Using surgical precision to drive effective strategic cost transformation

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Using surgical precision to drive effective strategic cost transformation

Confronting Uncertainty Intelligently

In turbulent times even stronger strategic positioning is needed. Analytics, with its prescriptive abilities to drive more accurate, actionable and scalable business interventions, is a key capability. The fourth and final article of the Confronting Uncertainty Intelligently series explores how to use analytics-enabled cost transformation to balance operational continuity with enhanced strategic positioning.

Luuk Brakel, Stephanie Brood and Dylan Bakema

In volatile times, organizations should use the power of analytics to recalibrate their position across a set of four integrated strategic choices. In our first blog we discussed how to apply scenario modelling to regain control in volatile times, by shining a light on the choice: ‘What future should we plan for?’. The second blog detailed the choice: ‘Where should we strengthen our focus?’, we explained how to deploy analytics to decide which geographies, channels, customers and products to focus on. The previous blog focused on the third choice: ‘How can we better serve our customers?’, we discussed how to effectively serve the most valuable customers. In this fourth blog, we will discuss the final strategic choice of this series: ‘How can we better allocate costs?’. We explore how to effectively allocate (scarce) resources in volatile times, balancing operational continuity in the short term with long term strategic priorities.

Blog series: Confronting Uncertainty Intelligently

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As a result of disrupted demand triggered by the COVID-19 crisis, many companies cope with pressured liquidity. As a short term response, companies can apply for subsidies, optimize working capital or cut cost to ensure operational continuity. However, the winners beyond the crisis manage to balance operational continuity in the short term with stronger strategic focus to build a winning position in the long term. Analytics-enabled strategic cost transformation enables companies to thrive in volatile times by more accurately diagnosing strategic cost improvement opportunities, designing the right strategic cost interventions and implementing with speed, agility and adaptability1.

Diagnose the fat from the muscle

During past recessions, companies that cut costs deep and fast had the lowest probability of outperforming competitors after the economy recovered (only 21%). For example Sony announced a cost-reduction target of $2.6 billion in December 2008, epitomizing an aggressive cost reduction approach. In response to the crisis it closed several factories, eliminated 16,000 jobs and delayed strategic investments in its core electronics business2. Sony succeeded in increasing its margin in the short term, but struggled to regain its market position once the crisis faded (only reaching pre-crisis stock value level in 2018, 10 years after the onset of the crisis).

The companies with the highest chance of flourishing after a downturn are often the ones that reduce cost with surgical precision, hereby staying financially sound in the present, while simultaneously securing future growth potential. Strategic cost transformation provides an opportunity to direct resources towards strengthening your future strategic position. Leadership can only realize this when strategic ‘Where to play’ and ‘How to win’ choices clearly articulate the company’s focus. Especially in volatile times, a company should channel (scarce) resources to building capabilities required to realize these strategic choices.

Analytics is a valuable tool to strengthen strategic cost transformations, especially for complex companies with access to large data sets. For these companies, the advantages of scalability (e.g. ability to copy from one to more business units) and pin point accuracy of interventions (modelling interventions on granular company dimensions e.g. functions, BU’s, customers, activities) outstrip the costs associated with the implementation & maintenance of analytical solutions.

Companies often lack (granular) insight in their own costs and processes, which is the foundation for diagnosing strategic cost improvement opportunities. Enrichment of cost data with (historical) data on operational performance (including back-office), customers, sales and competitors allows for internal and external benchmarking, hereby driving more meaningful and actionable cost assessments. The balance between SG&A costs and the size/productivity of operations within countries is an example where benchmarking could be of great value. Internal benchmarks can then be used to assess whether SG&A costs are in proportion to the company’s operations within a particular country compared to other countries (or compared to the historical balance of SG&A costs vs. operations in the same country). Additionally, external benchmarks allow leadership to place the internal benchmarks into perspective using competitor’s performance.

