Cost Restructuring in a Post-Boom Economy

Businesses are grappling with severe reductions in volume. Volumes have been down dramatically for consumer goods and industrial products companies alike-and even if you believe we have reached bottom-think again! Be prepared for a slow recovery and many years before volumes return to 2007 levels.

As many companies slip near or below the break-even volume dictated by their cost structure, the challenge is to reduce costs and either maintain some semblance of profitability or at least slow the red ink. One certainty is that shareholders will continue to demand ways to increase value and rewards for their investment. The easier cost cuts (e.g., temporary labor, extra shifts, travel expenses, etc.) are not best situated to change the underlying cost structure for the long-term, as they tend to quickly creep back when volumes begin to grow. A key component-now and when volumes return-is to focus on activities that are less dependent upon volume to reach profitability expectations.

Now is an ideal time. Real change takes time, resources and significant management focus. When we are in the steep up-curve of a growth cycle, change is much harder to achieve so fundamental changes tend not to get done during good times.

While we are in this current lull in volume, here are several ideas to reposition your business strongly for the recovery phase.

Aggressively Pursue Design Cost Optimization (DCO)

Because most of the cost structure is dictated by product design (i.e., amount and type of material, number of parts and manufacturing and assembly steps, etc.), operational cost-reduction opportunities are limited. However, DCO programs focus on design changes that drive cost. They are an important source of fundamental change in the cost structure.

Prioritize DCO efforts by selecting projects that have long product life cycles and reasonable future volume expectations in order to maximize the margin impact of DCO efforts. Incorporate key suppliers as integral members of the DCO team as they can provide valuable design expertise to further reduce material costs or value added steps. Finally, set design cost reduction targets aggressively so that DCO efforts result in competitive advantage.

Rethink Make vs. Buy Decisions

With a global supply base, now is an excellent time to forge new supplier alliances. Not only does this increase the variable portion of your cost structure (making your business more nimble and flexible to respond to varying volume cycles), but it also can be an opportunity to offload ineffective product design, process engineering and quality activities, and reduce SG&A.

Two important ingredients will help to achieve more than incremental success. First, view your supplier alliances holistically as a central activity to your entire operations strategy. Look broadly across all categories and create a strategic framework for what is made versus what is bought. Second, the make vs. buy analytical models should be robust enough to properly analyze a wide range of future scenarios. They should also factor in sensitivity to issues that impact global sourcing decisions (e.g., currency fluctuations).

Focus on Fixed Asset Productivity

Whether increasing levels of operating equipment effectiveness (OEE) or rationalizing the global asset footprint, one of the best ways to drive value is making the entire fixed asset portfolio do more. A large part of your fixed cost structure is dictated by the asset footprint. Think of your asset portfolio as a collection of facilities (plants, warehouses, distribution centers, etc.) which house your other fixed assets. Every facility in your collection imparts a heavy fixed burden on the cost structure. Weeding out the weaker parts of the collection at this current low period makes a lot of sense.

Doing this in conjunction with a rethinking of your make vs. buy strategy creates tremendous synergies. Each reduction in vertical integration frees up capacity that can either be rationalized or put to other productive uses. In either case, an increase in overall asset productivity will result.

Free up Cash by Reducing Working Capital

Cash is king for a business struggling with liquidity, and it is important for all businesses. One of the best ways to free up cash is by reducing working capital. Periods of volume decline are excellent opportunities to focus on inventory reduction. Less inventory is needed at lower turnover levels, and the operations team should have some available bandwidth.

Companies typically begin to lower their working capital by reducing slow-moving items and safety stock. But there are many other opportunities. For example, implementing lean manufacturing / Just-In-Time, consolidating SKUs, designing for late-stage customization, and improving forecasting. The goal should be to achieve a structural reduction in inventory, beyond simply keeping days-on-hand steady with lower volume, so that inventory remains in check when volumes return.

Implement an Overdue Business Model Shift

Companies often follow one of several typical business models to organize their internal and market-facing activities. The most common are focused on:

• Product (we sell widget A, widget B, etc.)
• Market (we serve customer group 1, customer group 2, etc), and
• Region (we focus on region X, region Y, etc)

But the model that is optimal may change over time. Companies that are open and flexible to adapting their models are at an advantage. For example, a company that is having trouble maintaining price might shift from a market-focused model to a product-focused model to lower their cost and improve efficiency. Companies often resist adopting needed business model change because effective transitions require significant time and energy. If your company fits that description, today's period of slower activity may be the right time to take those challenging steps.

Ultimately, embrace this period of economic recession as an opportunity to strengthen your business. Permanently reduce your cost structure through Design Cost Optimization, Make-Buy Decisions, and Fixed Asset Productivity. Extract cash with better working capital management, and if needed, implement that overdue business model change.

Mark Coming and Jeremy Wallach are management consultants with CRA International. They specialize in business strategy development and improving operational and managerial performance in the industrial and manufacturing sectors. http://www.crai.com