02 October 2020

Knock out Cost Drivers

Author/Compiled by
Hannah Wuzel

WHAT IF... you eliminated the most expensive step in your production or logistics? 

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There are plenty of steps a start-up has to take into consideration when creating a business model that effectively caters to its customers’ needs. Especially young entrepreneurs without a broad network or sectoral understanding, see themselves forced to fulfil a variety of tasks of the value chain to make sure their production or logistical process reaches the desired outcome. Some of these steps can quickly prove costly, either in terms of material or time investment, and crush the start-up financially. It is beneficial for you as an entrepreneur to regularly assess and evaluate each of your production and/or logistics activities to identify which ones can be outsourced, piggybacked upon existing structures, or even  eliminated entirely.  

Turning challenges into opportunities 

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When a new business idea is being developed, young founders tend to find themselves overwhelmed by the multitude of steps, processes and sequences they need to keep under control simultaneously. While struggling to build mechanisms to manage this daunting range of tasks, often without a significant professional network to speak of, and simultaneously crunching down on the optimisation of its own product or service, a start-up quickly becomes overburdened and loses sight of the key requirement: providing an excellent value proposition for its customer base and growing its market.  

This can quickly lead to dissatisfaction on the customer’s end, while at the same time exercising an immense financial burden on the start-up, as many of the steps it is trying to fulfil are cost- and time-intensive. Thus, production or logistical cycles can break a start-up’s back right in the initial phases of establishing itself, and lead to subpar delivery to its beneficiaries.  

However, these outlined challenges can also prove themselves to be the source of innovation. There are many ways through which you can optimise or entirely eliminate steps in your start-up’s value chain: By activating your personal and professional network to identify whether associates are already fulfilling steps of the pipeline that could be adapted to the entrepreneur’s needs; or by finding a way to cut down costs on one activity in particular by either streamlining it down to the essentials or identifying a way to circumvent it entirely.  

Take a look at some of the most well-known companies on the planet – many of these have opted to cut out activities in their value chain that may surprise you: The world’s largest taxi company, Uber, does not own taxis. The largest accommodation provider, AirBnB, owns no real estate. And the most popular media owner creates no content – Facebook. 

By the way – value chain refers to a set of activities that a business may implement to create value for its customers, according to the person who coined the term, Michael Porter. 

Moving towards a strategy

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If you want to cut down on cost-generating activities, you need to start by assessing your entire value and supply chain and thoroughly mapping out which activities your start-up is currently handling. This will allow you to identify ineffective or particularly costly steps. Next, you need to understand what your start-up does best – ask yourself where it is creating or could create most value for customers. When adopting a cost-factor elimination strategy, a start-up aims to focus on and highlight its strengths and find alternatives for its weaknesses. 

By cutting down on or eliminating cost-producing and time-intensive steps in the value chain, you can recover important resources that can be used to bolster up other aspects of the business model. Here are various examples you can employ to cut cost-intensive chain activities:  

  • According to your value proposition, you can opt to circumvent the middleman by selling to the customer directly (this could apply to high-end, consumer-focused products with attractive marketing), or pursue the opposite by outsourcing distribution to one or several capable, established dealers (this tends to be a good option for generic products with mass-appeal).  

  • You can put an upfront investment into a technology or IT system that will allow you to eliminate an expensive activity. 

  • Drop slow-sellers from your product or service portfolio and focus on the ones that have proven to work for a large share of customers, even if they may not cater to all of them. 

  • For production-based businesses, in order to ensure that you can always fulfil demand, you may look into storing a pre-manufactured inventory in a warehouse.   

It may initially seem counterintuitive to surrender control over what you may consider a crucial value chain aspect, to wave through a big investment into an alternative for a tedious chain activity or drop a product that may resonate with some of your customers. But it will allow you to quickly recover control over your financials and use them to bolster weaker activities in your chain, or invest into optimising your service or product, and corresponding marketing strategy, for your customers.  

Case Study 1

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There is a handful of start-ups in the Middle East that target plastic waste disposal reduction through at-source collection and shredding. In some instances, businesses and institutions even subscribe to the service for a fee.  

Waste tends to be collected in large bags, which end up being filled to the brim with plastic bottles and other hard plastic. This option requires many collection trips, since the bottles and plastic take up a lot of space, requiring long storage periods, until enough volume has been collected to justify selling the bulk waste to a customer. Both storage as well as transportation costs prove extremely cost-intensive in these cases. 

Some start-ups have overcome this challenge by developing on-site shredding or volume reduction solutions, therefore requiring less storage and warehouse costs and allowing the collection team to collect higher volumes in one go. These innovative logistics solutions are an excellent example of the Knock out Cost Drivers strategy. 

Library References

Shorten the Value Chain

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Long-standing value chain models are being transformed by new entrants who restructure the way value is delivered to the customer. Digital and other technological innovations help new entrants eliminate or shift stages in the design, manufacture, commercialization, distribution, and support of products to create and capture new value. The large amounts of capital and infrastructure required for longer and more complex value chains are no longer required when significant stages are eliminated or shifted to different participants in such a way that the economics are dramatically changed. Incumbents with longer value chains provide ample targets for new entrants to reconceive how, when, and by whom value is created and delivered.

HAGEL, J. et al. (2015): Shorten the Value Chain. Transforming the Stages of Value Delivery . In: Center for the Edge’s Patterns of Disruption series:

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