Reducing costs. Reducing spending. Reducing debt. Managing through the new austerity. Doing more with less. This familiar language that the private sector uses when times get tough, is becoming increasingly familiar to governments worldwide. And the message is clear: Business as usual will no longer be tolerated.
Around the world, the massive fiscal stimulus programs that were put in place to pull economies out of the 2008 Great Recession are now being translated into fiscal consolidation strategies, and for good reason. The unprecedented fiscal expansion has led to explosive–and, in some cases, unmanageable–sovereign debt levels. The 2010 Greek debt crisis, which created financial shock waves around the globe, indicated how volatile the situation has become for a number of countries.
Developed economies are now coping with a public debt-to-GDP (gross domestic product) ratio of more than 100 percent. That debt position is nearly equivalent to the level of indebtedness they had in the immediate post-World War II period. The outlook for the future is even more daunting. Unless developed economies enact significant fiscal adjustments-difficult though it may be politically-they could see their debt overhang increase even further.
In a World Economic Outlook report, released in October 2010, the International Monetary Fund (IMF) characterized this challenge as internal “rebalancing.” For countries addressing their debt predicaments, this rebalancing entails difficult economic, political and even generational tradeoffs. Consider these examples:
• In Germany, the government has embarked on a program to cut spending by €80 billion ($111 billion) by 2014. Bonn has also been pushing for strict adherence to euro-zone budget rules, although it has still offered support for more flexible interim approaches for countries experiencing difficulties.
• In the United Kingdom in June 2010, Prime Minister David Cameron signaled the coalition government’s intent to raise £40 billion ($64 billion) by increasing taxes and cutting spending. In October, the government announced plans for the biggest spending cuts since World War II, including cuts of 8 percent for the Ministry of Defense. Additionally, the government called in the top 20 companies providing IT services and outsourcing to meet with Treasury. The government wanted to obtain agreement for immediate price reductions across all lines of service. Many of the top 20 companies have since agreed to support these price reductions. At the same time, all central government spending on management consulting services was suspended, resulting in layoffs in the consulting sector.
• In France, the government’s campaign to extend the retirement age by two years, part of its austerity program, energized an estimated 4 million protesters in October.
• The United States’ debt-limit crisis showed that the country is not immune to such adjustments. This holds true even in seemingly “untouchable” areas such as defense. In September 2010, for example, then-U.S. Secretary of Defense Robert Gates announced that Department of Defense costs would be reduced by $100 billion during the next five years. His proposals include targeting affordability and cost controls, offering incentives for productivity and innovation, promoting competition, and reducing bureaucracy and unproductive processes. Even greater defense cuts now loom before Secretary Leon Panetta.
Many other examples exist of new government austerity programs, but the upshot is clear: Each side of a government’s supply-and-demand equation is under pressure to do more with less.
To combat budget pressures and meet new guidance standards, governments must not only become more efficient but also offer different incentives and adopt new budgeting approaches.
Such reforms might actually provide a rare opportunity for competitive differentiation, increased market share and improved profitability. Preemptive cost-cutters–organizations that can deliver more with less, or at least more with the same–will be in the best position to succeed in this new world order.
Learning from preemptive efficiencies in the private sector
Preemptive cost-cutting has precedence in the private sector. For example, a specialty chemicals company that supplies a large but struggling paper company recognized an opportunity to work cooperatively with its customer to reduce costs without reducing its selling price. The supplier proposed a collaborative effort to the paper executives.
While some groups within the paper company initially resisted the initiative, it ultimately adopted the approach to facilitate the process. Teams from each side met for a two-day workshop and identified total cost-of-ownership reductions. Technicians and finance managers presented and challenged ideas, discussed the benefits and risks, and agreed on a prioritized list of projects. Governance was shared by purchasing, paper-mill managers and business-unit leaders. These initiatives are still in process and are expected to yield 12 percent savings. To date, each completed project has exceeded its targets.
