Cost Management: The So-Called AIM & DRIVE® Process

Jimmy Anklesaria (The writer of Supply Chain Cost Management) asked Gene Richter (1937–2003, head of Corporate Procurement at Hewlett-Packard), what his goals were, it was not surprising that he said:

 

The only way we can stay in business and be competitive and profitable is by following these five steps: 

  1. Reduce costs
  2. Reduce costs
  3. Reduce costs
  4. Reduce costs
  5. Reduce costs

 

There aren’t many questions in the world of business with definite answers. But try this one: ‘‘Is your company facing increasing pressure to reduce costs?’’ The answer is probably a resounding ‘‘Yes! You bet!’’

It makes no difference whether you work for a Motorola or Nokia, Hewlett-Packard or IBM, Chevron or BP, Ford or Honda. The response is identical—cost reduction is imperative to long-term survival.

It really doesn’t matter whom you ask: engineers or buyers, production or sales people. Even top executives fall in the same boat.

Everyone is out to reduce costs. Go ahead and ask these people the next question, ‘‘How many of you truly understand your costs?’’ You would think you had hit the pause and mute button on your TV set. No movement or sound. Repeat the question and ask this time for a show of hands: ‘‘How many of you can honestly say that you understand and know the costs associated with what you do in your organization?’’

Over 90 percent of people feel the pressure to manage costs and yet, fewer than 10 percent of them can honestly say that they understand the costs associated with products, services, or equipment that they are either buying or selling. It seems that managers in most companies are sending their troops out to conquer an unknown enemy. Is it possible to reduce and manage something that most players (employees) don’t even understand?

Sadly, most companies embark on a journey of managing costs only when they suffer a major loss of profits or market share. How many times have we heard CEOs make public announcements that the company will aggressively pursue a goal of cost reduction in order to be globally competitive? Then the scramble begins. Managers hurriedly schedule meetings and bark out orders. Subordinates look at one another in amazement. How can someone in a responsible position give such a stupid order? Then, they go off and do nothing, or find ways to modify the orders, or think up excuses and exceptions.

The problem isn’t that costs can’t be managed. It’s that costs are extremely difficult to accurately define. Often, it is a question of conflicting definitions to the term ‘‘costs’’ that cause confusion and illogical actions. Alas, most executives fail to differentiate between cost management and cost cutting. Slashing personnel, travel, and training or R&D budgets is certainly not the way to be more competitive in the long run. It may work for state and federal governments, but not for globally competitive firms. Sure, it helps in the short run but ask yourself, ‘‘Is this sustainable?’’ Just look at GM and Scott Paper.

What we need is a well-thought-out, understandable, and implement-able strategy to reduce costs. The purpose of this book is to provide you and your company with a winning methodology to manage and reduce costs through the supply chain. It won’t be easy. There will have to be major sacrifices and compromises, shifts in paradigms, and changes in policy. No one likes change—but change you must if you want to stay competitive. The good news is that proactive companies like IBM, HP, Motorola, Nokia, T-Mobile, Texas Instruments, Philips, Chevron, BP, Anglo American, Mercury Marine, Capital One, Nordstrom, and a few others have already embarked on the journey of Cost Management. For these companies, taking the first step was half the battle.

If we don’t change our direction, we’re likely to end up where we’re headed. Think about where your company is heading. Do you have a clear road map on how to sustain revenue growth and implement genuine cost reduction strategies? Or are you one of those executives who feel that your job is to produce the ‘‘wow factor’’ with short-term results and get the heck out of the company before all hell breaks loose?

 

The AIM & DRIVE ® Process of Cost Management

Successful cost management initiatives often start with a kickoff meeting to make sure everyone is on the same page.

Well, here are some basic steps that could help realize those savings. Most companies are pretty good on the negotiation side of cost management. Unfortunately, although that brings them a good way down the path, it is not enough. At some point, there must be a change of gears as a company moves beyond negotiation and looks to breakthrough solutions to become competitive.

 

Before the Breakthrough

Even before a company begins the serious work of changing their procurement process, it will no doubt have taken some or all of the following steps: leveraging volume, analyzing price, and analyzing costs.

 

Leveraging Volume

Now, don’t fall off your chair when I say that many companies have spent millions of dollars on boutique consultants who spend hundreds or thousands of hours studying the procurement process of the client only to come up with a brilliant idea: ‘‘You need to reduce your supply base and give more business to fewer suppliers.’’ It’s called trading volume for price and is clearly one of the oldest negotiation tools. Seriously, do you need a consultant to tell you the obvious? However, if you have not already done so, then it makes sense to consider how you can best leverage your spend to take advantage of volume discounts.

