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Today’s cost-cutting may be tomorrow’s crisis

“I remember an illuminating conversation with a senior executive of a recently privatised water company. I was puzzled that so many companies seemed to be able to issue peremptory edicts to their managers to reduce costs, or headcount, and see these edicts fulfilled. Could it really be that there was so much inefficiency and, to get rid of it, little more was necessary than to tell people to sort it out?
The person I was talking to explained that water supply was largely automatic. Rain fell, and flowed downhill, the water went through treatment works and along supply pipes, all untouched by human hand. Most people were at the company to stop things going wrong, or to fix them when they did.
The system could always operate with fewer people. In fact, if you sacked the whole workforce, except for the billing staff, profits would soar and everything would be fine – for a bit. Over time, however, problems would first accumulate, then emerge.”

JOHN KAY, Financial Times (22 June 2010)

Professor John Kay is raising an important question here: how come, when companies need to cut costs, they can do it so easily? Why, when a demand downturn hits or investors and analysts demand a more streamlined company, can a CEO so easily say to his people: cut costs across the board? How come seemingly good and efficient companies easily manage 10-20% cuts in key cost lines?

This raises the alarming question: are these companies only pretending to be efficient in good times? Are they deliberately keeping some fat in the system so that they can be seen to be cutting when the market demands it? Or is there a natural human tendency to overdo things and spend more (of other people’s money) than we need to?

Let me tell you a story from an earlier life. Once upon a time I worked for a large global company. During a boom period, I attended an annual strategy retreat. We stayed at a remarkable boutique hotel at great cost, and ate and drank the very best. Our leader told us it was important for the key people to be rewarded for all their excellent efforts in creating outstanding shareholder value, and that this event was part of making us all feel valued and appreciated.

In the months that followed, demand fell off a cliff. We lost some key customers and our revenues suffered a serious decline. We still held an annual strategy retreat, but this time it was at what I can only describe as a roadside motel, and we were asked to share rooms between two (unheard of). This time our leader told us there was too much waste in the system, and that we owed shareholders a lean machine. The philosophy suits the circumstances.

You know it as well as I do: costs are rather too easy to cut. We shout out that people are our greatest asset during the good times; then, when tough days arrive, which two cost lines do we target first? Headcount and training. We send the clear message that people are not all assets, and that developing the asset is only something we do when the sun shines.

We recruit people too easily, and we fire them too easily. Too many companies pad their books with more people than they need, simply because they can. And too many cut ruthlessly and to the bone when it’s time to impress investors. But this can have severe repercussions: on safety, on customer service, on quality. Prof Kay wonders about BP’s recent crisis: did a culture of cost-cutting and compromises in the past lead to today’s problems? What have previous savings now cost in terms of reputation loss? And how many of us are merrily planting the seeds of tomorrow’s corporate crisis in today’s short-term cost-cutting exercise?

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