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Are Your Costs Too Low? Perspectives on the Management of the Cost Base
Any fool can cut costs – and most do.
Within a day of acquiring Cadbury, before the ink was dry on the contract, Irene Rosenfeld, Kraft’s CEO, was announcing $2 billion of cost cutting. How utterly predictable! How depressing! How unimaginative! But most important, how puzzling!
Costs are not the basis of a strategy, but the result of putting it in play.
You pay £11.4 billion for a thriving company and the very first thing that you choose to announce are cuts. How on earth can Kraft know that Cadbury’s costs are too high rather than too low? What evidence does Kraft have – that presumably the Board of Cadbury either did not have or that it misinterpreted – to demonstrate that Cadbury has for years been systematically overinvesting in, say, new brand development or advertising or product quality or working capital or wages?
ON COST STRATEGY
When you acquire a company – particularly if you have Kraft’s wretched track record of stodgy growth and insipid innovation – presumably you buy it for its potential to inject some imagination, energy and leadership into he system – not simply to become another victim of your own malaise. Wouldn’t it have been wonderful if instead Rosenfeld had announced: “We’re immensely proud of becoming the new owners of Cadbury and the enthusiastic stewards of its future success. We bought it because it is the best FMCG business in Europe. We bought it because it is a better, more talented, more innovative company than our own. With immediate effect, we are investing $2 billion in 4 highly innovative, global projects that will be designed, led and managed by the existing Cadbury management. We want to draw upon this talent, to learn from it, and to rediscover for ourselves the difficult and rare art of new brand development. No one in Cadbury will lose their job. On the contrary, we are investing $25 million over the next three years in a development initiative to make even better use of the assets and skills of Cadbury that we believe were neglected by its management over the last 20 years. The Cadbury cost base is simply far too low. In our eyes, the company woefully underinvested in its extraordinary people and as a result surrendered market opportunities that we would say truly “belonged” to Cadbury. Over the next 5 years, as Kraft makes up for past shortfalls in capital investment, we will see Cadbury achieve the success that it deserves.” My point is not that Kraft should necessarily add to Cadbury’s cost base (Irene Rosenfeld may well be doing the right thing) but merely to argue that in business generally there is a pathological bias in favour of cutting costs and against adding to costs – and that there can be no rational basis for this bias.
A cost strategy is a contradiction in terms. If it is a strategy, defined as a unique way of adding value, then costs are simply a measure of the monetary effort required to execute it; if cost is the focus of attention, then strategic thinking is superfluous. All that is required is the determination to cut costs. Toyota is not the cost leader in its industry because of the ruthlessness of its cost cutting but because of the radically original assumptions underpinning its production system. Its costs are the outcome of its operations strategy, not vice versa. This strategy has involved nothing less than the wholesale reinvention of the technology of mass production. Costs are not the basis of a strategy, but the result of putting it in play. If, when executed, the strategy proves to be uncompetitive, it is invariably the strategy that is flawed, not the costs that are too high. The most prevalent source of corporate failure is management’s conviction that their costs are out of line rather than that their strategy is misconceived. The majority of firms that are destroying wealth are doing so by focussing their attention on reducing their cost base rather than reinventing their strategy. Napoleon argued that it was a poor general who relied upon the bravery of his troops to win battles. In the same vein, we shall suggest that it is a poor CEO who relies upon the efficiency of his operation to earn economic profits. All genuine strategies, by definition, entail differentiation; but cost cannot be differentiated. Costs are different because strategies are different. Thus, the choice of strategy precedes the estimate of costs. Questions about performance concern not the magnitude of the cost but the strength of the strategy. Costs are the inputs required to achieve an output. The choice of output is the task of strategy. Since outputs, in order to be competitive, must be unique, it makes no sense to compare the costs of competitors. For example, comparing Porsche costs with Ferrari costs, or even Volvo costs, is meaningless. The only competitive comparison worth making is between the strategies of these companies. The only cost comparison worth making is between each company’s cost base and the market’s perceived value of the offering to which it gives rise. In other words, costs should be compared with prices, not with competitors. Copyright©2012 Value Dynamics LLP
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Are your costs too low?