 

Analyzing Price

In some cases purchase price is the only differentiator between competing suppliers. In such cases there is no need for detailed cost analysis. E-auctions are becoming increasingly popular with many companies. However, there are other techniques that need to be used, such as Competitive Advantage Measurement Systems (CAMS ), which measures a firm’s prices against a market index. Take the case of two category managers, one for travel and the other for metal castings.

Suppose the target price reduction was 6 percent. The travel manager shows a cost increase of 3 percent while the metal castings category leader shows a savings of 9 percent. What do you think would happen in most companies? The travel manager would probably be fired while the metal castings manager would be promoted or given a nice bonus.

Now, what if you’re told that during the same period, metal casting prices went down 15 percent while travel prices went up 8 percent? The metal castings manager just gave up 6 percent of competitive advantage while the travel manager helped the firm achieve an advantage against the industry of 5 percent. That’s why it’s so important for companies to monitor prices paid for all major categories against carefully chosen market indices. Every three years you may need to do an ‘‘absolute competitiveness’’ study where you can benchmark your prices and processes against a carefully selected group of similar size companies in your industry as well as other industries.

 

Analyzing Costs

As we saw earlier, you cannot manage what you do not understand. Cost analysis is necessary to understand the cost structure in the supplier’s price in order to determine whether the price is fair and reasonable.

There are several kinds of cost models:

  1. Should Cost models, which range from industry cost profiles to detailed process cost models
  2. Price Discipline models, which are used to determine a supplier’s request for a price change
  3. Total Cost of Ownership (TCO) models, which represent the present value of all costs incurred during the life of a product, service, or equipment

 

All these methods of negotiation can help a company get closer to the cost savings target set by their respective managements. The question is what to do after that. If your Chief Procurement Officer achieves the long-term target with one or more of the previously listed negotiation strategies, it simply means that the target wasn’t high enough. Hence, one must plan for the next stage of cost management: breakthrough solutions.

Before we get into the process, it is necessary to ponder on how we got into this mess in the first place. History tends to repeat itself, so a walk down memory lane should serve us well.

 

Historical Perspective

1950s: The Golden Age of American Manufacturing

After World War II, apart from the United States, the rest of the world spent more than a decade rebuilding infrastructure. While the United States prided itself in being the foremost industrialized nation, Japan, West Germany, France, Great Britain, and other countries in Europe and Asia were investing in new machinery and technology. Most of their purchases were from the United States. The strong, affluent U.S. market gobbled up whatever little these countries produced for export. he 1950s were indeed the Golden Age of American heavy industry—from equipment to planes, trains, and automobiles.

 

1960s: The Rest of the World Catches Up

In the 1960s, while America was ‘‘high’’ on Elvis, the Beatles, Woodstock, and marijuana, Europe and Asia continued their march toward World Class Manufacturing. Still, the United States reigned supreme. The rest of the world was merely catching up ‘‘with our monetary help and technology,’’ thought most American industrialists. No one cared to observe that while the average American firm used machines that were decades old, mostly reconditioned, Japan and Germany were making giant leaps in manufacturing. Using newer equipment with a dedicated and highly motivated workforce, productivity improved along with quality. The roots of ‘‘Global Competition’’ were beginning to take hold in the yet thin soil of these vanquished World War II countries.

 

1970s: The Dreadful Curse of Competition

Then came the turbulent 1970s. Apart from the Oil Crisis of 1973 and double-digit inflation, American consumers were bombarded with low-cost, high-quality goods. From automobiles to ships, hi-fi equipment to heavy machines, watches to electronics—the choices were unbelievable. To top it all, these products were not even built in the United States. Imagine that! Yes, the world had become one big market and the consumers loved it. Not everyone thought life couldn’t get any better. In boardrooms across the country, American executives were licking their wounded pride and looking for solutions. After much blaming, benchmarking, and brainstorming, a potential answer to their problems was pulled out of the hat . . . quality!

 

1980s: Can Quality Be the Answer?

