Axon FundamentalCostReduction

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Fundamental

Cost Reduction

Impossible or imperative?


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Lunacy is to

continue to do the

same thing

and expect a

different result

Anon


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Fundamental Cost Reduction

Executive Briefings is a series published by Axon designed to explore and

share insights about the pressing concerns of todays business leaders as they

reach for the opportunities of the new millennium. Each issue tackles a specific

challenge facing corporations, defines the problems firms encounter as they rise

to the challenge, and provides discussion and practical applications.

Few can doubt the scale and complexity of issues that organisations face if they

are to be successful in the 21st

century. To achieve this success business leaders

will have to address emerging global issues such as electronic commerce, industry

convergence, worldwide alliances, virtual organisations and corporate citizenship.

But even more importantly, they will need to find new ways to excel at

the fundamentals of business: leadership, management, strategy and

implementation.

In this issue we consider the question Fundamental Cost Reduction

Impossible or Imperative? The 1990s were epitomised by corporations

embarking on re-engineering efforts focused on removing the 30% of excess

cost. They primarily achieved this through headcount reduction. As the economic

landscape changes, gaining the next 30% reduction has moved back to the top

of the Corporate agenda. But this time it is meeting heavy resistance too

much has already been cut. In this Briefing we evaluate this opinion, conclude

that firms have no option but to find new and innovative ways of driving cost

reduction, and set out a series of proven approaches to achieve precisely this.

We hope this publication adds value to you as you continue to build your business,

and we encourage you to write or call us with your questions, observations and

suggestions.

Mark HunterChief Executive

Axon


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Impossible or imperative? 3

The impossible request 4

The business imperative 6

Not if, but how? 8

Cost strategies 8

Is re-engineering dead? 15

The spend lever 18

The role of people 22

So what now? 24

The Executive Agenda 25

About Axon 28

Axon 2003


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Impossible or imperative?When the great wave of cost reduction activities which tore through the business

community for five years drew to a close in the 1990s, the business press declared

that growth, innovation and new product development were the new priorities

for the leaner, more focused, Corporate arena. The cost card, considered by

many to be the easiest area to impact, had now been played. Radical cost

reduction was no longer an effective weapon in the Executive armoury the

30% of excess fat which had existed for decades was now gone.

However, as the global economy takes further unexpected twists, major

corporations need to focus on fundamental cost reduction more than ever before.

Weak market conditions, low investor confidence, economic instability and regional

tensions mean that cost is back on the Corporate agenda, and more critical than

ever before. Once again, it is a business imperative.

But unlike the re-engineering projects of a decade ago,

there are no easy costs to go after. Staff are working

harder and utilising better technology than ever before.

Yet the degree of improvement required is just as great. What are the second

generation cost strategies? Do they even exist? CEOs and Senior Executives

must seek out and grasp new and innovative step-change cost reduction

approaches. For if they do not, they will be embarking on a business-critical

mission where the chances of success are zero.

The 30% of excess fat

which had existed for

decades was now gone


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The impossible requestThe last year or two has seen a return to 1990s style budget cuts. A top down

dictate to take 10% or 20% out of budgets across the board.

No to international flights, travelling business class and team-

building off-sites. All new IT projects have been stopped,

and what was left of the training budget has just about disappeared altogether.

But resistance to this approach from line managers seems stronger than ever.

And these line managers are the ones that made their name driving cost out of

the business last time round. Have they lost their appetite for it, or is there really

no more to be had?

Too Lean Already

A recent survey covering 5,500 managers in the UK found they were working

longer hours, under increasing pressure with decreasing time for their personal

lives. They in turn are asking more from their employees. One manager recounted

how he had sent all 80 of his staff off on a stress management course to help

overcome the health hazards of the never-ending workload.

When Charles Handy wrote The Empty Raincoat some years ago, he recounted

what appeared to be the resourcing strategy behind the re-engineering generation.

Have one-third as many people, each three times as productive as they are

today, and pay them twice as much. If the working hours numbers are true, it

44% of managers claimworkload is impacting

their personal life

Source: @hand

Exhibit 1: Working Hours

75

48

44

28

% of Respondents


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appears the business world listened only too closely to Handy. And the request

is to cut costs further?

Only Fixed Costs Left

Whilst a cost centre manager may hold a budget of $2 million, and be instructed

to find a 15% saving, or $300,000, the challenge is far

greater than it first appears. Suppose this manager worked

in the telecoms sector. A typical split of the costs shows

that the manager has the ability to influence less than half

of the budget he owns.

