Does Cost Cutting Create Competitive Advantage?

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Many Fortune 500 companies have shown us that you can make more profit with fewer sales. Sealy Mattress’ second quarter 2012 sales down 2.9%, profits up 1.5%. MillerCoors’ domestic first quarter sales to retailers was down 1.6 percent but net income rose 16.6 percent. 3M’s second quarter sales were down 1.9 percent while income rose 3.75 percent. DelMonte Foods swung from a loss of $73.5 million to a profit of $89.3 million while sales declined 1.7%.

However, does cutting expenses to the bone increase the competitive advantage of the business? I say “no.” Here’s why. If you figure out how to shave ten percent off your shipping costs, today you have a competitive advantage. But how long does it last? Within a few months your competitors have figured out the same ways to shave costs and you are back to square one. In order to create a meaningful advantage you must do better than simply cutting costs.

Cost cutting does not provide competitive advantage or an improved business model. However, if you can find a method to strategically realign costs, you can create competitive advantage. What’s the difference between simply trimming costs and strategic cost realignment?

Here are some examples of strategic cost realignment:

  • Amazon’s no retail stores approach to retailing
  • Wal-Mart’s proprietary logistics methodology and scale
  • EBooks vs. paper books
  • Retailers who completely remove salespeople vs. change sales practices
  • ATMs vs. bank tellers
  • Moving a call center to the Philippines vs. trying to hire cheaper and cheaper local workers
  • Using software or technology to change a business process and significantly lower cost.

Typically, these radical changes are disruptive innovations rather than simply improvements to an existing system. If you are looking to radically change your cost structure, don’t think about improving things; think of starting over with a clean whiteboard and redesigning everything. This type of radical disruption creates meaningful competitive advantage that is hard to match.

Here are some easy ways to know if your innovations are strategic or simply cost cutting:

  • Working harder for less is rarely indicative of innovation. Cost cutting is painful and typically involves more work for less money for both employees and the company. If you are caught in one of these “race to the bottom” situations, find a radical way to realign costs rather than simply cut, cut, cut.
  • Innovations typically involve painful people or process changes. If your changes can be quickly implemented or aren’t too painful, they are probably not strategic.
  • Cost cutting usually provides immediate savings. Innovation frequently takes financial investment in the short term but pays off in the long term. The immediate payback of cost cutting is one of the reasons it is so appealing. However, once you jump on the non-strategic cost cutting treadmill, you will find yourself in a painful downward spiral.
  • Cost cutting typically does not scare the daylights out of you, radical innovation does. For instance, all the changes Sears is making to spin off divisions, sell assets, and attempt to cut costs the old-fashioned way are not working. Until Sears tackles the root issues with some radical ideas, expect the continued death by paper cuts.

In summary, most businesses need to cut costs now and again. However, do not let cost cutting substitute for the important work of innovating your business model.

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