It is the strategy of a company, not its management, which essentially sets the cost base of the business, that establishes the terms of competition and that defines the metrics of performance, including efficiency. Thus, cost pressures are, in reality, strategic pressures in disguise. When a company finds its margins are falling, looking to the cost base for a solution, such as finding ways of slashing prices without decimating margins, is invariably mistaken. It is the business model that is being questioned, usually for being insufficiently distinct from competitors. British Airways has been cutting costs for as long as anyone can remember, but the source of their difficulty lies in their legacy business model. No amount of cost cutting is going to return their business model to long-‐term profitability. When was the last time that you heard Stelios bang on about “headcount reduction” or “back office efficiency” or “operational excellence”? The brilliance of the easyjet strategy has released the airline from the demoralising effect of having to think of their business in these terms. In effect, strategy is the technique of thinking that renders cost management superfluous. An effective strategy makes operational efficiency a second-‐order activity. ON COST MANAGEMENT Costs are best managed by not managing costs directly. This is an example of the oblique principle, first formulated explicitly by John Kay when arguing that financial targets tend to be counter-‐ productive. Aiming for X is rarely the best way of achieving X. For example, focussing on one’s own happiness, according to JS Mill, was a recipe for unhappiness. He discovered late in life that the best way to be happy was to focus on the happiness of others. Likewise, profit in business tends to be maximised when management focuses its attention on customers rather than shareholders. Jim Collins’ research, reported in “Built to Last”, showed that those companies that made profit their primary goal were less profitable, on average, than those that chose “higher-‐ order” goals. Armies discovered long ago that soldiers fight best when they are fighting for each other rather than for King and country. Costs are no exception. They too are best managed obliquely. We shall look at three companies, all in the same industry, which have managed their costs supremely well by focussing on something other than cost. They each invented, at a particular stage in their history, a highly distinctive competitive strategy that enabled their cost base to be managed as a second-‐order activity rather than the primary focus of attention. Managing cost through managing price: the case of Ford Henry Ford is famous for the invention of the assembly line -‐ but this is to misunderstand his genius, or at least to ignore his own explanation for his success. Ford got to the idea of mass production by first imagining the possibility of mass marketing. He started with a hypothetical price, not a cost. He asked himself, “How many cars would I sell if the price were just $500?” The answers so excited him that he put his mind to finding a way of “making the price”. It was this “transitional object” that led to the assembly line. As Ted Levitt put it, “Mass production was the result, not the cause, of his low prices”.
This is how Ford himself described his philosophy: “Our policy is to reduce the price, extend the operations, and improve the article. You will notice that the reduction of price comes first. We have never considered any costs as fixed. Therefore we first reduce the price to the point where we believe more sales will result. Then we go ahead and try to make the prices. We do not bother about the costs. The new price forces the costs down.” In short, Henry Ford did not set the price on the basis of the cost; he set the cost on the basis of the price. This was his genius. “The low price makes everybody dig for profits. We make more discoveries concerning manufacturing and selling under this forced method than by any method of leisurely investigation.” Ford’s insight still has to be fully appreciated and understood. It is remarkable how many business people still to this day set prices on the basis of their costs, rather than vice versa. Managing cost through managing resale prices: the case of General Motors General Motors managed its costs very differently from Ford. Alfred P Sloan was much more interested in the depreciation of a car’s value than in its original price. According to Peter Drucker, who consulted to Sloan over many years, the main objective of GM under Sloan was to maximise the resale value of its cars, thereby encouraging customers to trade up more easily and more quickly to ever more desirable cars in the GM range. The “right cost” was that which best ensured high trade-‐in terms. Sloan’s strategy was based on 3 assumptions about car buyers: 1. American buyers of cars share the same tastes and preferences – or, in economic terms, the same utility function; that is, all Americans rank all American cars by preference in roughly the same order; 2. The only reason that all Americans do not buy the same car (the one they all place at the top of their rankings) is that not all of them can afford it; 3. In other words, the only basis for segmenting the American car-‐ buying population is income – and the only criterion of purchase is affordability. Copyright©2012 Value Dynamics LLP
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Are your costs too low?