Space, heat and light, server capacity, CPU time and Corporate services would

all appear in the monthly management accounts, even if the particular cost

centre does nothing. Depreciation is just the cost of a past spending spree, and

shaving a little off the stationery budget wont go far. Which is why the axe

always falls on the only major controllable cost area for the cost centre payroll.

Yet if all the savings are to come from there, i t is a 45% cut in headcount to

achieve a 15% total budget reduction. Impossible. But if its not from there,

then there is only fixed cost left.

Have one third as many people,

each three times as productive

as they are today, and pay

them twice as much

Exhibit 2: Typical Cost Breakdown

Facilities

Source: Axon Analysis

Payroll

Allocated = 52%

Direct = 48%

35

7

8

15

22

32

8

Travel andEntertainment

Training

Other Direct Costs

Corporate Services

Overhead Allocation

IT


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The business imperativePerhaps the reason for cost racing back up the priority list is that it is an area that

can be addressed quickly. Companies in difficulty either have a cost problem, a

revenue problem, or both. If they have a revenue problem, they have to develop

new products, pump money into promotions, or move into new channels or

partnerships. All of these take time to change, and often have a lag of up to

three years before the effect of decisions taken today filter back down into the

P&L. Price cutting and discounts being the main exception. Cost, however, can

be tackled tomorrow. You just stop spending.

Macro-Factors

As the European Union continues apace towards the goal of political integration,

common laws and policies and greater economic alignment, increasingly unusual

political games are being played. To describe the issue of whether or not Britain

should join the European Single Currency as highly contentious is perhaps an

understatement. The implications of the introduction of the

euro span a broad spectrum of subjects beyond the entirely

laudable objective of UK business trading in Europe without

fluctuating and different exchanges rates. Not the least of

which is the perceived devolvement of power to Brussels.

Labour costs across geographies will also impact competitiveness. The average

income of a US worker is over $35,000; whereas in parts of Africa and Asia it is

under $2,000. Take a more obvious example. When an american airline needed

to find ways of dramatically reducing costs, they moved all their telephone centres

to Ireland. Average sales cost was half of that in the States. The airline picked

up the extra phone costs and still made a 20% saving. The next morning, its

competitors had a 20% cost disadvantage and very little time to find a way to

match the new position.

All these examples illustrate the need for dramatic, and often sudden, reductions

in major areas of cost. And that is before considering the impact of recession,

market uncertainty, derivative markets exposure, and so on. The only thing that

is for sure is that the macro-factors will keep putting dramatic cost reduction on

The average income of a US

worker is over $35,000;

whereas in parts of Africaand Asia it is under $2,000


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Reproduced with permission from The Dilbert Principle by Scott Adams, 1992;

published by Nicholas Brealey Publishing Ltd, 36 John Street, London, WC1N 2AT

Exhibit 3: Cost Reduction vs Competitiveness

the Executive agenda, and demanding more structural and strategic methods of

achieving them.

There is 30% Left

Whilst we know that external factors may dictate that companies have no choice

but to dramatically reduce cost, the positive news is that there is still 30% of cost

reduction left to be had. But perhaps not where firms have traditionally looked

for it.

Traditional cost reduction projects were so often based on a premise which later

proved false. If you take people out, the activities will reduce. In fact what

happens is service levels fall, error and rework increases, activities grow and the

pressure on staff becomes enormous. But which of those activities actually add

value?

Activity value analysis (AVA) can be one of the most enlightening reviews a firm

can do. Quite simply, it looks at all the activities conducted by staff and categorises

them into those which add value, and those which dont. Checking, reviewing,

rework, down-time and so on all fall into the latter category. The conclusion

from AVA is: dont improve activities stop doing them altogether.

In an activity analysis conducted with a group of technicians,

over 50% of time was found to be non-added value. Typically, the answer is

between 35% and 65%.

There is still 30% of cost

reduction to be had

On average, AVA will highlight

50% non added-value time


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Exhibit 4: AVA Technican Study Results


Other timePoor workallocation

Lookingfor tools

Locatingproductionequipment

Waitingfor results

% %

52

48 515

15

25

40

Total Time Split Lost Time Split

Time

ProductiveTime

Lost Time

Winning organisations practise

a continuous culture of cost

optimisation

Not if, but how?It is a hard case to argue that fundamental cost reduction will not return time

after time to the top of the Corporate priority list. And that each time it does,

competitiveness - and often survival - is the prize of succeeding, or the cost of

failure. The key challenge therefore must be how to approach it this time round.

What are the cost reduction approaches for the second,

third or fourth wave of cost containment?

