Beware of Cost Cutters

About a week ago I heard a friend of mine had been fired as MD of a winery.  In addition, the marketing budget of the winery had been cut severely.  All of this on the advice of a “turnaround strategy specialist.”  This gentleman apparently was an expert from the motor vehicle industry.  Interesting, I thought.

What I also find interesting is that the whole wine industry is in somewhat of a problem situation.  Apparently the global financial crisis has hurt the South African wine industry quite a lot.  Add to that a Rand that has moved tremendously from the beginning of 2009 to the end of 2010.  A whole lot of wineries have sold wine at prices reflecting a US$ at about R10.  Now it is less than R7.  This is hurting the export component of the production of a number of wineries severely.

At a recent conference presented to a number of wineries, I had the opportunity to chat to people from a number of wineries.  One message I walked away with was that there were a number of wineries that had serious problems.  Yet, this particular winery was the first and only one thus far to take such drastic actions.  Are they being prudent, or are they taking actions totally uncalled for?

It sent my mind back to about 2002.  A certain diamond mining company had lost is CEO.  It had 2 very senior people at the helm of the ship at that time, both experts in the diamond industry, both very competent.  The 2 of them expected that one of them would take over as CEO and both were very comfortable with the idea that if the other one got the job, they would serve under that person.

What happened?  None of them got the job!  The board and shareholders brought in a young guy who knew nothing of the diamond mining industry to execute a “turnaround strategy.”  He was an engineer with a steel production background.  Only one of the 2 senior people stayed as the other chose to leave.  The remaining person did not stay on for too long after that in any case.  In addition, a number of the senior executives over time also left the company.  The engineer did well on the short term, by cutting costs and mining the “eyes” – the rich pockets of diamonds they all knew were there.  He left after a period of about 3 or 4 years, to pursue “other interests.”  During his tenure, however, it does seem that the culture of the company was not as productive as one would have hoped for.

The CEO subsequently appointed has been around for a while.  The company is still around, although it is not doing all that well.  The share price at about 2002 was in the vicinity of R10.  Currently it is in the vicinity of about R2.50.  The last year saw a profit of about R22 million, relative to a loss of about R798 million the previous year.  The drivers of this “turnaround” has been identified as cost cutting and an improvement in the diamond price.  It would be interesting to see what effect the recent rise in the strength of the Rand would have on the performance of the company.  The drivers have the disadvantage that the one is not sustainable (cost cutting) and the other you have no control over (diamond price).

It set my mind thinking back even further.  After 911, the airlines in the USA, worldwide as a matter of fact, were in for a very bumpy ride.  Most of them responded by laying off people.  This in spite of the fact that in good times they all refer to their people as their most important asset.  Funny how unimportant this “asset” becomes in tough times.

In any case, the airlines that laid off the most people, had the largest drop in share price.  Southwest Airlines, who laid off the least number of people, had the smallest drop in share value.

Why I use the US airlines as a case, is that here again there was a worldwide crisis, and the companies concerned responded by cutting costs and letting people go.  The US example shows me what could happen if you refrain from having a knee-jerk reaction and approach the problem in a more sustainable manner, like Southwest Airlines did.

This brings me back to the winery example.  The whole industry is hurting.  Hopefully not all are going to fire their MD’s and cut their marketing budgets.  Cost cutting is important, granted.  One should always look at ways to ensure that you have a lean and mean operating model.  Having unnecessary fat in your value chain is never a good thing, even less so in times of duress.  Two examples of companies with a very lean operating model I always use in this context is that of Shoprite, a South African food retailer, and SABMiller, the well-known global beer producer.

However, you cannot save yourself to prosperity.  You need to develop sustainable alternative sources of revenue.  Or redesign your revenue model to not be so vulnerable to changes in the exchange rate.  You need to relook your entire business model and innovate the building blocks to decrease your vulnerability to uncontrollable external factors.  You need to look at new market spaces to “grow” the market in new and innovative ways.  Doing more of the same and just trying to doing it cheaper will not help you in the long run.  I tell my MBA students that the moment you get the camel to go without water for 14 days, the bloody thing dies!

So these are the times boards should be working with their MD’s, and not against them.  Work with them to identify cost-saving opportunities where possible.  Work with them to identify new market spaces to grow the market and make the competition less relevant.  Also work with your MD to innovate the value proposition to your customer segments, to innovate the revenue model, the distribution model, and the relationship building model with the customers.

Also look at working with your MD to optimise the resource base required to deliver the customer value proposition, as well as the activities required to do just this.  Who are the partners required to optimise the process and deliver the best value?  What activities can you outsource and what can you pool with your competitors to the benefit of yourself and the industry at large?

I came across the following “Top Ten Tips” for building better wine businesses (from a “Wine Business Solutions” article published in Wine Business Magazine in March 2007).  These are not only applicable to wine businesses, but actually to business in general.

