99-Big Cost Differences in an Industry – Part 2

 

Cost reduction programs require both ideas to lower costs as well as the appropriate cultural setting to bring those cost reduction ideas into the real-world setting. We have discussed the cost reduction concepts and ideas in the previous blog. In this blog, we cite work done on cost reduction by two outstanding consulting firms, McKinsey and Company and Bain. Their insights are worthwhile.

Posted 4/27/09

McKinsey and Company has undertaken a detailed examination of Productivity in the pharmaceutical industry. This extensive study offers us an opportunity to see common patterns in cost management and productivity improvement. We described these patterns in Part 1 of this blog. These common patterns of Productivity improvement include four major concepts.

1. Reduce the rate of cost for the Input
2. Reduce the Inputs not producing Output
3. Reduce unique Intermediate Cost Drivers(ICDs) in products and processes
4. Spread fixed cost ICDs over new Output

McKinsey undertook a detailed analysis of 1900 pharmaceutical production lines at 150 plants located all around the world. The Firm measured the Productivity levels among the plants and companies in their study and found dramatic differences in Productivity among these 150 plants. (See the Perspective, “What Makes Returns High?” on StrategyStreet.com.) The top quartile of the companies involved in this study had manufacturing utilization rates that were more than twice those of the bottom quartile companies. McKinsey estimated that, if the average drug-maker would match the total labor productivity of the top players in the industry, it would realize an improvement of 5 to 6 percentage points in operating earnings, quite an improvement

Here are some of the cost management reasons for the superior performance of the best performing companies and how these cost management efforts fall into the four categories of cost reduction above:

• Measure of I/ICD and Concept #2: McKinsey found that the top performers used non-production labor extraordinarily efficiently. For example, the quality control employees for the top performers reviewed an average of 110 batches a year, while those in the bottom quartile did less than 5. This finding is a good example of both an Input, the quality control employee, and an Intermediate Cost Driver, a quality control batch. A company using this measure would reduce Inputs not producing Output through reporting to the employees of this measure of their efficiency. (Concept 2)

• Concepts #2 and #3: The high performers use standardized ways of measuring and controlling equipment, reducing line stoppages and waste. This is an example of two of the patterns. (Concept 2) This approach reduces Inputs not producing Output by eliminating unplanned downtime. It also reduces the unique ICDs in processes by standardizing processes. (Concept 3)

• Concepts #2 and #3: The top performers were more likely to use lean management tools to plan and schedule activities, so they released a higher percentage of their products to market without reworking. This approach reduced Inputs not producing Output by improving the accuracy of production forecasts. (Concept 2) It also reduced unique ICDs in the process by reducing the rework activities through a reduction in errors. (Concept 3)

• Concept #2: The top quartile players reached final delivery in half as much time as the average manufacturer, and more than five times faster than those in the bottom quartile. The top performers reduced Inputs not producing Output by speeding the process.

• Concept #3: The best performers eliminated unnecessary complexity from their production planning activities by using fixed, repeatable, short duration production schedules in order to avoid forced changes in production plans. These companies reduced unique ICDs in their processes by reducing the movements of Inputs.

• Concept #4: McKinsey found that small plants were substantially less productive than larger plants. However, the very largest plants were not the most productive. This illustrates the spreading of fixed cost ICDs over additional product Output. It also warns us of the limit of that concept when there are multiple products emerging from the plant.

Every drug maker that McKinsey studied had launched a lean, or Six Sigma, project in the recent past. Yet relatively few of these companies were effective in reducing their comparative costs.

For further explanation of these cost reduction patterns, and for over 600 cost reduction concepts, illustrated by 2400 examples of these concepts in action, please visit www.strategystreet.com/improve/costs. These concepts will help you improve your company’s productivity.

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Update 7/26

We found another helpful piece of work done by Bain and Company. This firm examined 68 large companies and their cost reduction efforts to see what works and why. We summarize their findings in this blog.

1. Market‑Based Target Setting (Not Internal Benchmarks). They set cost reduction targets using external, market based data to for some more aggressive, reality-based view of what ideal costs should look like.
2. Strategy‑Aligned Cost Cutting (Not Across‑the‑Board Cuts). They tailored cost reductions according to strategic priorities, where they protected costs adding to customer value while eliminating cost of redundancies and low value-added processes.
3. Precision Metrics and Cost Visibility. They built detailed cost metrics in the form of unit economics, process – level cost drivers and cross functional cost maps. The major benefit share was that it prevented cost creep by allowing continuous monitoring of costs.
4. Focus on Organizational “Seams.” They measured and attacked costs at the interfaces between functions where duplication, misalignment and inefficiency are highest. This eliminated structural waste, reduced cycle times and improve cross functional accountability.
5. Embedding Cost Discipline Culturally. The best companies built organizational wide cost ownership rather than relying on top down mandates. They created incentives tied to cost achievements, increased training on cost efficient processes, instituted transparent reporting and had leadership that modeled frugality.

The most successful companies created detailed market-based cost measurements, employed them over the long-term and created a culture of cost containment at all levels of the organization.

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