The winning organisations are those who see cost reduction as a progressive

way of life not a one-off programme when the P&L looks bad. The low cost

providers in todays business world did not get there by cost reduction projects,

but by a continuous culture of cost optimisation. And it is a review of the tools

and approaches that have helped those firms get there, that the remainder of

this Briefing is dedicated.

Cost strategiesProbably the greatest single barrier to effective cost reduction is the fact that

most organisations dont know what things actually cost them, nor where their

costs are really incurred. Cross-charging and allocation is the curse of clearly

understood drivers of cost. During a cost study at a UK Merchant Bank, one

particular category of IT expenditure, which ended its journey through the


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Everything is a variable cost

- its just a matter of time

accounting system showing on all the operating cost centres management

accounts, had actually gone through 39 journal entries since its inception into

the system in the purchase ledger department.

Nothing is Fixed

Everything is a variable cost its just a matter of time. That is the philosophy

which must be borne in mind before starting any cost review. The companys

Corporate headquarters in the heart of London are not fixed. They could be sold

and a cheaper option found. Its only a question of time. The two hundred

depots could be sold and turned into an asset-backed lease; the fleet of lorries

sold to owner-drivers and contracted back on a per mile basis. The approach to

understanding costs in this manner was pioneered by Bob Kaplan in his work on

Activity Based Costing. Whilst this is the basis for understanding what costs are

now, it often falls short of being able to help companies understand what will

happen to costs if they alter some of the inputs. Activity Based Scenario Modelling

combines both these requirements together. It has three stages:

1. Build a Traditional ABC Model:

Under such an approach, all general ledger costs (resources) get allocated to

activities, typically conducted by staff. Staff then allocate their time to cost

objectives, such as products, customers or channels.

Exhibit 5: ABC Structure

Source: Axon

Resources

Activities

Resource Drivers

(% of effort)

Activity Drivers

(% of times)

Cost Objects

Process


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Exhibit 6: Traditional versus ABC Costs

112m 112m

27

30

48

7 711

17

18

35

24

Traditional

Cost Structure

Activity

Cost Structure

Cumulative

CostsOther

Payroll

RawMaterials

Other

Quality Control

MaterialHandling

Packing

Compounding

Base Resin

FixedCosts

Example: Chemical Plant - Level 1


All general ledger costs are then allocated through the model to provide a true

picture of product or customer profitability, in a way that allocates both fixed and

variable costs down to the true use of those costs.

2. Understand the Nature of Each Cost:

Some costs, such as traditional variable costs like raw materials, will increase in

a linear fashion. So, for example, a 1% increase in volume relates to a 1%

increase in cost. Others will grow in a stepped fashion, such as building costs

and IT costs. The nature of each cost in the ABC model needs to be understood,so that decisions can be modelled to see the impact of volume changes.

One of the most common errors in doing activity costing is ending up with a

product profitability graph, cutting all the loss-making products, and then finding

that the traditional fixed costs which had been allocated to those products are

now being allocated to the previously profitable ones resulting in a whole new

set of products appearing unprofitable.


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Zero-basing the companys

activities is an entirely

different model from which

enormous benefits can be

found

3. Create a Simulator to Test Decisions:

If you understand both actual costs and the nature of the costs almost any

decision can be simulated. What if I did outsource an

operation? The impact on the direct costs in that area is

easy to quantify, but what other savings could be driven

out from Corporate or overhead costs?

Zero-Basing

The term zero-basing has been most commonly applied to the budgeting process

in recent years. Its not really much of a science, rather an attempt to change

the mindset of suppliers and managers alike. Rather than the basis of debate

each year being, This was last years cost, next years is x% higher, zero-based

budgeting says the assumption is that costs are static, and that budgeting becomes

a process to say Where can cost be reduced next year?.

Whilst this approach can have its benefits, it doesnt really help managers find

where they can save costs. However, zero-basing the companys activities is an

entirely different model from which enormous benefits can be found.

It is surprising how many things that organisations do are due to historic reasons,

or through the process of evolution. One of the major food retailers used to

send staff out every week checking that the prices displayed on the shelves

matched the prices inputted to the POS system which ran the tills. That was

until the IT manager pointed out that six years ago the

process had been changed such that the POS system now

printed the prices for the shelves, and therefore they could

not be wrong. Had this simple fact been realised six years

ago, the organisation would have saved 2,400 man-years

of unnecessary effort over the period.