These were brave assumptions. They were not shared by Ford or Chrysler. But for 70 years, they were true enough to secure for GM not only massive leadership in its chosen market but also its iconic position as possibly the greatest creator of wealth in the 20th century. Only in the early 1980s did these assumptions come under pressure and turn false, as international competition intensified and consumers developed more complex buying motives – ending with GM’s bankruptcy in 2009. Sloan was brilliant at seeing the full implications of his bold market assumptions. This was his strategy, an operating model that led to the invention of the divisionalised (or M-‐form) corporation: •
If affordability is the measure of how quickly an American family can climb the rungs of their preference ladder to the car of their dreams, then the resale value of a used car is the most important variable under management’s control;
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The higher these trade-‐in prices can be kept, relative to competitors, the faster the buyers can upgrade their next new-‐ car purchase to the next more desirable category of cars;
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As buyers climbed their preference ladder to more and more expensive cars, so the margins on these cars increased, benefiting GM’s profitability accordingly.
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Because frequent or radical changes in design serve only to depress trade-‐in prices, the art of m anaging these resale values is to produce long runs of mass-‐produced vehicles with only cosmetic changes from one year’s model to the next;
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And because American families are all climbing the same ladder, albeit at different rates, it is important to brand the cars at each rung differently, so that each model clearly signals its status and value; hence the hierarchical nature of GM branding – from Chevrolet at the foot of the ladder, through Pontiac, then Oldsmobile, then Buick, and finally to Cadillac on the top rung; And because brands are best managed independently by dedicated teams of managers, designers and engineers, Sloan structured his organisation into semi-‐autonomous divisions, each one focussed on its unique income segment of the American population; And because he didn’t want his 5 strategic business units to compete needlessly with each other, he set the price points for the brands in such a way that there was just enough overlap between successive brands for buyers of GM cars to trade up, provided that used-‐car prices were kept high.
Sloan’s genius was to incentivise the American family to climb its preference ladder to more and more expensive cars whose margins grew in proportion to their prestige, distinctiveness and brand value. By concentrating on the customer’s life-‐time loyalty to GM, Sloan ensured that costs were of secondary importance to brand value. The reputation of his 5 great brands drove the cost base, and not vice versa. Managing cost through managing organisational learning: the case of Toyota The Toyota Production System has been written about extensively. One version, that of Steven Spear and H Kent Bowen, interprets the success of the system in terms of a small set of tacit rules that every worker and supervisor discovers through a process of iterative questioning and problem solving.
The rules that guide production can be simply stated: •
Every task – its content, sequence, timing and outcome – must be specified in detail;
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Every connection between (internal) customers and suppliers must be unambiguous and direct;
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For example, every request for help or assistance must come from a single, pre-‐specified supplier;
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Every product must follow a simple, pre-‐specified path (with no forks or loops) – and at every step to a specific person or machine;
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For example, each type of part must follow only one production path through the plant;
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All improvements must comply with a scientific methodology whereby problems are stated, hypotheses are formulated, experiments are conducted, and conclusions are formed – publicly and under close scrutiny by others.
Workers and supervisors absorb these rules and learn how to do their work not by being instructed by managers but by being asked questions to which they are expected to discover the answer, questions such as: • • • •
How do you perform this task? How do you know you’re doing it correctly? How do you identify defects? How do you resolve problems arising from the task?
Under this form of Socratic inquiry, workers not only take ownership of their own learning but acquire the habit of critical thinking and an appetite for continuous experimentation and improvement. It is the respect paid to the worker’s desire and capacity to learn that puts energy into the system. The rules themselves are not the secret. Toyota’s cost base is managed as the outcome of a humanistic process whereby every employee shares the responsibility for the performance of the firm.
