Managing Costs: Introduction

The great American humorist, Will Rogers, once made the observation: "Even if you're on the right track, you'll get run over if you just sit there." He could have been talking about a company’s cost structure. Your work so far has ensured that you will create excellent Value for your customers.

One thing is still missing for a successful strategy. You must fashion your cost structure to make a good return on investment while you serve those customers. To do that, you compare your Company's returns to that of the competition and then put a cost structure in place to beat them.

Control of costs requires knowledge and judgment. If your personal income were reduced, you probably would know where to start reducing your spending because we all carry some knowledge of where we spend money and how that spending has grown as we have become more affluent. You would consider your major categories of expenditures. You would set a limit on each of those categories of expense based on what you think you must spend to live within your income. Then, if you still had not reached your new target for spending, you would examine each of your expenses in a colder light and cut back spending on some categories more than others.

Controlling costs in a company is much like controlling your own spending. You need someone to tell you how much you can spend. Competitors do that for you. They tell you how much you can spend by competing against you for customers. This competition produces revenues and costs for you that produce your financial results. You use the performance of competition to quantify your cost management objectives.

Once you have quantified your cost objectives, you begin working to reach them by using competition again. You evaluate their visible advantages compared to you in the rates of payment they make for their component costs and in the approaches they take to the management of key functional costs. In some cases, you may close your cost gap by emulating these competitive advantages.

The road toward your financial goals continues as you improve your mix of sales to your best customers. As you increase your proportion of sales to your Core customers and decrease the share of sales going to Non-core and Near-core customers, your margins increase.

After matching the visible cost advantages of competition and improving the proportion of your sales to Core customers, you may still find yourself short of your preferred cost and return destination. You must cover the remaining distance by creating more Productivity and Economies of Scale in your business.

The Diagnose/Costs section of StrategyStreet helps you evaluate your Productivity and creation of Economies of Scale by suggesting new measurements to use on your cost structure. First, you create countable measures of costs and customer benefits. Second, you use these measures to evaluate the Productivity and Economies of Scale of each cost function in the Company. Third, you measure the Economies of Scale the Company is creating with employees having higher compensation levels. With these tasks behind you, the Company is well prepared to create new Economies of Scale.

The approach and analyses we use in the Diagnostic section of StrategyStreet complements the Company’s current cost management system. In many cases, the Company may already compare itself in some detail against its competition and benchmark its desired financial performance against them. Many fewer companies, however, set about measuring and managing, in an explicit fashion, Productivity and Economies of Scale. The approach we discuss here converts the elements of the Company’s cost structure and its Value for customers into physical measures and then evaluates the current Productivity and Economies of Scale the Company produces.

We begin our cost management diagnostic by setting our financial goals and identifying the obvious ways to get there.

Summary Points Next: Part 1: Quantifying Cost Reduction Objectives