The psychology of enterprise cost reduction

Client: EY
David Nicholson consider why the unglamorous role of enterprise cost reduction (ECR) should be crucial in good economic times as well as bad...

“A banker is someone who sells you an umbrella when the sun is shining and then takes it back when it starts to rain.” – Pieter Schelte Herema, Dutch industrialist.

Some executives regard proponents of long term, sustainable ECR in a similar way – maintaining that cost reduction is a necessary but annoying fact of life in a downturn, but should be relegated to a back seat so long as conditions are good.

As a business process, ECR ranks alongside fire alarm practices and stationery audits in terms of its perceived glamour. At an extreme, it is associated with the penny-pinching attitude of Ebenezer Scrooge or sweat shop operators who refuse to allow their employees to use the bathroom.

Yet just as the former delivery clerk is now head of logistics, the person responsible for wiring the telephone is now the Chief Technology Officer and the librarian is now the Chief Information Officer, so the discipline of Enterprise Cost Reduction is shifting from irritating occasional necessity to a major element of corporate strategy.

As our survey shows, however, there is some distance still to travel before ECR is fully accepted in this way.  By far the most common reason (40%) given for carrying out an ECR programme was ‘to secure economic survival’. Just 17% saw cost management as a continuous process, while the same percentage said that a cost saving programme was ‘not a priority’.

So what is holding companies back? Why are businesses so reluctant to adopt a strategy that not only saves them money but increases their effectiveness and helps to secure their long term viability?  Despite the dire economic conditions, a quarter of our respondents have no plans to carry out any kind of cost reduction programme.  

Among the barriers to carrying out effective ECR we have identified:

  • Companies’ unwillingness to follow through on cost reduction, even where they have made firm commitments. This may stem from anxiety that the business will appear weak, that competitors will take advantage of lower investment, or from management inertia.
  • Difficulties in ‘selling’ ECR to executives and to employees in general. Most companies have an element of competition between departments or offices. Each is reluctant to accept that it should lower its costs – indeed it is a commonplace in business life that departments overspend in order to maintain their budgets for the following year.
  • The perception among employees of unfair treatment during ECR programmes. People react badly to lower rewards if they see executives receiving higher rewards at the same time.  
  • Issues of recruitment and retention. Candidates are likely to prefer to work for a company which is expanding and increasing its investment, whether in people or in new business. It indicates that their options will grow, that their remuneration and the status of the organisation will increase.
  • When businesses undergo change programmes, ECR is often dropped.  

To counter these concerns we recommend that business leaders do a number of things. They should refer to the process as ‘cost optimisation’ rather than cost reduction. Executives need to be patient, and to develop a communications strategy that stresses the improvements achieved through ECR and what they mean for the enterprise as a whole.

Time must be set aside for the change process to take effect, creating an environment where employees feel fairly treated. Costs saved in one part of the business can be invested elsewhere, so that there is still a sense of expansion and optimism.

Executives must have enough humility to accept where cuts need to be made, rather than playing competitive games with their colleagues over budget levels.

And finally, cost reduction and optimisation needs to become a routine, normal part of business operations, rather than something which is identifiably short term and done in response to a crisis.  

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