Cost Reduction Is Not Reengineering

"You hear a lot these days about Mexico's low wages and how much cheaper it is to manufacture there. What many companies don't realize is that, in many cases today, labor costs are just a small part of the value equation," explained management consultant Mike Donovan at a recent executive briefing session sponsored by ROI Systems and the American Institute for Manufacturing Excellence.

"Cost reduction is not reengineering," stressed Donovan, president of R. Michael Donovan Inc. (Natick, Mass.). "Yes, you usually have to reduce costs to achieve a lower price. However, a low price is not the most important factor to most customers. To be competitive today, companies have to offer the best total value, which includes fast delivery, excellent quality and a competitive price, not necessarily the lowest price."

Donovan described the case of one New England manufacturer that viewed the low labor costs in Mexico as its salvation. The company moved most of its assembly operation to Mexico. Parts were manufactured in New England and shipped to the Midwest for gold plating. From there, parts went to the U.S. border where they were processed through customs. The parts were then assembled and tested in Mexico and sent back through customs and on to customers.

On paper, costs were reduced, which was management's primary concern. However, delivery cycle time averaged 12 weeks. Sales began to decline, inventory increased, and profits plummeted.

The problem was, the company's restructuring program was focused entirely on the cost side of the operation, negatively impacting the value equation. Their compulsive cost-cutting led to a downward spiral of cut, decline, cut, decline, etc. As Donovan put it, "The company was going broke saving money."

At a meeting of district sales managers, the consensus was that customers wanted products within six weeks or less after placing an order, meaning the company's 12-week cycle time was unacceptable to a majority of buyers. Since most of the company's competitors were manufacturing within the U.S., one brave sales manager noted that if delivery time could be reduced to five weeks or less, sales could be increased at least 20%. And the best way to reduce delivery time, of course, was to bring assembly back to the U.S.

"Customers always determine whether a company is a success or failure," Donovan pointed out. "Companies that take just the cost reduction approach to the detriment of short cycle times and customer satisfaction are destined to fail." When management focuses solely on cost-cutting, the negative impact often shows up in such ways as: cycle times lengthening; inventory increasing; on-time delivery slipping; product quality suffering; customer satisfaction plummeting; and employee morale and loyalty declining.

"Not long ago, conventional wisdom held that inventory reduction, customer satisfaction improvement and production cost reduction were conflicting objectives," Donovan observed. "Today, we know that achieving significant improvements in the three areas can actually be complementary. It's possible to have them all."

The typical cost reduction program rarely results in long-lasting improvement. The costs that were cut tend to creep back over time. What is needed, according to Donovan, is to improve or redesign business processes so that change becomes institutionalized - so that there is no turning back (see sidebar, below).

"Start with the customer and work backwards," he advised. "Focus on value, which in manufacturing is quality products delivered on time and at a fair price."

How To Succeed In Reengineering

The characteristics of a successful reengineering program include:

A structured approach that examines and redesigns policies, procedures, systems, and performance measurement criteria.
Leadership at the highest levels. The CEO or president must champion the reengineering effort.
Cross-organizational approach. Start from the customer and work backwards. Customer satisfaction must cut across functional and departmental lines.
Communication is improved. There must be a free exchange of ideas from the shop floor to the board room.
Use technology as an enabler, but not as the only solution. Companies have to fix the root problems first. Watch out for the potential of a newly acquired system to automate already poor business processes and consequently institutionalize those processes.
Start with a small, manageable aspect of the business and build on initial success. The radical, start-from-scratch approach to reengineering is too unnerving for most companies. Build credibility with small successes, then take on more major processes.
Seek to delight the customer as your strategy. Always staying ahead of your competition should be the goal.
Eliminate micro performance measurements such as purchase price variance, direct labor efficiency and overhead absorption.
Measure results, not activities. Focus on the performance measurements that really matter, such as production throughput, cycle time reduction, inventory reduction, cash flow, and operating expenses.
Build a flexible organization. Change is a fact of business life. Anticipate change by building flexibility into business processes.

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