All Costs Are Not Created Equal

by BILL WADDELL

Everyone seems hell bent on cost reduction, most often without regard for the kind of costs they are trying to reduce.  For that matter, they are too often so tunnel visioned on a universal belief in the inherent goodness of cost reduction they are reducing costs they should be leaving alone – or perhaps even increasing.  The difference between value adding and non-value adding is too critical to be overlooked.

The value adding costs of direct material and direct, effective labor are a big deal – no doubt about that; but more often than not they have been the myopic focus of management for so long there is not much fat left.  It is difficult to trim much more of the fat without nicking the bone.  The siren song of China can be so alluring, however, that driving down the value adding costs, even at the expense of some deterioration in the value of the product is too strong to pass up.

The maddening aspect of this strategy is that there are other costs ripe for the cutting that are too often passed up.  There are costs in any business that are deemed necessary, even though they do not add value.  The cost of complying with GAAP in accounting to keep the tax man happy is one; there are other costs to keep OSHA and the EPA content.  There are all sorts of costs in communicating with employees, submitting records to the state and federal folks for purposes of assuring EEO compliance and keeping the Social Security records straight.  Employee records grow to voluminous size, not for any business purpose, but to head off any discrimination lawsuits at the pass should some problem arise with any particular employee.  Policy manuals are written and employee training can be relentless in teaching people what they need to know to keep the company out of legal trouble.

Quite often the people in the company responsible for these compliance issues are guilty of first degree overkill.  Unless there is some particular concern, the goal of the company should be to comply with the law – period.  While under-documenting and under-training are a mistake, over-documenting and over-training are a waste of precious time and money.  Too often the people responsible for compliance – either out of zealousness to assure the company never has a legal problem, or out of a desire to build an unassailable fiefdom – go way beyond the letter of the law.  Too often they use ignorance on the part of the rest of management, and a culture of fear of the wrath of the regulatory agencies to preclude oversight.

An accounting department that is competent and honest, working with a fairly straightforward business model, does not need much CPA support – a cursory audit by a competent auditing firm is enough. They do not need to call the CPA firm with the biggest name, working out of the the highest rent high rise building downtown. 

I once asked an HR Director about documentation procedures related to a problem a supervisor was having with a female employee that struck me as way over the top. He acknowledged that he had no reason to think that sexual discrimination was taking place and, no, the company had never been accused of sexual harassment or sex discrimination.  The lack of any legal problems in his mind was proof of the effectiveness of his processes.  In my mind, if the employees and management had no reason to think sexual bias was a problem, anything beyond documentation needed for basic compliance was a waste of money.

A bank official once told me that a loan officer was expected to have a small number of loans go bad – a loan officer who never had a default was very probably being way too conservative and losing money-making loan opportunities.  The same principle applies to all of these compliance efforts.  The company that has never had a regulatory auditor take exception to anything is most certainly erring way too far on the conservative side and wasting a lot of money.

That mindset is typical of many companies.  Spending several thousand dollars on something represented to the company as 'mandatory' drives management to bypass the process and head to the factory floor in search of cost reduction opportunities.  There is almost always opportunity in throwing a kaizen at a compliance process – beginning with having the kaizen team actually read the compliance regulations, rather than take the word of the expert that everything being done is necessary.

Even more fertile ground can be found in processes that are deemed non-value adding, but required, simply because a management decision had been made at some time in the past to require them.  The best example, and my favorite whipping boy in this area is ISO registration.  It was justified for some marketing reason some time in the past, and an institution ensued.  In one company, I came across a couple of hundred bucks being paid to an outside calibration firm to check rulers to be sure they were accurate – calibrating rulers to be sure they still measured an inch correctly! The person running the details of ISO compliance had no business sense, and the people running the business had no ISO knowledge.  For that matter, no one was asking whether ISO registration, the bureaucracy of compliance, and the cost of the audits served any useful purpose.  Often ISO was justified as a customer requirement, or as a necessary tool to get new business.  But no one asked a few years later whether the new business was actually obtained, or if the old customer still required it.  ISO registration can be bought, as anyone knows, without any legitimate quality management, so as to be meaningless in many cases.

Computer hardware and software are other examples.  Companies are paying to feed data into applications no one is really using, paying to renew licenses for software no one uses, and maintaining hardware so that everyone can have their own terminal, even though the terminals are seldom used.  At some point an analysis was made, and there is apt to still be some champion in the organization, but serious re-analysis and re-justification through kaizen can save a lot of money.

Just because someone says it is necessary due to some government regulation, or based on some management decision made long ago, does not mean that it is necessary at all; or if it is, that all of the cost associated with the activity is the least bit necessary.

Then, of course, there are expenses that are not justified by value adding, or by regulatory or management need.  They exist simply because management decided to spend money on them:  Office supplies and furniture, landscaping costs, company cars and company cell phones, generous travel policies, off-site meetings, company picnics and the like.  They may be important, but to walk past these expenses on the way to the factory to take a whack out of product value is absurd.

Of course no company should pay any more for the value adding tasks of the business, and no company should take on excessive risk in matters of compliance with any regulation.  But gutting the value adding end of the business, while maintaining a palatial office complex is silly.  It is a one way ticket to the low margin, low growth, low end of the market.  Saving a dollar by shutting off the fountain in front of the building, trimming the fat out of the regulatory compliance fiefdoms, and tossing out the ISO bureaucracy, and investing fifty cents of the dollar saved in the value adding processes to enhance product quality and customer value makes a lot more sense.