Bruce E. Jacbos05.19.08
Outperforming Your Competitors in a Downturn Economy
There is too much wasted energy, media, rhetorical debate and disagreement about the US economy being in recession, economic slowdown, minor recession or short-term stutter. No chief executive or his/her key managers need the Federal Reserve Bank, US government or the media to make that official declaration. It’s intuitively obvious to the casual observer, as order volume is down, the size of orders is smaller and less frequent, customers are taking longer to pay invoices, more customers are being put on credit holds and more receivables are being written off, to mention a few factors. Couple these with the housing market slump, higher unemployment, declining automobile sales, lower-than-expected retail sales during the holidays, higher fuel prices and the recent stimulus package approved by Congress to stir consumer spending, and it isn’t necessary to officially declare what already is obvious.
Managing any company through an economic downturn is not easy and not much fun, and companies that produce medical devices and equipment are no exception. Too many entities that were underperforming financially before the downturn will scramble desperately to survive the downturn in hope of making it through to the economic upturn—thereby playing the game “hoping not to lose.” These are companies that were marginal performers when the economy was strong but never able to optimize performance because their limited success was achieved by default of good management rather than achieving targeted performance by design from good management.
The true measurement of how well a medical device manufacturer (or any company) is managed can be ascertained by how well it performs in an economic downturn. Revenue may decline and costs may increase, but a well-managed company has the plans, mechanisms and processes embedded in the organization to be proactive and systematic about reducing the total cost structure, improving working capital and realigning the company’s structure with the level of revenue being achieved to maintain margins. Revenue may decline, but profitability is not optional and margin slippage will be minimal.
Unfortunately, too many companies are reactive, rather than proactive, in managing their way through the downturn. This is evident from pronouncements of major employee layoffs, supplier invoice payments being extended from 60 days to 90 days, the proliferation of outsourcing, consolidations of shared services and reorganizations. That is not to suggest that these tactics are not necessary, but they are reactionary.
What Works
Enterprises that are well managed during a downturn in the economy tend to recover quicker when the economy improves because they maintain a close balance between revenue, costs and profit margins. As revenue declines, costs are reduced accordingly to maintain profit margins. Consistency in profitability and the ability to demonstrate strong profit margins, even in an economic downturn, are the result of rigorous and relentless efforts to improve the total cost structure of the company. It is embedded in the enterprise’s management and is a management process that engages the entire organization every day to mitigate cost creep and slippage while continually adjusting the total cost structure of the company in response to market changes, revenue fluctuations and competitors’ cost pressures.
Fundamentally, the approach is to achieve and maintain the least total cost structure for the company. The result of a three-pronged approach:
• Lower the cost incurred and achieve the same value
• Increase the value achieved without increasing costs
• Eliminate the cost by incorporating major changes in the way things are being done
The objective of relentless cost improvement is to achieve the highest total value of output with the least total cost structure input. This objective is pursued year after year, and the results are demonstrated in year-over-year improvements that afford the enterprise the ability to offset cost increases that are either unable to be controlled by the enterprise or are the result of price increases passed along by suppliers.
Now that the economy is in the middle of a downturn, what should you do to get started?
• Assemble your management team and set its direction for lowering the total cost structure of the business to align it with the decline in revenue and maintain your profit margins
• Establish focused cost improvement teams and direct them to challenge every cost being incurred as identified on the general ledger
• Determine the overall cost improvement target that must be achieved to maintain profit margins, and allocate cost improvement targets to the improvement teams based on the costs’ distribution on the income statement
• Establish an operating plan scenario that reflects the adjustments to costs based on various levels of sales revenue and product volume, and identify the trigger points that when profit margins decline, defined cost improvement actions are taken
Proactive Management
It’s about executing a cost improvement plan designed to maintain profit margins in an economic downturn rather than reacting to the downturn and taking random actions trying not to lose margin.
There is nothing new in the concept of continuous cost improvement. What is new is the concept of continuous cost improvement being a rigorous and relentless effort embedded in the organization’s culture, management processes, performance measurements and compensation programs. Today’s business environment changes quicker than ever before, and the total cost structure needs to be challenged continuously to adequately adjust to the changes if profit margins are to be maintained. Too many companies wake up too late to recognize their total cost structures have not adjusted to reflect the economic changes in their markets. Consequently, when they do wake up, major cost elimination surgery is required.
Companies that understand the concept of continuous cost improvement are better positioned to survive a downturn. Fewer dramatic actions are required to adjust the total cost structure, and a company is better positioned to be successful financially when the economy improves.
One way to embed continuous cost improvement into an organization is to incorporate it into the return-on-assets (ROA) performance requirements of the company. Based on the targeted ROA, the cost improvement requirement is the difference between the present operating profit and the required operating profit needed to achieve the targeted return. As the targeted ROA is raised to achieve year-over-year improvement, the cost improvement target increases as well.
After several years of effort to improve the total cost structure, companies sometimes begin to suffer from delusions of adequacy about their costs and fail to recognize the infamous cost creep, which is like Jello on a paper plate at a picnic in 98-degree weather: Before you know it, it’s everywhere on your plate—in the potato salad, the pork and beans, fried chicken and biscuits. Therefore, the total cost structure always is challenged, and no cost is immune to the evaluation and improvement process.
During the journey to embed the concept of continuous cost improvement in your company, several principles should be applied:
• No cost improvement is too small
• Every improvement is measurable
• Least cost does not mean cheap
• Cost improvements may not be given away to the customer in the form of lower prices unless absolutely necessary
• Cost avoidance is not cost improvement
Successfully surviving an economic downturn with minimum slippage in your profit margins is hard work, and the cost improvement requirements always are more challenging.
Engage your employees—the challenge needs more intellectual capital around it. You don’t have to think outside the box to improve the total cost structure, but you may have to think a little closer to the edge of the box. Getting started now will better position your company to meet its profit margin requirements during the downturn and allow it to rebound quicker when the economy improves.