COST MANAGEMENT: THE ESSENTIAL SKILL OF BUSINESSES

Article by Herb Rubenstein, President, Sustainable Business Group 

Introduction

The worlds of business, non-profit, and educational institutions are merging. Nowhere are they doing so as quickly as in the area of cost management. When critics say that non-profits need to be run more like businesses, they most often mean that they must integrate service strategies with cost management strategies and figure out how to provide more service for less money. In business, strategic cost management makes companies focus on where to make investments and how to measure their profits and returns.

Cost management in most organizations is done in an ad hoc, tactical manner. The question, “How can we save money here or there?” is no longer adequate for running even the smallest non-profit, much less the largest conglomerate.

Today, organizations can operate at many different scales. They can sell “x” number of widgets or “10x.” Non-profits can do the same with, for example, serving “x” number of meals to the elderly or “10x.” The cost per unit sold (delivered) may significantly go down as the number of units goes up. Similarly, we know that cost per unit levels may go up when a business or non-profit offers more services or different products.

Strategic planning must take this type of cost into account when arriving at an estimate of the optimal size of the operation. The plotting of this analysis is called the “experience curve” and the generic term for this is “economies of scale.”

Strategic planning must take into account the impact on the overall cost structure of the enterprise resulting from adding or keeping diverse products and services in its range.

Cost leadership is defined as the ability to produce or distribute a certain product or service at the lowest cost, either within an industry or among a certain group of competitors. Low cost-per-unit is a strong form of competitive advantage. It is the key supporting link in the consolidation wave moving across America. It is certainly the driving force in the boom of “ecommerce,” where costs of service can be a fraction of the costs of doing business in the normal bricks and mortar way.

The alternative to cost leadership is a strategy of differentiation. By making your products different, by finding your niche, your organization can charge a premium or can seek contributions at very high levels without much direct competition. The strategy of differentiation involves costs – the costs to make your product or service better or different, the cost to serve one geographical area over another, and the cost of educating consumers of your differentiated product.

Strategic planning must focus on the costs of differentiation as compared to the returns. This will help you make economically rational decisions regarding when to pursue cost leadership and when to pursue value-added differentiation.

A critical role for strategic planning under the label of strategic cost management is to identify all of the costs associated with each part of the organization. EMMAUS of Washington is a non-profit organization in the business of serving the elderly population. However, when the company purchases a building, they are actually in the real-estate business. 

By identifying each of the costs associated with a business or non-profit, you can identify the “businesses” that your organization is actually in. Once you have identified and isolated each of these “businesses,” you can then manage each section by evaluating the costs and the returns of that section. This is often called “activity-based accounting.”

This way of looking deeply inside your organization is critical for strategic planning in several respects. Your organization may not need to be in all of these businesses. If you determine that you are losing money from one element, you can spin off or outsource that activity. The key distinction in deriving value from outsourcing is the notion that “leasing” is sometimes cheaper than owning.

Possible Value-Chain Analyses

The following are questions to ask and points to consider during this type of strategic planning. 

1. What are all of the costs that your organization incurs broken down into normal accounting terms and broken down again programmatically (if your organization has more than one program, service or business)?
2. Which costs are discretionary?
3. Which costs can be incurred in another manner – such as leasing rather than buying, outsourcing instead of hiring in-house, distributing electronically, moving locations or staying where you are, sharing costs and revenues of an endeavor with another organization or incurring all of the costs and returns within your own organization, foregoing the expense rather than continuing it?
4. Which overhead costs have little economic value added in the short run? In the long run?
5. What economic value added can you attribute to each employee, each division, each activity within your organization?
6. What economic value added can you attribute to each product or service that your organization provides?
7. What are your organization’s financing costs and how can they be minimized?
8. What are your organization’s cash, receivables and other asset management policies, and how can maximum benefit be obtained from securing the highest possible return from assets within your willingness to tolerate risk?
9. Is your organization promoting a “cost-aware culture?”
10. Are your organization’s cost information systems operable daily, weekly, monthly and are they well monitored?
11. What “sacred cows” are there in your organization that cost money, such as real estate, employee policies, pricing policies, etc?
12. At what price does your organization achieve quality internally in the administration and externally in services and products for customers and how can the quality/price ratio be improved dramatically?
13. Which 20 percent of your organization’s costs offers 80 percent of the potential for improvement?
14. Does your organization set target cost levels systematically?
15. Does your organization benchmark costs and outputs on a regular basis?
16. Does your non-profit or educational institution regularly compare the costs (including time spent by volunteers) of fundraising activities to their returns?
17. Is there significant underutilization of resources in your organization?
18. Are non-quantitative beneficial results targeted rigorously and monitored over time?
19. Are there areas of new investment that could greatly improve economic performance?
20. A re there areas of old investment that are not producing reasonable returns?
21. Are you in the right area of the market or should you migrate to another area of the market where your organization would have a competitive/financial advantage?
22. Is your organization’s strategic planning system running in accordance with a schedule?
23. Is implementation of strategies monitored for financial costs and economic or other returns both in the short run and in the long run?
24. Have the actual returns of your organization’s business strategies equaled, fallen below or surpassed the expectations expressed in the strategic plan?
25. Is your strategic planning process cost-effective, lean and dynamic?

By identifying which aspects of the organization provide economic value added, you will be better able to assess the overall value of each individual function of your business. This approach to strategic cost management will allow businesses and non-profits alike to offer more product and service for less cost.   

About the Author

Herb Rubenstein is the Executive Director of the nonprofit organization, THE LEEEGH, which stands for leadership in education, energy, environment, governance and health.  He is also the President of the Sustainable Business Group, a consulting firm to businesses, He is an adjunct professor of strategic management at the Global Energy Management Program of the University of Colorado Denver.

He is the lead author of Breakthrough, Inc.: High Growth Strategies for Entrepreneurial Organizations, lead author of Leadership Development for Educators, and the author of the American Bar Association book, Leadership for Lawyers.  He has authored over 100 articles and over 80 videos on business strategy, entrepreneurship, leadership, and improving organizations.

He can be reached at herb@sbizgroup.com or 303 910-7961. The website for the Sustainable Business Group is www.sbizgroup.com and for THE LEEEGH please see www.theleeegh.org. You can learn more about Mr. Rubenstein’s books at www.leadershipforattorneys.org, www.leadershipforeducators.org and view his videos at www.youtube.com/theleeegh and www.vimeo.com.

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