The moral of these three stories is clear: as a business executive, you incur a cost for no other reason than to pursue a strategy; and it is the strategy, not the cost, that determines the competitiveness of your business. Copyright©2012 Value Dynamics LLP
§ ON COST REDUCTION There is a common prejudice that holds that business costs are more likely to be too high than too low – that taking cost out leads to higher levels of competitiveness than putting costs in. Perversely, executives speak frequently of cost reduction strategies but rather rarely about cost enlargement strategies. This is illogical. A level of cost is like a level of service or a level of quality – the aim is to find the right level, not the minimum level. Both in theory and in practice, costs tend to be treated as “a bad thing”. They are seen as being too high; they need to be cut; they are symptomatic of waste, excess, profligacy and irresponsibility. Consultants are expected to reduce costs, not add to them. An incoming chief executive will normally want to rationalise costs, not justify them or grow them. Competitiveness is usually defined in terms of the cost base – and the lower the better. Predator companies will traditionally want to make economies in their newly acquired prey. It is rare acquirer who is looking to “grow the cost base”. Why is this? Why is there an assumption that costs are biased on the high side rather than the low side? Is there any evidence, for example, that cost-‐cutting strategies enrich shareholders? Do investors employ managers principally to strip out cost? Tom Peters is wont to point out that cost reduction strategies tend to reduce revenues at an even faster pace. At what point do (or should) shareholders step in and say “enough is enough; change the strategy, not the costs”. In capital markets, it is assumed with a high degree of reliability, that share prices are unbiased estimates of the true value of the business. In other words, it is meant to be just as difficult to buy a portfolio of shares that underperform the market as outperform the market. Why do we see costs differently? Why don’t we also assume that costs are an unbiased estimate of the optimal investment in human talent, in working capital, in research and development, in advertising and sales, in investor relations, and so on? Why do we tend to believe that managers are sloppy in their decisions on cost, systematically and wantonly paying people too much, holding excessive inventory, recruiting too many, travelling too much, over-‐ training their staff and supporting bloated research departments. When did you last hear a CEO proclaim: “Our costs are simply far too low. Our plants have become alarmingly efficient. We have made too many economies in our operations. Our cost base is perilously low. We must pay our people more. We must stop skimping on inventory. Our suppliers must be more generously remunerated for their efforts. We must raise our cost base to something closer to the industry average.” And yet these remarks are no sillier than their antithesis. The misconception that costs are biased on the high side owes a lot to Michael Porter’s typology of generic strategies. In this famous and influential theory, Porter distinguished between strategies of cost leadership and strategies of differentiation. Anyone who has ever taught this theory to managers will have been confronted on every occasion by the immediate challenge: “If these are different and contrasting strategies, how come almost every market leading company is characterised by both simultaneously?” In other words, how can one become a cost leader without being different? Why, for example, are the vast majority of global brand leaders both strongly differentiated and highly cost efficient?
Are your costs too low?
Indeed, economies of scale mean just that: cost is a function of scale, and scale is a function of (relevant) difference. The tiresome and obvious fact that should have killed this theory at birth – namely, that almost all successful companies are both differentiated and cost leading – would seem to have been wilfully ignored..
