Low Cost Strategy Paradox

Nearly every manager I know emphasizes the importance of minimizing costs. I think it is fair to say that the Low Cost Strategy has become virtually the Universal Strategy for most organizations.

It’s All About Profit

If we expect to stay in business (and keep our jobs), we need to deliver profit to our shareholders. Profit is most simply defined as revenue minus costs. Increasing our profit is therefore a simple matter of either increasing our revenue or decreasing our costs.

Unfortunately, actually increasing profit is not as simple as just boosting revenue or cutting costs. Obviously sales volume and manufacturing costs are directly related, and even if we have the capacity to produce more product, the market may not have adequate demand to profitably absorb our incremental output. Boosting our selling price may increase our sales margin, but may destroy demand for our product and destroy our profitability.

Most managers quickly realize that they have little control over the revenue side of the profit equation, but they have significantly more control over the cost side. Costs represent a “target rich environment” for managers seeking to boost profits for the benefit of shareholders, and to boost their personal bonuses and advance their careers.

Delegate to Celebrate

In order to be successful, a manager must be able to effectively delegate tasks to subordinates, and inspire the team to diligently and enthusiastically carry out assigned tasks to achieve defined objectives. Delegation can be quite a challenge for a manager, because no subordinate can successfully carry out a delegated task until he/she clearly understands the tasks.

Fortunately for our cost-cutting managers, virtually all subordinates quickly and easily understand the cost cutting task assignment.

Cheaper is Better?

One of the great advantages of doing business in Asia is that virtually no matter what product or service you need for your business, there is always someone ready to supply you with a cheaper alternative. If your factory isn’t located in Asia, don’t worry. Global logistics and a wide variety of Free Trade Agreements make it convenient for managers located anyplace in the world to source the lowest cost raw materials, equipment, and supplies to minimize their costs and maximize their business profits. We are living in low cost heaven.

Unfortunately, low cost heaven quickly evolves to low quality hell. It takes a brilliant and highly innovative organization to produce a high quality product from low quality, low reliability, and highly inconsistent inputs.

Agency Theory

One of the classical economic fundamentals is called Agency Theory. Basically, we operate by empowering people to execute tasks on our behalf. These people are technically known as Agents. We ensure that they faithfully follow our instructions through the use of incentives. Incentives can be as simple as a “thank you” and a pat on the back for finding a lower cost supplier, or more commonly it involves economic policy incentives such as bonuses and promotions for achieving measurable targets.

No need to get too technical here, but measuring cost savings is very easy, so it is almost child’s play to assign a cost cutting task and measure the resulting savings. This is great news for the cost cutting manager, because what is the fun of delegating if you need to do a lot of work to manage, mentor, motivate, and monitor your delegated task.

You Get What You Pay For

Monitoring costs is easy. Unfortunately, monitoring quality is not quite as easy. Congratulations on saving 15% on your widget. Are you now smart enough to define and monitor all of the ways your innovative low-cost supplier can find to extract at least 15% out of the cost out of your widget, and will any of these cost compromises adversely impact the quality of your final product?

You Can’t Delegate Accountability

With the best of intentions, you assigned your subordinates the vital task of cutting costs to maximize profits and ensure the competitive viability of your business. What will you do when (not if) your customers start making warranty claims for poor quality product, your sales volume declines precipitously, and your company’s hard-earned reputation is being rapidly destroyed and disparaged on social media?

If a manager accepts the easy path of cost cutting, the manager must also accept the hard truth that customers and markets aggressively and relentlessly punish failure. Don’t expect a second chance. Just be sure that your CV is up to date, and hope that your subordinates are also able to find new jobs after you have succeeded in destroying their company.

Maximizing Value

An enlightened manager reacts strongly and aggressively against any suggestion of “cost cutting” in the organization. Low Cost is the path to the Dark Side, and it is a one way trip.

Always reject “low cost” arguments. Emphasize to your team that our business success is built on Maximizing Value. Always reject any lower cost sourcing proposals unless and until it can be clearly demonstrated that the minimum quality and performance requirements will be reliably achieved.

Of course this suggestion is obvious. Were you expecting truly spectacular and amazing advice? Truth is often both simple and obvious.

Unfortunately, unless you consistently, diligently, and vociferously reject the Low Cost strategy in favor of the Maximizing Value strategy, your staff won’t understand that you are an enlightened manager. They will dutifully assume that you are like every other Industrial Manager and Leader who worships at the alter of Low Cost, and they will proactively seek to make you happy. Your quality and reputation will both evaporate and you won’t know what is happening until it may be too late to reverse.

But the Competition …

Yes, the competition is also competing for your customer’s business. Yes, they are putting cost pressure on your market. Yes, you can’t compete by being the high cost supplier, regardless of whether you have the high quality product. You are not Gucci or Ferrari, at least not yet.

