Setting business targets is an annual ritual. We always think of sales targets, profit targets, and quality targets, but how many organizations establish annual cost improvement targets? In terms of business factors, which can be influenced to produce higher profits or funding for other activities, the cost base will usually provide the single biggest area of opportunity.
When introducing cost improvement targets, you need to look at the whole business, and consider a few questions:
- On Costs: Would your administrative, material and labour costs remain stable, without cost improvement targets? What about unexpected or extraordinary costs? Do you know the main culprits of cost-creep? Our experience is that the cost base never remains stable. There is continuous movement and usually not in the right direction. We all talk about cost management, but how many businesses set cost improvement targets strategically and how many are really consequent in about their achievement?
- On Pricing: Are you in an industry where you set the market price and customers purchase anyway? Probably not. Most of us are operating in a highly competitive environment. In many cases competitive forces are pushing prices down. Therefore, in addition to cost creep, companies often face price erosion.
- On Profitability: Does your current level of profitability allow you to absorb increased costs or lower prices? Unless you are in a very special position, the answer is most likely to be no. You may even be under pressure from management or shareholders to increase profitability.
Therefore, to set cost improvement targets, it is important to look beyond basic costs. You have to consider unexpected and extraordinary costs, and also lower revenue from price erosion, and demands for higher profits. Taking these push / pull factors in to consideration, you will be able to establish the gap or main level of target required.
Once the main target is established, it is important that the target is distributed and applied appropriately. This means analysis of the cost drivers, developing cost improvement measures to achieve or even over-achieve the target. Strategic and well-focused cost improvement targets have a significantly higher chance at success.
In conclusion, once you have set your targets, you will need a world-class cost improvement program to ensure successful implementation. Without a well-structured cost improvement program – You lose 40% of annual savings potential – about 2% of sales!!