Unlike almost all other improvement methodologies, zero-basing does not start

with how things operate today. Instead, it lists everything the company needs to

do to meet its customer and Corporate objectives, then looks at what actually

happens and says, Why are these 100 activities occurring at all?.

One of the most common

errors in doing activity costing

is ending up with a product

profitability graph, and cutting

all the loss-making products


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Can an approach which is

over 40 years old still have a

use in this new sophisticated

Corporate world?

Target Costing Not Just for Cars

Toyota is credited with inventing the target costing approach in 1959. Can an

approach which is over 40 years old still have a use in this new sophisticated

Corporate world? Well, yes and no.

Toyota calculates the lifetime target profit for a product, such as the Celica, by

multiplying the target sales volume by the models return on sales. Toyota sets

the return on sales target with reference to the corporations long-term profit

goal. Estimated costs are determined from historic cost

tables, giving an estimated profit figure. The target profit

will be higher than the estimated profit, because the target

cost includes estimated savings due to value engineering

and other cost reduction activities. The difference between the two numbers is

the target cost reduction. As cost reduction activities are implemented, the

products estimated cost decreases, and the target cost and expected cost become

equal, as does the expected and target profit.

Great for cars! But can it work elsewhere? The answer is yes, but it has rarely

been used. Target costing is a powerful approach for linking Corporate cost

Exhibit 7: Zero-based Activity Methodology

Building a

Process Model

Deploy the Strategy

to the Process

Define the Deliverables

of each Process

Define Zero-Based

Activities

Compare toExisting

Build anImplementation Plan

1

2

3

4

5

6

What are the core processes?

What are the support processes?

Which processes enable the strategy to be achieved?

What role do they play?

What are the hard deliverables (e.g. products, reports)?

What are the soft deliverables (e.g. advice, control)?

What activities must exist to directly produce the deliverables?

What support activities are required?

What are all the activities that exist today?In how many places does each activity take place?

Where are the gaps and the savings?

What structural, process or system changes are needed?


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reduction targets to operations, because it is top-down, rather than bottom-up

driven. Yet it aligns cost targets to the products and services the company delivers

into the marketplace. Top-down targets then move away from being 10% of

everyones budget, to being 10% increase in the gross margin of products X and

Y. This will often cut right across the business processes and into the supply

chain, but its giving the organisation competitiveness from cost reduction, and a

clearer strategy which can be sold to the organisation.

Strategies for Speed

Whilst depth and understanding are desirable, so often firms

find themselves in a situation where cost reduction must be fast. What are the

Quick Wins that can be taken?

Whilst there are numerous areas for Quick Win identification, the following three

examples are common to all companies, and in many instances have yet to be

pursued:

1. Activity Eradication

We have already discussed the insight that activity value analysis can provide in

identifying tasks which consume vast amounts of time, yet do not add value.

Stop them. Now! Maintenance is a good example. How many things does your

company maintain that have never broken down? By focusing on eradicating

activity, one of the major oil corporations was able to save 10m in just six

months.

2. Cash, not just Cost

Ask the MD of any small firm what number is closest to his

heart and he will tell you the amount of cash in the bank. Ask a business unit

head at a major Corporate and he will tel l you the year-to-date profit figure from

the management accounts. What big firms need to learn again is that cash is

King, not cost. And that it can be addressed quickly. Reduce inventory, improve

cash management leading to less utilisation of funding, remove unallocated cash

from the balance sheet, gain early settlement discounts which are favourable

after funding. All these will help improve the lifeline of the firm, and quickly.

Target costing is a powerful

approach for linking

Corporate cost reduction

targets to operations

One of the major oil

corporations was able to save

10m in just six months


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3. Volume and Volatility

One of the simplest strategies to employ is to identify the drivers of volume and

volatility in each process, and then reduce both. Take a purchase ledger team.

Their key driver of cost is the volume of invoices processed. Do the analysis,

implement a strategy of asking suppliers to consol idate invoices monthly, provide

them electronically and set up call-off arrangements, and the volume could quite

easily halve in six months. And all achieved with no change whatsoever to the

process, procedures or working practices.

Addressing the volume lever is often most effective in

overhead cost areas. Simply list all the services provided and say, What could

be stopped, deferred, reduced in quality, amount, frequency, or substituted

altogether?

You may be surprised how quickly 20%-30% of total time can be reduced. Just

as startling can be the savings made available by reducing volatility of work.

Take the ever difficult relationship between the sales function and the delivery

function. Sales managers working to monthly sales targets are notorious for

sending in 80% of the months orders in the last two days of the month. Often

because theyve been hanging on to customer requests to see if they can get

higher prices elsewhere. Suddenly the delivery function, which has been sitting

idle for 20 days, is in absolute chaos for two days to meet all the commitments.

