Basic Cost Frameworks?

Cost reduction cost-benefit analysis fixed costs profitability cost reduction variable costs
Recent activity on Mar 08, 2018
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Lorenzo
Proficient
asked on Mar 08, 2018

Hello everyone

While for Revenues increase there are many basic frameworks (Ansoff Matrix, 4Ps in case of Selling process) to be used in the case, I personally found many less for Cost reduction.

Does it exist an "equivalent" of Ansoff for costs, for instance? Or some basic framework or drawing to use in case I am going to be asked how to reduce some specific cost component?

Thanks in advance

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Vlad
Expert
Content Creator
replied on Mar 08, 2018
McKinsey / Accenture Alum / Got all BIG3 offers / Harvard Business School

Hi,

As a candidate, I've struggled a lot with cost reduction cases since most of the case books don't have them, while you can face these cases on the case interviews. This is especially relevant for McKinsey interviews.

Based on my experience most of the candidates end up by segmenting into fixed and variable costs. Obviously, this structure is quite poor.

My recommendation is to use the process approach which is similar to what consultants usually use on a real project:

  1. Cost segmentation and prioritization - here you basically try to understand what is the cost structure and what are the biggest cost buckets
  2. Internal and External Benchmarking and understanding the potential - you compare your costs with competitors, industry benchmarks or internally (Imagine one of your entities having 1 accountant per 100 employees and another 5 accountants per 100 employees)
  3. Process improvements - in order to cut the costs you need to identify the best processes and scale them across the organization. You should take into account that there are "major process steps" like production, contributing to the output and "supporting process steps" like cleaning. The former are usually optimized with technology or best practices, the latter are usually cut
  4. Costs & benefits - here you calculate the total impact and the rollout plan

One great advantage - it is really hard to argue with that approach since it's based on the real consulting projects.

Best,

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Lorenzo on Mar 08, 2018

Thanks for the quick answer!

(edited)

Francesco
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replied on Mar 08, 2018
#1 Coach for Sessions (3.900+) | 1.400+ 5-Star Reviews | Proven Success (➡ InterviewOffers.com | Ex BCG | 9Y+ Coaching

Hi Lorenzo,

in order to structure a cost case I would proceed as follows:

Step 1: Clarify the goal. Ask which is the absolute amount you should reach and which time frame you have to do so

Step 2: Identify the problem. You can proceed through the following steps:

  1. Segment by profitability/revenue channels. Ask the interviewer how many business units they have – or any other segmentation that may be present. The segmentations depend by the type of business and should be provided by the interviewer (although he/she may ask your point of view on that)
  2. Identify which channel is the priority. Ask how costs changed for each channel. Then start from the one with the biggest increase in costs.
  3. Identify the cost components in the selected channel. You may brainstorm costs using fix or variable costs, or dividing through the value chain
  4. Identify the component that is underperforming. You can do so comparing the client performance with its past performance, or benchmarking competitors on that area.
  5. Identify the reason for the cost increase. The final point in this step is to analyse why costs went up. Usual areas to consider are:
  • External
    • Supplier issues (eg increasing prices)
    • Competitors issues (eg lobbying strikes/ regulations against us)
    • Client issues (specific customization that increased labour cost)
  • Internal
    • Client issues (eg wrong process development/budgeting)

Step 3: Propose a solution. In general, there are two main things you can do to cut costs for the specific cost component you have identified:

  • Decrease the cost of each unit; typical strategies include
    • Decrease quality of units bought
    • Negotiate with suppliers
    • Find another supplier
  • Decrease the number of units of cost; typical strategies include
    • Increase efficiency of units
    • Substitute input units with other units

Step 4: Risks. As potential issues and next steps, you should take into account possible negative effects on revenues and how to avoid them.

For the specific question on how to reduce the cost components, you can focus on Step 3 above, thus dividing in ways to decrease the cost per unit or the number of units of a specific cost area.

Hope this helps,
Francesco

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Lorenzo on Mar 09, 2018

Thanks a lot for the answer!

Vlad gave the best answer

Vlad

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McKinsey / Accenture Alum / Got all BIG3 offers / Harvard Business School
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