Challenge

Traditional approaches to cost cutting - across-the-board budget cuts, slashing expense codes like travel and training, or eliminating entire groups - can damage an enterprise's ability to deliver anything, even the important things.

The truth is, staff cannot magically "do more with less" on command. Your enterprise will do less with less. The key question is, how is that "less" decided?

Traditional approaches leave it to individual managers to decide independently what will fall through the cracks. The result:

• A patchwork quilt of failures not linked to strategy

• Collapse of teamwork as one manager's highest priority becomes a team-mate's lowest

• Critical sustenance activities are cut, and productivity deteriorates

• Staff won't take on anything new, even if it's highly strategic

The bottom line: widespread ineffectiveness, and deteriorating enterprise capabilities.

How can you cut spending without undermining the enterprise's ability to deliver anything well?

Solution

Instead of cutting just the inputs (expenditures), cut the outputs and then let costs fall in line.

Strategic cost cutting begins with a deliberate look at each department's deliverables, trimming what's expected of them.

Then, the full cost of eliminated deliverables can be removed, while the few things the enterprise must do well remain fully funded.

Challenge

In an emergency, there's no time to carefully analyze where cuts should be made, and where they should not because the resources are critical to strategy. You had no choice but to slash spending quickly.

Now you're left with a smaller organization, and you know it's unwise to try to spread your resources too thinly and end up doing everything badly. You've got to focus on the few things that are strategic.

The problem is, the places that the cuts happened may not have been carefully planned; so the resources remaining may or may not be aligned with the key strategies of the enterprise.

Even if the resources are in the right places, priorities need to be realigned with the more tightly focused strategic objectives.

The issue is not a matter of strategic planning. You know your strategies. Now, you have to move your chess-pieces into the positions where they can contribute the most, and avoid wasting resources on strategies you can no longer afford.

How can you rally remaining resources around key enterprise strategies?

Solution

First, you must identify the few key strategies and ongoing processes that are critical to the future of the enterprise.

To do so, you need to understand the full cost of all enterprise deliverables, and then deliberately choose among them the few that you can now afford.

Full cost includes more than just direct contributors on project or service-delivery teams. Each enterprise deliverable consumes a share of support services and other indirect costs.

Understanding the full cost of enterprise deliverables is an exercise that pays off at the next step, too. By knowing what resources are required by chosen deliverables, you can fully fund and staff the ones you've chosen.

Using the full-cost model, the strategic choices you make can be translated into budgets and staff levels in both direct and indirect support functions. With that data, the rest is just mechanics: revising budgets and headcount targets, staff redeployment and retraining, and realigning performance targets and accountabilities.

Challenge

You have a sense of how much money (operating expense and capital) will be available in the coming year. Now, in the enterprise budget process, you've got to allocate it to business units and support functions.

Of course, the total of their requests is greater than available funds. They all want more money!

Your challenge is to allocate scarce resources in a way that will optimize shareholder value (or, for government and not-for-profit organizations, the mission of the enterprise).

You know that funding current headcount and expenses (last year plus/minus a percentage) may not accomplish this goal. Past budgets may have funded low payoff activities in some areas, and missed great investment opportunities in others.

What objective method can be used to decide the right level of budget for each organization within the enterprise?

Solution

Ideally, the budget process should decide each organization's budget based on the investment opportunities at hand. It should allocate resources to the best investment across the entire enterprise, then the next best, and then the next after that, and so on until available funds are committed.

This is termed investment-based budgeting.

Obviously, keeping the enterprise running is a great investment. You've got to "keep the lights on." But there may be some lights that should be turned off to free funds for strategic initiatives.

To allocate budgets this way, you'll need to understand the returns on investments in specific organization's projects and services. You may not need to quantify everything, but you at least need to know the products and services you'll get for a given level of funding.

Thus, organizations need to submit budgets that forecast the cost of their products and services -- what they propose to "sell," not just what they want to spend. Their budgets should describe the costs of specific projects and ongoing services, not just compensation, travel, training, etc.

