Breaking Out of the Cost Reduction Doom Loop

By Jason Green, CEO, The Cambridge Group, and Dan Vucovich, former SVP, President U.S.,
The Hershey Co.

For many companies, cost reduction efforts become an endless downward spiral.  As soon as one cost reduction program is completed, it’s followed by another.  Competitors become locked in a race to the bottom, as price reductions predicated on cost reductions are countered by more cost-cutting from competitors to drive another round of price declines.  Before you know it, the industry has shrunk and retailers, manufacturers and consumers alike all lose out on greater growth and access to greater innovation.

It’s a dangerous cycle, but one we know how to break.

The first step is dispelling the notion that cutting costs and driving growth are opposing objectives. Put another way, you don’t have to spend money to make money. Taking a demand-based view of growth opportunities can identify significant expense that is misaligned with profitable demand. What that means is that the growth opportunities identified by assessing your business from a demand-based perspective can be funded through the cost savings identified in that same assessment. In fact, the typical savings realized are sufficient to fund the new growth initiatives identified and much more.

At its simplest, a demand-based perspective is one that tests every expense against one touchstone: What does the consumer want? When we do this, we generally find that companies are overspending in four areas in which they are particularly prone to take a supply-based view: investments in the supply chain, in distribution, in media spend, and in innovation. The degree of overspending can often represent as much as 20% or more of a company’s total cost, and often translates into billions of dollars of waste. These are areas of wasted spending that most traditional cost reduction approaches miss entirely, precisely because, from a supply-based point of view, they look reasonable. When you look for growth from a demand point of view, however, you will necessarily identify costs that are not justified—which is why the savings to fund the growth can be found by the same process that identifies the growth opportunities.

Overspending in the supply chain

We identified a growth opportunity for a division of a large multinational food company by repositioning its core brand—originally treated as a lunch or dinner entrée with a summer spike—as a year-round snack. Looking at the nature of the demand for the brand, we found that moms preferred that their teen and tween kids eat our client’s brand between school or camp and afternoon activities—that is, as an afternoon snack—to most other snacking options, which they considered less healthful. Focusing on the seasonal spike meant that the company was overlooking profitable, year-round consumption. Hence the growth. But focusing on the spike also meant running a peak-and-valley supply-chain, which was more expensive than a steady-state year-round model—hence the savings. In addition, savings were available from focusing only on those materials aligned with demand (which in our experience can often be less expensive). Supply chain savings alone can be significant once the lens of demand drivers is applied to total supply chain costs, including raw materials, processing and packaging.

Repositioning the brand as an afternoon snack worked almost immediately: Sales, which had slumped through endless rounds of cost-cutting (a common issue with seasonal products), increased dramatically throughout the year. In fact, for the first time in its entire history, our client’s brand surpassed the competitor brand that had always dominated the market. With higher year-round volumes, the client was able to expand its own manufacturing and eliminate costly seasonal co-packers, which dramatically reduced supply chain costs.

Distribution and retail investment. We find that, without a robust understanding of demand, both manufacturers and their retail partners significantly misallocate resources by class of trade, by store and within stores. When Dan Vucovich was Chief Customer Officer at Hershey’s, he and his team found that their retail investments were not aligned with the stores their most valuable consumers shopped most frequently—which also meant that their distribution system was not optimal. According to Dan, “ I remember a CAGNY meeting where we shared our success lowering inventories, reducing SKUs, reducing complexity, creating efficiencies and generating improved cash flow. The magnitude of improvement in the business was something I’d never seen before.”

Specifically, by developing a granular understanding of shoppers who patronized thousands of stores across the U.S., Dan and his team were able to show retailers how to drive growth across stores and within stores by expanding the candy assortment and upgrading the candy aisle and check-out lanes with collateral, products and a layout more in keeping with an updated understanding of demand. The essence of the program was that only some stores received new investment. Once again, applying a demand lens to the challenge made it possible to fund areas where investment could yield dividends by reallocating spending away from areas where investment was not yielding a return. In 2009, retailers rated Hershey’s 13th among consumer products companies that added value to the relationship, as measured by Advantage Program Ratings, a business tool used to evaluate a company’s performance relative to their competition. In 2014, Hershey’s ranked second in this same report.  

Media spend. Many companies invest in media based on industry benchmarks. We recommend optimizing media investments simply by identifying the right audience and delivering the right message to them. We have always found that this results in a more effective, more efficient total outlay.

But you can’t do this without understanding who your primary consumer is and what motivates them, which is why benchmarks are a familiar fallback. But the result is that most companies end up buying against broad demographic audiences rather than getting their messages to those who really matter. To address this, we helped Crown Media, owner of the Hallmark Channel and Hallmark Movies and Mysteries, harness big data to identify high-value audiences for a range of brands and categories and understand what they tune into on TV. This enabled agency and advertising clients to drive better ROI by allocating media spending to networks that delivered these high-value customers. “We are constantly collaborating with Nielsen to identify new opportunities that optimize value for our clients and help them more efficiently reach their audience,” explained Ed Georger, EVP, Ad Sales & Digital Media. Identifying the most effective TV properties for advertising and measuring incremental sales potential with actual retail data is valuable to Crown Media and its advertiser client base.

Innovation. One personal care company had successfully negotiated lower costs from vendors for some key ingredients used in their product. However, we found that consumers wanted an added benefit that could be delivered through an innovative reformulation of the product that used less of the most expensive ingredients and that added a new, lower-cost ingredient. As it happened, using the lower cost ingredients made the product easier to produce, which improved plant throughput. Because the new product actually looked different, too, it made it possible for the marketing team to trademark a successful “new and improved” claim, which also helped drive sales.

This last example is a perfect demonstration of the way in which applying a demand lens brings to light not just growth opportunities, but savings opportunities that will necessarily remain invisible to traditional cost-cutting efforts. This is because applying a demand lens leads you to do things differently, rather than simply focusing on doing the same thing more cheaply.

These client experiences are typical. What we’ve found across both industries and markets all over the world is that developing a profound understanding of consumer demand and aligning all activities to it identifies growth opportunities that can be funded—and more than funded—by cost-savings identified by the same process. Why is this so? Many businesses build in unnecessary costs over time by chasing the wrong opportunities as well as the right ones. When they do cut costs, it is often by seeking to do the same thing more cheaply.  And if “the same thing” is right in some areas but wrong in others, cost-cutting across the board may well inadvertently eliminate processes critical to long-term growth. Aligning the business system with profitable demand grows the top line while optimizing supply chain, distribution, media and innovation costs. “Spending money to make money” suggests that cost-cutting and profitable growth are mutually exclusive. A demand lens shows that they are in fact entirely consistent.