Why we often fail to hit planned cost reductions
Direct experience and survey after survey demonstrates that organisations are generally poor at the delivery of projects. It is also normally the case that unless cost reduction and efficiency is in the very DNA of the organisation, cost discipline is inconsistent to poor. Therefore, it should be no surprise that bringing the two together in a cost reduction programme, if often a recipe for a poorly delivered range of activity that falls well short of expectation and requirements.
This article looks at some of the typical reasons why reality falls short of expectation, and some of the mitigations. In essence, take the early programme definition stage seriously, design the programme to address each source of leakage, and simultaneously aim higher than the required target, recognising that there will be some leakage no matter how hard you try.
The graph below shows a series of typical 'losses' that occur.
| Issue | Description |
| Double counting | Two or more cost reduction initiatives overlap, and hence duplicate the possible savings. This is particularly prevalent in the early stages. The double counting can occur in two ways. First, double counting of the financial outcome (eg reduce IT contractors costs by 50%), or double counting of the change in the underlying cost driver. It is important to remove the double counting as soon as possible. |
| Incompatible | Individually, the interventions may make sense, but in aggregate be incompatible. For example, in a manufacturing environment, a headcount reduction intervention may involve reducing the quality control team by 10%. Another intervention may seek to reduce rework and warrantee costs by improving quality control and increasing the quality control team by 20%. |
| Not feasible | Some identified interventions may be excellent in theory, but simply not feasible, or at least not feasible in the current situation. This is a double edged sword, as often possible interventions are discarded too easily without real assessment of innovative delivery or commercial models, or more detailed cost-benefit analysis of the necessary investment to save. Conversely, many interventions will continue to be considered due to an unreal assessment of feasibility, savings and timeline. |
| Mis-aligned Or ringfenced | This refers to interventions that whist on paper are able to save money, they ultimately damage core, strategic capabilities of the organisation; are so tangential to the main direction of the business that there is a significant opportunity cost, or are simply defined as out of bounds by the leadership. |
| Cost To implement | Obvious, but sometimes overlooked, the analysis needs to calculate the net savings, not the gross. Ideally each intervention should break out the cost and benefits, so as to understand cash flow timing, and prioritise the ROI/payback. |
At this stage we should have a portfolio of possible interventions that are strategically aligned, compatible, deliverable, costed and mutually exclusive. We next need to recognisopte implicit human nature to interfere and to be overly optimistic.
| Political interference | At an individual, functional, divisional and organisational level, there will often be politically (small and large p) motivated reasons why proposed cuts cannot possibly take place. Issues such as pride, perceived power and control, size of team, historical precedence, and personality (he who shouts loudest) can have a disproportionate impact on the end result. As an aside, the Geddes report (an Independent panel set up by the Prime Minister Lloyd George in 1922 to make recommendations on reducing public sector expenditure), recommended cuts totalling £100m (20%). The individual and departmental manoeuvring ultimately reduced this to £64m, of which only £54m could be implemented in the desired timescale. |
| Optimism bias | There are many psychological traps including the anchoring, framing and sunk costs traps. All are relevant, but perhaps the most important is the fundamental optimism bias in human evaluations. Typically this results in an overstatement of benefits (bigger, earlier, longer lasting) and an understatement of implementation timescale and costs. |
Initiative | A major barrier to the delivery of planned interventions is often initiative overload, as a frenzy of official and unofficial initiatives vie for the attention and action of the workforce; coupled with poor delivery of the major programmes and projects. This will often result in an ever tightening grip of 'control', taking away even more time from those tasked with delivery. |
| Mis-reporting | If you have anything other than a single, central, audited reporting regime, you run a high risk of individual business units and functions self-reporting selective positive highlights of their achievements that ultimately cannot be reconciled with the net financial reports. |
| Unintended consequences | There will be unintended negative (and positive) consequences from the interventions. These need to be identified, so that sum of the individual interventions can be reconciled with the overall net organisational impact. |
Mitigation
As we have seen there are a myriad of reasons why the outturn will differ from the plan. There are three fundamental approaches to addressing these issues.
- Recognise the issues and seek to mitigate each individually
- Implement the right processes, structures and most critically have the right people in charge, to collectively address the issues
- Recognise that no matter how hard you try you will never eradicate the losses, and consequently build in an overarching 'leakage' adjustment factor
Taking the latter first, as a general rule we would recommend using a leakage factor of at least 30%, if not 50%-70%, particularly earlier in the process or under higher intrinsic uncertainty. If the factor is 50%, this means that an initial list of cost reduction interventions delivering say £10m of savings, will only translate into £5m of actual savings. Therefore, if the target is £10m savings, you need to start with a potential for £20m. For clarity, this leakage is not from a long list, 'brainstormed' in a workshop - in that case the leakage factor could be 80%-90% - but a more rigorous filtered list making up the provisional programme plan. This contingency should be centrally managed, and clearly used to manage external, senior management and other internal expectations.
The good news is that the many issues listed above can be addressed and minimised.
| Issues | Mitigations |
| Double counting | Common data source, definitions, and baseline case |
| Incompatible | Review planned interventions for potential inconsistencies and incompatibilities in direct activity or underlying assumptions |
| Feasibility | Independent and peer assessment of feasibility and key delivery risks |
| Mis-aligned or ringfenced | Assessment, clarity and agreement on strategic direction, core competencies and 'ring-fenced areas |
| Cost to implement | Ensure all interventions have defined benefits, costs, scope, assumptions and risks, and for larger interventions a full (but light touch) business case |
| Political Interference | Ensure data and evidence based decision making |
| Optimism Bias | Recognition of the main psychological traps |
| Initiative overload and poor portfolio, programme and project management | Recognise that serious cost reduction is not a bolt-on the existing activity set |
| Mis-reporting | Don't rely on just self-reporting. Demand evidence |
| Unintended consequences | Minimise by ensuring proper and realistic analysis in the first place |
In summary, the principal mitigation is a healthy recognition of the issue, and use of a small, independent central team at the heart of the programme. They must have a pragmatic but challenging attitude to the programme, be supported by the right data, and empowered to influence and make decisions at the most senior level. In addition, aim high to ensure the ultimately delivered benefits are what you need.
© 2011 Moorhouse.
