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Vlad

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2

Cost reduction - which framework to use?

Hi all!

I have a question regarding structuring answers for cost reduction cases.

I usually use a basic cost breakdown of the different business units of the company, as a way to investigate potential for cost optimization and associated risks.
The solution suggested for one of the case* I just did encompasses a much wider scope, including financial reports, company structure, competitors, business unit strategy, market trends and other industry factors.

Generally, when asked for cost reduction potential, should the first framework be more of a "business situation framework", or is a "cost breakdown" presented as an investigation of reduction lever an acceptable approach ?

Thank you very much for your insights,
Best

Marie-Eve

PS: if the prompt may be decisive in which framework to chose, what specific indicators to look for? Here is the prompt of the case I refered to, in case there is something in the prompt, or the initial question that would help determing why opting for a business situation framework is better than a sheer cost analysis, I am interested in understanding it :)

* "Your client is the CEO of a leading diversified healthcare products and pharmaceuticals company - HealthCareCo.
The company’s principal business is the discovery, development, manufacture and sale of a broad and diversified line of healthcare products.
Thinking ahead for the next 5 years, the CEO of HealthCareCo wants to consider cost optimization as one of the important elements of his strategy.
He has engaged McKinsey to help him with this effort.
What would be the key factors that you would consider in preparation of your first meeting with the CEO and his team?"

Hi all!

I have a question regarding structuring answers for cost reduction cases.

I usually use a basic cost breakdown of the different business units of the company, as a way to investigate potential for cost optimization and associated risks.
The solution suggested for one of the case* I just did encompasses a much wider scope, including financial reports, company structure, competitors, business unit strategy, market trends and other industry factors.

Generally, when asked for cost reduction potential, should the first framework be more of a "business situation framework", or is a "cost breakdown" presented as an investigation of reduction lever an acceptable approach ?

Thank you very much for your insights,
Best

Marie-Eve

PS: if the prompt may be decisive in which framework to chose, what specific indicators to look for? Here is the prompt of the case I refered to, in case there is something in the prompt, or the initial question that would help determing why opting for a business situation framework is better than a sheer cost analysis, I am interested in understanding it :)

* "Your client is the CEO of a leading diversified healthcare products and pharmaceuticals company - HealthCareCo.
The company’s principal business is the discovery, development, manufacture and sale of a broad and diversified line of healthcare products.
Thinking ahead for the next 5 years, the CEO of HealthCareCo wants to consider cost optimization as one of the important elements of his strategy.
He has engaged McKinsey to help him with this effort.
What would be the key factors that you would consider in preparation of your first meeting with the CEO and his team?"

(edited)

2 answers

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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,

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,

Thank you very much Vlad, this is of great great help! — Marie on Sep 26, 2017

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Hi Marie-Eve,

I agree with Vlad; in general you can proceed clarifying the goal, understanding where the problem is and identifying a solution for the issue. Adding a couple of more details to Vlad’s approach:

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. In your case, it may be done via the different healthcare products
  2. Identify which channel is the priority. Ask for absolute amount in cost and/or any recent increase for each channel. Then start from the one with the biggest absolute amount in costs or that had the biggest increase in costs, according to what you found before.
  3. Identify the cost components in the selected channel. You may brainstorm costs using fix or variable costs, or dividing via 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. (Optional) Identify the reason for the cost increase. In case you are dealing with a cost increase case, you could analyse why cost went up. Here you may go through a partial business situation framework. Usual areas to consider are:
  • Supplier issues (eg increasing prices)
  • Competitors issues (eg lobbying strikes/ regulations against us)
  • 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

For both the elements of step 3, as potential risks, you should also take into account possible negative effects on revenues and try to avoid them.

Hope this helps,
Francesco

Hi Marie-Eve,

I agree with Vlad; in general you can proceed clarifying the goal, understanding where the problem is and identifying a solution for the issue. Adding a couple of more details to Vlad’s approach:

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. In your case, it may be done via the different healthcare products
  2. Identify which channel is the priority. Ask for absolute amount in cost and/or any recent increase for each channel. Then start from the one with the biggest absolute amount in costs or that had the biggest increase in costs, according to what you found before.
  3. Identify the cost components in the selected channel. You may brainstorm costs using fix or variable costs, or dividing via 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. (Optional) Identify the reason for the cost increase. In case you are dealing with a cost increase case, you could analyse why cost went up. Here you may go through a partial business situation framework. Usual areas to consider are:
  • Supplier issues (eg increasing prices)
  • Competitors issues (eg lobbying strikes/ regulations against us)
  • 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

For both the elements of step 3, as potential risks, you should also take into account possible negative effects on revenues and try to avoid them.

Hope this helps,
Francesco

(edited)

Thank you very much for these further insights! — Marie on Sep 27, 2017

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