The Right — and Wrong — Ways to Cut Costs

HANNAH BATES: Welcome to HBR On Strategy, case studies and conversations with the world’s top business and management experts, hand-selected to help you unlock new ways of doing business. When companies cut costs, they tend to trim spending across the board. But Cesare Mainardi former CEO of Booz & Company, says that cost cutting should be a careful, strategic process. In this episode you’ll learn how to ensure that your company’s strategic capabilities aren’t negatively affected by necessary cuts. You’ll also learn how top leadership can work with teams to understand the trade-offs involved in reducing costs. This episode originally aired on HBR IdeaCast in September 2009. Here it is.

PAUL MICHELMAN: Hello. I’m Paul Michelman from Harvard Business Publishing. And I’m delighted to be joined today by Cesare Mainardi. Cesare is managing director of Booz and Company’s North American business. And he is the co-author, along with Shumeet Banerji and Paul Leinwand of Cut Costs, Grow Stronger; A Strategic Approach to What to Cut and What to Keep. Cesare, thanks for making the time to talk today.

CESARE MAINARDI: Pleasure to be here, Paul.

PAUL MICHELMAN: Cesare, implicit in your decision to write this book, I think there’s an important, kind of profound idea, especially considering the economic times we’re living in. And that’s that most companies, and particularly their leaders, don’t know the most effective way to take costs out of their organizations. So before we get into the solution, what’s the problem? What are companies doing wrong?

CESARE MAINARDI: Well, we have found that most companies, when confronting cost reduction, tend to make cuts across the board. I believe most executives know that that’s not quite right, but they resort to that. They’ve come to the conclusion that they need to act fast, and then they pull the trigger in that way.

And we have come to realize that the activity of expense reduction is really a strategic choice. And in fact, there’s no time like that to make some very sharp decisions about what’s important? What is strategic? And to make decisions around costs in that context.

PAUL MICHELMAN: That sounds great in theory. I take it we need some kind of framework, or lens, to do this effectively. So where do we go next?

CESARE MAINARDI: We’ve come to learn that the best way to define activity is around capabilities. And we have found that if a firm is able to concentrate its expense around the capabilities that make a real difference in terms of winning in the market, then great things happen. And not only are they able to cut costs where things matter less, but they’re able to invest in the areas of business that will cause them to thrive and to grow, even as an economy returns, for instance.

PAUL MICHELMAN: Dumb question. What’s a capability?

CESARE MAINARDI: A capability is a combination of know how people, expertise, processes, all that happens in a business that allows that business to out-execute competition in the markets that they serve. It’s not many, many different capabilities. But it’s a few– 2, 3, 4, 5, 6– things that make all the difference in terms of winning in market.

PAUL MICHELMAN: Does the average CEO or senior leadership team know what their capabilities are? Can they freely list them when asked?

CESARE MAINARDI: In a moment of reflection, sort of away from the day today, if you were to ask an executive what 3, 5 things might really make the difference in the business, the majority can, in fact, tell you. I think many times in the day to day, it gets lost in all the different things that happen in the big corporation, all the functions, and other activities. And then, at times, it’s hard to see the forest through the trees.

PAUL MICHELMAN: Is there an example of a company, maybe quickly you could talk about and what their capabilities are, just to cement this?

CESARE MAINARDI: Sure. Frito-Lay comes to mind, a division of Pepsi. And they built a tremendous capability to market up and down the street, as they call it. And it was a combination of trucks and highly motivated salespeople, and the tools and techniques to know what product to place in those stores, and direct store delivery. Decisions about pricing. Everything that is required to serve that market, and that channel, extremely well. They built a tremendous capability in that regard. And it caused them to secure leadership for quite some time in terms of salty snacks.

PAUL MICHELMAN: OK. So we have an understanding of what our capabilities are. Maybe we could use Frito-Lay as an example here. How do we transfer that knowledge to a strategy for taking cost out of the company?

CESARE MAINARDI: Well. Take Frito-Lay as the example. If clear minded that is the capability that they’re building over time, what is it that they do that is, then, not essential to that activity? And any corporation has many, many different activities in it. And the key is to figure out what is essential to the success? And then what is just required to keep the lights on? And what’s important is to triage the two. And invest in the activities that cause success, relative to competition, and then to be as lean as possible in everything else.

PAUL MICHELMAN: So does this mean we’re looking for things that we might classify as non strategic to focus on them? Or are there things that might actually seem to be strategic that we should be also looking to cut?

