The Riddle of Supply Chain Cost Reduction:
Here's a Hint -- Cut, Cut, Cut is Not a Strategy

By Jim Tompkins
President and CEO, Tompkins International

When global economies, credit markets, and other economic and financial institutions begin to falter or fail, even the 'smartest' companies begin to forgoe strategy in favor of blindly cutting all expenses they possibly can. Many cut payroll, cut advertising, cut consulting, cut strategic initiatives -- cutting, cutting, cutting.

But what should you do? Follow along and also cut, cut, cut? No, as it's not a strategy that leads to success. Across the board cuts, without understanding where your company's real profitability lies, results in average performance at best and leaves your organization wide open to failure at worst. What can you do instead of cut, cut, cut? This question is a bit of a riddle. Here is an outline for answering it.

Model of Success Comes First

First, a company's success begins by having everyone in the organization aligned with a Model of Success. A clear, effective Model of Success consists of:

• Vision: Where we are going
• Mission: How we will achieve the vision
• Requirements of Success: The things we must do well to accomplish the vision
• Guiding Principles: The values we will practice in pursuit of the vision
• Measures of Success: The key performance indicators we will measure as we pursue the vision

Once an organization is aligned with its Model of Success, move to what I call the Big 7:

1. Strategic Plan
2. Action Plan
3. Budget
4. Risk Mitigation
5. Contingency Plans
6. Execution
7. Accountability

So where does cut, cut, cut fit into this equation? To be clear:

• Vision precedes Strategy.
• Strategy precedes Action.
• Cut, cut, cut is an Action, not a Vision or a Strategy.
• Cut, cut, cut is wrong unless it is consistent with the Vision and Strategy.

The Difference Between Cut and Reduce

What is the difference between cut, cut, cut and cost reduction? Unfortunately, the difference between the two approaches is zero in most organizations. The answer depends upon the type of organization that is doing the cost reduction.

Some may consider cut, cut, cut and cost reduction to be the same thing. This can be a disastrous point of view, as cut, cut, cut done across the board without more definition will not result in greater organizational success. On the contrary, it will lead to stagnation and declining profits.

However, in an organization that is aligned with its Model of Success and is pursuing the Big 7, the difference between cut, cut, cut and cost reduction is great.

In these visionary / strategic firms, costs are broken into three categories:

Category 1: Capital and operating costs: Traditional ongoing expenditures

Category 2: Talent costs: Expenditures for key resources that are required to operate the business profitably

Category 3: Strategic costs: Expenditures for strategic profit improvement initiatives

Category 1 is wide open for cost reduction and should always be pursued, but pursued even more when atempting cost reduction efforts.

Category 2 must be carefully analyzed. Companies cut so deeply in Category 1 that the people left do not have the capacity to bring about the cost savings. Organizations can run so thin that they cannot accomplish a million dollar cost savings, because they do not have on board the $100,000/year employee needed to realize the savings.

Organizations that could have saved millions of dollars via a consulting project costing 20% of the savings can be stymied by a mandate to cut, cut, cut all consulting costs. It takes talent to reduce costs, and without it, you can cut, cut, cut, but your costs will not go down, only up.

Category 3 expenditures must be segregated and protected, so companies can pursue the strategy that will result in long-term competitive advantage.

By correctly focusing on Category 1 cost reduction, you will generate sufficient profits to allow you to maintain your Category 2 and 3 expenditures. Gain a competitive advantage by focusing on:

1. Segregating Category 1, 2 and 3 expenditures
2. Aggressively and intelligently going after Category 1 cost reduction
3. Protecting and pursuing Category 2 and 3 expenditures

Aggressively and Intelligently

Why emphasize "aggressively and intelligently" when talking about going after Category 1? What is the meaning of 'aggressively' and 'intelligently' in this context?

Consider these real-world examples:

A company eliminates all overtime in its distribution centers, and the result is a loss of customers from the West Coast.

A company cuts transportation costs in its distribution center by receiving product floor loaded, but the cost of palletizing upon receipt at the distribution center is greater.

A company shifts production to an offshore location to reduce purchase price, but the result is an increase in the total delivered cost.

A company sources a product line to reduce total delivered cost, but does not consider sourcing clusters, and thus its costs are higher than its competitors' costs.

A company fails to include the margin from lost sales in its supply chain cost model, and therefore makes bad buying decisions.

These are just a few scenarios of how organizations can miss opportunities to increase profitability by not making intelligent and aggressive cost reduction decisions.

Holistic Cost Reduction

To capture immediate cost reduction opportunities, take a holistic view of your supply chain and focus on Buy-Make-Move-Store-Sell. Here is an outline to begin this process:

Buy:
-- Sourcing

• Source strategically to find the right partners
• Reduce material cost
• Reduce transactional cost

-- Customs and Trade Management

Make:
-- Lean Manufacturing -- Waste Reduction

• Increase operation throughput
• Improve labor productivity
• Reduce lead-time

-- Product Quality

• Improve production process
• Implement Supplier Relationship Management (SRM)
• Measure KPIs and performance

Move:
-- International and Domestic Transportation

• Find hidden costs in practices
• Use analytical tools to shrink cost drivers
• Use best practices to plan, procure and manage freight

Store:
-- Distribution Centers

• Leverage best practices to eliminate unproductive labor
• Reduce material usage and waste
• Reduce energy costs
• Improve space utilization and reduce off-site storage

-- Material Handling Systems

• Find extra throughput capacity via improved equipment and software controls
• Increase labor efficiency and optimize operational practices

Sell:
-- Inventory Management

• Reduce days of supply
• Minimize non-performing inventory
• Improve stock-outs and order fill rates

Overall:
-- IT Systems

• Identify obstacles such as data accuracy, timeliness, completeness
• Configure systems to maximize full potential
• Integrate with other internal systems
• Integrate with trading partners

-- Outsourcing

• Identify operations that will save money when outsourced
• Select and implement service providers
• Audit current service providers and develop improvement initiatives

Toward this end, explore these cost reduction pages and the information on reducing costs for an in-depth discussion on aggressive, intelligent supply chain cost reduction on specific elements of Buy-Make-Move-Store-Sell-Return.

The Riddle is Solved

The marketplace is full of people who want to help reduce your Category 1 costs (capital and operating) in a piecemeal fashion. Transportation costs, purchase costs, customs and duty costs, inventory carrying costs and distribution center costs are all very important expenses that sometimes need to be reduced, and you should do so aggressively and intelligently.

Now you know the answer to the supply chain cost reduction riddle. It is not about piecemeal cut, cut, cut, and it never will be. The answer to the riddle is an integrated, holistic approach that increases profitability and puts your company in a stronger competitive position.

About the Author

Jim Tompkins has a unique perspective that prepares corporations and executives for the future. He is an internationally known authority on leadership, business planning, logistics, warehousing, manufacturing, material handling, outsourcing, and supply chain best practices. As an innovator who has consulted with numerous Fortune 500 companies around the world, he has an insider's view into what makes great companies even better.

Podcast: Supply Chain Cost Reduction as a Strategy

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