Government and Cost-Cutting

Government officials have mastered the cost-cutting game, or should I say the cost-non-cutting game. The trick they have learned is that whenever budget or tax cuts are proposed, they threaten to cut the most critical expenditures.

Now, as I have pointed out, such behavior in a private company would result in one’s termination.

When I was in the corporate world, if I wanted extra funds for my projects, I would have to go in and say “Here are all my projects. I have ranked them from 1-30 from the most to least valuable. Right now I have enough money for the first 12. I would like funding for number 13. Here is my case.”

But the government works differently. When your local government is out of money, and wants a tax increase, what do they threaten to cut? In Seattle, it was always emergency services. “Sorry, we are out of money, we have to shut down the fire department and ambulances.” I kid you not — the city probably has a thirty person massage therapist licensing organization and they cut ambulances first. In California it is the parks. “Sorry, we are out of money. To meet our budget, we are going to have to close down our 10 most popular parks that get the most visitation.” The essence of government budgeting brinkmanship is not to cut project 13 when you only have money for 12 projects, but to cut project #1.

I can just see me going to Chuck Knight at Emerson Electric and saying “Chuck, I don’t have enough money. If you don’t give me more, we are going to have to cut the funds for the government-mandated frequency modification on our transmitters, which means we won’t have any product to sell next month.” I would be out on my ass in five minutes. It just floors me that this seems to keep working in the government. Part of it is that the media is just so credulous when it comes to this kind of thing, in part because scare stories of cut services fit so well into their business model.

Matt Welch has a great 8-point takedown of similar scare story on the current California budget crisis. You should definitely read it, but I wanted to add a #9 — this idea that the core, rather than the marginal, expense is always the first to be cut. From the LA Times:

Gov. Arnold Schwarzenegger has proposed slashing state spending on education by $3 billion to help close the budget gap, and the state would pay dearly for canceling classes, firing instructors, cutting class days and shortening the school year, experts said.

Promising students would go to other states, taking their future skills, earnings and, possibly, Nobel Prizes elsewhere. California companies would then find it harder to attract high-value employees who might be dubious about moving to a state with sub-par schools. [...]

John Sedgwick, co-founder of Santa Clara solar-energy company Solaicx, agreed.

“When you think about the genesis of Silicon Valley, it really started from its superior educational base” at Stanford and UC Berkeley, said Sedgwick, whose company makes the building blocks for photovoltaic cells. “That indicates that you don’t want to kill the goose that’s laying the golden eggs.” [...]

The only way the most “promising” students would be affected is if, when the schools cut back, the best professors (rather than the worst) are fired and the most promising students (rather than the most marginal) are denied admission for limited spots. Really? If Berkeley has 10 fewer spots, it’s going to start cutting admissions with the Physics wiz kid who had a 2400 on her SAT?

Further, is it really true that California only attracts people to its work force who went to school in California? A top Michigan or Harvard grad won’t do just as well? I went to college in New Jersey yet have never held a job in that state.

Now, I understand that part of the argument is that workers may not come if the local primary schools for their kids are bad. And that is true. But California has had poor performing schools despite years of high and increasing spending. Matt has much more on this in his piece.

Postscript: Of course, as crazy as it seems, there may be some reality to this threat. I could easily see the University of California system, when faced with the choice of cutting back on some post-modernist social science program or a physics program that has produced 7 Nobel Laureates, choosing the latter to cut in a fit of outrageous political correctness.

At the primary level, it is very possible that the bloated school administrations filled with rafts of useless assistant principals will choose to fire teachers rather than themselves. So unfortunately the plans to cut the most useful spending in a crisis and keep the most useless is not just a threat, it is a reality.

How to cut costs without firing staff

AS layoffs mount amid the slowing economy, some employers are cutting costs without axing jobs.

Hypertherm has never laid off a permanent employee in its 40-year history. A 20 per cent downturn in sales in recent months led the closely held maker of metal-cutting equipment to eliminate overtime, cut temporary staff and delay a facility expansion, says chief executive Dick Couch.

Managers are transferring employees to busy segments from those with less work. The company may also bring some outsourced manufacturing in-house to keep its 1100 workers busy, Mr Couch says.

Companies such as Hypertherm are the exception. Managing labour costs has become a top priority for US employers, which have eliminated about 1.9 million jobs since December 2007. Last month, US employers cut 533,000 non-farm jobs, and the unemployment rate rose to 6.7 per cent.

Some workplace experts say layoffs are a useful part of the business cycle, allowing employers to weed out poor performers, increase efficiency and promote a high-performance culture.

Layoffs "are not inherently bad," says Mark Nadler, a partner at management consultancy Oliver Wyman's Delta practice. "Some people...are just more crucial to the survival of the organisation than others."

Others say employers often underestimate or overlook the costs of layoffs.
Anat Lechner, associate professor of management at New York University's Stern School of Business, cites expenses for planning, legal fees, severance, outplacement and redistributing work. Layoffs also reduce productivity among survivors and cost a company institutional knowledge, she says.

Add the cost of recruiting and training new workers when business picks up, and layoffs "simply do not make any sense," Ms Lechner says.

In lieu of layoffs, some employers are freezing hiring, offering voluntary retirement packages, cutting hours, reducing salaries or delaying raises.

Other cost-saving tactics include raising employee health-care contributions and slashing bonuses, employer contributions to retirement plans and budgets for training, travel and other perquisites.