The collaborative approach was so successful that the customer–the paper company–decided to roll it out in a broader program encompassing more suppliers.
We believe it can work for both private-sector and government organizations provided it takes into account four elements:
- A supplier conference brings together top strategic suppliers with senior executives, business stakeholders and decision makers.
- The group develops improvement ideas within a given scope: ideas for both quick hits and longer-term payouts, previously surfaced but unimplemented ideas, projects that benefited other customers, and ideas to overcome customer-generated bottlenecks or unnecessary costs.
- Cross-functional teams formally evaluate the ideas.
- Companies implement the winning ideas as soon as possible.
This type of approach can deliver results. For example, one company achieved $14 million against a goal of $12 million in realized savings. A project designed to deliver $4 million in annual savings for another yielded $5.5 million. After one conference, a forward-thinking supplier aggressively pursued additional business and submitted a major proposal with 65 significant improvements.
In government terms, these absolute numbers are rounding errors; but as a percentage of costs they can be significant.
For both public and private sectors, such a structured collaborative approach works to break through the typical obstacles to putting new ideas into practice by requiring organization-wide alignment, thorough review of ideas and deep cross-functional involvement.
Lessons learned in making collaborative cost reductions apply to both sectors:
• Make sure corporate goals are aligned across functions before embarking on the project.
• Drive the process with a sense of urgency. Time is of the essence.
• Require senior executives to participate in the supplier conference and provide visible leadership and sponsorship.
• Identify the right supplier executives to participate in the conference.
• Involve cross-functional teams in validating and in implementing the ideas.
Government suppliers: Leading the charge?
How many large government suppliers are ready for a preemptive efficiency push? In our experience, not very many.
Large, entrenched government suppliers typically want to protect their positions, not streamline them. They maintain or grow their dedicated workforce levels and shield visibility of their upstream supply chains. Particularly in the defense sector, where cost-plus contracts are the norm, suppliers’ profits are a mark-up to costs incurred and a strong disincentive to reducing expenditures.
In the U.S., cost-plus cushions appear to be an endangered species.
As times change, old habits can change, too. One large U.S. defense contractor has initiated cost reductions in some major programs where it is the sole-source prime contractor. Its stated reason: to improve program affordability in light of the defense budget situation.
The contractor has set up joint company and government teams to reduce costs in areas ranging from program management and governance to material buying practices. While results are yet to be determined, potential savings are estimated to be in the 10 to 20 percent range.
Habits and long-held beliefs are also changing in the United Kingdom, where many central government departments have been wary of-or even vehemently opposed to-moving government projects offshore. Departments now recognize that for strategic suppliers to make a sustainable profit and deliver value for money, they must be allowed to send work to their offshore organizations where costs are lower and quality is sometimes higher.
If your company is among the large entrenched supplier group, how do you become a leader in the “doing more with less” crowd? How can you improve market share and protect profit margins in a time of cutbacks and general belt-tightening?
Start by acknowledging that “sacred cows” don’t exist today. Every bid and every program is subject to scrutiny and revision. Once your company’s corporate mindset is recalibrated, you can answer the following overarching questions:
1. Where’s the fat? Conduct a rigorous self-examination of your cost-to-value equation, even for the programs in which you are the entrenched incumbent. The goal is to find out where waste or low-value activity occurs across the value chain:
• Look at every cost element, including direct labor, sub-tier suppliers, cycle times and overhead.
• Address both prospective (potential new initiatives) and existing programs.
• Examine program by program and cost center by cost center.
• Establish lean Six Sigma teams to improve processes and performance in a long-term and sustainable way.
2. What’s feasible to execute? Redefine cost-reduction priorities in terms of value to the organization versus ease of capture. Define ease of capture along multiple dimensions: actions you can directly implement with no investment versus those that require investment; those that require your customer to change behaviors or requirements; or those that require changes beyond your customer’s immediate control (for example, new regulations).
