Delivering Savings That Stick - The CFO Report - WSJ

What is it that gives your company an edge over its competitors? Is it technology? Strategy? Market position?

Among industry-leading companies, more than 40% of executives say their key competitive advantage is their ability to keep costs low. And not just during a downturn. Companies with consistently lower costs can out-invest rivals in R&D and marketing, compete on price, and quickly shift resources to gain market share, all while maintaining strong margins.

Given those incentives, you’d think companies would keep costs low all the time.

Yet even when times are tough, many companies struggle to achieve the reductions they aim for. Despite the flurry of cost-cutting efforts in response to the economic downturn, a recent Bain & Company analysis reveals that nearly 60% of corporate managers who tried to shave expenses by 20% or more failed to reach their goal. And when the economic pressure to slim down eases, as it seems to be doing now, fat begins creeping back in immediately.

But some companies not only reduce costs, they keep them low over time. We analyzed the performance of 68 large U.S. public companies that announced major cost-reduction initiatives in the first quarter of 2009 and found that, a year to 24 months later, more than 20% of those companies had maintained or grown their EBIT despite revenue drops of 10% or more—a remarkable achievement.

What do these companies do that the others don’t?

First, they set spending targets based not on what they think they can achieve, but on external, market-based factors. A company facing new competition from rivals in China and other developing markets is unlikely to restore its competitive position with an arbitrary cost-reduction target of 10%.

During the market crash that began in late 2000, discount brokerage Charles Schwab, once a cost leader, realized it was being undercut by online competitors. Schwab needed to lower its price per trade significantly just to stay in the game. The company set out to determine the right price point and predict future pricing trends, then used that information as the basis for building a new cost structure.

Leading companies also tailor cost cuts to their overall business strategy. A bank whose strategy focuses on high-touch customer service obviously has a different level of costs than a bank focused on low-price accounts and self-service. Failing to consider strategy in cost control efforts is a recipe for trouble.

Using the wrong metrics is another pitfall. For example, one Asian telecom company looked at its call center cost per call handled and the cost per visit by its field technicians. Both appeared to meet industry benchmarks. But the two units operated separately. It turned out that call center agents were controlling costs by keeping calls short—even if that meant dispatching a truck on a far more expensive service call. By integrating the call center with the field unit and giving one executive responsibility for all customer service operations, the company saved millions.

Companies that maintain a low-cost position also focus on costs that build up in the seams of the organization, where units bump up against each other and authority and incentives are often unclear. At one major energy company, we found that a startling 40% of overhead costs were in such areas. Much of the corporate IT budget, for instance, went to support business units and was charged back to the units below the profit line. Division managers were not held responsible for IT costs. The company eventually reined in this expense with an effective chargeback system and created a board of business unit heads responsible for ensuring that IT charges were competitive.

Each of these techniques is an essential element of any sustained cost transformation—the table stakes, so to speak. But to make cost-reduction efforts stick, frontline managers and employees need to buy in to the changes. Executives surveyed identified employee behavior as the single biggest obstacle to capturing lasting value from cost-reduction efforts.

If the people on the front line don’t begin to think and act differently, initial cost savings won’t last. Rather than forcing changes from the top down, successful companies recognize and address the natural anxiety that results from change and work to involve the entire organization in the effort. Before long, the company develops a new culture in which keeping costs low is a primary objective. This is the key to delivering sustained cost savings year after year.

Peter Guarraia is a partner with Bain & Company in Chicago. Hernan Saenz is a partner in Bain’s Dallas and Mexico City offices.