Companies that are slashing costs or laying off people across the board may be making a serious mistake, says Robert G. Atkins, vice president with

Mercer Management Consulting

.


Robert G. Atkins
Vice President,
Mercer Management Consulting

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Rather than making wholesale cuts, Atkins believes companies would be smarter to selectively jettison the 5% to 10% of their staff who are the least productive, focusing on the areas of their business that are the least profitable. And -- slackers beware -- Atkins also says companies should know who those least productive workers are at all times.

If companies make these cuts, Atkins says they will have the money to invest in areas in which they can attract the most customers, as well as in technology and capital, thus positioning themselves to rebound strongly from the economic downturn.

TSC: The elimination of jobs is continuing at full force, as evidenced by the reduction of 235,000 nonmanufacturing jobs in April. Should investors pay attention to what kinds of jobs companies are eliminating?

Atkins:

I think so. People who make cuts without a clear understanding of what their next business design is going to be are really cutting in the dark. In such a case, cost-cutting can be pretty dangerous.

These days, business strategies only last three to five years, so if a recession lasts six to 18 months, chances are, your business will run out of gas just before, during or right after a recession ends. If you don't know what your next plan is going to be, it's very difficult to know what cuts to make. You may be cutting just the wrong things, things that are going to be required in order to accelerate your growth coming out of a recession.

It's like taking out a buzz saw and putting on a blindfold. When you're done cutting, you'll have cut some trees and you'll have cut some legs, and you can only hope they're not the legs for your next business plan.

Investors should be asking themselves if the companies that they have invested in can describe what they want to be when the recession is over. If the company doesn't know what that postrecession strategy is, then investors should take no comfort from cost cuts.

TSC: What's the most common approach you find companies make in cutting costs or laying people off? Do they typically eliminate people with the biggest salaries, or those in customer service or perhaps marketing first? What are some common mistakes?

Atkins:

Unfortunately, the most common approach that we find is something we call "hunker down" -- a classic across-the-board 10% cost cut. That's very ineffective because it cuts muscle equally along with fat and bone.

A smarter approach is something we call "de-averaged" cuts, where a company might make cuts much more than 10% in some places, and invest in others. There are places in an old business design that could be dying that need to be cut quite deeply -- maybe 20% or more. These deep cuts are required in order to fund the investments that are going to grow and power them out of a recession.

Regarding layoffs, companies need to make sure they are really laying off the bottom 5% or 10% of their workforce in terms of performance, and not necessarily cutting evenhandedly. To do this, you need to know who the bottom 5% or 10% of your workforce are. Unfortunately, companies often don't.

Microsoft

(MSFT) - Get Report

actively identifies them every year. Many companies don't have this kind of rigorous appraisal process to detect poor-performing people or businesses.

Last but not least, a company should know what costs it has that are not critical to its customers and be willing to cut these costs deeply.

TSC: Doesn't all this information show up every year, anyway, in a budget review?

Atkins:

It does, but the sense of rigor and discipline that goes into addressing these costs is dependent on the economic climate.

TSC: Which companies are making intelligent cuts or layoffs right now, thinking ahead to an eventual economic rebound?

Atkins:

IBM

(IBM) - Get Report

is doing a terrific job of actually using the recession to strengthen their competitive position, and some of the language they are using is very resonant with what we would say. They are spending an additional $111 million on marketing for their software businesses because they believe now is a great opportunity to take advantage of some weakened competitors in that space. And they just bought the database software unit of

Informix

(IFMX)

the other day.

On top of that, they positioned themselves wisely before the onslaught of the recession to offer more solutions related to their hardware and software. Their larger client base is actually helpful, too. IBM didn't become as dot-com oriented as some.

Intel

(INTC) - Get Report

in 1990-91 increased their spending on manufacturing facilities by 60% in 1990 and 40% in 1991. Their thinking was that that would allow them to lead the way out of the recession. Their competition was cutting back at the same time. They also increased their spending on the brand and came out with the "Intel Inside" slogan at a time when others were cutting back. Once again, the company seems to be doing similar things to what it did in 1990-91.

Merrill Lynch

(MER)

took advantage of the 1997 downturn in Asia to buy

Yamaichi Securities

, which was essentially bankrupt at the time. They picked them up very inexpensively and kept 200 outlets and a couple thousand salespeople in Japan. As I understand it, they are the only non-Japanese financial services firm with a retail presence in Japan.

