OOPs! Some Cost Savings Are Hard

You need to look at more than numbers to make good decisions.

In 1999 GM lost a lawsuit.  Damage award $4.9 Billion.  The reason was a poorly designed gas tank location in the 1979 Malibu.  They knew about the problem early on but decided to do nothing.  They estimated that it would cost $8.59 per unit to make it right. They further anticipated that it would cost only $2.40 per unit to defend and pay out awards resulting from lawsuits.  An easy saving of $6.19 per unit.

Overlooking how cynical the decision was, it was stupid on its face.

Numbers are good for a lot of things but they are too sterile for this kind of decision.  Numbers need context to have meaning.

For example, what does 10 mean?

Blood sugar, bad.  Rating on a dating site, very good.  Score on the 16th hole.  Very bad.

Cost accountants and others like them do not approach value the right way. They think numbers are a symbol of a deeper meaning and then ignore the context.

American industry has suffered for decades with people trying to squeeze the last penny out of costs while ignoring that the cost saving is merely an input into some other problem.  Worse still the $2.40 lawsuit number was a guess.  Probably the $8.59 was a guess too as it would depend on volume. I suppose it might have turned out right if GM built 2,000,000,000 of these vehicles.  Seems unlikely.

The tendency to use sterile numbers for analysis came out the “Whiz Kids” activity in WW II.  One of them, Robert MacNamara became president at Ford, secretary of defense under Kennedy and Johnson, and president of the World Bank.  Systems analysis was very fashionable.  They call it program analysis now.

Numeric analysis makes sense up to the point where it becomes the sole basis for a decision.  No situation is so simple that a number will fully describe it.  In business, numbers should guide decisions by pointing to the most fruitful areas to explore and compare.  Executives should use deeper metrics to decide. 

Or have a clear organizing principal.  If GM’s organizing principal was provide greatest customer value, the misplaced gas tank problem would have disappeared easily and quickly.

Numbers can do many things but they cannot know how customers will decide on something.  I expect most Malibu purchasers, fully informed of their choices, would have preferred to pay an additional $8.59 for safety, but that is not how this kind of analysis works.

I can recall 25 years ago discussing GM trucks with an executive there, and pointing out that acquiring durability by adding $2,000 to their parts cost would add about 30% to their total and if they charged me the extra $2,000 I would pay only about 10% more for all that quality.  No cost to them net.  Big advantage to me.

Their answer, “If we did that the truck would last too long.  We could not sell you another one.”

My reply, “You can’t sell me another one now.”

Perfecting efficiency and the price of parts are an example in the price-cost-value equation.  If you reduce the quality of some component to reduce the price, there will be a cost.  If the manufacturer does not bear the cost of poor quality, then the customer will.  If the customer discovers that what remains of the product has a value in use less than the retail price, they will buy elsewhere.

And they will discover the shortfall eventually.  How hard will it be for you then?  What is reputation worth.

People who shave quality to reduce price should add in the additional cost of marketing, advertising and defending lawsuits.  If they did that analysis, adding both price and quality could easily become their optimal course of action.

Never assess your costs absent a complete customer value template.  Charging a little more to provide much more value is a sound strategy.


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Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: don@moneyfyi.com  

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