Cost reduction as a strategy for rapid growth
During my career, I have saved millions of dollars for the organisations I’ve worked for and helped avoid billions of dollars for the industry I’ve represented. Cost reduction and cost containment is the name of the game in the air transport industry. Over the course of the last 60 years, the airlines have not been able to make an adequate return on the cost of capital employed, with profit margins being less than 1% on average over the period. Net profit margins of close to 5% in recent years are truly exceptional, and are the result of strong demand, improved efficiency and reduced interest payments. But operating margins are being squeezed again by rising fuel, labor and infrastructure expenses, and thus cost management will continue to play a crucial strategic role. And herein lies a useful lesson for any industry and any business.
Last week I spoke of price simplification, whereby you dramatically reduce the price of the product or service by making its delivery simpler, thereby reducing its cost. This can be achieved in one of two ways, through both product redesign and business process redesign. Through product redesign you can reduce the product or service offering to its bare essentials and nothing else. Think of Southwest Airlines, and other low-cost carriers that offer no complimentary food or drink, no reserved seating, no lounges, and no free baggage handling. You can also reduce the variety on offer, as in the case of an airline reducing multiple class travel to a single class, as the low-cost airlines have done. For a product, think of the simple Swatch that provides the basic function of telling time, but not much else that more complicated and luxurious watches do.
Once the product has been simplified, its cost of delivery can be further reduced through business process redesign, for a simple and standardized product can be produced more easily and efficiently through automation and mass production. In the process, an entirely new mass market can be created through an accelerator effect that can cut the price of the product or service by half or more. The classic example is that of the Ford Model T, which was designed in such a way that it could be easily mass produced on the production line. It became the affordable car for the masses. The most successful low-cost airlines have simplified and standardized their product and redesigned their business processes to such an extent that traditional carriers have had a hard time to compete.
During my days with KLM Royal Dutch Airlines, while in the midst of yet another cost reduction initiative, I was told by those who questioned such draconian practice, “you cannot cost-cut yourself to prosperity.” At the time, I felt there was some truth in that. Today, I couldn’t disagree more! A sure way to prosperity and profitable growth is to cut costs – dramatically – for it has been proven that radical price reduction will lead to an exponential growth in demand and the creation of a new market.