by Rene T. Domingo (email comments to rtd@aim.edu)

Let us evaluate the performance of two companies, making different products. Both have excellent marketing operations and market shares; the only difference is their bottom lines.

Most students of management would say that, overall, Company A did better than Company B. A made $10 M while B lost $5 M. The implication of this view point could mean promotion and fat bonuses for the management of A, and penalties for that of B or even its closure.

What could go wrong with this seemingly solid logic of the popular process called "management by results" or "bottom-line management". Let us dissect the item that made the difference between the two companies: COST.

In any company or in any operation, cost is always a combination of value-adding expenses and non-value adding ones. In other words,

COST = VALUE + WASTE

Waste is expenditure on any resource or activity that does not add value to the product or service sold by the company. It can be in any form: materials, machines, men, services, etc. All wastes are therefore unnecessary and avoidable, if they can be recognized and acted upon. Waste accounts for any proportion of costs: it could 5% of costs or 95%. Unfortunately, the accounting practice does not break up costs into value and waste. All expenditures are lumped as costs, thus giving management the illusion that all costs are value-adding and unavoidable. Or it could lead management, given the lack of information, to have that false sense of optimism that waste or avoidable costs could be just a small fraction of total costs.

Suppose we are able to properly classify and identify these two cost components in our previous case. Let us see one possible scenario.

COMPANY A COMPANY B

We can now see that A actually caused the company to lose $30 M and B, $10 M for their failure to eliminate waste or avoidable costs. We are not talking here of potential loss. Company A actually spent $30 M on resources that did not yield anything but wastes. Its profit could have been $ 40 M. The paradox from this example, is that while A made profits, it caused the company to lose more money than B. A deserves no congratulation. Even if we do not compare A with B, A still had a dismal performance of failing to save the company $30 M, or making only $10 M when it could have made $40 M.

What are the lessons we can learn from the examples above? One is that a company could be making money and losing more money at the same time. Bottom-line profit is an illusion; it makes us believe that there is no loss if there is profit. We could have profit and losses simultaneously.

The other lesson is that bottom line management condones wastefulness and inefficiencies. It allows sales, or high sales, to compensate, hide, and cover up for high costs or wastes. As long as the profit goal is achieved, nobody looks at cost and everybody assumes there are no wastes. This management style will eventually take its toll when sales drop, and losses are incurred because of uncontrolled costs or waste. By that time, cost cutting is already too late.

The final lesson is to always consider cost as potential profit and to institute a continuous cost reduction (waste elimination) program in your company - whether you are "profitable" or not.