Overhead Value Analysis

November 30, 2017

 

Q. My small business is breaking even, actually, we are losing a little bit of money. We’re making a good gross margin for our industry, but I think our overhead has gotten out of control. I’m sure I need to cut cost, but I’m not sure where or how much. Can you help?

 

A. It does sound like you need to reduce overhead costs. On the other hand, you are right to avoid indiscriminate cost reductions. Across the board cuts (e.g., cutting the same percentage of cost from each department) have the allure of sounding fair, but can lead to bad decisions. Cutting in the wrong places could do irreparable harm to your company. Over the years, we have helped numerous small businesses reduce their overhead costs safely. 

 

We use a process called Overhead Value Analysis. The intent of this work is to identify savings in the company’s overhead costs. You could conceivably do this work yourself, but we have found that there significant value to having it done by an unbiased third party. The steps in this process are:

 

  • Get an overview of the operation – We meet with the owner and perhaps some of his/her key Lieutenants to get a clear picture of how the organization runs and the key responsibilities of each department. This always involves getting an organization chart (which we often have to create ourselves). The goal of this step of the process is to gain a very clear understanding of how the senior people think the organization runs (caution, the understanding of senior people, even in a small company, does not always match reality).

 

  • Identify the tasks and the time people are spending on each – We meet individually with each employee, or at least a reasonable sample of the employees, to ask how they spend their time. We have them layout exactly what tasks they do. Then we will ask how long it takes to do each task. When the estimates don’t pass the sniff test, we push back, asking penetrating questions and requesting to see work products. We want the estimates to be as accurate as possible and we want it to be difficult to sandbag. Amazingly, after we do the math, we often find that the sum of the time people spend doing their tasks is significantly less than the number of hours for which they are paid.

 

  • Determine the number of hours it should take to do each task – We have already identified the time that people said they spent doing each task. Now we need to determine how much time it should take them. We do this by cross checking the estimates from other employees that perform the same task. It may be necessary to get two individuals together to resolve any significant differences. We then meet with supervisors and senior managers to get their assessments. Ultimately, we settle on an estimate of how long it should take to complete each task.

 

  • Identify opportunities – We find opportunities to reduce overhead in three areas:

 

    • Tasks that do not need to be done – We sometimes identify tasks that are redundant or for some other reason do not need to be done. Obviously, we can eliminate such tasks and save the time required to complete them.

 

    • People who are underutilized – We now have the best estimate we can attain of how long each task should take. We do the math and determine the number of hours we need to complete the tasks of each department versus the number of hours that are available and identify areas of underutilization. 

 

    • Work that could be done by a less costly resource – We often find that highly compensated people are spending significant amounts of time doing things that could be delegated to less expensive resources.

 

  • Finalize the action steps and calculate the benefit – Now the hard reality—you have identified many possible savings opportunities. However, capturing real savings requires a reduction in:

 

    • The number of employees

 

    • The average compensation per employee

 

    • Money paid to third parties 

 

Sometimes companies can achieve savings by not filling vacancies or by delaying hiring as the business grows. More often, the owner faces difficult, gut wrenching decisions. But, if the company is going to save money and become profitable, difficult choices must often be made.

 

Overhead Value Analysis is a powerful tool for reducing waste and increasing profitability. Capturing the benefit most often requires tough decisions, but in some cases, this is the best alternative.

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