Lesson 5: Real cost control

Two worlds

Everything so far adds up to two different philosophies of running a business:

	Cost world	Throughput world
Focus	Improve efficiency everywhere: local optima	The whole system: the global optimum
First priority	Reduce operating expense	Increase throughput
Second	Increase throughput	Reduce investment
Third	Reduce investment	Reduce operating expense
Main tool	Product cost and variances	ΔT, ΔOE and ΔI of each decision

Both care about all three measures. The difference is the order, and the order decides where management attention goes every day.

Pause and think: why does the throughput world put cutting operating expense last?

Because expenses don’t matter
Because cutting costs is illegal
Because OE has a floor, it can’t go below zero, and cuts often damage the capacity that produces throughput; throughput has no ceiling
Because investment is more important than throughput

Cutting can help once; growing throughput can keep helping for years.

Three strategies for cost control

Picture three companies over the next few years:

Cut costs: operating expense goes down, throughput stays where it is.
Grow at any cost: throughput goes up, and operating expense rises just as fast.
Grow throughput faster than costs: both grow, but throughput much faster.

Which is a good cost-control strategy? Try them.

Strategy 1 helps once, then hits its floor: the people and capacity you cut are often the protective capacity that kept the constraint fed, so throughput starts to slip. Strategy 2 is expansion: a bigger company with the same thin profit. Only strategy 3 compounds.

What real cost control means

Real cost control is making sure the rate of growth of costs is much slower than the rate of growth of throughput.

This is not cost reduction. Each head of operating expense is accountable for spending in line with plan, and the business as a whole is accountable for making each rupee of expense bring in more throughput every year.

The Five Focusing Steps are how you do it:

Identify the constraint.
Exploit it: make sure not a minute of it is wasted. This raises throughput with no new cost.
Subordinate everything else to it: release work at its pace, protect it with buffers, keep protective capacity elsewhere. Again, throughput up, little or no new cost.
Elevate it only when exploiting is done, and only with a ΔT, ΔOE, ΔI case that pays.
Don’t let inertia become the constraint: when it moves, start again.

Steps 2 and 3 typically release a great deal of capacity that was hidden by poor flow. That is throughput without operating expense: exactly the shape of strategy 3.

Exercise: name the strategy

Releasing work at the constraint’s pace lifts output 15% with no new hires.
Every department must cut its budget by 10% this year.
A new plant doubles capacity and sales, with the same margins.
A second shift on the constraint only, because orders are waiting.

Check your understanding

Answer all five. Get four right to complete the lesson.

1. In the throughput world, the first priority is…

Increasing throughput
Reducing operating expense
Reducing investment
Increasing efficiency everywhere

Then reducing investment, then operating expense.

2. Real cost control means…

Cutting every budget every year
Freezing all spending
Allocating costs more accurately
Making costs grow much more slowly than throughput

Profit then grows year after year.

3. Why does cost cutting have limited power?

Accountants resist it
Operating expense has a floor, and cuts often damage the capacity that produces throughput
It is illegal in some countries
It always raises prices

Throughput has no ceiling.

4. Which focusing steps raise throughput with little or no new cost?

Identify and elevate
Elevate only
Exploit and subordinate
None of them

They release hidden capacity at the constraint.

5. Throughput and operating expense both grow 10% a year. This is…

Expansion: a bigger company, no more productive
Real cost control
Cost cutting
A decisive competitive edge

T ÷ OE hasn’t moved.