Masters of the Cost Cutting Universe

General Mills is a $13.7 billion food company. In 2007, the company increased its profits by 13% on a 10% increase in sales. It enjoys higher margins than either Kraft or ConAgra.

The company reaches these margin heights by a constant and unrelenting focus on improving the efficiency of its operations. The attention to cost containment emanates from the very top of the company.

Here are some of the cost savings the company has implemented in the recent past:

* Get rid of some of the fourteen different pretzel shapes in its Hot’n Spicy Chex Mix.

* Eliminating half of the more than fifty versions of its Hamburger Helper product.

* Eliminate unimportant spice and cheese pouches in the Hamburger Helper product.

* Shrink the size of the product box, while keeping the product serving size the same in order to reduce shipping costs.

* Eliminating multi-colored lids on Yoplait yogurt.

We have studied patterns of cost reduction for a number of years. Costs are Inputs of people, purchases or capital. These Inputs produce product Outputs. The cost reduction objective is to reduce the ratio of Inputs to Outputs. We have observed that there are four separate approaches to reducing costs:

* Reduce the rates the company pays for the use of an Input

* Reduce the number of units of Input that are wasted or idle in the production of the Output

* Redesign the product or the process to avoid activities or steps that are currently undertaken in the production of the Output

* Find new customers and sales volume, i.e. more Output, for fixed cost Inputs

The examples of the real-world cost reductions at General Mills all fall under the third category redesign the product and the process in order to reduce activities. In this case, the company eliminated components of the product that brought little value to the customer. The components the company eliminated may have generated some revenues, but the revenues they generated were far lower than the costs they caused the company to incur. (See the Perspective, “Cutting the Right Cost”, on StrategyStreet.com.)

The Improve/Cost section of StrategyStreet contains several hundred brainstorming ideas to control costs in even the best of markets.

Nike Builds Brand Loyalty

Nike, ever the innovator, has found a new way to build brand loyalty. It has created a web site, NikePlus.com, that connects runners around the world. This web site tracks a runner’s data and allows a runner to join with other runners all over the world to improve their times.

To make this online group work easily, the company developed a $29 Sport Kit sensor that, when synched with an iPod or Nano, calculates the runner’s speed, mileage and calories burned and provides a method to upload that data to NikePlus.com. The company has sold over a million NikePlus iPod Sport Kits. Runners have used the web site to create groups where members challenge each other to improve their times and distances. Does this work? Well, in 2006, Nike accounted for 48% of all running shoe sales in the U.S. By 2008, its share was up to 61%. At least some of that must be due to the social networking site.

Over the last few years, we have studied several thousand product innovations. We have found that product innovations fall into three major categories: First, you can provide information to your customer; second, you can reduce the resources your customer uses with the product; and, third, you can improve your customer’s experience with the product.

Recently, we developed an article which outlines eleven questions, based on these three categories, that you can use to develop your product innovations. (See “Patterns of Product and Service Innovation” in the Perspectives on StrategyStreet.com.) Nike’s innovation falls under the “improve the customer’s experience” category. Nike has provided a good answer to one of the eleven questions: Can you add to your customer’s sense of pride and well being?

Congratulations, Nike, on another customer insight.

The Two Best Consultants in the World Warn the Associated Press

The Associated Press is a cooperative. This “non-profit” is owned by 1,500 newspapers. It employs its 3,000 journalists in 97 countries to provide news stories to these newspapers, as well as others in the media, including radio and T.V. stations and web sites. This company has been getting some significant warnings lately about its cost structure.

Many of its customers are struggling in the new media world. Newspapers and radio stations, especially, are suffering from the onslaught of web-based advertising. The first warning has come from its customers, one of the two best consultants. (See “The Two Best Consultants in the World” in Perspectives on StrategyStreet.com.) More than 100 newspapers have announced plans to cancel their Associated Press subscriptions. By defecting, these 100 customers have told the Associated Press that its value proposition is out of line. The company is asking too high a price for its performance. In response, the company has cut some of its rates.

It has gotten equally ominous warnings from the second of the two best consultants in the world, competition. New competitors are entering underneath its current price umbrella. These new competitors offer competing services at lower prices. (See “New entrants are penetrating the distribution channels of the industry’s leading competitors” in Symptoms and Implications on StategyStreet.com.) CNN has announced that it is starting a wire news service. PA SportsTicker offers stock tables and sports scores at very low prices. GlobalPost is creating a network of international news correspondents with a planned launch in 2009. Several of Ohio’s largest newspapers have formed an organization to pool in-state reporting. All of these entities must have a low cost structure in order to survive under the discounts they must to offer in the marketplace to pull customers away from the Associated Press. (See “Substitute products have grown in importance” in Symptoms and Implications on StrategyStreet.com.)

The Associated Press has to listen to both of these sources of warning. They are telling the company that the cost structure and prices it enjoys today is not sustainable in the current competitive world. The company must examine its cost structure soon to ensure that it is able to create economies of scale to use against these low-end new entrants. Then it needs to re-segment its market to be sure that the benefits it offers each segment are more than worth the price it charges the segment. Finally, it needs to restructure its pricing system so that each customer segment gets good value; that is, performance for price.

Nearing End Game for the Domestic Auto Industry

Consumer Reports recently had a load of bad news for the domestic auto manufacturers. The big car retailers had even worse news.

Consumer Reports issued a report showing that the three domestic automobile manufacturers, GM, Ford and Chrysler, trailed Asian manufacturers in quality. The Chrysler cars were rated very low on the quality scale. The GM cars were hit and miss: some of good quality, others of poor quality. Ford generally rates as the best of the domestic automobile manufacturers in automobile quality. The knock on Ford from Consumer Reports is that its car styling was boring.

