Shift Your Foundational Cost Structure

This is an edited extract from Rethinking Operating Models.

Any company looking to reduce costs significantly and sustainably should first consider big choices, as they often have the largest impact on a company’s cost structure and complexity. Big strategic choices take significant leadership commitment as they may fundamentally change who a company is or how it operates. It requires significant stakeholder buy-in from investors, the board, and senior leadership. For these reasons, there is often a reluctance to entertain big shifts, opting instead for incremental improvements. However, it is important for leaders to understand that incremental improvement produces incremental value. Most forms of incremental standalone optimization, such as co-location and process standardization, yield 5–10 percent financial value.

To achieve material results, companies need to look first at big, strategic choices. To get big, you need to go big.

The first big choice is to understand the company’s power relationship across business units and between the business units and corporate center, and then to align power relationships to the right organization strategy. The second choice is to consider if there are other ways to group and manage the middle of the business portfolio.

Business configuration and cost

A significant driver of cost comes from the misalignment of strategy and business unit portfolio power and decision-making with regard to the role of the center—what we call “business configuration”. In Networked, Scaled and Agile, authors Kates, Kesler, and DiMartino defined the operating framework continuum. It summarizes the amount of autonomy given to business units, the role of the center, the implications to management processes, and ways of working.

Fully integrated single business

Companies using a fully integrated single business configuration have a single strategy and culture, and nearly all processes and practices are common. They have found a business model that can sustain growth around a tightly related set of products, services, or experiences. Growth comes from innovation within the portfolio of offerings or expansion geographically. The center drives functional policy, staffing, and standards to build a consistent global way of working. Because of this underlying commonality, the single business model creates the greatest opportunities for shared services, standardized processes and enterprise-wide technology and automation at scale. Complexity and cost are usually the result of geographic diversity where local regulations or commercial practices require some differentiation.

One practice that can be employed most easily in a fully integrated single business is that of looking at processes from an end-to-end perspective. Rather than orienting around functional silos, where many handoffs are required to complete a process, fully integrated businesses have the best conditions to work across functions in a boundaryless manner. Examples of this end-to-process approach include order-to-cash and hire-to-retire, which enable lower function costs through scale, process standardization, and enterprise technology.

Companies can take this practice one step further by considering end-to-end value streams. By connecting end-to-end processes to make end-to-end value streams, such as “plan to make” across the company, workflow can be redesigned holistically, tracking back from the customer. Value streams are a major operating model change, but, in addition to cost reduction, this approach can improve customer experience.

Closely and loosely related portfolios

The most complex cost questions arise in closely and loosely related portfolios. In these cases, business leaders want to allow some degree of business unit and market autonomy while gaining the benefits of resource leverage that come with shared functions and processes.

Loosely and closely related portfolio companies require a very nuanced approach to understanding drivers of complexity and cost. A closely related portfolio provides greater opportunity for cost structure optimization.

Closely related portfolio

A closely related portfolio provides greater opportunity for cost structure optimization, given the greater possibility for shared technology platforms, common processes, and company-wide talent practices. The scope of process routines that are well-suited for consolidation and standardization expands to include all enabling functions, together with aspects of business functions.

Enabling functions

• Finance: record-to-report, invoice-to-cash, procure-to-pay, acquire-to-retire, management reporting, and aspects of planning, budgeting, and forecasting
• Human Resources: talent management, employee services, administration and payroll, and HR operations and support
• IT: end-user computing, application development and support, service desk and data center, voice and data network, and aspects of business intelligence
• Legal: contracting and employment law
• Real estate: facilities management and project management.

Business functions

• Marketing: consumer marketing, marketing support services, and aspects of product development
• Sales: sales support services, internal communications, and aspects of trade marketing and channel and customer sales
• Supply chain: demand planning, supply planning, and aspects of fulfillment.
• Innovation centers
• Enterprise data and analytics.

In a closely related portfolio, there are a broad range of service delivery models, including internal centers and third-party outsourcing relationships. Considerations are often about the prioritization of how to deploy internal talent and which distinctive capabilities are worth owning versus renting.

Loosely related portfolio

Too often we see companies with a very loosely related business model seek to pursue enterprise models that require a high degree of standardization and shared technology. The result can produce tension between the business unit’s need for flexibility and the enterprise functions’ desire to drive toward standardization and centralized service delivery.

Enabling functions, however, are where the company with a loosely related portfolio can find value from optimizing through consolidation and standardization. Some examples include:

• Finance: invoicing, accounts payable, accounts receivable and cash application, fixed assets, and managing master financial data
• Human resources: benefits administration, leave of absence administration payroll, and HR master data
• Procurement: contracting, requisitions, payments, travel and expenses reimbursement, and managing supplier master data
• IT: data center support, infrastructure support, application support, information security operations, and help desk support.

Companies with loosely related business portfolios often take consolidation and standardization further by electing to have a lean internal team manage the relationship with an outsourcing provider.

Holding company

In a holding company or a conglomerate, each unit has a high degree of empowerment to operate the business in an autonomous manner. The concept of “enterprise” is very limited, often referring to a very small corporate center focused on high-level talent and financial decisions. As a result, corporate leaders typically have limited ability to reduce cost and complexity from the center beyond the distribution of top-down targets.

Even with these constraints, one way today’s holding company leaders can generate scale and streamline cost is to make a big choice around outsourcing. This often takes the form of precision-focused infrastructure, application, or business process arrangements. A third-party provider uses their expertise to drive optimization both within a portfolio company and across the portfolio companies. The focus is on using technology to improve work orchestration, automation, and analytics to reduce the cost of delivery and improve the quality of outcomes within an operating company or portfolio-level company. Selective outsourcing or centralization, such as accounts payable and payroll, can improve control and reduce risk, while increasing consistency and optimizing the cost of the process. Outsourcing can also make the holding companies’ assets more attractive as they can be sold without complex Transition Service Agreements (TSAs), simply allowing the existing outsourcer to continue providing the same services under new ownership.

It is important to note, there is no “better” or “worse” business configuration. Two companies within the same industry may conclude the key to their competitive advantage is reflected in different configuration choices. Coca-Cola, for example, is focused on beverages with a higher degree of operational similarity than PepsiCo, which includes beverages, breakfast foods, and snacks. Acknowledging that there are many dimensions to evaluating operational complexity, when it comes to the product portfolios of the two companies and the associated operational complexity, Coca-Cola is more likely to be the left side of the business configuration and PepsiCo to the right of center. Typically, we see a high correlation between operational sameness and cost to operate, but it is not always the case.

What does create cost is when leaders espouse one configuration and operate in another. We often see senior executives praising the benefits of scale, common processes, technology platforms, and shared capabilities and resources while remaining squarely committed to the philosophy of general managers having broad autonomy over investment choices and ways of work. This mixed message allows operators to “opt in to” or “opt out of” enterprise capabilities and services, leading to unproductive tension between business unit leaders and those who have been tasked with making the “stronger center” model a reality. The result, all too often, is wasted time, energy, and money.

Read more in Rethinking Operating Models.