Paul Carroll
What advice would you give to insurance executives on how to think a little differently about operational efficiency?
Paul Leinwand
The environment we're in right now, with so much uncertainty, is leaving a lot of executives anxious about placing big investments for growth. The concern is that the environment could shift, and those investments might not pay off. The cost lever is always available and it's very easy to see why executives turn to cost in managing performance.
Costs are often seen as a negative topic, right? Well, cost is actually the precious investment we make in the most important things we can do to drive growth.
So the advice we provide is that executives need to think about costs in a strategic way. We really believe that taking costs out as an independent cost exercise often leaves companies weaker. You're just managing costs down rather than fundamentally rethinking where does the investment need to go in the business?
That’s quite different than how most companies take out cost “Let's do across the board 10% or 15% cuts. Everybody will figure it out.” That approach will often cut the good cost and the bad cost all at the same time. An article we wrote for Harvard Business Review delves into how to think about cost strategically, using a framework we've described as Fit for Growth. It describes a segmentation of costs and explains what to do with the various elements. Should you keep them? Should you take them out? Should you actually invest more in some of the costs because there is significant upside?
Paul Carroll
What are the elements of that framework?
Paul Leinwand
We think of costs in four main categories, which span every business unit, every function, every geography, and they can be used to rethink the nature of where we put investment.
The first is what we describe as “lights on.” A cost that's “lights on” is required to operate, to be legally compliant, but we certainly don't think of those costs as providing any mechanism to drive differentiation from competitors. So, we want to be as lean as possible in those categories.
The next category is what we've described as table stakes. These are defined by what your customer expects and what your competitors are providing. Here again, while these might be more than required legally or operationally to run the business, they aren't the source of growth. They aren't the source of why a customer is going to choose us versus another organization.
That is the third category: differentiation. Those capabilities help determine whether customers choose us today or might choose us tomorrow. They are a pretty limited set. There are probably three to six areas where you’re really going to be better than anyone else and should be because you believe it supports your value proposition and has a meaningful return.
The fourth category is “not required.” These could be areas that maybe supported projects five years ago that were going to drive growth but didn't. They might have supported parts of the portfolio we no longer own. They might support things that some team believes are important but may not be important.
The exercise around these four segments of costs is to in some ways take everything out of the building. Then each area has to be meaningfully debated based on tremendous objectivity. We often take a lot of costs for granted, but we want to look at everything through a fresh lens: Is this cost generating the type of return we need? Or is there a better use for that money?
One of the really interesting things about this exercise is that executives often have a clear list of areas where they’d like to invest more to drive growth. But there's always a shortfall of cost available to do that. The perspective changes when executives realize they’re protecting a cost at the expense of something that could differentiate them. There might be a better use for that cash.
Paul Carroll
But if you wait until you see the big opportunity for differentiation, you don’t have enough time to cut costs and free up the funds, at least in a measured way, right? What example or two would you offer of a company approaching cost-cutting correctly?
Paul Leinwand
There are various companies approaching cost-cutting efficiently across industries. As mentioned in our book published under PwC’s Strategy& division, Strategy That Works, companies like IKEA are approaching cost-cutting strategies in an effective manner every step of the way. The key is to incorporate such cost exercises throughout the business and not view it as a last-minute mundane task. In other words, you don't wait until you need to take out cost. You think of cost reallocation as strategic. You prevent the growth of costs beyond what they should be, and you have the opportunity to constantly reallocate the investments that you have.
One of the things we see a lot with all our client work is that annual budgets typically represent plus or minus from the year before. I have a marketing budget; maybe it's plus 2% this year. I have a finance budget; it's plus three. I've got an HR budget….
If every year we're just doing plus or minus, our budgets are largely representations of the world of maybe 10 years ago and cannot possibly be the right allocation of cost, given today's priorities.
The opportunity that I think some companies seize is being able to reset their budgets based on what is needed and what's most important and not getting locked into the idea that the budget is the budget. In our view, there is no such thing as a strategy until it's been translated into the budget itself. If the strategy effort is over here, and the budget is running over there, and they're not talking to each other, there is no such thing as execution of the strategy.
Paul Carroll
That’s great. Is there anything I didn’t ask you about that I should have asked about?
Paul Leinwand
I'd be remiss not to mention another article we wrote in HBR recently, on growth, with Paul Blase. The article points to companies that are building a growth engine, rather than just searching for growth.
Searching for growth is thinking about paths to pursue: Do I go into a new business, do I acquire something, should I consider adjacencies? Should I pursue new customer segments, new product segments? The companies that have really done well have first built the capabilities to grow. Then, when they thought about the places to grow, it was much easier to succeed because they were differentiated. They had the underlying wherewithal to innovate, to drive customer success, to drive insights that are going to yield the type of growth that we need.
So there’s a very different way of looking at growth, one being very much about the growth itself, and the other being about the underlying system that an organization needs. The article highlighted a really helpful analysis that showed that growing consistently has significant excess returns. For companies with the same CAGR across time, those that grow consistently saw greater returns to shareholders. Shareholders return companies that don’t just randomly find growth, but have built the unique capabilities to do so repeatedly.
There's no way to build the system of growth without spending money in the right places. So tphere has to be a connection back to the cost agenda and to the reallocation of that precious investment that we have. When you run through the cost exercise and take everything into the parking lot, the argument for taking something back into the building has to be that it links to your differentiation, to that underlying system of growth.
Some of this works against human nature. We want to be amazing at everything. But we can’t be. We need a lens that lets us decide: It’s okay to be just good enough on this capability, so we can spend money on something else.
That's a pretty hard concept to put in place, but it's a really important one to get right.
Paul Carroll
Thanks, Paul. It’s been great to catch up a bit.
