benchmarks. What’smore, the HR and IT departments substantially duplicated certain activities becausedifferent layers in the organization were doing similar things. Much deeper cuts couldtherefore be made in these functions, with little strategic risk. But the company cut costsacross the board, and just six months later, technology and operations were lobbying hardto bring in new staff to take on an “uncontrollable workload,” while substantial duplicationremained in HR and IT. We suggest a better way: companies should start any cost-cutting initiative by thinkingthrough whether they could restructure the business to take advantage of current and
projected marketplace trends (for instance, by exiting relatively low-growth or low-prot
 businesses) or to mitigate threats, such as consolidating competitors. An important part
of the analysis is to understand a company’s nancial situation and the range of potential
outcomes under a number of different external economic scenarios. Second, within theresulting strategy, take time to understand which
activities
drive value—in the public
and nonprot sectors, a good proxy might be mandated outcomes, such as the number of 
 workers, health metrics, or school performance—and which activities do or could makethe organization competitively distinctive. Organizations should invest in value-creating
activities and cut costs in others while meeting clear nancial goals in a set time frame
(see sidebar, “Exploring three sources of value”).The changes that result from this kind of thinking can be dramatic. A government-fundedenvironmental organization, for example, spent a lot of time on monitoring individualspecies and campaigning against their extinction rather than on climate change, which
 
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the organization’s leaders actually regarded as more important and where they could havea greater impact. The organization took cost cutting as an opportunity to look intensely at what it did. It decided to stop the extinction-related lobbying and policy activities,undertaken by about 20 percent of its employees, and instead move the work of another20 percent of its staff—along with some of the people undertaking that work—into otherorganizations with suitable mandates. The organization then reinvested a large portion of the savings to increase the number of staff members working on climate change. It also
invested in building the capabilities of its relatively weak HR and nance functions.
 When cost cutting in existing functions is appropriate, companies should explore bothradical approaches to restructuring and more traditional tactics, as our recent work with
a professional-services rm shows. For each support activity (such as IT, procurement,and nance), we identied ways to cut costs by working more economically and looked forentirely new ways to deliver support. In ofces—representing almost 10 percent of support
costs—this approach meant considering both a reduction in the amount of space allocatedto each person in the present location and a more radical change to promote work at home
or a hub-and-spoke ofce arrangement, with spokes in much lower-cost locations. In other
1. Restructuring to refect your uture.
 When considering each o the areas below, think aboutthe right structure, given the strategy to pursue in themost probable uture; what structural changes to makeregardless o the uture; and specifc events that wouldtrigger structural moves.
Reconsider the core business model and ocus;whether to enter or leave businesses, geographies, or joint ventures; and vertical integration.
Rethink organizational design, including therelationships among the corporate center and thebusiness units.
Resolve unfnished business, such as incompletemerger integration.
Exploring three sources o value
2. Cutting the at. 
To determine which o the potential actions below will bemost eective, create an accurate cost baseline, withdetails at the regional and business unit level, and assessthe value o potential costs against that baseline. Setpriorities by assessing each action’s potential value andease o implementation.
Remove layers rom the organization and expandmanagers’ span o control.
Eliminate redundant or irrelevant unctions, processes,or activities.
Apply lean techniques to repeatable or low-valueactivities.
Reconsider the role o the corporate center.
Consolidate activities to gain scale, scope, orknowledge.
Clariy roles across the company to createaccountability; reset pay grades.
Enorce high-productivity standards.
3. Building capabilities. 
To determine which capabilities to ocus on, quantitativelyassess the potential gain rom improving them andqualitatively assess the value o greater organizationaleectiveness.
Identiy where the organization is now weak—perhapsbecause complexity is slowing action, the right peoplearen’t in the right places, pivotal roles are weak,perormance scorecards or the business or employeesare ineective, or leaders don’t have time to ocus oncritical tasks.
Determine where stronger capabilities—in unctionssuch as IT, fnance, or sales or in specifc activities—could help.
Senior executives should ensure that cost-cutting eorts refect a company’s strategy. Here are three ways to do so.

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