Why Cost Cutting Can Sometimes Become Too Costly?


Whenever a company announces a cost-cutting drive, the markets respond with enthusiasm, driving up the share price. There are at least four assumptions underpinning this enthusiasm:

In most cases where I have been personally involved in cost-cutting exercises (and these number in hundreds by now), these assumptions hold true. Indeed, the projects are created only when the evidence of excessive fat is readily available. Diagnostics are carried out intelligently and implemented diligently. Long term unintended consequences are minimized by taking these into consideration during the strategy formulation.

However, there are ample examples in press of one of the four assumptions above not holding up. This news-story from a recent edition of Bloomberg Business Week tells us the case of Walmart. As per the article:

Wal-Mart Stores (WMT) has been cutting staff since the recession—and pallets of merchandise are piling up in its stockrooms as shelves go unfilled. In the past five years the world’s largest retailer added 455 U.S. Walmart stores, a 13 percent increase, according to company filings in late January. In the same period its total U.S. workforce, which includes employees at its Sam’s Club warehouse stores, dropped by about 20,000, or 1.4 percent.
A thinly spread workforce has other consequences: longer checkout lines, less help throughout the store, and disorganization. Last month, Walmart placed last among department and discount stores in the American Customer Satisfaction Index, the sixth year in a row the company has either tied or taken the last spot.

The article goes on to compare the current woes at Walmart with the HomeDepot experience a few years ago.

That’s what happened at Home Depot (HD) in the early 2000s, when it tried to trim expenses and boost profits by cutting staff and relying more on part-time workers. Eventually customer service and satisfaction deteriorated, and sales growth at established stores fell.

Perhaps this is symptomatic of the dilemma faced by all brick-and-mortar retailers. As the customers move to online channels, and increasingly use traditional retailers as mere show-rooms to get a touch and feel experience of products that they later buy online after comparison shopping using smart apps, all retailers are experiencing challenges that require ‘fresh thinking’ and ‘newer business models’.

However, as per the article, not all retailers are exhibiting the same symptoms of mis-guided cost cutting. The article quotes the case of a shopper who finds the shelves in competitors’ store amply stocked and serviced, as follows:

Margaret Hancock long considered her local Walmart superstore her one-stop shopping destination. But during recent visits, the retired accountant from Newark, Del., says she failed to find more than a dozen items, including certain types of face cream, cold medicine, mouthwash, bandages, and hangers. Walmart’s loss was a gain for Kohl’s (KSS), Safeway (SWY), Target (TGT), and Walgreens (WAG)—the chains Hancock visited for the unavailable items. “If it’s not on the shelf, I can’t buy it,” she explains. “You hate to see a company self-destruct, but there are other places to go.”

This article, and the example quote above, has hit a nerve among Walmart customers – setting the cybersphere abuzz with comments, mostly quoting similar experiences, or worse. Walmart’s drive to cut-costs has not gone un-noticed by its customers. No doubt, online retailers such as Amazon are fast gaining market share due to their lower overheads and drive to gain market share at the expense of margins. It will be very interesting to see the outcome of this particular battle.

More interesting question is, however, What should be Walmart’s strategic response to the current challenge?

Also, if you have read this far, you might be interested in spending 2.5 minutes more to review this new-fangled technology called Prezi, and comment on it:

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  • James says:

    I’m working on cost reduction project of my company. I found important learning by this blog. Specially few negative aspects which can be avoided after reading it. Something similar to this, I’m reading more blogs to get success, one of I’m reading on McKinsey:
    “Cutting sales costs, not revenues”
    I’m focusing this lines mainly “To avoid these mistakes, companies should consider a fundamentally different approach. First, examine the customer portfolio. How much effort really goes into each customer and transaction? Which services does each of them need? What are their real profit margins? Which customers and markets are growing and which are shrinking? Understanding customers allow companies to focus sales resources where they are needed and to cut waste, not value. In fact, the sales force can become better and less expensive if organizations reject some traditional practices, such as assuming that big customers need or want big sales coverage, and embrace opportunities to become more efficient by sharing knowledge and resources.” (You may refer for more details: https://mck.co/2N9X1BS)

    Could you give comments on these line as I found you are expert in this area? Thanks

  • Riley says:

    Reduce payroll costs by outsourcing activities. Redesign processes to eliminate duplication of effort and time. Make more use of technology and automation. Consolidate purchasing with fewer suppliers to get better discounts and build strong relationships.

    How? Serious efforts to shed costs require substantial investments, as evidenced by the cumulative $44 billion in restructuring charges reported by the Fortune 500 during their most recent fiscal year, per a scan we conducted in 2016.

    here are instances when the ratios are actually far worse. We know of one consumer products company that invested $125 million in a cost-cutting program that delivered just $20 million in cost savings. Compounding the problem, costs that were successfully taken out via cost-cutting programs tend to creep back in before long, making the entire effort an expensive exercise in futility.

    Wonderful blog!!! I liked the complete article…. great written, Thanks for all the information you have provided…

  • Cendren says:

    Look closely into why cost-cutting gets expensive, and you often find that some components of the company’s strategy demand investments disproportionate to the attainable savings.

    For example, a U.S. company shuttering a European manufacturing facility can incur significant social costs, particularly mandatory funding of pensions, that force it to take a huge cash charge right away. If the cost-cutting strategy includes too many such components, the net impact on the bottom line can be the direct opposite of what management intended.

    And there is no doubt to agree with mr. sood on their Statement “There will be few long-term unintended consequences of the cost-cutting exercise.

    When management sees few options they like, they often make no decisions at all, in effect kicking the can of unnecessary costs down the road, thus perpetually limiting the company’s profitability potential.

    There are instances when the ratios are actually far worse. We know of one consumer products company that invested $125 million in a cost cutting program that delivered just $20 million in cost savings. Compounding the problem, costs that were successfully taken out via cost cutting programs tend to creep back in before long, making the entire effort an expensive exercise in futility.

  • Hunter says:

    During periods of slow economic growth, companies instinctively move to curtail their costs, often via strategies shaped by the CFO. Yet many cost-cutting programs actually cost the company money.

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