The Dangers of Short Term Cost Cutting: An Interview with Brad Power

With the economy in the doldrums and many companies cautiously approaching the year ahead – cutbacks, layoffs and cost cutting appear to be back on the agenda. But is there a right and a wrong way to make cost savings?

Brad Power, a consultant and researcher in process innovation, explains why he thinks many companies go about cost cutting in the wrong way, arguing that companies need to start thinking long term about improvements that cut the waste (rather than people's jobs). In this interview with PEX Network, Power argues that the "C-Suite need to understand that [cost cutting is] part of a strategy" and needs to be built as an "institutional capability to do it on a longer term and consistent basis" rather than a short term reaction to a problem.

Editor’s note: this is transcript of a podcast conducted with Brad Power earlier this year. To hear the original podcast please go here: The Smart Company's Guide to Cost Cutting. This transcript has been edited for readability.

PEX Network: Isn’t cost cutting - which can come in the form of layoffs - a necessary evil in business, especially given the current economy?

Brad Power: Yes, when organisations have a decline in revenue, then they need to cut costs to maintain their profits. So, yes, cost cutting is necessary; the question is whether it needs to take the form of layoffs. Organisations such as Toyota try to make layoffs their last resort and so they try to re-deploy people who are free because of lower work levels to do other things, maybe develop new products, maybe to improve processes, and so they use layoffs as a last resort. But, of course, it may always be necessary, if an organisation is hit with an unexpected decline in the economy, or some other event that they haven’t really planned effectively for.

What do you see as the problem with the way that many companies go about cost cutting?

If companies don’t have an continuous improvement activity then in the good times things get fat because, to take a health metaphor, they lack a continuous fitness programme. In the good times they get overweight – fat – rather than following a regime that helps keep them lean all the time. So organisations that maintain an ongoing approach to improvement, even in the good times, are better prepared when there is a downturn.

So you’re saying that a lot of companies are quite reactive when it comes to cost cutting; they grow when things are good and then they just cut and slash and burn as soon as things get bad?

It’s like guardrail management - they’re veering from side to side instead of keeping the car in the middle of the roadway. It would be better if companies kept themselves fit all the time to be prepared for that rainy day.

Can you give us an example, of a particular company recently in the news, or any examples that you can think of to really help illustrate this, and why it doesn’t work?

The short term reaction example would be mostly in financial services. The European banks, of course, and in the US, companies like Bank of America had a fairly well publicised rounds of layoffs numbering in the tens of thousands that they would have to have as a result of their improvement activities. And the problem is that you see this, again, this veering of back and forth and to, and again the same with health metaphor, it would be like liposuction that they’re pulling people out. But, unless they change the underlying work, the concern would be that they would reduce the people, get the costs out, but they really haven’t changed the underlying work so the cost then will creep back. So the other downside of this kind of cost cutting is that when you do across the board head count cuts without changing the underlying work, you really haven’t changed the cost structure over the long term.

And aren’t there also problems in terms of employee morale and loss of knowledge from the organisation?

Exactly right. It’s also going to mean that people are fatalistic, demoralised and they’re not going to participate in cost cutting. You want the front line to participate in improvement in order to sustain improvement. If they know that the improvements that they come up with will be used for their own firing or to fire their friends and colleagues, they’re not going to participate. A big problems these layoffs is in effect on employee morale and their willingness to participate.

There’s been steady drum beat of doom and gloom that we’ve been getting recently about how we may be heading into a second recession. Companies are obviously going to have to make some cutbacks; what would you see as a better approach for companies to keep costs down?

In the short term, there may be nothing that you can do. If you’re a bank in Europe that all of a sudden is faced with a crisis, you’ll have to cut costs in the short term. But there are two good examples of situations where you can take a longer view. First, in the US health care reform will be legislated and will be rolling in over the next several years. A hospital or a pharmaceutical company can look at the projections of the reductions in reimbursement in that legislation and know that revenue is going to be going down by whatever it would be - say 5% - and take steps to cut costs. Given the advanced warning, they can afford to cut costs in a more thoughtful way. I’m currently working with a hospital, which is building continuous improvement into its way of working so that it can get cost reduction as a by-product of improving patient experiences.

The second example would be the future of defence spending, or even government spending in general. Currently in the US, all the talk is about needing to cut defence spending and there are some automatic cost cuts that are coming. As a defence contractor or a government agency, you need to cut to get ready for this reality - they may need to cut costs by up to 20%. So now you can do that in a more thoughtful way by improving the work, getting the work (waste) out and not waiting until the last minute when the only recourse is to cut heads.

Do you think there’s an improved way that C-suite executives should be thinking about their approach to operating costs and keeping costs down?

Well, there’s a classic challenge between the Wall Street view of making the quarter and the pressures of those C-suite executives to meet quarterly, monthly, or even weekly, performance targets around costs. There’s also the underlying problem that, in many cases, senior executives have such short tenure. The turnover of senior executives can be measured in a few years and, if that’s the case, they want to come up with solutions that work within that time frame. If, on the other hand, their view is that they’re stewards of the organisation over the long term, then they might make different decisions about building capabilities and building a better cost structure for the long term, as opposed to meeting a short term financial target.

What do you think it would take to both change the approach of the C-suite executives but also maybe change some of that underlying structure that encourages those weekly, monthly, quarterly target settings and a short term emphasis on costs?

If an organisation believes that low cost is its strategy – for instance Walmart, Ryanair, or South-West Airlines - then you want to build an ongoing capability for cost reduction into the way you operate and the way that your employees are rewarded and in the kind of people you hire. The C-Suite need to understand that it’s part of a strategy, that it’s a capability, and it’s an ongoing thing, and not just something you stumble onto and realise you’ve got a problem. You build cost reduction as an institutional capability to do it on a longer term and consistent basis.

What companies do you think are really taking the right approach in terms of attacking their cost structure, and could you elaborate on why you think they’re taking the right approach?

Process excellence or operational excellence is about consistent low cost, reliable operations. Many companies say, we want to be the "Toyota" of our industry. What they’re saying with that is they want to have continuous improvement, they want to have everybody looking everyday at ways to reduce costs and improve the way they work. That becomes the strategy and the way that the companies compete. So Toyota’s an example of that and as I mentioned, Walmart. I’d say it’s any company where you say, I buy from them because I know that I’m going to get consistent low cost reliable service.