So explain to me, how does producing a crappy product help you win in your market?

A Maximizing Value strategy is not the opposite of a low cost strategy. Mistakes are expensive. Defects are expensive. Warranty claims are expensive. Reputation damage is expensive.

I am not suggesting you purchase a Rolls-Royce when a Toyota would be adequate. However, ensure that if your product requires “Toyota quality”, don’t settle for a Yugo, Reliant Robin, or a Trabant (yes, they are all famous crappy cars).

Pay a fair price for the appropriate quality and performance, and your product will be competitive in your marketplace. Your sales team will be confident and inspired to represent your product, and your customers will recognize and appreciate your product value proposition.

Operational Excellence

I last mentioned Operational Excellence when discussing a Safety First operating philosophy. Maximizing Value is just another facet in the quest to avoid mistakes to achieve Operational Excellence.

Most companies have separate managers for Safety, Quality, Purchasing, Operations, etc. This doesn’t mean that each manager and each department gets to run their department and discharge their responsibilities without regard to what is happening in the rest of the organization.

Be a principal driven manager. All operational philosophies and strategies eventually tie back into a common organizational culture. Operational Excellence is driven by a Safety First mentality of always executing every activity as close to perfection as possible, diligently avoiding mistakes. Maximizing Value is just another arrow in the Operational Excellence quiver, ensuring that sourcing mistakes are always avoided so product quality and reliability are ensured, and customer satisfaction and company brand reputation are maximized.

Frank T.


The New Case for Gold: James Rickards 2016

The New Case for Gold

“The New Case for Gold” by James Rickards, was just published in April 2016 and is a Wall Street Journal Business Best Seller.

James Rickards is one of today’s thought leaders on Global Currencies and the Global Financial System, and he is a strong advocate for a return to the Gold Standard. “The New Case for Gold” builds on foundation established by Rickards previous books “Currency Wars” (published 2011, see my blog post dated March 2015) and “The Death of Money” (published 2014, see my blog post dated June 2016).

Rickards has done a masterful job of packing a great deal of historical and technical information into a relatively short book of only 192 pages. Rickards writing is clear, concise, well researched, and well reasoned. He makes a very strong case for returning to a Gold Standard, which has been the prevailing global currency standard for most of the past 5,000 years.

“The New Case for Gold” debunks many commonly held misconceptions about Gold, especially why Gold is no longer suitable for use as a Global Currency. One of the most common criticisms of gold is that “there’s not enough gold”. Rickards explains that what this really means is that there isn’t enough gold at its current valuation. Rickards analyses the valuation of Gold based on several potential valuation scenarios, and theorizes a current valuation, consistent with historical models, of $10,000 per ounce. This valuation model gives strong insight into how badly debased the US dollar has become since it became a fiat currency.

Much of the current monetary economic theory is based on the work of John Maynard Keynes. Central bankers have been using and abusing Keynes’ economic theories for decades. However, Rickards notes that “Keynes was an advocate for gold early in his career, an astute adviser on gold in mid-career, and an advocate for gold again late in his career.” Rickards notes the famous Keynes quote “In truth, the gold standard is already a barbarous relic” which many observers use as evidence against a return to the Gold Standard. However, Rickards explains that Keynes was not advocating against Gold backed currencies, but rather complaining about the “Gold Exchange Standard” that was in place between 1922 and 1939. The Gold Exchange Standard was notoriously flawed and Rickards agrees that “it should have been abandoned long before it died with the outbreak of the Second World War.”

Some of the most tantalizing sections of “The New Case for Gold” involve Rickards research into current gold reserves held by various nations, and the ongoing stealth purchase of gold by China and Russia. Today there are approximately 35,000 tons of gold owned by central banks, finance ministries, and sovereign wealth funds. Rickards observes that “China, like Russia, is acquiring gold so that it will have a comparable ratio to the United States and Europe. The gold-to-GDP ratio will be critical when the monetary system collapses because it will form the basis for any monetary reset and the new ‘rules of the game.'”

Rickards also explains that China is buying gold to hedge its position in US Treasuries. If Inflation gets out of control and China doesn’t have its portfolio of US Treasuries hedged, “China will be left in the dust.” However, if China can reach its target of eight thousand tons of gold, China will have its US Treasuries holdings adequately hedged.

Rickards advocates for prudent investors to hold 10% of their portfolio in physical gold, and gives prudent justification for his recommendations. He discusses best practices for acquiring and holding gold, and also discusses serious pitfalls especially concerning various forms of “paper gold.”

I enthusiastically recommend “The New Case for Gold” to anyone keenly interested in the Global Financial System, is skeptical about the safety and security of Fiat Currencies, or has an interest in prudently diversified investments.

Frank T.