Know what to expect when reallocating resources

A former professor told me about the Canadian cost-cutting philosophy, the so called “Canadian cut”: 25% less all around. I remembered this phrase when I realized that lack of activity is being reported as cost-cutting, or that some costs, seemingly useless at first glance, actually prove to be necessary for keeping others costs under control.

When the “efficiency” spiral starts, everybody immediately assumes that it means “cut costs”. And everybody starts doing it, without understanding that what you need is not smaller costs, but more efficient resource management, in other words “spend less for more”. Most of the time the only message that gets across is “spend less”.

Coming back to the example above, one company made the decision to close 85% of the regional warehouses. In the initial plan submitted to top-management, only 2 pieces of information were included: rent expenses today – 1.000.000€, rent expenses tomorrow – 250.000€. The plan was approved. Going into implementation phase, the employees from Logistics got wind of the plan. First questions that popped up were:

- what will be the new transportation cost with 85% less regional warehouses?

- how big does the remaining warehouse capacity need to be?

The answers to these 2 questions revealed a different set of information: expenses (including rent and transportation) today – 1.500.000€, expenses tomorrow – 2.000.000€. There was indeed a saving opportunity, but the optimal percentage of warehouses to be closed was 57%.

In order for a cost cutting imitative to qualify as “streamlining”, the first criterion should be “how does it impact the activity of the company?” Anybody can decide to eliminate a cost, but only by asking the right questions can you find which costs can be eliminated without adverse impact on business performance.

The “boom” is a beautiful stage for most companies in terms of P&Ls and exit values, but it’s only when the party ends that we start noticing that growth brought along chaos, complexity, uncontrolled spending behavior and undiscerning growth strategies.

In most cases, following the boom, the companies find themselves stuck with large retail operations with poor geographical distribution, waiting for customers that don’t show up anymore and have become immune to all the noise created by increasingly aggressive advertising.

There are two paths for reaching an effective resource allocation in a post-boom economy:

Companies encumbered by an unsustainable burden in P&L and cashflow (path A, steps 1a and 2a):

- Optimizing redundancies (step 1a)
- Re-allocation of remaining resources (step 2a)

Companies that experience inefficiencies, but the burden is still bearable due to financial stability:

- Re-allocation of resources (step 1b)
- Optimizing redundancies (step 2b)

Let us take an example:

During the boom stage, the retail network of a company grew by 10-20% per year (the big spread is due to the fact that the company hardly tracked down all retail shops opened through distributors, there was so much chaos that counting them in real time was truly a challenge). After the boom, the company realized that 20% of the shops were bringing in less than 2.5% of total sales.

In this case, path A would lead to:

- Eliminating the money-pits – step 1a

- Finding the best street locations (and there still are a lot of them available) to relocate the next cluster of shops in terms of profitability – step 2a

Path B consists in same steps, but in reverse order:

- Relocating the PoS that stand a chance of being profitable – step 1b

- Closing down the PoS that lack traffic – step 2b

Major differences between the 2 paths are:

Path A, which brings immediate savings, is preferable for SMEs that can’t afford another year of losses and are not yet mass-market. Being a small company also brings the advantage of knowing more precisely where your clients are. Path B on the other hand has the advantage of enabling the company to keep a close contact with all its customers throughout the process. Of course there is a price to pay for this, and this price is getting the savings only in next year’s P&L.

The two steps can hardly be taken at the same time. It is just like walking: taking one step at a time is walking, easy to do even by people with a cast on; taking two steps at a time is more like jumping, a task which only people in decent physical shape can attempts, which requires moving both feet at full capacity. The same goes for companies: as long as you can track and drive both processes at the same time it is ok to take two steps at a time.