CESARE MAINARDI: It’s a combination of all of the above. We think about three kinds of costs to some extent. There’s a minimum that’s required to keep the lights on. It’s not very strategic. But if you’re a public company, you have to report, you need an accounting department, and the like. The rest of it, we think about as investment. It is, in fact, expense investment in the business, as opposed to capital investment, that drives growth and expansion, and new decisions, new markets, innovation, whatever it might be.

And when you look at expense investment, there are a number of things that really are essential to success. And we call those the core capabilities of business. And the rest of it might be an investment step too far. And so what management does is a triage between, what I need to keep the lights on? Where is it that I’m spending that will make a difference in terms of winning over time? And then, how is that I keep the rest as lean as possible.

PAUL MICHELMAN: Who is involved in making these decisions?

CESARE MAINARDI: Well, because we believe cost reduction is, in fact, strategy, and is some of the most important strategic choices that are made, we believe that top management has to be in the lead on significant cost reduction.

PAUL MICHELMAN: How far down in the organization is the cost reduction team? Or is there a team that comes into place to focus on this? Or is this just part of the regular course of business?

CESARE MAINARDI: We view this as a different way of doing business. So there’s the regular course of business, and then there’s changing the business. And where we’ve been most successful, we’ve taken on these programs as a change the business kind of program. It begins with top management coming to a clear determination about a big target to reach. And in fact, the greater the aspiration, the greater the result, always. So they’ve set a big hairy target. And then have a discussion about what might be different about the markets today, and where can we be more clear minded about the capabilities that make a difference to win over time.

So distillation of the 3, 5 things that are so terribly important to the future and to growth in the future. They set the stage. They build their hypotheses then about what is important and less important. And then they launch teams into doing their work. And the teams have to come back and inform management as to were the hypotheses right or wrong? Were the risk trade offs entailed with going down the path of reducing costs in some places versus investing in others? And it’s an iterative process where management debates with working teams throughout the organization, in terms of making the best decisions, and the best risk return trade offs around that expense investment.

PAUL MICHELMAN: This sounds like a very rational approach. But in the face of, say, surprisingly dismal results, and an unexpected pressure to take cost out of an organization– sadly, an experience that many companies have had over the past 12 months or so– can a process like this be implemented quickly for short term savings? Or is this really just a longer term approach?

CESARE MAINARDI: We have found that the majority of executives don’t believe that this can be done quickly. In our experience, it can be done very quickly.

We have found that it doesn’t take a very long time to distill the 3, 5 things that are most important in the corporation. And that, in fact, if you mobilize everybody around those concepts, there’s a positive upside around thinking about the future and growth. But more importantly, it really frees up thinking. It eliminates the barriers to what has caused expense to be what it has been before. And it causes people to really engage on making trade offs that are far different, and far more aggressive in terms of cost over time. And those decisions can be made quite rapidly.

PAUL MICHELMAN: By quite rapidly, you mean–?

CESARE MAINARDI: We’ve been in situations where the bottom was falling out fast, and we were able to turn around. For instance, the battery division of Johnson Controls, working with management there, together, they were able to take out dramatic cost in the span. They started with four weeks of activity, and costs already was starting to come out and completely transformed over a half year time frame. And we have found that you can move very, very quickly with this approach.

PAUL MICHELMAN: Can this approach only be applied from the very top of the organization down? In other words, if I’m the general manager of a division of a company, can I implement this approach, just within my group? Or is it, by definition, really an organization wide approach?

CESARE MAINARDI: Within a division, you can implement elements of the approach. One can be clear minded about what is most important in terms of activities and the capabilities in that division, and then make decisions within that context, as to where it invests in expense. How to think about how the product line, for instance, matches against those capabilities. That can be done, certainly, with the division. Where capabilities are shared across divisions, then, obviously, there’s an interplay with the much larger organization.

PAUL MICHELMAN: Cesare, this seems like such a rational, smart, approach. Why don’t more companies do it? What are the barriers to entry here?