Challenge

The scarce resources of an enterprise should be allocated to the investment opportunities at hand based on returns on investments and strategic alignment.

But traditional budget processes don't accomplish this. Instead, budgets are decided based on past years' spending, current headcount, and what various departments would like to spend.

This gives little assurance that resources will be aligned with enterprise strategies.

In fact, traditional budget processes add little value to strategic thinking or execution. This is why many managers view budgeting as a bureaucratic nuisance at best, or at worst a game of building in "fat" and seeing how much of it you can retain.

Furthermore, traditional budget processes engage senior executives in micromanaging subordinates. ("Do you really need to do that much travel?") This is quite different from a dialog about what each business unit and supporting department will contribute to the key imperatives of the enterprise.

It's as if enterprise executives need to help subordinate executives with their tactical management responsibilities, or check up on them, rather than guide the firm. It's disempowering, a waste of senior talent, and takes attention away from the important issues.

How can you change the nature of the budget dialog to strategic issues, and ensure that resources are well aligned?

Solution

Consider every group within the enterprise as a small business, there to "sell" its products and services.

In this context, one group will be the "prime contractor" for a given strategy. That prime will subcontract with other groups for needed components and support services. Subcontractor may, in turn, buy what they need from peers.

Thus, every strategy (or ongoing operational process) engages groups throughout the enterprise, and all their deliverables together add up to the cost of the strategy or process.

Budgeting in this paradigm is a matter of deciding what the enterprise needs to buy from each group. Budgets aren't based on past years' spending, but rather on what the group is to produce in the coming year. This is termed investment-based budgeting.

As a result, resources are directly linked to strategies and operational processes. Even better, resources are linked to specific management accountabilities.

Implementing Investment-based Budgeting requires that every group submit a budget that forecasts the costs of proposed products and services.

Challenge

When you're deciding a strategy, you have a sense of value. But what about its cost?

The full cost of a strategic option is more than its direct costs. For example, entering a new geography may require budgets for engineering, marketing, sales, and logistics (direct costs).

But it will also place an incremental burden on indirect support services like IT, HR, Finance, Purchasing, etc. And these functions may, in turn, draw more heavily on those who support them.

Indirect costs may add up to as much as the direct costs. Ignoring them puts you at risk of making an unprofitable choice.

How can you know the full cost of a strategic option, including its implications for budgets enterprisewide?

Solution

With investment-based budgeting, every department submits a budget for its products and services (not just expense codes by manager, as in traditional budgeting).

When considering a new strategy, each includes the appropriate deliverables to in its business plan, and calculates the full cost of those internal products and services.

Then, you can total up the full enterprisewide costs of various strategic alternatives.

Challenge

In a traditional strategic planning process, executives collaborate on a written plan. Then, these strategies are translated into management performance objectives for the year. Sometimes this is through an enterprise performance management process; in other cases, its left to individual managers.

All this is done at a high level, and the process rarely defines the specific contributions of each managerial group to each strategy. There's no way to really know if all the pieces are in place to ensure effective execution.

Furthermore, this traditional planning process does nothing to ensure that resources are aligned with strategies. It's not clear that managers have all they need to deliver their pieces of the strategy. Again, execution is at risk.

How can a planning process improve strategy execution by clearly defining all the needed deliverables from every relevant group, and aligning resources with those deliverables?

Solution

In most cases, strategies require contributions from many groups within the enterprise. And those involved groups rely on others for various support services.

Consider every group a business-within-a-business, "selling" products and services to peers within the enterprise or to external customers.

In an organization that understands this paradigm, strategy is translated into the set of specific products and services needed from groups throughout the enterprise.

Executives can then check to be sure all the needed deliverables are planned.

As an added benefit, individual accountabilities are absolutely clear. Well beyond the vague language of performance objectives, each manager is signing up to deliver a well-defined result -- a product or service.