To illustrate how analytics strengthens diagnosis of strategic cost improvement opportunities, we will use the example of a utility company that serves SMEs with utility contracts (based on monthly energy consumption), offering a broad range of IT applications (e.g. virtual customer support, application to communicate variable pricing and environmental impact, energy trading portal for producing customers and an advanced insight portal for high volume customers) to ensure a high quality customer experience. The company was looking to strategically transform their cost base following the COVID-19 crisis. First they wanted to obtain an understanding of whether costs significantly differed per customer type. Advanced clustering techniques, such as K-means, were applied to over 20 customer variables from CRM and sales databases (e.g. contract length, sales channel, geography, sales volume) to group customers into distinct segments based on similar demographics and purchase characteristics. The company’s IT costs were allocated to customer segments based on an algorithm that extracts and combines insights on the type, usage intensity and support requested for different IT applications. It turned out that the IT costs allocated to several low value customer segments vastly outstripped the generated revenue. Moreover, external benchmarks using competitor information indicated that the overall investment in IT applications was relatively high compared to the utility company’s revenue. Based on these insights, the utility company diagnosed strategic cost improvement opportunities, by reducing IT investments for low value segments and reducing spend on IT applications.

Trim the fat with surgical precision

Once the focus areas for the cost transformation are identified, concrete strategic cost transformation interventions can be designed by e.g. using zero basing. Zero basing starts with listing all activities and corresponding costs of the company, and moving them into a metaphorical “fridge”. One-by-one the activities are evaluated based on their contribution to the strategic priorities. Company simulation techniques are applied to quantify the short- and long term impact of eliminating or re-introducing specific activities at a granular level. Consequently, high impact activities required to realize the future strategic priorities will be provided with the necessary resources to realize their full potential, non-essential other costs are reduced.

Let’s consider the same utility company, where strategic cost improvement opportunities were diagnosed for the IT department. A machine learning model was trained on the customer database to determine customers’ expected lifetime value (CLV) and its sensitivity to limiting access to specific IT applications (reduced access to IT applications increased the probability to churn, lowering CLV). Based on the profitability and IT application usage of previously defined customer segments, the optimal IT application mix and support levels per segment were defined. Hereby allowing access to specific (more expensive) digital services only to customer segments for which this resulted in a (more than) proportional CLV increase. This intervention significantly reduced the amount of customers with access to the most expensive IT applications. Consequently, capacity for those services could be scaled down, leading to lower resource cost and reduced third party licensing fees (e.g. market data was bought on a pay-per-view basis)

Evaluate, perform surgery, repeat

To reach the full potential of the strategic cost transformation, while also managing risks, leadership should implement with speed, agility and adaptability in mind. It is unlikely that you will be able to fully plan the transformation at the start, as market conditions may change throughout the journey. Best practice is to start small, with prioritized use cases or pilots in specific business units. Agile teams drive short (e.g. six-week) sprints to create momentum and demonstrate the success of the interventions3. Consequently, these interventions can be scaled to other organizational units by reapplying the developed algorithms, tools and processes from the initial pilot project. Progress can be tracked real time using dashboards, which allows leadership to closely monitor the program and enabling mid-course corrections where necessary.

Looking at the utility company example, applying the segment-specific IT application mix wasn’t conducted in a single push for all customers. As a first use case, the updated IT application mix & support levels for the loyal, but lower value CLV customers were tested on 10% of the segment. Dashboards tracked key KPIs (churn, IT application usage) real time resulting in insights on these customers versus the remainder of the segment (the control group). After monitoring and iterating interventions to generate optimal results, they were scaled to the entire segment. Learnings, dashboards and algorithms were then applied to the next segment.

In volatile times, such as the COVID-19 pandemic, the companies that will come out on top are the ones that effectively ensure operational continuity while driving long term strategic focus. Analytics, with its abilities to help companies make accurate, actionable and scalable strategic decisions, speeds up the process of identifying and executing the right strategic cost transformation interventions.

In the Confronting Uncertainty Intelligently blog series, we have guided you through our approach, combining strategic thinking and analytics, to enable companies to thrive in volatile times and beyond. We discussed: 1) how to make better strategic bets using analytics-enabled scenario modelling, 2) how to use analytics to fuel strengthened focus, 3) how to intelligently increase customer equity, and 4) how to use analytics-enabled cost transformation to balance operational continuity with enhanced strategic positioning. All of these choices begin and end with our key assertion: now more than ever, data and analytics must be front and center to define and deliver on effective company strategies!

More information?

For more information about ‘Using surgical precision to drive effective strategic cost transformation' and/or the ‘Confronting Uncertainty Intelligently’ blog series, please do not hesitate to contact Stefan, Laurens or Hanneke via the contact details below.

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