One – Start by understanding your customer value proposition.  Only part of this stems from your company’s unique heritage and / or personality.  To be successful, this needs to be strongly linked to what your customers ultimately want from the experience of your brands.  There is some excellent research on this that is publicly available.  Getting it right is therefore not out of the reach of small companies.

Two – Once you understand what customers value most, you can then remove what they don’t want (thereby reducing costs and freeing up cash), focus your communication on what they do want (often at no additional cost), differentiate your company on the basis of fulfilling customer needs more accurately than any competitor (again often at no extra cost), and raise prices (because your offering is more highly valued).

Three – Always ask yourself the question – “If I could start with a blank canvas today – what would our wine business look like?”  It’s all too easy to let existing assets, existing product lines and existing ways of doing things blind us to what it is that our consumers value most.  Often it’s simplicity.  Complexity usually adds to costs and often only serves to confuse customers.  Retaining unnecessary or irrelevant product lines, assets, or business processes is the worst contributor.

Four – Make everyone in the company accountable for securing customer preference.  This is not just the job of marketing but of everyone in the company, the owner most particularly.  Make this the focus of the way every employee innovates their job processes on a daily basis.

Five – Invest in relationships.  This is particularly so with major distribution partners.  Make sure sufficient time and money is invested before demanding results.  Be prepared to invest upfront in bringing them to your home base and entertaining them in order to build enduring friendships.

Six – Make all employees champions for profit.  Develop a culture of honesty around net revenue.  Make sure everyone knows the actual price achieved net of all discounts, rebates, bonus stock, and anything else that might otherwise cloud the true profit picture.  Keep them focused on reducing costs but let them know that a percentage increase in wine company revenue is, on average, twice as effective as the same percentage decrease in the cost of goods sold and 3-4 times as effective as the same percentage saving in operating expenses.

Seven – Optimise your pricing mix.  Focus first on selling more, higher margin product in high value markets to high value customers.  Beware of people in love with “big volume.”  Big numbers make for big stories but often mean a lot of running around for no additional profit.

Eight – Build better business intelligence gathering systems – most companies are good at monitoring their own press.  Very few have effective systems in place to monitor competitors, track changes in consumer preferences, and turn customer feedback into customer value added.

Nine – Build 5-10 year Strategic Plans, forecast rolling 12 month budgets, link them to the most relevant KPI’s and tie remuneration to these where ever possible.  Everybody knows they should do this.  Few do.  The difference in performance of companies that do is enormous.

Ten – Watch your cash flow – building a cash flow forecast is a relatively easy exercise with the right software and some quality assistance.  Some people survive years of losses but you can only run out of cash once.  In a cash hungry business like wine – Cash flow is not just King, but Oxygen.

I came across these tips in an online publication called The Wine Paper at the following website in Australia – http://www.winebusinesssolutions.com.au/Resources.  Their monthly publication has a lot of good food for thought.  And looking at the tips, as a board you should look at working with your MD to execute these tips instead of against them.

Having said all of this, my central thought is to be less hasty to fire your MD and cutting costs indiscriminately.  If he/she needs firing, by all means do so.  But let that be the last option.  If he/she is that bad, what were you thinking when you appointed him/her in the first place?!  A successful business requires efficiency and effectiveness in a range of elements of the business.  Look at the big picture.  If you treat your MD like dirt, what chances do the lower level employees have?  It would come as no surprise if they all start running for the hills!  And you as the board would only have yourself to blame.

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5 Responses

  1. Thanks Johan. Well said! I saw it happening twice in a big financial services company with bad results for years!

  2. André Engelbrecht says:

    There are many reasons for companies not to follow tip number 9:
    1. By doing it you are actually telling the world, your colleagues and yourself what you are planning to do. For most this is setting yourselves up for failure and to be avoided at all costs.
    2. Imagine how humiliating it would be to pay that obnoxious marketer, you do not like, more than the MD just for reaching and exceeding her budgets and targets – too ghastly to contemplate.
    3. This would seriously cramp the style of the adventurous amongst us. What about that impromptu opportunity that must be taken at all costs? No, to evaluate it properly against the current options are way to boring.

    • johanhburger says:

      Brilliant! This touch of sarcasm has made my day on this 30th day of the last month! But unfortunately there is so much truth in what you have said that it actually should not be funny!

  3. Gerhard says:

    It is quite amazing the similarity in all industries! The stuff we all battle with. Hence, this is why leadership is such an interessting field as the leadership should find solutions for challenges and build the business, not destroying wealth. As Einstein said: “Two things are infinite: the universe and human stupidity; and I’m not sure about the the universe.” Johan, your article is spot on. Thx. We need more.

    Gerhard