How to Reduce your Costs

June 24, 2016

 

Q.  I run a small business. Profits have declined. I feel that my costs have gotten too high given our revenue. Do you have any tips for how can I cut costs to improve my profit?

A.  Even in good economic times, some companies will find that profits have slipped. Most may be doing okay, but for whatever reason, some companies will struggle. When this happens, a focus on growing profit is crucial. A wise CFO once explained that when you cut costs to generate more profit, the upside is limited. There is a limit to how much you can cut without damaging the business’s ability to generate revenue. When you increase profit by growing sales, there is no limit. Therefore, we would encourage you to think about opportunities to grow revenue before cutting costs.

That bit of wisdom notwithstanding, companies should run as efficiently as possible and there will come a time in the lifecycle of most businesses when expenses need to be reduced. Following these five tips will make the process more successful.

1.     Eliminate the frills – First class airline tickets, luxury hotels, lavish company parties and expensive conferences are the first things that should go―particularly excessive perks at the executive level. Enforcing austerity measures on the rank and file while executives live high on the hog is a recipe for destroying the positive culture in your company.

2.     Look to suppliers for cost reductions – In good times, companies often buy from suppliers with which they are familiar. There may not be a push to get the absolute best deals. Difficult times provide a reason to review all of your company’s vendors. Does your company absolutely need the product or service the vendor is providing? Given the hard times, can you negotiate a better price or more favorable payment terms? Are there other vendors who would offer the same or equivalent products and services at lower prices? Are there ways of working with vendors that would reduce the total cost of doing business? For example, we once worked with a client that purchased chemicals in plastic drums. They then paid to dispose of the drums. Discussions with their supplier uncovered the fact that the drums could be recycled. Our client was able to negotiate a lower price because they reduced their vendor’s costs and they saved the disposal cost.

3.     Dismiss weaker staff members first – The time will inevitably come when a business has to reduce staff. While this is never easy, it can be necessary. Companies facing this challenge should make a concerted effort to dismiss those who add the least value to the organization first. This will probably mean that some longer tenured employees need to go, while newer, more talented employees are retained. Tenure based cuts will inevitably result in a weaker, less competitive company.

4.     Consider across the board reductions – If you would be just as happy hiring a new employee as keeping the one you have, these people are candidates for dismissal to reduce costs. However, if you have talented employees who you would absolutely hire back if you could, consider across the board reductions rather than dismissing these valuable people. First, eliminate all overtime. If revenue is below forecast, there is generally no need for overtime. Across the board reductions can come as reduced salaries and a commensurate reduction in hours (e.g., reduce salaries by 20 percent and cut hours by the same amount). Alternatively, salaries and hourly wages can be reduced, but hours maintained. A caution, make sure that executives share equally, if not more than equally, in these reductions.

5.     Replace guaranteed compensation with incentive-based compensation – If salaries and hourly wages must be reduced, consider implementing an incentive compensation program that ensures employees will earn back their lost compensation and more when the company’s performance improves. Not only does this type of compensation provide incentive for employees to work hard to make the company excel, it also provides automatic cost savings when times are hard.

Implementing an austerity program is always difficult, but sometimes it’s essential. When you face this challenge, following the five tips above will help make your company stronger.

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