Further compelling evidence this week from McKinsey that sustainable business improvement is what really counts.

According to McKinsey: many cost-reduction programs are “illusory, short lived, and at times damaging to long-term value creation”.  Their research concludes that only 10% of cost reduction programs show sustained results three years later. Yes, you read that right: 90% of cost reduction programs fail.

Hat tip to McKinsey for its report this week Five Ways CFOs Can Make Cost Cuts Stick which forcefully highlights the importance of building capability in cost management,not cost reduction,

Amongst McKinsey’s advice on best practice in cost accounting and data integrity, three things stand out for anyone looking to build a framework for sustainable performance improvement.

(1) ‘Seeing’ the Process

McKinsey reports a fundamental difference between Manufacturing costs and Sales, General and Administrative (SG&A) costs.  Manufacturing costs have fallen consistently over the past decade, whereas SG&A costs are unchanged. McKinsey suggests one reason why SG&A costs have proven so difficult to reduce: that ‘managers lack deep enough insight into their own operations’.

This diagnosis fits exactly with the New Balance case study. New Balance focussed its Lean program on its manufacturing activities, with dramatic results in service, lead times and reduced costs.  But, away from the shop floor and looking at SG&A costs, it was far more difficult to achieve the same results with the same techniques.  New Balance’s explanation: it’s easy to see what’s happening on the production line and in the warehouse.  It’s far more difficult to figure what’s going on in the office. New Balance described Nimbus Control as allowing them ‘to see the process’ – after which their Lean program could deliver SG&A cost reductions.

(2) Local Engagement

McKinsey notes that: “Most cost innovation happens at a very small and practical level.”  Which is why any process management application must engage end users and the process stakeholders. The people who are closest to the process are best placed to see the cost reduction opportunities, and to assess the trade-offs.  Cost management must be an ongoing exercise, they say, part of the culture [and not a one-off unsustainable initiative].

Some discomfort for the Six Sigma community because, for the same reason, McKinsey’s recommendation is that: “The process planners who run programs such as Six Sigma improvement efforts are generally the wrong choice to manage cost-cutting programs.”

(3) Understanding The Whole

The report stresses that cost reduction has to be seen in the round: Initiatives in one area of the business can often have unintended negative consequences elsewhere.  It quotes a global manufacturer where cost-cutting in manufacturing led to the loss of clients and market share because the the cost-cutting leaders were working in isolation from the sales and marketing teams.  They simply didn’t understand how customers used the products.

All in all, more solid evidence that sustainable performance improvement across the enterprise requires a complete, integrated and end-to-end view of the business processes, and in a language and format that enables enagement at every level.

Five ways CFOs can make cost cuts stick- McKinsey Quarterly, May 2010