This powerful paradigm can be taken a step further with investment-based budgeting. Managers submit budgets that describe the costs of their proposed products and services, and budgets are awarded based on the specific deliverables the enterprise chooses to buy from each group. This ensures that resources follow strategy.

With Investment-based Budgeting, each manager not only understands exactly what's expected of his/her group, but also has the resources needed to successfully deliver it.

Challenge

Many of the products and services produced by internal service providers (such as IT, HR, engineering, marketing, etc.) can be outsourced.

On the surface, one would think that paying other shareholders a profit to do what you're already doing wouldn't save money (unless there are real cost efficiencies that cross corporate boundaries). But an inefficient internal service provider can be more expensive.

In such cases, a fair comparison should reveal opportunities for either internal cost savings or outsourcing. Benchmarking compares internal costs with external vendor (outsourcing) costs.

But most benchmarking or outsourcing studies don't answer the question, "Can I buy this particular product/service for less outside?" Instead, they compare high-level summaries of costs (sometimes called "towers") with past outsourcing deals for other companies.

This doesn't tell you much. Are your service levels really comparable, or are you getting more, or a higher quality, of services that those other companies. Are you really less efficient, or have you found ways to make better use of internal services to leverage the business? Are there attributes of your business (such as location or market niche) that drive higher costs, whether internal or outsourced?

Also, at this high level, the only options you're provided are in-house versus outsourcing entire functions (or major portions of them). But it may be that your internal service provider is very cost effective at many of its products/services, and only a few are good candidates for sourcing.

Benchmarking studies which compare your spending to others in your industry have all the same problems. In addition, you can't buy from your competitors; so the comparison provides no realistic opportunity to reduce costs.

And neither of these high-level cost comparisons give you data in sufficient detail to know where cost-savings opportunities can be found.

Solution

The only accurate way to know if your internal service providers are producing fair value is a like-to-like comparison of products/service rates with external sources.

To do this, internal service providers need to publish a catalog of their products and services with rates based on fully burdened costs. All items in the catalog need to be things their customers actually buy. And rates have to be based on a cost model which associates all indirect costs with just the right products and services.

Then, comparisons with external rates for specific products and services tells you whether you can save money through selective sourcing. A repository of external rates can grow and evolve over time.

Challenge

In most organizations, managers are held accountable for spending no more than budgets permit. Variance analyses cause managers to explain why spending exceeds plan.

This metric does little to build a culture of acccountability for results. Consider the following example:

• Jane is entrepreneurial, successful, and grows her shared-services business. Her customers in the business find more money to spend on her services, so her revenues and her expenses exceed plan. She has a variance to explain.

• John is a poor performer and produces very little, but he spends exactly what he said he'd spend. No variance.

How can you hold managers throughout the enterprise accountable for results while still controlling spending?

Solution

An adjustment to the budget planning process can trigger a culture of accountability virtually overnight.

Investment-based budgeting requires that departments submit budgets that describe the cost of their deliverables (not just expense codes by manager, as in traditional budgeting).

Budgeting is then a matter of deciding what the enterprise will "buy" from each department.

As a result, when budgets are awarded, they're linked to specific deliverables -- a detailed definition of the accountabilities of each department.

In the example above, Jane delivered everything funded funded in her budget; and she delivered additional results to clients utilizing budget they provided.

John, on the hand, failed to produce the deliverables his budget paid for; he's the one with the variance to explain.

It's a matter of managing people to their bottom lines, not their top lines.

Challenge

A friend who'd just taken a new executive position said to me, "I've got good people. They're technically competent, hard working, good at managing others, and loyal. They just don't have a clue how to run a business."

Senior manager, even executives, may have risen through the ranks based on their professional competence. Along the way, they acquired supervisory skills -- the ability to manage and motivate others.

But few have actually run businesses. They may know how to read budgets and financial statements. But they've never had a chance to develop entrepreneurial skills.