And so America marched into the 1980s with renewed confidence in its ability to lead the industrialized world from the front. Companies that earlier shunned the gurus of Quality, atoned for their sins and unabashedly began to woo the great stalwarts like the late Dr. W. Edwards Deming, Joseph Juran, Dorian Shainin, and Philip Cosby. The quest for Total Quality Management (TQM) had begun. Everyone from the CEO to the line worker spent hours attending courses on TQM, Design of Experiment (DOE—a true winner), Statistical Process Control (SPC—the tail that wags the dog), Just-In-Time (JIT), Quality Functional Deployment (QFD), and Concurrent Engineering (CE). With the frenzy to educate its workforce, it’s amazing that any company had time to implement quality. The Malcolm Baldrige Quality Award was initiated to emphasize the need to achieve and spread the gospel of Quality. Companies like Motorola, Xerox, Cadillac, Solectron, Zytec, and others drove the message of total quality, not just through their respective firms but also through their much-reduced supplier base. Today any company that claims to be competitive will agree that most, if not all, suppliers are firm believers and practitioners of Total Quality. The non-performers have fallen by the wayside rather unceremoniously. The critics of American quality would do well to look at Motorola’s Six Sigma, Xerox’s Leadership Through Quality, Tennant’s Zero Defect Program, or the strides made in the area of product quality by Hewlett-Packard, Harley-Davidson, Herman Miller, and Texas Instruments, to name a few. While there is a long way to go, quality can no longer be used as a scapegoat if a firm is not competitive today.

 

1990s: We Can Reengineer Anything

Then came the 1990s, which could best be described as the decade of reengineering and slashing. For the first time there appeared to be a sensible approach to managing costs through the supply chain. There were gurus like Michael Hammer, who preached that processes had to be reengineered and simplified if firms were to be more competitive. Companies like IBM, Texas Instruments, Hewlett-Packard, Kodak, DuPont, Deere, Honda, and Philips, for example, discovered that working with their key suppliers led to process improvement and breakthrough cost solutions. Then again, there were the likes of GM and Scott Paper who reversed the gains of active supplier involvement in managing costs, with their short-term focus on slashing costs. The very suppliers who provided leading edge technology and quality were mercilessly dragged through the dirt in order to squeeze a couple of percentage points off their prices. The macho price slashers called this ‘‘brinkmanship.’’ In hindsight, some would call it ‘‘stupidity.’’ As we closed out the century the focus was on e-procurement. Or just ‘‘e’’ something, although most firms didn’t know what they really wanted, but ‘‘e’’ sounded ‘‘cool.’’

 

The Twenty-First Century: The Power of the Internet Emerges

At the turn of the century, emerging nations like China and India began to pose a competitive threat to the United States, Europe, and Japan by providing the world with a highly educated workforce at a third the cost. With the Internet proving to be the great equalizer, India grew from being a cheap place for data entry to a haven for business process outsourcing (BPO), design centers, biological research, software engineering solutions, and even medical evaluation.

The list will continue to grow as trade barriers come down not just in India and China but in Brazil, Russia, Bulgaria, and other eastern and central European nations.

So, here we are in the twenty-first century. What will differentiate your firm from its competition? Will it be technology? Or maybe it’ll be quality and reliability? Perhaps speed of delivery? Or excellent customer service? Or do you think your firm is the only one in the industry doing e-business? The answer, dear reader, is that nowadays, frequent technological breakthroughs, high quality, reliability, on time delivery, top customer service, and e-business are merely the prerequisites for being in the global race for market share. Today’s customer expects this from a supplier; rather, demands it. And there are enough firms around the world that have overcome the ‘‘preliminary rounds’’ of technology, quality, reliability, delivery, service, and e-business.

 

So why should they choose your firm?

If you went shopping for a mobile phone, your choice would be, among others, a handset from Motorola, Nokia, Samsung, Lucky Goldstar, Sony-Ericson, or Sanyo. All world class companies. All vying for your money. Which one will it be? In a few years the only differentiation will be cost. Companies that best manage their costs through the entire supply chain to bring you the latest technology, best quality with on-time delivery at a price lower than the others will take home the prize—your check. There’s no prize for coming in second.

Read also other cost management topic related below :

  • Cost Management: AIM & DRIVE® Process – The Eight-Step
  • Cost Management: The Story of Anything Inc.
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    Author: Lie Dharma Putra

    Putra is a CPA. His last position, in the corporate world, was a controller for a corporation in Costa Mesa, CA. After spending 15 years as a nine-to-five employee, he decided to serve more companies, families and even individuals, as a trusted business advisor. He blogs about accounting, finance and tax, during his spare time, and helps accounting students (around the globe) to understand the subject matter easier , faster. Follow him on twitter @LieDharmaPutra or add him to your circle at Google Plus Lie+

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