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Redirect Your Cost Savings into the Most Productive Investments

By Donald Mitchell

Republish: EasyPublish™ Published: 02Jul2008 Word count: 1023 Viewed: 438 time(s) Get Free Content For Your Site

As difficult as it to find better cost-based business models, these challenges are much smaller in scope than are requirements of redirecting the bulk of the cost reduction benefits into providing more desirable and attractively priced and delivered offerings to customers. This latter point is poorly understood in all but a few companies, yet its importance is paramount in establishing and improving upon a better business model. Focusing on converting cost reductions gains into the greatest customer benefits is one of the most important secrets that companies have in establishing and improving upon competitive advantages.

As a case in point, let's consider General Motors in the period from World War II to the mid-1990s. GM started this period with the highest market share and the lowest costs in the world.

During those years, the company primarily saw its cost opportunities as avoiding strikes, reducing head counts, making fewer production errors, creating greater parts commonality among car lines, acquiring high technology businesses that could help GM, and investing in computer technology and automation. In the process of pursuing those cost-improvement opportunities, GM probably spent more capital than any other company in the world.

Yet, outside observers reported that after 50 years of this approach that GM had ended up with costs that were substantially higher than most of its car manufacturing competitors and a much reduced market share.

What went wrong? Several books could be written on that subject, but for our purposes a few areas deserve special attention because they represent common problems with the ways many companies pursue cost reductions.

First, the bulk of the benefits from the cost reductions that occurred were shared with only two stakeholder groups: employees and shareholders. Labor peace had a high price in increased wages, benefits, and work rules. During the entire period, these costs rose much more rapidly than for most worldwide competitors.

Because Ford and Chrysler produced many fewer of their own parts, these high-cost labor contracts affected the General Motors cost structure more than anyone else's. In addition, a very high percentage of the earnings of General Motors were paid out in dividends to shareholders. Such funds were not available to reinvest to lower costs, create more customer and end user benefits, and more attractive pricing.

Companies that reinvest the bulk of such cost proceeds in ways that benefit customers create the potential for further gains in cost position, while those who consume the gains in other ways may lose many of the benefits they have if competitors do more, or more effective, cost-improvement reinvesting.

Second, the company did not do significant work on creating and applying new business models for its base automobile business until the Saturn experiment began offering cars in the 1990s. During those same years, Toyota pioneered the so-called lean manufacturing process that provided customers with cars built to their own specifications with higher quality in just a few days while investment levels and costs were slashed by these improved methods.

Although GM did some experimentation in this same area by partnering with Toyota, the lessons of Saturn and lean manufacturing were not widely disseminated throughout the company. As a result, most of GM's investments came in support of the company's outmoded, high cost business model.

That does about as much good for customers as literally gold-plating an obsolete piece of electronic equipment to make it look better. Chrysler's development of the minivan and SUV were also a new business model that GM was slow to follow, although GM has now become competitive in those products.

Third, the focus on cost reduction at GM often paradoxically led to higher costs. For example, over those 50 years GM often employed the worst quality alternative for its cars due to cost-related decisions. In the 1970s for example, GM was slow to put in systems that dipped parts in paint baths to help cars resist rust and the need for repainting.

People who were disappointed in these cars were sometimes reluctant to buy new GM offerings. Yet it was cheaper in the short-term to use the traditional spray painting process that created the spotty results.

At the other extreme, GM spent billions in the 1980s to put robots into its factories. Observers noted that these robots were not always less expensive than the people they replaced and made it more difficult to shift to lean manufacturing processes that individualized cars.

Further, by making many models of GM cars on the same design platforms to lower parts and assembly costs, customers noticed that cars as different in image as Chevrolets and Cadillacs were often very similar . . . yet sold at vastly different price levels. As a result, sales were often shifted away from the more profitable models and the most common GM design platforms to the offerings of other manufacturers.

Fourth, the company acquired its cost reduction capabilities expensively. For instance, GM became interested in what more modern computing management could do for the company, and purchased Electronic Data Systems while it was headed by H. Ross Perot.

Now, would EDS have been willing to take on GM as a customer without being purchased by GM? Probably, because having GM would have been a bonanza, more than doubling EDS's revenues and profits. GM's investment in EDS probably yielded no benefit to the company beyond what any other customer would have received, until a portion of the company's shares in EDS were used to pay auto worker retirement benefits in recent years. In fact, knowing that the GM business was not a "lock" might have led EDS to perform even better for GM.

Fifth, the company was slow to make structural changes in its costs that would permit GM to shift its business model. Despite much public and private hand-wringing about its high-cost parts operations, the company waited many years before making those activities independent of GM. The company also had problems with Oldsmobile for many years before announcing a decision to suspend production of that automobile brand.

Copyright 2008 Donald W. Mitchell, All Rights Reserved

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