Addressing the volume lever

is often most effective in

overhead cost areas

Exhibit 8: Options for Cost Reduction in an Overhead Function

Reports

Forms

Analysis

Advice

Decisions

EndProductsor Services Eliminate Defer

ReduceQuality

ReduceAmount

ReduceFrequency Substitute


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What could the staffing levels have been if the daily demand pattern was the

same?

Call centres are often similar. Take the total of inbound and outbound calls over

the day and graph it against your staffing profile. How much are you paying to

meet the peaks? And the answer is not always to change shift patterns; there

are plenty of ways of encouraging customers to call in during the times of day

when you have excess capacity.

Is re-engineering dead?For some, they are still ruing the day it was born. Whilst there are almost as

many methodologies, viewpoints, definitions and experiences of re-engineering

as there have been projects, one common criticism does seem to pervade. Typical

BPR exercises did not push up into the strategy enough to find discontinuities

which could drive real, fundamental change, nor did they get into the nitty-gritty

of day-to-day tasks to plug the thousands of instances of duplication, error and

rework which were truly draining the organisation of

productivity. And it is in these two areas that second

generation cost reduction activities are being focused:

Business Re-engineering and Micro-Engineering.

Business Re-engineering

The typical BPR project starts by saying Heres the supply chain, now re-engineer

it. Out come the classic re-engineering tools; cycle time analysis, activity value

analysis, error and rework studies; and the result is a slicker, faster and less

costly process. But was the process even required in the first place? Take Direct

Line insurance. They didnt say, How do we design our branch process?. They

decided that they did not need that process at all and would take a different

approach to market a unique channel strategy.

Or the oil company which acquired overseas operations. They did not say, How

do we align finance and HR functions into the existing business, they said, Lets

have a shared services operation, and not have those processes overseas at all.

Business, not process, re-engineering.

Typical BPR exercises did not

push up into the strategy

enough, nor did they get

into the nitty-gritty


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Business re-engineering always starts from the strategy, rather than a bottom-

up analysis of whats broken. It also tends to require a much greater emphasis

on external analysis and learning. What are the truly innovative approaches to

the functions all companies must perform? Dont re-engineer your 10 call centres,

merge them into one and locate it in Asia. Save 40% of the cost.

The results and actions of Business Re-engineering tend to be structural,

strategically-driven, and almost always far reaching. They do, almost as a direct

result, tend to be higher risk. But that is what companies must be able to

manage if they are to find the fundamental savings this time round.

Micro-Engineering

Possibly the hardest thing for companies and managers to come to terms with is

the reality of where the savings actually come from. In most organisations, the

next level of cost savings exist at the heart of day to day operations. The power

of leveraging small changes at this level is the multiplying effect back up the

organisation in terms of efficiency, productivity and ultimately cost. The philosophy

of making 100 things 1% better, rather than one thing 100% better.

The basis for the whole micro-engineering approach is an

absolute understanding of how front-line staff actually spend

their time. A quantification of the Day in the Life Of(DILO) a front-line worker.

However, analysing a series of typical working days to assess and quantify these

issues is only the first step towards making cost savings. The studies will indicate

many causes of lost time which need to be prioritised. For example, in a Pareto

chart, by frequency, cost impact or lost time. This provides focus for establishing

root causes and prioritising corrective action plans.

The key to unlocking root causes and solutions, as well as ensuring the

sustainability of implementation, is the active involvement of the people who

experience the problems on a daily basis. For example, a major oil company

used this process to reduce the number of unplanned shutdowns on their

production facilities. A team of technicians had been recommending the use of

a new type of electrical connection in control cabinets for years, but no action

The philosophy of making

100 things 1% better, rather

than one thing 100% better


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An oil company saved 4,800

barrels of oil a day by micro-

engineering

Exhibit 9: Frequency and Cost Paretos

Issue

2,000

18,000

4,000

6,000

2,000

7,200

11,000

27,000

1,800

4,500

36K

252K

54K

48K

15K

22K

22K

54K

2K

5K

1. Telemetry false alarms

2. False alarms in CCR

3. Waiting for isolations

4. False alarms - GPA

5. Searching for equipment

6. Restricted access delays

7. Waiting for well handover

8. Operator error - shutdown

9. No work allocated

10. Rework - wrong instructions

FrequencyCost

per EventValue Impact(Priority Order)

16

14

12

8

6

3

2

2

1

1

Example: "Day in the Life Of"

(5)

(1)

(2)

(4)

(8)

(6)

(6)

(2)

(10)

(9)

had been taken. The connecting pins in use would corrode over time and wear

down slightly. This occasionally caused a spike sufficient to trip an alarm and

shut down all or part of the platform. A priorities programme to replace the

connectors on production critical control equipment, along with several similar

low level changes, generated a saving of 4,800 barrels of oil per day.

