What is the difference… and does it matter?
I was recently working with a client, helping them to review, analyse and optimise various areas of their operation.
Recent economic events (no prizes for guessing what) had had a substantial impact on their revenue, and exposed some previously hidden “clunky” parts of the operation which seemed to be screaming out for optimisation.
The meeting objective could have been summed up to:
“My expenses [in this area] are higher than I’d like. I want to reduce them and keep more of my profit”.
Pretty simple huh? Business in a nutshell.
Surprisingly (or maybe unsurprisingly as you may have found in your business journey) – the levers and cogs and concepts hiding behind this statement can be a bit more complex to operate.
Which approach to take then: Cost Out - or Cost Down?
Taking a simplistic view of the core differences:
Cost-Out (aka cost cutting, cost removal) actions are short, sharp decisions or events designed to directly carve out business cost(s). Easy peasy.
Cost-Down (aka cost optimisation, cost reduction) activities refer more to sustained processes, activities and decisions that aim sustain and manage cost reductions, while still attempting to maintain and/or maximise value for the business. Yeah ok… sounds… about right.
One is a tactical reaction, quite often reactions to unpleasant or unwanted cost outcomes. The other is a strategic response: a sustained, informed effort, guiding expenditure towards delivering maximum value for money, underpinned by taking a procurement approach towards those expenses, and involving a more complete cost-to-serve modelling and analysis exercise, ensuring you get the best bang for buck.
(I see your eyes starting to roll back... but bear with me).
Both actions / responses have their time and place – so it’s important to understand which response is appropriate before committing to it.
The trick is in understanding that sometimes the “obvious” response isn’t actually quite as obvious.
Simply by understanding this allows you (if you’re in the wrong gear) to quickly shift into the right gear (or response) when necessary.
Human nature (and therefore humans) can be weird, especially when it comes to finances – and once committed to a course of action or response – we'll often dig our heels in and stick to our guns... even if it’s the wrong response for that circumstance.
Don’t be afraid to shift gears – it will often save us from unintended consequences like service degradation, high opportunity costs, lower CSX scores, and ultimately higher cost-to-serve outcomes that an inappropriate response would deliver.
Phew. So… Underpinning these two responses are two key concepts, which I quietly slipped in. Did you spot them?
Here they are again:
These are both critical concepts that every business owner and decision-maker must understand, and don’t fret – we will unpack both concepts in a whole lot more detail in another post – but super-simplified:
Procurement – this is actually a huge gotcha area for so many businesses when analysing their costs - and often trips up even the most seasoned manager and business owner.
A quick Google search defines Procurement as being:
“… the process of finding and agreeing to terms, and acquiring goods, services, or works from an external source…”
Sounds a whole lot of fancy words for simply “buying something” huh?
And therein lies the problem. It's too often easily confused with just that. Buying stuff.
A good mate of mine, and CFO of a large multinational Supply Chain Management firm has a really good analogy for explaining the differences between Procurement vs Buying:
“You can go out and buy pens and stationery, but you must procure business-critical products and services".
Procurement describes a wide-scope of strategic activities – from pre-purchase / pre-selection activities like Purchase planning, product / service requirement specifications, supplier validation (including strategic fit), value analysis and pricing. Importantly, it also covers post-purchase / post-selection activities like supply-contract planning, and if it relates to physical goods, then it also includes inventory management and control, distribution, and supply chain strategy.
You take a before and after sales view of procurement activities. If it's a core product or service input of your business, you need to take a procurement approach to it's expense.
Cost-To-Serve (aka Cost to Service) – this is also a key concept often overlooked, and not just by the rookie.
It involves a comprehensive review and categorisation of all business costs, fixed / indirect (depreciation, interest, rent, insurance, salaries etc…), and variable / direct (wages, COGS, utilities…) – and then critically, applying some smarts to blend those costs and allocate to your product or service delivered to the customer.
Put simply – the purpose of a CTS analysis is to get as clear a picture as possible of the true cost to deliver goods or services to your customer – thereby getting a true picture of that customers value to your business.
One reason CTS analysis is overlooked is that it can quickly paint a bleak picture over your business and stir up strong emotions.
But don’t panic – paint the picture anyway, review it objectively, and then take action.
This is actually quite an important step and needs to be taken, as understanding your CTS is a vital component for setting the correct pricing, marketing and sales channel strategies for your products and services.
1. Cost Out Activities (Tactical)
Blunt tool(s) used to deliver short, immediate outcomes that carve out cost.
2. Cost Down Activities (Strategic)
A more refined approach, less immediate, but uses multiple tools to deliver sustainable cost outcomes, whilst delivering maximum value.
3. Procurement (Strategic)
Describes a series of strategic activities, covering pre-purchase activities, and post-purchase activities – with multiple value objectives including best pricing, supply, and strategic fit.
4. Cost To Serve (Strategic)
Analysis which analyses all costs, fixed and variable, and applies smart allocation logic to the to a product and customer level. Provides visibility into profitability by customer (and furthermore, by region, product, sales channel and so on).
If you'd like help with your cost to serve analysis, procurement activities or just want to bounce some questions off us - you can access more support materials and templates free on our website (we don't charge for, or even ask you to sign up to 97 different mailing lists before you can download them).
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