9. The Mechanics

The above four rules of strategic cost cutting all depend on some basic mechanics:

1. Organizations throughout the company must define their deliverables, and calculate the full cost of each (including a fair share of their indirect costs, i.e. product/service costs).

2. Managers at every level must be frugal with their indirect expenses and run competitive businesses within a business.

3. Across organizations, primes and subcontractors must link their deliverables into value chains.

4. Executives must understand the payoff of each value chain in the context of company strategic directions.

5. Executives must understand how much spending power is in their checkbook, and establish a decision process for determining which value chains will and won't be funded.

The first mechanical requirement -- understanding the deliverables and the costs of each -- is the most fundamental. It provides a basis for all the remaining mechanics.

This first step requires investment-based budgeting.

Consider a budget spreadsheet, where the columns represent expense codes such as salaries, travel expenses, professional development, etc. The rows represent deliverables -- i.e., specific projects and services.

 

                  Salaries        Travel      Training... 

Project 1                $             $             $

Project 2                $             $             $

Service 3                $             $             $

Service 4                $             $             $
 

The problem is this: After filling in the cells in the spreadsheet, most organizations total the columns instead of the rows, and present a budget for each of the expense codes. This doesn't give executives the information they need to manage their portfolio of investments.

On the other hand, with investment-based budgeting, organizations identify their rows (deliverables) and total the costs of each (mechanics 1). Costs include direct costs, plus a fair share of all indirect costs.

Indirect costs include the cost of unbillable time (time spent on sustainment activities such as training, business development, and administration). Indirect costs also include products/services bought from outside vendors and from other groups within the organization (e.g., overhead).

Investment-based budgeting provides an explicit medium for planning, scrutinizing, and managing indirect costs (mechanics 2). It makes all costs transparent.

Investment-based budgeting is similar to activity-based budgeting (ABB). However, ABB does not examine the deliverables within an organization; it treats internal support services as "activities" and amortizes the cost directly to external deliverables. Thus, it misses opportunities for entrepreneurship and cost savings inside of organizations.

Once investment-based budgeting identifies the rows, these deliverables can be linked to value chains (mechanics 3) across organizations within a company. This aligns primes and subcontractors, and provides the basis for understanding the total enterprisewide cost of a product/service or strategy.

The proponents of these value chains can then speak to the benefits (mechanics 4).

Investment-based budgeting is relatively straightforward. Tools and a step-by-step "cookbook" have made practical what, until recently, was considered only theory.

Of course, there's more to portfolio management than knowing options and costs. The identification of "checkbooks" of spending power and the decision-making (demand management) and accounting processes around each checkbook (mechanics 5) are resource-governance processes that operate all year long.

These resource-governance processes do not need to be bureaucratic. Like in the economy as a whole, market economics is by far the most powerful way to channel scarce resources to the places they're most needed. It provides a clear vision of how internal resource-governance processes should work.

The resource-governance processes should be considered only after the implementation of investment-based budgeting, since it depends on definitions of every organization's products and services, and their rates.