As an aside, it is intriguing how simple, well-‐known and incontrovertible facts can so easily refute so many, highly publicised and commonly accepted principles of management. Jeffrey Pfeffer, for example, has shown that the so-‐called “war for talent” is based on the popular misconception that the best companies have the best people, an assumption for which there is barely any scientific evidence. By demonstrating that there is no evidence for this assumption, a whole host of HR policies has been shown to be useless and wasteful. We shall argue that any cost carried by a business is just as likely to be too low as too high. In other words, we assume that cost levels in a business are not biased one way or another. In the case of inventory, for example, as many materials, parts and products will be under-‐stocked as over-‐stocked. In the case of quality, as many products will be under-‐engineered as over-‐engineered. In the case of marketing, as many service levels will be set too low as too high. In the case of compensation, as many salaries will be too stingy as too generous. It is not, for example, self-‐evident that the CEO is being paid too much – or too little. The presumption that costs are more likely to be on the high side than the low side is simply sloppy thinking – and an insult to earlier (possibly more entrepreneurial) generations of management who once (boldly and against the odds) chose to put these costs in. The management of cost is never as easy or straightforward as simply cutting it. It is as difficult to cut costs profitably as to raise costs profitably. Disinvestment is as skilful as investment. If firms want to be more competitive, then their strategy is as likely to include “upsizing” as “downsizing”, “insourcing” as “outsourcing”, and “on-‐shoring” as “off-‐shoring”. If this were not the case, then management would be easy. We would simply keep “taking cost out” until there were no costs left to cut. By definition, at some point, we would have over-‐cut costs. As a working hypothesis, wouldn’t it be wise – and conformant with market theory – to assume that current levels of cost are, on average, unbiased? If our line of reasoning is valid so far, then certain corollary arguments can also be made: The rule for cost control should be: cut back on those existing costs that are not germane to the strategy and invest in those costs that, if they were to exist, would strengthen the strategy. The benchmark of competitiveness should be value not the competition. For example, James Dyson was right to outsource his manufacturing to Malaysia because his strategy was in no way dependent on domestic manufacturing and it reduced his cost base. But we should not be under any illusion that when the story of Dyson’s global success is finally told, it will focus on his design philosophy, his entrepreneurial resilience and his world-‐beating products; it is unlikely to dwell on his decision to off-‐shore his manufacturing. Cost cutting in the context of a game-‐changing strategy is very different from cost cutting as the only game in town.
Copyright©2012 Value Dynamics LLP
§ As a concept, cost leadership is as meaningless as price leadership or operational leadership or working capital leadership. Cost leadership makes sense only in the context of a commodity market which, by definition, is a set of trading conditions characterised by an absence of competitive strategy. Every company is competing on the same terms. Thus, the only differentiating variable is the cost base. The more that companies are seduced into believing that cost leadership is a viable strategy, the more commoditised markets become, the less their wealth-‐creating capacity and the slower the growth of the economy of which they are a part. Recessions bring out the worst in cost cutters. It is irrational for costs to become more important when economic conditions are difficult. If costs are important, their significance should not vary at different stages of the business cycle. Perhaps there is an implicit assumption that costs have something to do with affordability, and that in a recession firms must cut back on costs, not because they don’t produce a return, but because there isn’t enough money to go round. However, a cost is borne not because it can be afforded but because it leads to sufficient revenue to cover it. Recession is a lame excuse for giving up on strategy and choosing instead the lazy option of cost reduction. The “back office” invariably – and unfairly -‐ bears the brunt of every efficiency drive and change initiative. Why should the back office provide easier pickings for cost savings than frontline services? Cutting costs in the back office is somehow regarded as less harmful or less contentious or less provocative than cutting “front-‐line services”. This is illogical. It suggests that when these costs were originally put in they were massively biased towards the back office and that therefore this degree of slack can safely be cut out. A recent monograph on public sector efficiency by the think tank Reform reversed this logic by showing that waste is more likely to be a feature of “front-‐line services” than of the back office. The emphasis that top management places on cost is inversely proportional to the trust they place in their middle managers to make responsible decisions. When dealing with costs, managers are more often assumed to be profligate than frugal – and generally to err on the side of waste, extravagance, irresponsibility and indiscipline – hence the need for supervision. Left to themselves, most managers would become spendthrifts, with very little concern for shareholder value, particular when times are tough. Indeed, the main role of senior management is to rein in the natural exuberance of middle managers. The traditional model of management has the unintended consequence of making cost-‐cutting the default option. In the standard version, top management sets the strategy and everyone else executes it. Skilful execution is defined as the minimum cost to deliver the strategy. The only variable subject to middle management discretion is operational efficiency. It is no surprise that many managers interpret this rule to mean “the lower the cost base the better”. When pressures on margins increase, better execution implies even lower costs. Managerialism has a built-‐in bias to interpret competition in cost terms rather than value terms. ON COST COMPETITIVENESS Competitiveness, defined as the ability to compete profitably, is set by the firm’s strategy, not by its costs. There are many companies that boast the highest costs in their industry that are also the most competitive – such as Porsche, Prada, Dyson and McKinsey. Indeed, the most valuable brands in the world typically combine the virtues of high cost, high price, high perceived quality, and high profitability. Low-‐cost brands typically under-‐perform their higher-‐cost
Are your costs too low?
