Bruce E. Jacobs06.10.08
"Right-Size" Your Company
Bruce E. Jacobs
The term “right-size” may have been developed by management consultants with expertise in profit improvement, cost reduction and productivity enhancements—not to mention overhead cost reduction. You may know these consultants as the “BodyWhackers,” whose primary focus is head count reduction. Their work is relatively easy and requires little expertise to become skilled at removing people fromthe payroll. All that is needed to execute this type of work is the company’s organization chart, payroll register, list of employees that key executives view as troublemakers, a quiet workroom and a target of the cost improvement that must be achieved through the workforce reduction program. The consultants arrive, management steps back, perfunctory interviews are conducted with employees, some work processes may be observed and six to eight weeks later, employee costs are down—savings will be forthcoming after employee separation packages and severances are paid. The remaining employees who were not rightsized out of the business then perform the work previously completed by 10% to 30% more employees.
The formulaworks. Management blames the workforce reduction on the consultants and poor business climate while taking no responsibility for letting the company get oversized. The consultants get paid for their dirtywork and proforma profit improvement from the headcount cost reduction, and the same work volume gets completed—giving the perception of productivity improvement.
As the economy continues to flounder and the gap between a company’s revenue and total costs becomes increasingly smaller or total costs begin to exceed revenue, more executives are reacting to their profit degradation by right-sizing their company. Few industries are exempt from margin degradation and operating losses during a recession, and medical device companies similarly have no safe right of passage.
Definition of Right-Size
The right-size is a continual balance of a company’s total costs, asset investment and usage, debt, working capital requirements and other related inputs required to profitably serve customers based on the revenue being generated. The operative word in this definition is profitably—meaning, you don’t jeopardize your profit margin. You protect your profit margin from the profit migration factors that accompany every economic downturn: higher material costs, lower sales volume, higher transportation costs, general inflation, utility cost increases, customers not accepting your price increases, customers taking longer to pay your invoices, higher invoice write-offs, larger working capital requirements and increased inventory, among others.The right-size for your enterprise is the size that generates the required operating profit, regardless of the economy.
When should you look inside your company to right-size it, and where should you look? You can’t just wake up one morning and decide to right-size your company. Any executive who does has violated his or her fiduciary responsibility to the company.Right-sizing is a management journey to maintain the required gap between revenues and total costs. Therefore, every activity that generates costs, consumes assets and drives revenue is included.
Starting to Right-Size
If you choose to right-size, your first step should be a review of your revenue, sources of revenue and costs to generate the demand that results in revenue. These would include revenue by customer, product groups, market segments and locations. Analyze your customers’orders and segment the data by order size and customer annual volume.This should give you a good indication of how your revenue is being generated and direct you to the related costs of servicing the customer orders.
In addition, it will give you a good indication of the contribution made to the total revenue by specific product groups. The right-size is where the revenue being generated is too incrementally small and the customers that generate the incrementally small volume are too numerous that, by eliminating the incrementalism, the offsetting cost improvement is significant. To keep any of the incremental contribution, the rules of play must be changed—ie,minimum order sizes, freight allowances, annual volume discounts, terms and conditions as well as other related costs and discounts. The concept is not about minimizing growth; it’s about maximizing resource usage and eliminating areas that consume resources and provide very little return but still generate costs.
Next, focus on your primary assets and the deployment of these assets. They would include cash, trade receivables, inventory, plant property and equipment. Right-sizing requires the determination of the amount of each the company should maintain to support the current revenue base, generate growth, support reinvestment and deliver the products and services at the least total landed cost. Anything other than the minimum amount is excess and thereby needs to be right-sized and used better. There is a tendency to underuse and undermanage these assets, which results in lower cash flow, higher working capital needs, excess inventory and underused plant property and equipment.
Right-sizing the cost structure requires more diligence—not only to keep the total cost structure of the company in line, but also to manage the cost structure effectively as the sales volume changes—to maintain the profitmargin. The total cost structure and the proportional gap between revenue and total costs should remain the same, regardless of the level of revenue.Therefore, the total cost structure requires a rigorous management effort, especially in a downturn.
The simplest adjustments to these costs generally pertain to the payroll costs because employees are visible, and every employee has an accompanying overhead cost in addition to his or her wages. But good employees are an asset and do not create a cost burden. If workforce reduction is necessary, the elimination of personnel should be directed at underperformers. Be careful not to cut into your “muscle”—employees with strong performance and capabilities. These employees will be needed to build the company in the future.
Attack the remaining elements in the total cost structure and align these costs accordingly with the revenue. Every cost item on the general ledger—from customer discounts and freight to cost of goods sold, selling, general and administrative costs. Just because these costs were budgeted doesn’t mean they are justified.
Developing and maintaining the rightsize for your company requires executives to have a tight grip on the cost structure. Enterprises that understand the concept of right-size have action plans developed
and in place that are triggered when revenue, the cost structure and profit margins change.
Action Plan
If the financial performance of your enterprise is underperforming and profitability is eroding, now would be the time to right-size:
• Review your current financial performance and operating budget
• Realistically adjust your projected monthly revenues based on the current market and economic climate
• Define the operating profit the company requires
• Determine the total cost reduction amount needed to achieve the targeted operating profit
• Identify the percent improvement for the total cost reduction amount (Note: The cost improvement as a percent of the total cost structure gives an indication of the level of effort that will be needed to bring the cost structure in line.)
• Identify themajor cost components to be improved and determine the required improvement level
• Establish employee teams to analyze the costs and implement the cost improvements
• Modify your operating budget to reflect the revised revenue targets and the cost improvements
• Prepare a“Plan B”for additional cost reductions if the profit margins are not achieved with the present cost reductions
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Maintaining the right-size for your company is the responsibility of company’s executive management team and requires relentless effort in economic downturns (as well as in economic upturns). Too many executives wait too long to right-size their company in a downturn, hoping for a turnaround in the
economy. The first time usually is painful, but by embedding the process in the organization to right-size on an ongoing basis, the pain and emotional stress dissipate as the adjustments become a continual reoccurring process, rather than a hatchet job to save the company.