Cemex

(CX) - Get Report

, a Mexican cement manufacturer, also took advantage of the Asian downturn quite aggressively and bought facilities in the Philippines and Malaysia for 50 cents on the dollar. They applied their digitized business design to those companies and made them much more profitable.

TSC: What about the smaller companies that may not have the capital to make such acquisitions? What should they be doing during an economic downturn?

Atkins:

Cash is only one currency for acquisitions. There are other ways to invest. It's also a good time to pick up talent. It's a good time to pick up systems capabilities; they are heavily discounted right now. There's also the opportunity for limited acquisitions or shared facilities.

TSC: You also suggest that a company might consider ridding itself of less profitable products or services during a downturn. Isn't that difficult to do at a time when a company might want to find any revenue it can?

Atkins:

A company should determine if it is providing services that customers don't really care about or that are unprofitable. It's not uncommon for a company to build up this assumption about what its customers want. One of my clients, an automotive paint supplier, actually reengineered its product, taking a lot of the features out of the paint. They improved their margins from 35% to 60%.

Another client, a PC manufacturer, had a very diverse product line to meet the needs that they thought were out there. At one point, they had more than 1,000 different types of units. We helped them find out what their customers really cared about and took their product line down from 1,000 different products to less than 100, and over the next couple of quarters, their market share improved by 3%.

When you strip down the product line, you can supply product faster, have less inventory and much lower overall cost, so you can also lower your prices. That's what I would call the cost of complexity. A recession is a great time to focus on the

few

things that customers really care about.

TSC: Is the economic downturn of 2000-2001 posing any challenges unique from other recessions or downturns?

Atkins:

Knowing where to cut costs is an issue in this downturn. If you went back to the 1990-1991 recession, you would find that people didn't have too much trouble making the 10%, 15% cost cuts without getting into muscle. There were areas of companies that were not essential to their businesses. My sense is that companies have really slimmed themselves down in the last 10 years, and while we have been growing quite rapidly, we have done it without inflation or price increases. Economic discipline in many companies has been quite strict, even during boom times.

So one of the challenges of this recession is that there isn't a lot of low-hanging fruit to cut in the cost side.

TSC: Has technology lowered costs considerably for companies and helped them to be leaner?

Atkins:

In fact, one of the areas we would look for a company to invest in during a recession is in something we call "digitize the business." It's one of the few things you can do to improve customer service and lower costs at the same time, and the opportunities there for improvement are often substantial.

Automation has helped businesses make very dramatic improvements in cost control and in customer service. You'll often see 10 times improvement in productivity in areas that have been effectively automated. We've seen companies improve their working capital turnover from six times a year to 60 times a year. We've seen companies lower their purchasing costs from $200 to $20. Cemex, the Mexican cement manufacturer, reduced their cycle time for delivery from two hours to 20 minutes.

Some folks believe since the dot-coms have died that the Internet is passe and that the competition is diminished. I think those people are mistaken on both counts. The dot-coms that come out of this will come out very strong, much more disciplined competitors. Incumbents who digitized effectively are going to be very powerful, well-financed competitors coming out of the recession.

Companies should be taking advantage of the fact that equipment and service costs are lower, and the employees who are available to do this are much less expensive than they were 10, 12 months ago.

TSC: What has your research showed on how effectively, or ineffectively, companies have cut costs in past recessions?

Atkins:

We looked at 120 companies that cut costs in 1987 through 1992 and found less than one-third of them experienced growth in the five-year period after that and even fewer than that in the 10-year period. Most companies don't achieve profitable growth, and cost-cutters are even less likely to achieve it.

The key is focusing on your next business design in order to accelerate your growth when the economic recovery begins. When this economy bounces back, it's not going to look like it did five years ago, or even last year. Different sectors are going to come back first. Consumer attitudes are going to be somewhat different. There will be technology capabilities that didn't exist before. The Internet will be much more pervasive. Depending on how long the recession lasts, we might even have things like wireless Internet capabilities.

If you haven't redesigned the business for this environment, you will recover slowly, if at all. If you have anticipated the business design you will need and made the investments to develop it, despite the recession, you will rebound stronger and faster than the competition.

For the smart companies that use the downturn to build winning business designs, these "bad times" will prove to be some of the best years for moving ahead of the competition.