The micro-engineering methodology is in one sense so simple that it is almost

not worth mentioning. Yet so few organisations seem to do it, and perhaps the

fact it seems almost too simple to do is the reason why. If it is not that, then it

is certainly because it relies on the one capability which

almost all businesses have struggled with. Implementation.

Implementation is one of those concepts that many

companies talk about, but find very difficult to deliver. So much time and energy

is spent on reviews, focus groups, and design workshops, yet 70% of these

recommendations do not turn into reality because, quite simply, they are not

implemented.


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The spend leverRead any Purchasing text book, and it will have the equation below in it somewhere

guaranteed.

If the company wishes to double profits it could achieve it by doing any of the

following:

Double revenue

Remove all sales cost

Cut variable cost by 25%

Reduce raw materials by 10%

Ask any CEO, and they will tell you that if they had to choose which one to go for,

it would be the latter. And for many organisations, external expenditure accounts

for nearer 80% of total costs. Hence the power of the Procurement lever.

Getting the Strategy Clear

Many organisations suffer from having a philosophy for Procurement, rather than

philosophies within Procurement. Too often, companies become caught up on

the partnership bandwagon, and view it as a panacea for

all. When cost reduction looms large, years of partnership

development can be lost when the instruction is to gain

whatever price reductions are possible from suppliers. Like so many things,

Procurement is about horses for courses.

When cost reduction looms

large, years of partnership

development can be lost

Sales 100

Selling Costs 5

Operating Costs 40

Fixed 20

Variable 20

Raw Materials 50

Profit 5


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Exhibit 10: Supplier Positioning Matrix

Value of Spend

Business

Criticality

High

High

Low

Low

Ensure Supply

- Spare Parts

- Software

Partnership

- Core Raw Materials

- Capital Items

Ignore

- Stationery

- Couriers

Lowest Cost

- Car Hire

- PC's

Supplier Innovation

Keeping close to innovation in supply markets will almost always pay dividends.

New entrants to the supply markets tend to succeed by bringing innovations that

can leave the existing players standing. Take two examples as illustrations:

Own-Managed Car Scheme:

Under UK tax rules, companies and employees can save in the order of 20%

each on the cost of company cars through moving to a basis of own-managed

leases. This provides a significant tax saving, and reduces the employers risk of

being left with cars surplus to requirements when employees

leave.

Lease Buy-Backs:

IT equipment, like servers and desktop hardware is notorious for being expensive

to buy, being out of date almost immediately, and never matching the business

need. Major providers are now offering lease buy-back deals, whereby they will

buy all your existing equipment, lease it back, and agree to ensure it remains up-

to-date and matching the business requirement. The benefit to the supplier;

they are your natural provider for all new equipment (so choose carefully!). The

benefit to you; a 20% plus reduction in operating costs.

New entrants to the supply

markets tend to succeed bybringing innovations


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Exhibit 11: Prevalence of Outsourcing of Key Functions

Source: Saunders et al, Celia et al, Laver

% of Functions Outsourcing Part of their Activity

65

69

62

50

30

28

17

Benefits

IT

Training

Payroll

Recruitment

HR Info Systems

Finance

Compensation

The IT outsourcing market has

grown from $10 billion in 1991

to over $100 billion in 2003

Whilst most innovations tend to be industry specific, the list is growing dramatically.

Companies should be using their external assets more to enable their internal

cost reduction objectives.

Another Look at Outsourcing

A recent US survey of IT outsourcing found that on average a 16% cost saving

had been made. Perhaps this could help explain why the IT outsourcing market

has grown from $10 billion in 1991 to over $100 billion in 2003. Success stories

abound, and more unusual areas are coming under the outsourcing banner. Like

Roche, which outsourced the entire R&D, product development, clinical trials

and approval of three new drugs. This innovative approach, they claim, saved

them 40% of the total product cost compared to doing it in-house.

However, there are probably just as many horror stories as there are successful

ones. A European survey found that 70% of companies

wanted to change the supplier they were dealing with under

an outsourcing arrangement. Interestingly, only 12% actually

did. The same US survey of IT outsourcing which reported average 16% savings

also cited the example of a firm that saved $16 million by walking away from

their provider and bringing IT back in-house. An example of insourcing.


