Cost reduction

Such a contrast

I was looking out my office window near Charles de Gaulle airport in 1982. The phone rang just as I was watching Concorde take off on its daily flight to New York. In hindsight, the contrast was complete. The roar of the afterburners was the symbol of no-expense-spared extravagance. The phone call was the start of the opposite: my first participation in a major corporate cost-cutting exercise.

I was a cost reduction expert

I was no stranger to cost reduction. I graduated as an Industrial Engineer in Ireland in 1977. There was amazing demand at the time, and my entire class had signed employment contracts before our final exams. High-tech did not exist in its current form. Following a student project and summer work at Imperial Chemical Industries, I had an ICI mentor; R. T. O’Kelly, an Englishman known universally simply as RTK. He advised me not to start my career at ICI, but to choose a company that was growing quickly and would let me work in other countries. Remember this was before high-tech. A few weeks later, I signed my contract with Blue Bell Apparel, the parent company of Wrangler Jeans, among other brands. A week after starting, I found myself in rural Commerce, Georgia with a stopwatch in my hand. Industrial Engineers were measured on saving at least 15 times their pay. I got good at it while I lived and worked in the USA, Ireland, France, Italy, Spain and Scotland, all in the space of seven years. I became an expert in warehouse automation, which turned out to pay very well in high-tech, but that is another story.

McKinsey Overhead Value Analysis

The Parisian phone call in 1982 was from my boss, asking me to attend an introduction to McKinsey’s Overhead Value Analysis of our company, for which I was to be a project lead. The work was my first and purest customer-centric cost reduction exercise. Keeping customers at the center of your cost-reduction work is challenging, at best. Employees who are worried about being able to feed their families don’t care much about customers.

Communication and perceptions of fairness

Communication of customer-centric cost reduction is also challenging. A coherent customer-centric message about priorities will be something like this: “Since we must preserve or increase spending in departments A, B and C to ensure great service to our customers, we will need to cut even more in departments X, Y and Z, which have no direct customer impact.” This is a much harder message to deliver than “In the spirit of fairness, everyone’s budget will be cut 20%.”

It took me years to understand how to keep customers loyal while cutting costs

Over the following years I learned different methods of cost reduction and how to maintain or improve customer loyalty as you design and implement the reductions. It is not easy. I have managed programs that made things much worse for customers too. I did not do it deliberately. I just had nobody around me with relevant experience and advice. It is not easy. That is why I wrote Customer-Centric Cost Reduction; to save you a lot of the pain I went through.

McKinsey Overhead Value Analysis description

Overhead Value Analysis or OVA is rather ancient and excellent McKinsey cost reduction methodology. Back in 1982, times were suddenly tough for Blue Bell Apparel, the parent company of the Wrangler brand. I have to say I don’t know whether this was due to the market, or a proposal to take the company private. In any case, the corporation wanted to reduce costs. OVA is no longer mentioned by McKinsey on their website, though it may exist under a different name.

The OVA process

Using OVA was my first and most meaningful experience with a process in which the Golden Rule was applied: “Those who execute have to do the planning.” This avoided the all-too-common issue where plans are prepared by one team, passed to another team for implementation, and the second team rejects them, protesting that the first team understands nothing about what they (the second team) do.

After deciding which overhead functions will be targeted, each team leader is given an overall objective: find ways of reducing the work by 40%. The actual objective is a 15% reduction. McKinsey’s experience at the time was that companies who target 40% wind up achieving 15% on average, either because some reductions are too extreme, or because some are really cost shifts, moving work from one department to another.

I continue to admire this design. The 40% target means teams have to think differently about their work, while the underlying 15% real-world goal means that solutions that are quick to implement can be prioritized. This is what happened for us in practice. A little more than 15% savings were achieved while the McKinsey team were engaged. There were additional ideas among the 40% list, such as moving to a smaller distribution center, that took more time, and were achieved up to two years later.

Who was overhead?

While it may seem odd, the definition we used was not what you might expect. I worked in the leadership team for France, the Benelux and Italy, based in Paris. The team leaders who led the work were explicitly told that they themselves would not be eliminated. Everyone else was overhead, with the exception of the sales people who actually called on customers.

The first step

After we were all introduced to the program, the first step was the analysis of how everyone spent their day. The methodology was quite clever. It used individual face-to-face interviews. Each person was asked what work they did, what was the output, who received the output, and what proportion of their time was spent on each activity. Everyone’s time added up to 100%, no matter how many hours a day they worked. At its simplest level, the output of an individual OVA analysis would look like this today:

The most interesting step

Personally, I found the second step to be the most interesting. We then spoke to the people who received the deliverables mentioned in the tables from the first step. The questions were easy: Do you use the deliverable? How often do you get it? How often do you need it? Who else uses it?

There was one painful example: a person in Italy spent all of her time preparing a weekly sales report. This was printed and sent to the regional sales leader in Paris. When we spoke to him, his answer was “I don’t use it. Is it sent to anyone else?” Unfortunately for the Italian lady’s job security, it was not. This had been going on for about two years.

The 40% reduction goal

The following step was to examine all the work and deliverables, looking for opportunities to reduce them by 40%. The McKinsey team placed the emphasis on trying to completely eliminate all deliverables that were not absolutely necessary, then decreasing the content or frequency of what remained. I found this a realistic approach.

Suggestions were categorized by impact and ease of implementation. Since the true objective was a 15% reduction, things that would make life easier in one department but create additional work in another were quickly eliminated. The 40 to 15 gap also meant that we did not have to pay extreme attention to avoiding different departments proposing the same reduction ideas. There was a little of that, and the targeting method meant that it did not matter.

Learnings

OVA was my first experience with a major corporate cost-reduction effort. I embraced the process and learned a lot. I also learned what happens in an organization when almost everyone (correctly) feels their job is at risk. New rumors circulated every day. Good people were proactive and got jobs elsewhere, rather than taking the risk of staying.

Only the sales teams were happy, since they were explicitly the ones to benefit from the reductions. Since they were also the people who spoke the most to customers, they were able to keep the customers on our side, and we continued to have the top market share in Europe.

I also learned about the positive power of what I can only call paternalistic management. For example, the division leader, David Hayes, tried his best to find out about the personal situations of each employee who was on the redundancy list, before it was communicated. He learned that one of the Parisian warehouse workers had difficult family circumstances and lived in a small trailer in a trailer park. We found a different person to let go; one who would have an easier time getting a new job in the area. My own personal paranoia made me suggest eliminating my own job, a proposal I accompanied by a request to move to a new green-fields distribution center project in Spain. That experience is a whole other story.

Conclusion

There are various ways of ensuring customer loyalty during a cost reduction exercise, and of ensuring the support of at least part of your workforce. We explore them in more detail in our book Customer-Centric Cost Reduction, of course. Your comments and suggestions are welcome, as always.