Until the recession of the early 1980s, both companies and employees considered layoffs temporary says Peter Cappelli, director of the Centre for Human Resources at the University of Pennsylvania. As the idea of permanent layoffs gained acceptance in the late 1980s and 1990s, employers stopped trying to avoid them, Mr Cappelli says.
Today, many companies argue that alternatives such as across-the-board salary freezes and budget cuts are more harmful, because they can drive away top performers.

Private companies, like Hypertherm may feel less outside pressure to cut jobs and a deeper commitment to employees than publicly held firms, some experts say.

Still, a few public companies - including Lincoln Electric and steelmaker Nucor - also have no-layoff policies.

Lincoln Electric, a Cleveland maker of welding and cutting products, guarantees employment to US workers with at least three years experience, says spokesman Roy Morrow. He says the company, with 9000 employees worldwide, hasn't had a US layoff at least since 1949.

In the early 1980s, the company drew attention for shifting blue-collar factory workers into white-collar sales jobs to avoid layoffs. Today, it routinely cross-trains US workers in key business areas so they can be redeployed, Mr Morrow says.

The current recession is testing Lincoln's policy. The company recently dismissed about 50 contract workers and an undisclosed number of poor performers with less than three years experience. It is also cutting some employees' hours and moving others into positions with lower salaries. Chief executive John Stropki said he's acting "in anticipation of a long, deep recession".

Hypertherm's policy is part of a "social contract" with employees, Mr Couch says. In a downturn, workers are willing to identify inefficiencies because "you know you are not going to work yourself out of a job," he says.

For several months in the early 1980s, Hypertherm adopted a four-day work week. Mr Couch calls that step, "the last of the last resorts," and says he hopes to avoid it this time.

Small businesses, which often have less fat to trim than larger employers, can identify creative solutions. Alex Chang, founder of real-estate search engine Roost.com says, "every $US10,000 a month you can save is a person.”

A big drop in business this fall prompted Mr Chang to cut "every expense we didn't have to make" in order to keep all 17 of his staffers, each of whom he considers vital. He eliminated the marketing budget and asked vendors for discounts. Mr Chang also is considering licensing Roost's technology, moving to a smaller office space and allowing some employees to work from home.

Keeping company costs cut

'Corporations must understand why costs escalated in the first place, to therefore avoid the need for frequent cost cutting,' explained Bahjat El-Darwiche, a Principal with Booz & Company.

Going after structural issues alone while ignoring the three other critical strands of every organization's DNA - decision rights, information, and motivators - will not help to cut costs and keep them cut.

Transparency of information and costs at all levels is central to any sustainable cost-cutting effort, in addition to the metrics required to monitor these costs.

'Business units and departments without access to such information act as though they have a blank check, which can lead to an explosion of IT costs,' commented Rabih Abouchakra, a Principal with Booz & Company.

With transparency on costs - companies can allocate services by forcing departments to make decisions on the basis of fixed prices, or by open, competitive bidding between service providers.

Once information on the real costs is available, companies can use this to make better, more sustainable cost-cutting decisions - as long as the governance structure is clearly defined, logical, and consistent.

Decision rights involves identifying who is responsible, authorized and accountable for making various decisions.

If these rights are at a high, centralized level, companies will lose time waiting for top executives to make key decisions, and if decision-making authority is too decentralized, redundancies and inefficiencies result as divisions and departments replicate one another's efforts.

Worst of all is a company that hasn't defined these rights, meaning decisions are made by everyone - or by no one at all.

'Senior managers should push decision rights further down the org chart while monitoring the decisions their direct reports make,' commented El-Darwiche.

That expands the senior manager's control and with good information, decision makers become more efficient, lowering the cost of the decision-making process.

Giving managers more responsibility can save money by slowing the increase in organizational layers.

That effort must be accompanied by a system of motivating incentives; 'It means creating a bonus system that rewards managers who meet specific cost targets, not just business targets, as well as developing a promotion strategy that goes beyond standard vertical promotion schemes,' Abouchakra stated.

Companies should develop strategies for top performers that emphasize lateral promotions - conferring more responsibility and higher salaries without a move up the management ladder.

Such moves open up the channels of communication with the increased movement of managers between departments.

Combining structural changes, better managed decision rights, a new approach to incentives and motivators, and the access to cost information, involves taking an integrated approach to a sustainable cost management program.

In one company, distribution costs were a considerable expense, as they were treated as fixed costs and charged back to sales teams as a percentage of sales.

Executives knew that expenditures on distribution varied widely, due to special requests for services such as more frequent delivery and expedited shipping.

Top managers decided the answer was to fix the problem beginning at the level of information transparency.

Introducing a 'rate card' that defined specific charges for added services - at prices competitive with outside distribution services - forced the customer teams to make decisions within a true supply-and-demand regime.

Lower-level managers were also given rights to make decisions on the basis of the information on the rate card, and their incentive structure was changed to reflect not just their sales gains but also their ability to keep costs low.

'Costs came down even more than the company expected and stayed down, and newly empowered managers took the rate-card mantra with them. These changes allowed each division to maintain its lean structure, given team managers expanded spans of control and greater flexibility in making decisions,' concluded Abouchakra.

Costs, once cut, have to stay cut. The only way to do so is to reach deeper into a company's makeup, to put in place an integrated program that takes into account all four of its DNA strands.