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Exhibit 12: Outsourcing Success

Type of Relationship

Partner (Core)

Loose

Tight

Supplier (Commodity)

outsource

success

outsource

failure

ContractType

Key Characteristics Key Characteristics

- No basis for success

Key Characteristics Key Characteristics

- Commodity activities only

- Customer-driven and managed contract

- Unambiguous contractual agreement

- Clear and reviewed service level agreement

- Aligned measures and objectives

The outsourcing argument has always been based on the premise of core

functions. If they are core they stay in-house; if they are

commodity, outsource them if it is cheaper to do so.

However, many recent business authors claim that core functions can be effectively

outsourced if the right relationship exists and is managed effectively. And recent

outsourcing activity certainly seems to suggest that many firms are following this

approach. But how do you make it work?

Clearly commodity activities can be outsourced under a classic supplier-customer

relationship, whilst core activities demand a partnership approach. But what is

really the difference? The acid test is based on the total amount of money (the

pie) available. If the pie is fixed, i.e. better performance cannot increase it, it

is almost impossible for the two organisations to share the same profit motive,

and therefore a tight contract is needed. Where the pie can grow through

better performance, the two organisations can share the same profit motive

and, if effective measures are put in place, can exist under a looser contractual

framework, operating in a partnership style.

Revisiting the make-buy and insource-outsource options can be a key strategy in

cost reduction.

If they are core they stay

in-house; if they are

commodity, outsource them


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The role of peopleIt is a generally accepted view that people had a pretty hard time of it the last

time the business community went into cost reduction in a big way. Many lost

jobs, and the ones that remained were often simply doing more work, because

no improvements had been made to the underlying processes.

Oh No, Not Again!

Overcoming the cynicism is one of the greatest challenges in launching cost-

focused change programmes again. Theres hardly an employee who hasnt got

that T-shirt! The key to this, apart from the traditional list of How to Run a

Change Project Well, is demonstrating an understanding of cost. The Cost

Strategy. If cost reduction plans can be clearly linked to

market-place competitiveness, then the organisation can begin

to get engaged. Cutting the cost to market of product X,

because it is 10% more expensive than the same product

sold by competitor Y is a much more engaging objective then 10% off payroll.

There is a logic. Which forms the basis for communication, acceptance and

commitment.

Let The People Decide

One of the most useful contributions by HR, or Personnel, since the 1990s cost

reduction campaigns is a whole new cadre of reward and recognition systems.

Flexible benefits let people decide how to take their pay, but bonus systems

provide the opportunity to let staff influence how muchthey get paid.

A US chemicals firm developed their entire pay strategy around an externally

produced pay benchmark study. Its commitment to staff was that they would

always be competitive with the marketplace, but as supply and demand in the

job market, triggered by Corporate fortunes, led to fluctuating pay deals, so this

could be transferred to the firms internal marketplace.

Effective bonus schemes are those which clearly link an individuals objectives to

Corporate goals. And which are flexible enough to recognise that growth may be

King one year, and cost the next.

Bonus systems provide the

opportunity to let staff

influence how much they

get paid


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But it is not only reward and recognition where progressive HR functions have

been able to add value. There are many other areas of non-headcount related

employment costs which can be addressed. Annualised hours, job sharing and

shift patterns to name three. And understanding how to

use these new tools effectively can make it a different story

for the employees this time around.

Implementation is All People

With all the methodologies, approaches, strategies and tactics discussed in this

Briefing, there is still one immovable fact that remains. All that really matters is

implementation, and all implementation is about is people. Changing the way

they conduct their daily operations.

Most organisations in business today have very little opportunity in the easy to

doareas. This is where first generation cost reduction focused. The reality is

that the next level of sustainable cost reduction will come from actually making

the things which people routinely do happen differently. In other words, changing

behaviour. The hard truth is that unless behaviour changes, nothing changes.

The good news, however, is that if sustainable behavioural change can be made

There are many other areas

of non-headcount related

employment costs which can

be addressed

Exhibit 13: Change Pyramid

ChangeBehaviour

ChangeCulture

ChangeStructure

Change Roles

Change Tasks

Discomfort

Easy to Do(visible)

Hard to Do(invisible)

Leverage

ProcessDesign

OrganisationDesign

JobDesign


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Executive Briefings

24

in the organisation, the company finds itself achieving that other Holy Grail by

default: culture change. Perhaps the most important message from the change

pyramid is that cultural change is actually the consequence, not the goal in itself.

