A common cost trimming conversation in R&D that might sound familiar goes like this: “This year we need to reduce product costs by 4%. Think of some cost-reduction projects to achieve that.” When you’ve cut costs on existing products for several years, you’ve probably already squeezed most of the blood out of the stone, and it’s difficult to know how to do it again. Sales are flat and you’d like to develop some new products. But you say, “Sure I’ll get the team together to come up with some proposals, but it will be tough”. The good news is that there is often room to optimize recently launched products through cost-cutting innovation. But don’t lose sight of growth projects in the process.
Cost Reduction and Golf …Cost reduction projects improve your margins but they should not dominate your R&D new product development (NPD) portfolio. Think of cost reduction projects as a golf club in your R&D golf bag, maybe a putter for example, that should be taken out and used only when the time is right. They are best when you have had a successful new launch but maybe the manufacturing process or ingredients/components haven’t been fully optimized for cost. If the new product is successful and accepted in the market place, then executing a cost reduction project will improve margins and easily pay for any R&D investment required to make it work. In this way cost reduction projects could be considered as the final stroke when you play a golf hole. To complete the analogy, the drive might be considered as the launch of the original new product and the chip onto the green as a line extension and the putt, a final finishing touch. Then you play the next hole; i.e. develop the next product.
Cost Reduction and Incremental Innovation …Before we discuss how to manage your R&D portfolio, first consider that Innovation can be broken into two types of Innovation: 1) Disruptive Innovation and, 2) Sustaining or Incremental Innovation. The definition of incremental innovation is: a series of small improvements to an existing product or product line that usually helps maintain or improve its competitive position over time. Incremental innovation is perhaps the most common type of innovation project that companies have in their R&D portfolios . It fosters a slow and steady approach that minimizes risk. Also once a company has launched a product or service, it will have built up a considerable amount of investment in people and product expertise so it is well placed to improve the product or/and reduce costs in its manufacture.
Let’s dive a little deeper into incremental innovation and identify what exactly defines incremental innovation. It can be: 1) adding wanted or removing (unwanted) features of a product or service, 2) making your product or service better, 3) reducing the cost of your product or service (this is where cost-reduction innovation comes in), or 4) improving the customer experience when buying or using the product/service.
Cost-Reduction Innovation …Companies in the incremental innovation game have products that are, or will be, under price pressure. This means that projects that focus on cost reduction are attractive because of potential gains in market share. If you can deliver a high quality product/service for a price lower than your competitors then you will gain market share. For example, cost reduction projects can focus on:
1) improving the efficiencies of manufacturing processes,
2) replacing raw materials/ingredients with alternatives which cost less,
3) consolidating strategies which bring economies of scale or streamline operations.
Cost reduction projects that achieve one or more of the above three goals without the consumer/customer being able to recognize a difference in quality of the product or service will be successful. However the trap is that (multiple) cost reduction projects can result in the customer recognizing a drop in quality and any improved margin is offset by a drop in sales.
The Unbalanced Portfolio doesn’t sustain Growth …I have talked previously about the need for companies to engage in active portfolio management and the need to constantly balance and optimize the portfolio for capacity [2,3,4]. If your company’s portfolio is heavily weighted towards cost reduction projects to the exclusion of other types of innovation, this is a warning sign that your company might be in innovation trouble. Cost reduction projects tend to have a law of diminishing return. It becomes harder and harder to squeeze blood out of a stone especially if sales are declining. At some stage old products will have to be replaced with new products. To return to the golfing analogy, you can’t keep putting forever….you must sink the putt and start a new hole if you plan to grow.
If these companies don’t address portfolio imbalances they will slip into the cost reduction black hole where their products become commodities which compete solely on price. If you are an R&D leader, make sure your company’s R&D portfolio is balanced. Just as a retirement portfolio should be balanced to distribute and even out risk, so should an R&D portfolio. Gradually add innovation projects that add features to your product and/or improve it. Maybe even add a high-risk blue-sky project that has the potential to be a big disruptive innovation. This will increase the probability of revenue from new products while minimizing investment risk. Referring to the golf analogy again …this will put you on the tee for the next hole.
Another trend I have seen in some companies is to separate cost reduction projects from innovation projects. Some companies use separate portfolios and governance systems for cost reduction projects verses innovation projects and some even have separate R&D groups that execute cost reduction projects verses innovation projects. The problem with this approach is that the cost reduction side can grow and overwhelm the innovation side. Cost reduction projects can involve new manufacturing technologies or new ingredients/components that can be transferred to innovation projects but separating cost reduction projects from innovation projects will often hinder cross-fertilization of ideas between the groups. In my opinion, the distinction between cost reduction and innovation projects is artificial and they should be managed as one portfolio in one governance system. In that way it is less likely that one type of project will dominate the NPD portfolio and R&D resources. Having one R&D group execute both innovation and cost reduction projects also gives the R&D leader the flexibility to implement changes in innovation strategy and increase or decrease cost reduction projects quickly, simply by allocating different projects to members in the group.
The Role of Culture …The culture of a company with an unbalanced portfolio often hinders significant innovation. These companies often have inflexible/hierarchical cultures that make it difficult to initiate higher risk innovation whereas more flexible cultures seem to be able to cultivate innovation that is more comprehensive and disruptive. Since the culture of a company often affects its innovation strategy, often a change in innovation strategy must be accompanied by a change in culture. The whole company has to be informed, invigorated and educated on the new innovation strategy. The new product development (NPD) process and NPD governance system may also need tweaking for a more innovative culture to stick [5,6,7].
Other Models …Alternatively, some companies use acquisition strategies almost exclusively to grow. These companies devote little R&D resources for internal organic growth. They acquire new products via merger and/or acquisition and use cost reduction projects and some incremental innovation to maintain profitability. While this strategy can work over the short term, it carries the risk of being torpedoed by a bad acquisition. Also the costs of integrating new organizations and products into the existing organization are usually underestimated. There are examples of some companies successfully implementing this strategy, but generally they are the exception to the rule.
Summary …Larger companies with established market share and products are well suited to utilizing incremental innovation methods to update or save costs on a large range of products or services in order to prevent them from falling behind the competition. However, some larger companies often fall into the habit of investing too much time and effort into cost reduction projects while neglecting other types of incremental innovation and disruptive innovation. As such, they eventually fall behind organizations with a more balanced mix of innovation techniques.
If your company has an R&D strategy focused predominantly on cost reduction, it might be time to rethink your strategy. New competitors will be emerging and experimenting with new innovation strategies. Inaction is not an option or you might find your customers spending more on another company’s more compelling new product.
© Dennis Nelson 2014