October 8, 2009
by Mark Walters and Calum Semple
Canada’s automotive industry is in the midst of a major change. The economic downturn, legacy costs and a rapid decline in sales has pushed many parts suppliers and manufacturers to reduce costs. Companies are looking to adapt to the ever-changing environment—and asset conservation and cost control is emerging as a short- to medium-term strategic necessity to preserve shareholder value, and, in many cases, survive.
Why do things unravel?
In this challenging business environment, knee-jerk reactions often do more harm than good. Ad-hoc spending cuts can damage reputation and infrastructure, and demoralize employees. For cost conservation and reduction measures to stick, companies must clarify the cost drivers of the business and use that knowledge to create a culture of cost consciousness, in both good times and bad.
The essential elements of a cost reduction and control framework include financial management and control, procurement and supply chain, business process execution and performance management.
But, frequently, companies swing between the two extremes of cutting short-term costs and placing big bets on transformational plans. Sudden measures driven by “We need to reduce costs now, and I don’t care how” are reactive and unsustainable.
Large-scale, ambitious plans executed during times of extreme stress are equally risky because they tend to implement a system the company may not need, may not be suited for, or cannot handle.
Here are three common cost reduction methods and the reasons they unravel:
Top-down approach. Senior management focuses on transformational opportunities to reduce costs. The company is hoping a single solution will solve its long-term cost issues, without paying attention to the behaviors and decision making processes that drive costs in the first place. If the existing spend behaviors at the company haven’t changed, any new savings will not be sustainable.
Slash-and-burn approach. Companies conduct business as usual, but departments are directed to reduce spending by a set target. The target is often arbitrary and reactive to market conditions. This results in cost cutting without long-term action, management or tracking plans. And because of the random nature of the cuts, there’s likely to be a negative impact on morale and culture.
Boil-the-ocean approach. All departments conduct extensive interviewing, process analysis and benchmarking in order to improve efficiencies, leverage technology and identify cost savings. This is an unwieldy process with an open-ended time frame and typically results in a loss of momentum and focus. Departments become personally invested in their own budgets and rarely find waste. In the end, the process produces a list rather than creating sustainable cost reduction.
A strong foundation is critical
Establishing a strong foundation is essential to sustainable cost savings. The management team must understand its cost baseline and view it as a result of the business decisions it makes on a daily basis. The journey to a strong foundation and sustainable cost savings involves the following:
• Reducing non-essential spending.
• Clarifying internal/external business cost drivers.
• Improving accountability.
• Taking control of third-party spend.
• Tackling the company’s cost culture and behaviors.
A culture of sustainability: where to start
First and foremost, it’s crucial to establish an environment for cost reduction. Confirm the cost reduction targets and process, agree on the in-scope cost base and complete a preliminary reduction analysis.
• Agree on cost ownership. Decide up front who is responsible for challenging which costs. Working from a pre-allocation cost basis will prevent costs from falling through the cracks.
• Challenge the financial plan. Have operating managers clarify cost drivers, challenge operating cost assumptions and reduce discretionary spend.
• Look for contract leakage. A forensic review of suppliers may uncover recoverable claims, cost avoidance areas and off-contract savings opportunities.
• Be aware that pushing too much onus for cost reduction onto suppliers may impact quality and/or delivery or even force them out of business.
• Gauge performance by measuring results. Do so by monitoring activities, capturing related spend results and producing robust reports for senior management. Establish monthly or weekly goals, which build towards the final goal, and manage these—don’t just keep aiming for the end point.
At the same time, focus on these cost management and control activities:
• Rigorously control spending. Immediately establish a tighter span of control for spend approval to begin the spend culture transformation.
• Stabilize cost controls. Complete a gap analysis of critical cost management and controls to identify immediate actions required to stop the bleeding and create a culture of cost awareness and ownership.
• Using cost management and control processes, successful companies often strategically position themselves during downturns to emerge stronger after the economy recovers.
In this economy, many auto parts suppliers and manufacturers are anxious to reduce costs. By using cost management control and processes, companies can develop an approach that sticks—and position themselves to emerge stronger when the economy recovers.
For more information, visit www.pwc.com/ca/auto.
Mark Walters is the Automotive Industry practice leader and Calum Semple is the Operational Turnaround practice leader of PricewaterhouseCoopers Canada.