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  • Mike Donoghue

Penny Wise and Pound Foolish

Updated: Jan 26

During the 2008-2009 depression, the prevailing wisdom was to cut costs. However, the Harper government in Canada invested CAD $63 billion in fiscal stimulus. This investment proved to be a wise decision, as it also did for companies that maintained their labor force, they bounced back quicker with higher productivity and profits. Why? Their teams were established and trained and able to recover faster.

Operations efficiency management is critical to the success of any business. This management philosophy is based on the idea that small, incremental improvements can add up to significant cost savings and performance gains over time. However, there is a danger in focusing too narrowly on short-term savings at the expense of long-term success. In my experience there have been times where operational costs were challenged to the extent that facility production performance tailed off long before it should, whilst expensive new wells were developed that ultimately fed into the same cash starved facilities. Cutting continuous improvement initiatives during a downturn such as defect elimination teams is like "panning for fools gold"

The issues above are captured in the adage "penny wise, pound foolish," which warns against being overly frugal in the short term in the wrong areas, only to pay a much higher price down the line. One example was the oil and gas sector choosing to cut costs and paying the long-term price for it, which was seen as a result of the 2014-2016 oil price crash (the reasons for this, are well documented and we can talk about them another time). During this period, many oil and gas companies focused on cutting costs in order to weather the downturn by reducing capital expenditures, delaying projects, and reducing their workforce.. Although they had increased their debt to finance projects and grow quicker than they were feasibly able too prior to the downturn.

While these measures helped some companies to survive in the short term, they had significant long-term consequences. By delaying projects, companies missed out on opportunities to develop new fields and increase production. This left them with fewer reserves and reduced their ability to respond to future market demand. Additionally, by reducing the workforce, companies lost experienced employees who were crucial for maintaining and improving operations. Furthermore, the focus on cost-cutting also had negative effects on safety and the environment. With fewer resources, companies were forced to make compromises in areas such as sustaining continuous improvement initiatives in the areas of maintenance and process. This resulted in increased risks of accidents, spills and long-term environmental damage, as well as reduced production volumes due to reliability and availability issues.

As a result of these short-sighted cost-cutting measures, many oil and gas companies have struggled to recover in the years since the oil price crash. With some Energy companies such as Chesapeake Energy, SandRidge Energy, and Linn Energy declaring bankruptcy. To attempt to survive the crisis they implemented cost-cutting measures that included reducing staff, selling assets, and cutting back on capital expenditures. While these measures helped to reduce expenses in the short term, they also had longer-term consequences, such as reduced production and reserves. Chesapeake Energy, once the second-largest natural gas producer in the United States, filed for bankruptcy in 2020 after years of financial struggles. SandRidge Energy also filed for bankruptcy in 2016 after its debt load became unsustainable. Linn Energy, which had pursued an aggressive strategy of acquiring properties and drilling wells, also filed for bankruptcy in 2016 after being unable to meet its debt obligations. Each hold a message of cutting one's cloth according to one's measure.

Overall, this example highlights the dangers of focusing too narrowly on short-term cost-cutting measures and spending beyond ones means. While it may help companies to survive in the short term, it can have significant negative consequences in the long term, both in terms of production capacity and safety and environmental impacts.

On the other hand, there are also examples of companies that have successfully applied the opposite approach, investing in long-term improvements that have paid off in the form of improved efficiency and profitability. One such example is Amazon, which has invested heavily in automation and technology to improve the speed and accuracy of its fulfillment operations. These investments have allowed Amazon to process orders more quickly and accurately, while also reducing labor costs. As a result, Amazon has been able to offer faster delivery times and lower prices, while still maintaining strong profitability. Another example of successful long-term investment can be seen in the energy sector. Many companies are now investing in renewable energy sources, such as wind and solar power, which have higher upfront costs but lower long-term costs than traditional fossil fuels. This approach not only reduces the carbon footprint of these companies, but also helps them hedge against future price volatility in the energy markets. In summary, while it is important to focus on efficiency and cost savings in operations management, it is equally important to avoid being penny wise and pound foolish. Short-term cost-cutting measures can often lead to much higher long-term costs and risks, while smart long-term investments can pay off in the form of improved efficiency.

Whilst recognizing that practicing a practical and realistic plan with regard to what can be afford and not overextending, can safeguard against falling into the trap of being "penny wise, pound foolish,".

By investing in long-term solutions, companies can maintain control over the quality and reliability of their products, reduce labor costs, and become more sustainable. Striking the right balance between short-term and long-term thinking is crucial for businesses to achieve success in today's fast-paced and competitive business environment. In the end, it is better to invest in long-term solutions that provide lasting benefits rather than cut corners in the short term and face the consequences down the road.

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