Cost Cutting

Focusing too much on cost management can blunt a competitive advantage might allow the firm to gain a premier position in the industry. Someone said a long time ago "you can't cut your way to growth." That means that you cannot just manage costs down and expect you can cut costs down far and expect your company and your supply chain to function well. It is important to manage costs. It is important to be efficient. However, it is more important to be effective. Effectiveness means successful completion or implementation of an action or task.

Value is not the same thing as low cost. For example, Wal-Mart often has a low price and consumers might want the low price. Wal-Mart also has the largest number of his doors and so is convenient for shoppers. They also have the highest product availability in the industry. Wal-Mart's stockout rate is below or present.

On April 18, 2006, Eduard Castro-Wright, CEO of Wal-Mart Stores USA said that Wal-Mart is start going after the “value” customer that is more selective. The selective customer is a customer is a customer that has been shopping at Wal-Mart for low cost consumable and food. They now want to market to that customer so that they “shop the rest of the box.”

In the early 1980s, there were several initiatives within the procurement world that went by the name of “value analysis.” The idea behind value analysis was that you would look at the product and try to reduce the cost of that product by using lower-cost materials, a less expensive process, or reengineering the product to get a similar performance at a lower cost. The problem with initiatives like value analysis is that at some point in time the gains received from cost-cutting tend to decline. The firm that has gotten five or 10% gains due to of cost-cutting initiatives have often built those cost-cutting gains into their forecast and budget plans. It makes sense that at some time these cost-cutting gains will end. When they begin to taper off, it causes real difficulty for those firms that have built these gains into their forecasts and budget plans.

A problem is often that cost cutters keep cost cutting after the point that where there is much fat left. Moreover, they do not pay attention to all of the attributes of the service supplier or the product. Instead, they just keep working on the cost side because their managers tell them that is what they need to do.

Another issue is that each company in the supply chain needs to focus on the ultimate goal of serving the end consumer and looking beyond their own selfish interests. This is very difficult to do in a short-term oriented firm. It may be impossible. They need to work together because if the supply chain works well for everyone, each company should receive more benefit in the long run than if they “locally optimize.” The old fairy tale about “killing the golden goose” is an example of a short-term orientation that resulted in a disaster.

In the late 1990's and the early 2000's electronic exchanges were developed. Many of these functioned as reverse auctions. These exchanges were often based on a business model that assumed that supplier firms wanted the business so badly that they would do anything to get including giving suicidal pricing. And, in some cases they would.

In early 1990s, there was a famous procurement officer at General Motors. He would bring teams of his handpicked people to go through GM operations and GM suppliers' operation sand look for opportunities to cut costs. He would challenge the suppliers to dramatically reduce their costs. As you might imagine, the suppliers were not happy to see him arrive. He had an interesting way of working. He and all of his direct reports wore their wristwatch on their right hands and ate a very low-calorie "warrior diet at" that he developed. His operation was military.

He meant well, and the short-term savings from his efforts were large. However, the suppliers had suddenly realized that they were no longer partners with General Motors. Instead, they were suppliers who could be whipped around at General Motors whim. This realization did not did not lead them to believe that they should continue to unselfishly support General Motors. It caused them to pull back and think seriously about everything they did for GM or told GM they were doing. It forced them to hide things that previously they would have shared with General Motors.

This group of “warriors” were heroes at GM until they left for Volkswagen. After they were gone, the long-term damage that they did to the supplier relationships and development processes became clear. The injury to General Motors and its supply base was substantial.

The question is "was the long run damage greater than short-term gains?” That is difficult to tell. What we do know 10 years later is that the effect of the injury is still manifested in the supply base and inside GM operations.

Eduard Castro-Wright, CEO of Wal-Mart Stores USA , on Squawk Box, April 19, 2006.

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