competitors. This was the main finding of Paul Farris of Harvard Business School, when he researched the profit structure of brand leaders. The concept of competitiveness is often misunderstood and misapplied. If it is to be used at all, then it can only be applied logically to corporate strategies or business models or what Porter’s refers to as a company’s “unique mix of activities”. A cost or an expense cannot be described as competitive any more than can a revenue stream or a cash flow. These are simply the visible manifestations and inseparable elements of a strategy. Divorced from their strategic context, a particular level of working capital, for example, cannot meaningfully be called either competitive or uncompetitive. The popular managerial expression, “relative cost”, is equally misleading. Comparing your cost with a competitor’s cost – a remarkably popular form of benchmarking – can only be relevant if both companies are competing with identical strategies, in which case the cost base is carrying the entire burden of delivering profitability. But if this is the case, the problem is not the magnitude of the cost base but the absence of strategy. The attention of management should not be focussed on relative efficiency but on the need for a differentiating strategy. In short, reliance upon efficiency usually betrays an absence of strategy. The rhetoric of “operational excellence” is generally camouflage for a dearth of strategic ideas. The way that firms account for their performance accentuates and encourages the bias away from strategic vitality and towards operational efficiency. A good indicator of the general bias that steers managers to being more concerned with levels of cost than with the generation of revenue is the extraordinary importance that financial and management accounts give to costs rather than revenues. Revenues are normally limited to a single line in the accounts, as though fate or some exogenous force had delivered this income to the company and the only task for management was to meet this demand with the minimum level of cost; by contrast, costs are typically disaggregated into numerous lines, as though profitability depended mainly on how successfully these awkward and burdensome penalties on the firm could be reduced. Tim Ambler has brilliantly diagnosed the problem as follows: “Any board of directors is naturally preoccupied with its firm’s wealth. You would think that it would be equally preoccupied with generating it, but the astonishing fact is that, on average, boards devote nine times more attention to spending and counting cash flow than to wondering where it comes from and how it could be increased.” The role of accounting should be to understand better the source of the cash flow. Failing that, it should at least detect any backsliding to cost management as a surrogate for genuine strategy. A useful role for the finance department could be to provide lead indicators of any change in the strategic health, competitiveness, or overall performance of the firm, focussing particularly on those “default settings” whereby management resorts to easy short-‐term gains that are rationalised in terms of “cutting out waste” but which tend to emanate from managers who are short of ideas and out of their depth. A senior management team that is unable to formulate a strategy for making wealth-‐creating use of the resources available to it has every right to reduce the headcount provided it starts with its own heads. Firing others simply on account of being unable to find Copyright©2012 Value Dynamics LLP
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Are your costs too low?
gainful employment for them – which is the job of senior management – is all the evidence that shareholders should require to invite these senior managers to find work elsewhere.
