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Kay Plantes is an MIT-trained economist, business strategy consultant, columnist and author. Business model innovation, strategic leadership and smart economic policies are her professional passions. A former Madison, WI resident, Kay now resides in San Diego, CA. The views on her blog are not those of her employer, IBM.

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October 16th, 2013

Has the drive for efficiency through cost cutting gone too far?

The drive for efficiency is a dangerous temptation, which often comes with unexpected costs.

The drive for efficiency has gone too far in my estimation.

“But efficiency is always good,” you might protest. True, productivity gains increase incremental profits all else equal.

But “all else equal” rarely holds true in practice. Therefore, like all good things pushed too far, gains from incremental efficiency initiatives may not be worth the price paid to secure them.

Why is the Efficiency Goddess who brought us big box miracles like Staples, online retailing and record corporate cash balances failing us?

Efficiency initiatives usually pay attention only to readily measurable costs, ignoring unintended consequences and opportunity costs. Why do CIOs limit support to only PC-computers? Why do CFOs reduce support staff, forcing administrative work onto revenue-generating managers? Such is the thinking of modern corporate managers: They are brilliant at measuring costs and lousy at measuring professional productivity.

Shortsighted trade-offs are magnified as companies globalize and outside business services proliferate. Managers must decide which activities (e.g., shipping) to outsource and, for those that remain (e.g., software testing), which to centralize or not.  And then there are the critical location decisions for the centralized and dispersed activities.

These decisions are complex, interdependent and consequential. The challenge is to identify activities that do not define the company in its marketplace and therefore are ripe for efficiency initiatives.  Some of these activities are critical to success (e.g., Apple’s manufacturing), while others are merely necessary (e.g., GE’s Accounts Payable process). Generic activities are best suited for elimination, outsourcing, automation or centralization and location in the lowest cost countries, any of which increase profits.

This compartmentalization of activities – initially for decision-making and then for management ­– does advance efficiency. Company-wide metrics and cultural norms are then adopted to keep the parts aligned like a well-oiled machine. But in practice, the company’s performance slows like a rusty machine. Leaders of critical and generic processes pay more attention to the cost-driven metrics. They begin to steer their activities in ways that compromise the company’s differentiation and complicate the work of the revenue producers.

Leaders of business units in large corporations with matrix structures must then spend an inordinate amount of time trying to get leaders of shared operations and support services – who are driven primarily by cost metrics – to support their business unit’s success.  Doing battle steals time from revenue generation activities and may result in service or quality issues that prompt customers to consider alternative suppliers.

Consider how my bank created a “mortgage loan approval process” so full of twists and turns that local Realtors steered buyers to banks with clearer procedures. The bank’s finance leader probably gets rewarded for low default rates, but profits suffer.

Or consider the common story of how large companies aggressively acquire successful niche players only to squeeze any innovative juice out of them by integrating the back office or more. Overhead is lowered, but the action gives rise to wave after wave of new niche competitors.

Such examples of breaking companies into parts to squeeze dollars out of less important components ignores how work really gets done and, worse, undermines worker passion and innovation, key drivers of revenue growth.

Cost cutting also ignores external costs – what economists call externalities. These are societal costs imposed by a company’s decisions and activities. For example, when companies manufacture in China versus the US, global air quality deteriorates and Chinese life span drops as China has weaker air regulations. Global competitive forces and customer location might demand this choice, an argument we can understand.  But how do we explain Walmart – the US’ largest employer with some 2.1 million employees and no overseas competition – paying such low wages that its domestic employees disproportionately use public healthcare, imposing a cost on taxpayers?

Enlightened leaders are holistic thinkers. Rather than break their business into processes, they break their business into businesses and then give general managers authority to run them well. Any shared platforms are in service to the businesses, not fiefdoms. Their structures will cost more, but innovation, agility and revenue growth will be higher. A company that thinks about how it can positively impact the world also advances its market success, talent retention and brand equity.

Just ask Gore, COSTCO, Google, Patagonia and EPIC – companies that know there is far more to success than efficiency. And short the stock of any company whose earnings growth arises largely through efficiency efforts.


2 comments to Has the drive for efficiency through cost cutting gone too far?

  • Some very good insights. Since the beginning of the great recession I have seen companies turn to deeper and deeper cost cutting. Companies are reacting in fear of losing sales and losing market share. They often term cost cutting “getting back to basics”. However, they have taken their eyes off of the margin, where their profit lies. We need a return to innovation and better understanding of the competition, the customer and the marketplace.
    Beth Plutchak´s last [type] ..Data Analysis in Banking

  • Your insights are right-on, Beth. You cannot cost-cut your way to revenue growth as IBM is showing clearly.

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