When Externalizing Costs Erodes Brand Value

By Jon Miller Updated on August 22nd, 2016


What would you say if your lean expert suggested cutting the cost of poor quality by drastically reducing inspectors and letting customers find the defects after they left the building? Ludicrous! You exclaim. That’s no cost reduction at all, and we risk losing trust with customers. That is an example of local optimization, or making one process apparently efficient at the expense of the whole. It happens when people are pushed to hit the wrong goals. A Bloomberg article about how Walmart’s out-of-control crime problem is driving police crazy is a good example of how the externalization of costs by corporations in the pursuit of cost reduction can erode brand value.

The point of this post is not to knock Walmart, but rather to use this example as a reflection on how even leading companies such as Walmart or Toyota can sometimes end up paying more by cutting costs. Toyota experienced growing pains not long ago, cutting seasoned engineering staff and experiencing expensive setbacks in supplier quality as a result. Many companies who claim to practice lean furiously reduce operational costs while neglecting product development, marketing and talent development processes, resulting in short-term savings and long-term mediocrity.

According to the article, Walmart cut staffing costs in its stores, making it easier for people to walk out with merchandise without paying for it. As a result, these Walmart stores call the police more often. As one Police Seargeant commented, “It’s ridiculous—we are talking about the biggest retailer in the world. I may have half my squad there for hours.” Walmart in effect has outsourced its security to the city police, at no cost. Or has it? This type of externalization of cost does indeed have a cost. Only the cost is paid by people externally, the taxpayers in this case. Often externalized costs are only visible over long periods of time. The rising cost of policing may have a complex web of causes not easily traced to retailers externalizing costs. The cost savings appear immediately, but benefit only a narrow group of people, Walmart executives and shareholders in this case. Externalized costs are in fact often system-level cost increases, because a police officer costs more than a Walmart security person. The costs of police responding to shoplifting incidents and not to more important crimes is much harder to measure than costs Walmart reduced for itself.

When manufacturers send production offshore in the name of cost reduction, or even operational excellence, they may gain lower immediate manufacturing costs. The externalized costs may include a generational loss in machining skills, higher unemployment claims because of fewer manufacturing jobs, competition for lower-skilled jobs increasing teenage unemployment which can lead to further crime, reduced property values in inner cities until idle factories are repurposed, and so forth. These costs don’t appear in the offshoring calculation because corporations, unlike people, suffer no consequences from acting irresponsibly towards society as long as they increase shareholder value.

Lean thinking offers a remedy to the ills of the externalization of costs, if leaders can resist the temptation of the quick cost reduction. Lean thinking requires that we listen to customers and deliver what they value, rather than simply hawking lower-priced products at the expense of paying for basic security. Lean thinking encourages us to reduce costs by taking out wasteful activity, not by flushing our waste downstream for someone else to clean up. Lean thinking encourages us to look at processes end-to-end to understand the true total cost, not only the piece price. Lean thinking encourages us to think long-term, beyond quarterly financial performance and into the impact of our actions on future generations. Lean thinking requires that we internalize our costs so that we can get a firm grip on reducing them, and externalizing value so that customers recognize and reward us for this.

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