CESARE MAINARDI: It is a simple, powerful concept. And we’ve asked ourselves the same question. And as we’ve reflected on, we really have found four major reasons why companies will tend to shy away from adopting this kind of approach to cost reduction. The first is around believing they just can’t do it in such rapid amount of time. If we have to inspect our strategy and think about really what will cause growth to happen long term or not, we won’t be able to take cost out rapidly. And we would argue that, in fact, top management always has a perspective like that in play. And may get some things wrong along the way, but those are eminently adjustable. And that, in fact, it is a navigation of top management responsibility just taking the easy route out, and asserting that strategy, or strategic thinking, cannot be done while costs are coming up. The second challenge is that sometimes it’s hard to see the forest through the trees. And we have found that good strategic thinking is a distillation of a few capabilities that make the difference. You can count them on one, maybe two, hands at most. Many organizations tend to think about capabilities and a long list of functions and activities and the like. And the important thing is to raise the thinking into those few things that really do make the difference. And sometimes, that’s difficult. It’s difficult as you’re facing and all sorts of different parts of the organization and the like. Third, sharp capability choices. Sometimes entails some pretty sharp portfolio choices. And so once you are clear minded and have communicated to everybody what a business is going to be really good at, then the outcome might be a decision to exit from certain product lines and from certain brands, from areas that wouldn’t thrive in that case set. And that’s a really hard decision to make. It’s a bit of a reset on the business. I’m willing to make some different choices about my new revenue run rate. Passionate about the fact that betting on those few capabilities, and keeping in the portfolio what will thrive in this capabilities, will, in fact, deliver a growth profile over time that will surprise and delight investors. And then the last reason is the one around aspiring to be best at everything. Top businesses frequently function by function, always benchmark against other top business. And certainly, the noble aspiration of every leader within a function would be to achieve those best in class performance, best practices, whatever it might be. But you know what? Being best everywhere may not necessarily be the best thing for the whole. What’s important is to invest in the capabilities that make the difference. But the pressure is always very high on management to support people everywhere in terms of their aspiration to be the best in any one particular area or function.

PAUL MICHELMAN: So there are some hard decisions here. Can you tell us about a company that has made these decisions and follow this approach effectively?

CESARE MAINARDI: Pfizer comes to mind. And in particular, the consumer health care part of that business. Years ago, they acquired Warner Lambert. And frankly, the acquisition was all about Lipitor, on the pharmaceutical side. But with Lipitor, came a large consumer products business within Warner Lambert. And historically, the presumption within Warner Lambert was that they were consumer businesses. And so, some consumer insights and some excellent marketing, and those kinds of activities, would cause all those businesses to thrive over time.

As new Pfizer Warner Lambert management started to consider the portfolio, they realize that, in fact, they had four very different businesses in the portfolio. They had a confectionery business. And that is all about rapid innovation, new flavors, owning the front end of the store. That was different from a personal care business, like body lotion, where you were making claims about beauty, and maybe new scents, and whatever might be a different part of the store served. Two other areas of business that lend themselves more to a medicinal approach, consumer health care, like mouth wash, and then, tradition over the counter medications. And in those last two businesses, we realized that the capabilities required to win were very, very different. They had everything to do with pharmaceutical like research. And health claims based marketing. And regulatory management. And owning channels that were different from general trade channels.

And so, we realized that they were trying to do too much in the portfolio. With management, they pared down the aspects of the portfolio that didn’t match the way that they were going to play in the market; their sweet spot. And then they invested in building the capabilities to really accelerate growth in over the counter and in consumer health care. They built the capabilities that I described.

And the outcome was paring of the portfolio. Significant cost reduction within what was left over. But then, a real focus on what made the difference in terms of winning and what conferred upon them the right to win, and, in fact, the ability to out compete everybody else. By choosing to focus the portfolio on the capabilities that mattered, by choosing to invest in the capabilities that mattered, they were able to drive industry leading growth coming out of that significant restructuring. Tremendous success, to the point where Pfizer, at a certain point decided to focus on pharmaceuticals– they had a jewel in the crown with the consumer health care business– and was able to sell that business to Johnson and Johnson, terribly interested in the kind of capability, for over 20 times EBITDA.

PAUL MICHELMAN: Great. Cesare Mainardi, thank you very much.

CESARE MAINARDI: My pleasure. Thank you, Paul.

PAUL MICHELMAN: To learn more about this approach, you can read Cut Costs Grow Stronger; a Strategic Approach to What to Cut and What to Keep, which is available in digital form for the Kindle, and as a downloadable PDF from HarvardBusiness.org. Thank you very much.

HANNAH BATES: That was Cesare Mainardi in conversation with Paul Michelman on the HBR IdeaCast. Mainardi is an author and the former CEO of Booz & Company. We’ll be back next Wednesday with another hand-picked conversation about business strategy from the Harvard Business Review. If you found this episode helpful, share it with your friends and colleagues, and follow our show on Apple Podcasts, Spotify, or wherever you get your podcasts. While you’re there, be sure to leave us a review. We’re a production of the Harvard Business Review – if you want more articles, case studies, books, and videos like this, find it all at HBR dot org. This episode was produced by Anne Saini and me, Hannah Bates. Ian Fox is our editor. Special thanks to Maureen Hoch, Adi Ignatius, Karen Player, Ramsey Khabbaz, Nicole Smith, Anne Bartholomew, and you – our listener. See you next week.