So what now?If fundamental cost reduction is a business imperative for your company, there

are two over-riding principles which should guide your path forward. The first is

that cost optimisation should be a routine process within the firm, not a one-off

event. And to achieve this costs must be understood if they are to be effectively

removed. A Cost Review and Strategy is the foundation stone. Secondly, once

the strategy is clear, focus all efforts, energies and resources on implementation.

For it is there that the savings will be realised. But fully utilise Quick Wins in

order to create confidence in the ability to implement. We hope the following

pointers inThe Executive Agenda- which sets out the lessons learnt from

many companies in these two key areas - will help you achieve radical cost

savings.


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The Executive Agenda

Cost Review and Strategy

Do you have an existing and on-going strategy for

improving the cost base?

Is there a well-defined and consistently understood

process for optimising cost?

Is this process routinely used across the organisation?

Are activity costs understood and used as the basis for

evaluating top-down cost targets?

Can Corporate cost objectives be easily translated into

target gross margins for all products and services?

Does the company know where costs are incurred, and

how committed the organisation is to incurring them?

Is any external cost evaluation conducted?

Have key activities conducted by the organisation ever

been challenged to see if they are actually needed?

Does cost targeting include a robust bottom-up element

to routinely make multiple small cost improvements?

(Check)


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Quick Wins

Is it a common occurrence in your organisation to

analyse, conclude, make decisions and action within a 4

week period?

Do you know the actual activi ties performed by any

department?

Does the firm have a clear grasp on how many people

duplicate each others work, like scheduling, reporting,

checking, and so on?

Has your firm ever formally stopped an activity which

used to be performed from being conducted in the

future?

Do you know how much unallocated cash is sitting on

the balance sheet?

Does a report on cash levers exist within the

organisation? Does it cover stock, WIP, late payments,

unprofitable early settlement discounts, unnecessary

loan usage, credit notes claimed back late, debit

balances on supplier accounts and duplicate payments?

Do monthly reports look at volume drivers as well as cost

and service measures?

Is smoothing demand an objective of any function which

generates the workload for another?

(Check)


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Implementation Success

Is there an agreed implementation model for the

business?

Is this a step-change or continuous improvement that

needs implementing?

Should line management lead and manage

implementation, or just lead it?

Is it an organisation change, or a systems change?

Have I made contingency for people leaving during

implementation?

Does the line organisation have enough resource to

implement without support teams?

Do I have a review and measurement process to assess

the degree and effectiveness of implementation?

Do I have an agreed, owned and understood

implementation process?

(Check)


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Executive Briefings

28

Axon is a leading business transformation consultancy with over

twenty years experience of helping companies achieve their

ambitions.

At the heart of the Axon consulting approach is a focus on

delivering long-term sustainable improvements to the

organisations key stakeholders. Axon consultants work alongside

client senior teams, to help them set direction and analyse their

current performance, identify the gaps and then put in place a

change effort that will close those gaps.

But designing new strategies, processes or organisations is not

where it stops. At Axon we see that as the beginning.

Implementing those designs so that they become embedded as

the new way of doing business as usual is what matters. And

helping companies do that is what we see as our greatest

strength.

Fundamental cost reduction can be one of the most challenging

periods in a companys evolution. Which is why it must be

directed by the firms own leaders. That is why our vision is to

support companies through self-managed change efforts.

For more information onAxons services, please visit

www.axonglobal.comor contact:

Mike Carton in Europe (+44) (0)1784 480 800

George Russel in the Americas (+1) 203 973 0344

Chris Bailey in the Middle East (+971) 4 332 1418

Saeed Sadek in the Asia Pacific (+61) 2 9238 6869


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Discovery consists

of seeing what everybody

has seen and thinking

what nobody has

thought

Albert Nagyrapolt


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Europe

AxonCentreChurch RoadEghamSurrey TW20 9QBEnglandTel: (+44) (0)1784 480 800Fax: (+44) (0)1784 480 900

America

Two Stamford Landing68 Southfield AvenueStamfordCT 06902U.S.A.Tel: (+1) 203 973 0344Fax: (+1) 203 973 0345

Middle East

Suite 1601BCity Tower 2P.O. Box 28966DubaiUnited Arab EmiratesTel: (+971) 4 332 1418Fax: (+971) 4 332 1367

Asia Pacific

Level 67, MLC CentreCnr King/CastlereaghSydney NSW 2000Australia

Tel: (+61) 2 9238 6869Fax: (+61) 2 9870 8456

Documents

Axon FundamentalCostReduction