3. How do we benefit? Determine how your company can share in the cost reductions. Much will depend on where you are in the acquisition life cycle, your existing contract structures, procurement regulations, and government-imposed program-management requirements. For example, you might need to add a gain-sharing element to existing business arrangements. If you incorporate rigorous and realistic efficiency efforts into a bid for a new program, however, you could win the contract and share gains throughout the program’s life.
4. Whom in government do we approach? When proposing initiatives within existing programs, ask yourself, “Where can we find someone who is open to new ideas and approaches? Which officials are feeling acute budget pressure and are open to changing the status quo?” Depending on the size and scope of your proposed initiative, you might need to start at a very high level. Assuming you find a receptive entry person willing to champion the cause, you can discuss which other government relationships must be established to implement your proposals throughout your company’s various programs.
5. How do we make it happen? Work the relationships and get commitments of support and action. You might need to start with a pilot or series of pilots to demonstrate value and work out the wrinkles before rolling out an initiative on a wider scale. You’ll want to be armed with detailed implementation plans that include resource commitments on both sides, success measures and governance structures. These plans are essential to keep actions on track, break up logjams and recognize successes.
If successful, your approach will become a model that others will rush to emulate, and you’ll have a jump on the competition.
What If You’re the Customer?
If suppliers don’t step up for preemptive cost reduction on their own, the government can take the initiative to solicit and implement ideas for collaboration. Furthermore, there might be a unique opportunity to enable and encourage acquisition reform.
Of course, change takes time. Acquisition laws and regulations won’t be revised tomorrow. Government acquisition professionals must be fully included in change programs to adapt to the new environment. Political pressures to sustain or increase spending in congressional districts will not abate. However, as a result of unprecedented budget pressures, senior government officials are increasingly more receptive to different acquisition approaches, including tackling the 800-pound gorilla known as the annual budgeting process.
A compelling business case exists for adopting a multi-year budgeting and funding model for major programs that span many years in development, testing, production and sustainability. Such an approach would be similar to a corporation’s capital budgeting process. Multi-year budgeting could smooth out the “lumpiness” and uncertainty in budgeting and funding that add to suppliers’ costs. More predictability would also help suppliers manage more efficiently, from hiring and deploying their workforces to procuring goods and services from their upstream suppliers.
Even where major acquisition reform is not an option, government program managers, acquisition officials and policy makers can encourage supplier innovation. Their tools include capabilities-based acquisition, total-cost-of-ownership perspectives, and performance-based contracting.
Government program managers and acquisition officials can also examine the governance requirements they place on suppliers. While it’s easy to add a data request or a reporting requirement, or establish another review board, over time these additions simply slow progress and increase costs. A zero-based examination of how agencies work with suppliers should highlight ways to benefit both agencies and suppliers by reducing program-management costs without jeopardizing success.
Finally, most government acquisition organizations need to upgrade their internal capabilities. Not enough people have up-to-date skills in cost analysis or understand industrial operations and lean process approaches. Too often the knowledge base is tilted sharply in favor of the supplier.
In such cases, the government is not in a position to understand, much less balance, the cost-schedule-performance equation. While encouraging preemptive efficiencies from suppliers, governments might also need to become more aggressive or directive in a world of severe budget constraints.
For governments and suppliers this is a new world order where spending, costs and debt levels must once and for all come down while efficiencies must come up. Governments will have to become preemptive-and focused-in an environment where desired results are not only achievable but also achieved and where everyone learns to do more with less.
About the Authors
Bob Willen is partner and head of A. T. Kearney’s public sector, aerospace and defense practice. Randy Garber is also a partner in the public sector, aerospace and defense practice. Erik Peterson is managing director of the firm’s Global Business Policy Council.
Charles Hughes is a partner in the government practice in Europe. The authors wish to thank Paul Inglis for his valuable contributions in writing this article.