A more enlightened approach to cost control: cost control must be prioritized and synchronized with the company's strategic plan in order to sustain working capital in tough times and drive growth when conditions improve.
"Are we there yet? I don't know--I'm measuring the temperature and ordering fewer office supplies." And so it goes for companies that think cost control, metrics, key performance indicators (KPI's) and dashboards can solve problems and sustainably improve results without a cohesive strategic plan.
Worse yet is a belief that cost-cutting metrics and other controls can somehow replace the need for a clear strategic direction. This belief not only serves to distract company management from making sustainable progress, but also, and more significantly, undermines the firm's credibility with customers, employees and stakeholders.
A structured approach to strategic planning is essential for coordinating a firm's short - and long-term mission, vision and actions, which includes cost controls. While a successful strategic planning process can serve to set the direction, realizing long-term goals necessitates a tight linkage of strategic, tactical, financial and cost-control plans.
Cost-control decisions, a concern for all businesses especially during tough economic times, must be prioritized and synchronized with the strategic plan so resources (labor and working capital) are sustained in bad times and can drive growth when conditions improve. If they are not, the company runs the risk of cutting costs in areas that are vital to the company's present and future success.
Aligning Budget and Control Systems
When decoupled from strategy, cost-control decisions and targets often result in actions that are heavily influenced by short-term financial or other non-strategic factors. Research indicates that budgets and control systems are rarely strategically focused. As a result, they concentrate on cost reduction rather than enterprise-wide value creation. Moreover, 70 percent of companies believe they choose the right strategy, but fail to execute it properly.
This is often due to the use of management systems and cost controls that do not align strategic goals with organizational targets. The cost controls and metrics against which they are measured promote short-term profit-and-loss focus over long-term value creation.
Alternatively, when the planning, budgeting and control processes are grounded in strategy, financial resources are directed toward the areas or initiatives that create maximum value. The alignment of strategic planning with budgeting and cost-control systems helps ensure that once an actionable strategic plan is created, it drives budget-related decisions, performance measurement systems and operating targets.
A significant challenge in aligning strategic planning and cost control lies in linking long-term strategic goals and short-term operating activities, including specific cost-control targets. Ideally, a structured, long-term strategic plan helps focus efforts around the most potentially valuable initiatives, while budgeting and cost-control processes are added to ensure the proper resources are allocated to best fund those initiatives.
However, difficulty in quantifying strategy statements, along with pressure to perform against short-term financial goals and earnings estimates, often results in less emphasis on long-term strategy. As a result, a company's resource allocation decisions become disconnected from the most valuable strategic initiatives.
A structured strategic planning process, driven by critical thinking and dialogue, will cause businesses to think systematically about competitive positioning. From there, the process should create a clear line of sight from market requirements to plans, more actionable outputs and comparability and alignment across business plans.
Explicitly articulating the progressive links from long-term strategic initiatives to short-term operational activities and financial goals is a fundamental step toward creating an actionable strategic plan supported by current resource allocation decisions.
If cost controls are to be useful for strategic purposes--that is, to help managers increase the likelihood of achieving strategic goals and objectives their designs and use must follow a clearly-defined mission statement and set of competitive objectives.
There are many valid approaches to strategic planning--see the tables on page 66 and above for summaries. Note that all structured strategic planning processes contain measurement systems and metrics to measure success. The chosen strategy in turn determines the firm's critical success factors:
* Delivering superior product and service quality and achieving high price recovery for firms that are pursuing differentiation strategies; or
* Achieving economies of scale, improving productivity and delivering threshold product and service quality at low prices for firms that are pursuing low cost leadership strategies; and
* Informing choices (operating choice variables) regarding the design of products and configuration of operations that drive costs and revenues.
BALANCED SCORECARD APPROACH MISSION What is our purpose? What do we do? VISION What is our picture of the future in three to five years? STRATEGIC What performance lenses should we use to evaluate PERSPECTIVES results? STRATEGIC What are our main focus areas (pillars of THEMES & excellence)? What results do we need to achieve? PERSPECTIVES OBJECTIVES What continuous improvement activities are needed to get results? STRATEGY MAP How do we create and improve value to customer and stakeholders? PERFORMANCE How will we know if we are achieving the results we MEASURE AND want? TARGETS STRATEGIC Specifically, what projects and programs will INITIATIVES contribute to the desire results?
Regardless of the planning approach used, once a company's critical success factors have been identified, a unique set of performance measures (for example, cost controls) must, if they are going to be relevant in a strategic context, be related to the firm's mission and strategic framework, selected strategies, critical success factors and operating choice variables.
For example, if a company is pursuing a differentiation strategy, cost cutting that negatively impacts product quality (cheaper materials that don't meet specification) or service support (reduced field service coverage or customer care attention) could be counter-productive and inconsistent with the firm's value proposition and pricing strategy.
Conversely, if the company, whose strategy is based on improved productivity and being a low-cost provider, is unwilling to invest or maintain its investment in technology, systems and process controls, it could fail to streamline these processes and thereby reduce direct labor costs.
Pursuing a low-cost provider strategy without the requisite resources and tools is an invitation to no man's land--unacceptable margins without the strategic ability to either raise prices or cut costs.
Strategic clarity and targeted cost controls, within the bounds of a structured strategic plan and consistent with the firm's critical success factors, are prudent and necessary. A decoupled or scatter-shot approach to cost control can prove to be not only misguided, but also can significantly dilute the management's effectiveness and cause long-term and potentially irreversible harm to the firm.
RELATED ARTICLE: MONITOR GROUP
Ask Tough Questions Frame
Answers To Address
* What are specific business unit aspirations in terms of market leadership, share, penetration, customer loyalty and brand image?
* Three years from now, why are you the company of choice for your various customer groups?
* Operating margin
* Earnings growth
* Industry-specific metrics
WHERE TO PLAY
* In three years, how will your customer base change?
* What types of customers will you gain or lose?
* In which specific markets will you play?
* In which markets will you riot play?
* How will the types and mix of products be different from today?
* How will distribution channels differ?
* Customer segments
* Geographic areas
* Product types
* Distribution channels
HOW TO WIN
* What are specific features of your future products?
* How do these differ from today?
* How do your major competitors look in three years?
* In which areas are they dominant?
* Value proposition to target customers
* Sources of competitive advantage
CAPABILITIES REQUIRED FOR SUCCESS
* In which core capabilities must you excel, compared to your competitors?
* What processes or functionalities are necessary in three years, but are currently present to a lesser degree, or absent altogether?
* Critical competencies
* Required investments
PERFORMANCE MANAGEMENT SYSTEMS REQUIRED
* How will you measure success in creating value for the customer?
* What incentive programs are necessary to promote this value creation?
* Metrics to judge success
* Reward systems
* Feedback mechanisms
David Douglass (David.Douglass@TatumLLC.com) is a CFO partner with Tatum who has served as CFO, president or COO of a variety of companies ranging from very small (early-stage through IPO) to very large domestic and international companies and nonprofits as well as public reporting companies involved in fundraising and merger/acquisition transactions.