Try managing costs, not cutting them.

• Author: Spitzer, T. Quinn

MAKE NO MISTAKE about it, the 1990s are the cost-cutting decade. Downsizing, restructuring, re-engineering --whatever the politically correct circumlocution--this is a time of corporate meltdown. Americans have come a long way from the acquisition binging and junk bond dealing that prevailed in the Age of Excess.

As the economy sputters and as forces ranging from structural changes in the workplace to soaring health costs conspire to keep the lid on corporate spending, the axe has become the central metaphor for today's business enterprise. Once upon a time, corporations like AT&T, Kodak, General Motors, and Sears would have been shamefaced to admit they were downsizing. Now, cost cutting has become a kind of red badge of management excellence. A company hasn't arrived unless it has cut costs, and cut deeply.

There is nothing wrong with being lean. In a world of savage competitive pressure and economic retrenchment, organizations must do more with less. However, few executives approach cost containment as a business discipline or process that is woven into everything an organization does in good times and bad. Too many executives are adept at cutting costs, but don't know how to manage them.

The result is round after round of reductions. In a survey of 350 senior executives, nine out of 10 said they had undertaken an initiative for restructuring, downsizing, or cost reduction at least once within the past five years. This was not a big surprise, but, of those who had undertaken a cost-cutting initiative, nearly two out of five anticipate similar action during the next 12 months. Executives who slashed costs two, three, or more times are most likely to repeat their actions.

Why has cost cutting become an addictive behavior? One reason is that most such actions do not remove work, only the people who do it. So, expenses seemingly are cut. It's like one of those penny arcade games. You pound down one nail with a mallet, and another one immediately pops up. You try again, and the same thing happens. In organizations, the heads roll and the compensation budget goes down. Stockholders and the investment community applaud. Because the work itself remains, though, costs eventually pop up in the guise of "special projects" or temporary help--or when times improve, new hires--and the cost-cutting cycle repeats itself.

Nevertheless, some companies are more effective than others in managing the cost equation. They reduce expenditures without falling prey to defensive strategies that prop up the balance sheet for a few quarters, but have dire strategic consequences for an organization's products, customer relations, and people.

What separates thriving businesses from their less successful counterparts? Here are seven principles that characterize those firms that have learned to manage costs effectively:

Use strategy to manage costs. Think of strategy as a compass point that guides an organization's major decisions about products, markets, people, financial resources, and results. When the typical company goes through a cost-cutting exercise, the reasons for being in business often get lost in the shuffle of corporate initiatives. Managers and workers are told to slash costs, improve quality, please the customer, rev up productivity, shrink the workforce, and improve decision-making. All too frequently, they're not brought into the strategic vision. As a result, they minimize or even negate their competitive advantage. In a survey of 170 leading organizations, half admitted that their managers--let alone their hourly workers--had little or no grasp of corporate objectives.

Senior managers who fail to use strategy as a guide throughout a reduction plan run the risk of compromising the long-term competitive advantage of their organizations. Without an understanding of the strategic implications, expenses can be reduced successfully in the short term, but the ability to compete over the long haul may be lost.

In one giant North American pharmaceutical company, senior management reacted to the malaise affecting the industry by cutting deeply into the research and development budget. The move made short-term sense, given the long lead time needed for basic research. Investments in new products simply don't show a return for many years. Yet, the company's long-term strategy was built on the...