As a result, they're not contributing all they might to the strategic thinking of the enterprise. And where will the next generation of leaders come from?

How can an enterprise cultivate entrepreneurial skills in all its up and coming leaders?

Solution

This is one of many reasons to treat every group at every level of the enterprise as a business within a business -- there to produce well-defined products and services for peers within the enterprise or external customers.

In this kind of organization, every manager has a business to run, has customers to please, has suppliers (other managers) to motivate, and has competition to beat (decentralization and outsourcing).

Step One in implementing a business-within-a-business organization is an annual business and budget planning process such as FullCost.

In it, managers learn to define a catalog of products and services that customers want to buy. They forecast expected sales in an annual business plan, and figure out how they're going to fulfill those sales. They manage their costs, knowing that customers may choose to buy from their competitors if they don't offer good value.

As much as any technical competencies, this experience prepares them for the next level of their careers (or quickly filters those who'd rather remain at technical levels).

Through participation, managers also contribute their in-depth knowledge of their portions of the organization to the business plan, and they make commitments that become the basis of measurable accountabilities.

"...it was like a mini-MBA. It's given me grounding in finance and changed the way I manage my unit and approach my customers."

Cindy Mitchell Director, Applications Engineering, University of Maine

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Challenge

As companies grow, complexity grows to the point where one individual (such as a founding entrepreneur) can no longer personally manage everything. Ironically, the founder who created the company may seem like the constraint to its continued success.

To eliminate the bottleneck at the top and refocus the CEO on strategic issues, and to tap all the talent that's already in the organization, the next tier of leaders must be empowered to manage their respective parts of the organization, exercise their creativity, and work directly with one another without the need for day-to-day involvement of the CEO.

However, empowerment cannot mean chaos. Everyone must be aligned with strategies; resources must be controlled; and activities must be coordinated -- functions formerly done by the CEO.

Disciplined business processes must take the place of an individual at the top personally governing resources and coordinates everybody's activities.

How can you install business discipline without destroying the entrepreneurial culture on which the company was built?

Solution

The best place to start is by implementing a business and budget planning process in which managers:

1. Define their group's products and services.

2. Associate all their costs with those products and services (not just direct costs).

3. Agree on the specific list of products and services they're expected to deliver, with a budget matching those costs.

With such a plan in place, the CEO can now measure both results and financial performance.

As an added benefit, the CEO can coordinate activities across the enterprise (without micromanaging leaders) by funding all the products and services from various groups that will be required to execute a strategy.

With both control and coordination in place, the CEO no longer needs to be personally involved in the day-to-day management of the enterprise.

Challenge

When companies are acquired or merged, and when functions are consolidated, it should not be a matter of "winners" dominating "losers." Synergies and cost savings depend on integrating similar functions and capitalizing on the best of breed regardless of source.

Furthermore, the integration must occur without missing any commitments.

It's not enough to jam together groups with similar sounding titles. The specific deliverables (lines of business) within each group should be culled out and integrated with similar functions.

The only way to achieve this degree of precision is to get all involved leaders -- acquirors and acquirees -- to work together to identify what each organization brings to the table in resources and commitments.

Collaboration must be structured in a process that is methodical and equitable, and leads all participants to a consistent framework that makes the identification of redundancies and synergies apparent.

Solution

A structured integration process engages all participants in the following steps

1. Deconstruct their organizations into component "lines of business" using a consistent framework.

2. Define their organizations' products and services.

3. Define their commitments (projects and SLAs) as "sales" of these products and services.

4. Associate all costs (not just direct costs) with those sales.

5. Calculate rates, and identify best-of-breed by comparing rates across organizations for each line of business.

6. Use the definition of commitments and resources to structurally combine similar lines of business.

With documented frameworks, a well-structured process, and open participation, a merger/consolidation process can attain its promised synergies and savings, build morale, and establish an entrepreneurial culture -- all at the same time.