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A NEW PERSPECTIVE ON COST AND OPERATIONAL EFFCIENCY •
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The art of management is to manage a business in such a way that the need for operational excellence, continuous improvement, “right first time”, cost leadership, process re-‐ design, corporate renewal, cultural change, charismatic leadership and financial incentives is redundant and the declared pursuit of these objectives counts as a clear admission of failure. When executives reach for these remedies, you can be sure that the business has been mismanaged and that failure is on the cards. There are no surer signs of the inadequacy and delinquency of corporate leadership than that 1) cost efficiency should be extolled as the dominant issue facing the company and 2) the tactics of outsourcing, shared services, restructuring and other short-‐term palliatives are being paraded as the main drivers of profitability. You don’t make yoghurt, you make the conditions and the yoghurt makes itself.” Likewise, you don’t manage costs, you design the business strategy and the strategy establishes the necessary cost base. Costs are an outcome of the strategy, not the goal of the strategy. Cost efficiency is always relative to a strategy or to a business model, never to a competitor or to an absolute standard or benchmark. Strategy is therefore the skill of staying one step ahead of the need to be efficient. As soon as the firm starts to attract competitors and pressures on cost start to be felt, a winning strategy will already have been invented to ensure that the business is moving into a new, distinctive and unassailable market position where its quasi-‐monopolistic power enables the firm to be a price-‐maker, not a price-‐taker or cost-‐cutter. The true test of the innovative capability of a firm is that it never needs to worry about, let alone wrestle with, the cost competitiveness of its business model. Its creativity and courage are of a quality that they immunise the firm against ever having to resort to such mundane and mind-‐sapping activities as cost reduction, business re-‐organisation, zero-‐based budgeting, or change management. The job of accounting is to keep the firm honest to this purpose. Financial accounts should be designed primarily to pick up signs of commoditisation at the earliest possible stage by detecting any backsliding to policies such as “taking cost out”, or “downsizing”, or “restructuring”, or “outsourcing”, or indeed any other management fad that is being used as a surrogate for strategy. Time spent on strategies of cost efficiency is time stolen from the much more important and wealth-‐creative activity of innovation, differentiation and entrepreneurship. A poor management sees its job as scaling its workforce to fit its strategy. If the strategy is stunted and unimaginative, then a proportion of the workforce will inevitably be made redundant. This goes by the euphemism of “headcount reduction”.
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A gifted management takes the talents of everyone in the organisation as a given, and pits its imagination against the challenge of inventing a strategy that makes maximum use of everyone’s capabilities. It is questionable whether management has the right to cut the workforce to suit its strategy; its moral legitimacy depends upon its ability to find market opportunities whose capture depends upon applying the talents of the entire workforce. Indeed, this is the central responsibility of senior management. If it cannot do this (if its only strategy is to cut costs) then it should step down and give other management teams the chance to do so. Put another way, the top management team should start its cost-‐cutting drive with itself. Managerialism is steeped in an instrumental ethic, where employees are called “human resources” or “human capital” and are treated as “factors of production” or the “agents of stakeholders”. Kant’s categorical imperative warns us against treating other people as means, rather than ends. In many firms, the prevailing model of management, with its fixation on control, coordination and compliance, has effectively institutionalised the instrumental treatment of other people. Managers typically get to a better result by thinking of the organisation as the means to the fulfilment and betterment of individuals than as an end in itself. The lead indicators of strategic failure are typically three: 1) the notion of “best practice” creeps into the management lexicon; 2) the practice of benchmarking the performance of competitors takes hold; and 3) business managers are set targets to match or exceed the benchmarked performance of key competitors through the implementation of best practice. Most firms that go bankrupt are paragons of this style of management. Over the 40 years that GM gradually moved towards Chapter 11, there wasn’t a single quarter in which management missed its cost reduction targets or failed to “make budget”. Since 1970, when GM first chose Toyota as its benchmark, its remorseless and unwavering pursuit of operational excellence, cost leadership, world-‐class manufacturing and best practice never faltered. Eventually this mindset drove the business bankrupt – as cost reduction strategies nearly always do eventually. The story of GM could serve as the epitaph of managerialism.
Copyright©2012 Value Dynamics LLP
Are your costs too low?
About Value Dynamics
Value Dynamics is a unique strategy consulting firm dedicated to addressing our client’s most critical business challenges, and discovering potential for optimum market and performance advantage.
We secure unreasonable performance for clients.
We achieve this through; … strategy and governance framework, … decision making and rules, … performance planning and targets.
We use the principle that the key to profitability and performance is exploiting the differences rather than doing the same as competitors.
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The Author
Dr Jules Goddard Jules is a Non-‐Executive Director of Value Dynamics, a strategy consultancy based in London. He is also a Senior Fellow at London Business School.
• Directly engaging with our knowledgeable partners, and their highly commercial perspectives and experiences. • Analysing the nature of the business in a new way, using a new lens, uncovers new and undiscovered opportunities. • Design of forward looking and precise solutions and targets. • A collaborative and inclusive approach with transfer of k nowhow. • Quicker and more cost-‐effective interventions compared to contemporize. For more information visit the company website www.valuedynamics.uk.com
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