We have observed, through thousands of customer interviews that all customers purchase using a hierarchy of criteria: Function, Reliability, Convenience and Price, in that order. (See “How Customers Buy” in the Perspectives section of StrategyStreet.) Automobile styling is a form of Function. Automobile quality is a measure of Reliability. In all Hostile markets, those industries with overcapacity, the winners in the industry succeed on the basis of high Reliability. Function and Price usually mean little because competitors copy any successful Function or Price innovation very quickly. Convenience is important. However, a company that loses its Reliability will also lose its Convenience, even if it is the leader in the industry.

The domestic auto manufacturers have lost their reputation for high Reliability. Now they are losing their Convenience, as the big car retailers write off the value of their domestic branded stores. Recently, the third and the fourth largest automobile retail chains, Sonic and Group 1, wrote off the major portion of their remaining investment in GM, Ford and Chrysler stores. In each case, the dealerships of the big three automakers accounted for less than 20% of the sales in the group. These big retailers are Very Large wholesale customers, those who determine the future of the industry and the Convenience with which retail customers may purchase automobiles. Many of the domestic brand of stores will close, particularly in these large dealership groups. Very few new outlets will open. As a result, the Convenience advantages previously enjoyed by the domestic automobile manufacturers slowly ebb away. That leaves them with little left to stand on. Neither Function nor Price will save them. Convenience has been their major strong point, but they are losing that as their Reliability slips.

You might ask why Reliability has slipped. The companies made choices that reduced the quality of their automobiles. This is an example of a self-defeating cost reduction, which sinks many competitors in Hostile marketplaces. (See “Success Under Fire: Policies to Prosper in Hostile Times” in StrategyStreet.com.)

A Win Win Cost Reduction/Performance Innovation in the Cell Phone Industry

The cell phone carriers are about to introduce a product innovation, called a femtocell, to improve cell phone reception within a home. These femtocells are about the size of a toaster. The wireless carriers will install these mini cell phone towers. The tiny tower will connect with cell phones inside the consumer’s home through a broadband internet connection to the telephone network. The wireless carriers hope that this innovation will increase the reliability of the wireless system to the extent that the consumer will be able to get rid of the $50 a month average land line cost. The consumer will pay about $100 for the femtocell, plus ongoing monthly service fees for the “enhanced” telephone service. (See the Symptom & Implication, “Companies are trying to create upscale niches” on StrategyStreet.com.) This sounds like a pretty good deal for the consumer, assuming they can get rid of their land lines. The innovation should substantially reduce the customer’s telecommunications costs. (See the Perspective, “The Choice of New Products” on StrategyStreet.com.)

It is an even better deal for the wireless carriers. These carriers pay about $200 for each of these boxes. They will recoup that $200 through the $100 installation fee plus the ongoing “enhanced” service fees. The beauty of the technology is that it lets the wireless carriers shift some of the cost of an increase in wireless capacity to their consumer customers. The capacity addition helps the carriers avoid some of the costs of adding new and expensive transmission towers.

We have studied patterns of cost reduction for a number of years. Costs are Inputs of people, purchases or capital. These Inputs produce product Outputs. The cost reduction objective is to reduce the ratio of Inputs to Outputs. We have observed that there are four separate approaches to reducing costs:

- Reduce the rates the company pays for the use of an Input

- Reduce the number of units of Input that are wasted or idle in the production of the Output

- Redesign the product or the process to avoid activities or steps that are currently undertaken in the production of the Output

- Find new customers and sales volume, i.e. more Output, for fixed cost Inputs.

This femtocell innovation is an example of the third cost management technique: the redesign of a process to reduce activities. This particular redesign reduces the capital requirements in the industry by shifting activities and investments to the consumer for no compensation. In fact, in this case, the consumer pays for the shift directly.

This certainly looks like an attractive win win deal.

The Improve/Cost section of StrategyStreet.com contains several hundred brainstorming ideas to control costs in even the best of markets.

Standard Leader Expands in Tough Market and Uses Price

Kohl’s Corporation is opening forty-six stores soon as part of a plan to gain market share as the busy holiday season starts in the U.S. Today, Kohl’s has something less than 1,000 stores open in the U.S. The company expects sales at stores open for a year or more to be down 2 to 4% during this year’s holiday season compared to last, so they are opening stores to make up for some of the sales fall-off.

But that’s not all they are doing. The company is a middle market chain competing with the likes of Penney’s and Macys. The company plans to renovate sixty existing locations in 2009, twice the number it will renovate in 2008. Probably boldest of all is their plan to use low prices to gain share.

The company expects to advertise its lower prices in its holiday marketing early in the season to be sure that customers know their spending goes further at Kohl’s. This price thrust will work only if Penney’s and Macys do not follow Kohl’s lead. (See the Symptom & Implication, “Large competitors are maintaining price levels as smaller competitors discount”, on StrategyStreet.com.) If they don’t, they are in a Leader’s Trap. A Leader’s Trap occurs when an established industry competitor maintains a price umbrella and cedes share to a discounting competitor in the mistaken belief that customers will stay loyal to the established competitor by paying a premium for its product. Over time, the company in the Leader's Trap not only loses share, but also sees prices fall to a level near the price established by the discounting competitor. (See the Perspective, “The Leader’s Trap”, on StrategyStreet.com.)

Kohl’s is almost certain to gain market share at the expense of weaker competitors, such as Mervyn’s and some of the regional department store chains, who do not have the financial where-with-all to stay with them. But this market share is available to Penney’s and Macys, as well. If these latter two Standard Leaders don’t follow, they will be making a mistake.