This month we are beginning a series of columns by Robin Cooper and Regine Slagmulder on the topic of strategic cost management. The first column explains the term and lays the groundwork for future columns that will discuss various facets of strategic cost management in greater detail.
What Is Strategic
In todayís highly competitive environment, cost management has become a critical survival skill for many firms. But it is not sufficient to simply reduce costs; instead, costs must be managed strategically. Strategic cost management is the application of cost management techniques so that they simultaneously improve the strategic position of a firm and reduce costs. Strategic cost management can be applied in service and manufacturing settings and in not-for-profit environments.
The concept of strategic cost management is illustrated best by example.1 There are three types of cost management initiatives: those that strengthen the firmís competitive position, those that have no impact on the firmís position, and those that weaken it.
The first class of initiative can be illustrated by a hospital that redesigns its admissions process for patients so that it is simpler, faster, and less stressful on the patients to be admitted. If patients have a choice of hospital they will enter, the new process will make the hospital more attractive to them. Hence, the strategic position of the firm has been strengthened.
The second class of initiative can be illustrated by an insurance company that redesigns its accounts payable system to make it more efficient. This project has no strategic significance other than to make the firm more profitable. Unless the additional profitability is significant, the project will have no strategic implications. The strategic position of the firm remains essentially unchanged.
The third class of initiatives can be illustrated by an airlineís decision to reduce headcount by no longer having "floaters" ask passengers why they are queuing up to get their tickets. This question is important because at this airlineís hub there are two types of ticket desks and hence two sets of queues. One type of desk deals with normal conditions, and the other desk deals with special conditions. The average passenger does not know which is the appropriate queue because there is no easy way to delineate between the two. When queues are long, being in the wrong one is very upsetting, especially if a passenger has waited over an hour in one queue and then is told, "You are in the wrong queue. Start again over there." This cost-reduction initiative leads to extreme customer dissatisfaction and thus weakens the airlineís strategic position, which is based on high levels of customer service.
Firms can benefit by undertaking a quick audit of every cost management initiative they have planned or are currently undertaking and see how many actually strengthen their strategic position. If the answer is very few, then it is time to refocus the firmís cost management program. For example, cost reduction programs that "reduce costs 10% across the board" are at best strategically neutral and typically weaken the firmís strategic position. For this reason, among others, the cost "savings" frequently disappear once the crisis is over.
The ways the three initiatives are different often are not as great as might first appear. To convert the third example from a negative to a positive simply requires a change in orientation. The correct starting point is not to remove the floaters but to ask why they are needed in the first placeóthat is, to undertake a root cause analysis. There are two answers to the floater question: first, because there are two types of desk, and, second, because demand exceeds processing timeóhence the queues. The most effective cost management initiative would be to reduce processing times so that the queues go away, then collapse the two types of desks together. This procedure removes both sources of passenger dissatisfaction and, if successful, reduces costs. The initiative now illustrates strategic cost management in action.
But suppose that the processing times cannot be reduced and the two types of desks cannot be collapsed together.2 Then what? One solution is to understand why demand is so high at certain times, causing the queues to be so long. The primary cause of the long queues (other than excessive processing times) is bad weather.
Bad weather causes people to miss their connections, hence the increased demand for ticket desk services, hence the queues. One solution could be a videotape on every plane that clearly spells out the differences between the two types of desks and suggests that passengers who are not certain which desk they require ask the flight attendants. If this program is effective, the number of people in the wrong queue will drop to near zero, and the floaters can be removed without negative consequences. Costs have been reduced (there are no floaters), but the project is strategically neutral because the queues and hence customer dissatisfaction remain unchanged.
Thus, our floater problem illustrates all three types of initiative. Simply removing the floaters reduces costs but increases customer dissatisfaction, strategically weakening the firm. "I missed my connection, waited for over an hour in the wrong queue, and then had to wait in another queue for over an hour, causing me to miss the next flight." Removing the confusion decreases costs, but it does not change customer satisfaction. "I missed my connection, and it took over an hour for them to find me a new one." Essentially, the status quo has been maintained. The project is therefore strategically neutral. Removing the queues and the queuing errors decreases costs and increases customer satisfaction. "I missed my connection, but they found me a new one almost immediately." This solution strengthens the firmís strategic position of delivering high levels of customer service.
As a rule of thumb, initiatives that lead to a weakening of strategic position should never be undertaken. They should be viewed not as cost reduction programs but as revenue reduction programs. For example, passengers will begin to avoid the hub that has excessive queues and high queuing errors during bad weather and fly direct or to another hub, both instances frequently requiring a switch to another airline. In most cases, the resulting revenue reduction will exceed the cost savings many times over.
Occasionally, managers argue that the savings will be so great that weakening the firmís strategic position will be offset by the increased profitability. We are almost never persuaded by this argument. We believe that there always are solutions that will enable the costs to be reduced and the firmís strategic position to be strengthened, not weakened. Once a firm grasps the concept of strategic cost management, finding ways to achieve both objectives (simultaneously reduce costs and strengthen strategic position) is easier than it first appears.
This first column was a basic explanation of the concept of strategic cost management. Next month we will describe the scope of strategic cost management, and, in subsequent articles, we will explore different applications. Our objective is to illustrate the broad array of cost management techniques currently available to managers and the challenge of applying them in other ways that strengthen the strategic position of the firm.
Robin Cooper is professor of management, Peter F. Drucker Graduate Management Center, Claremont Graduate University, and honorary visiting professor of strategic cost management at Manchester Business School.
Regine Slagmulder is professor of management accounting, Tilberg University (the Netherlands) and visiting professor at the University of Ghent (Belgium).
1The hospital, insurance company, and airline examples are drawn from practical experience.
2The authors would always challenge the assumption that nothing could be done whenever the cause of the problem is known.