How to reduce costs
This Article was posted on 04.02.11 in Managing
Cutting costs is arguably the quickest and easiest way to improve the profitability of your business. Introducing a cost-control system can bring immediate savings and ensure that you remain competitive in the longer term.
But cost control needs to be carefully managed. Eliminating waste is clearly beneficial, but indiscriminate cost cutting can lead to a drop in quality and poor morale among staff if people fear being made redundant or are not given the tools they need to do their job efficiently.
Systematic cost control
Start by identifying your major cost centres. These are likely to be purchasing, production, sales and marketing, financing, administration, premises, facilities management, and research and development (R&D).
Assess your profit and loss statement for the last six months and rank all your expenses from highest to lowest, then start working your way down, identifying areas where you could save costs. It is smarter to spend your time on a 5% saving on a $200,000 expense, than on a 5% saving on a $10,000 expense. Focus on applying cost-saving tactics in areas where you’ll see the most reward. For example:
- Can you save on wages by outsourcing some work, or employing someone on a part-time basis, rather than full-time?
- If insurance costs are high, try putting your insurance needs out to tender – you may find a cheaper supplier.
- Other costs such as long-term fixed rate loans or fixed price contracts for raw materials are hard to control in the short term, but identify when these are up for renewal and plan to tender out to suppliers.
Comparing actual costs with budgets
Record your actual costs and compare them with the amount allocated in your budget. Try to work our why there is a discrepancy between what you planned to spend and what you ending up spending. In general, the larger the cost overrun, the more scope there should be for savings.
Actual costs that are higher than your budgeted costs usually indicate room to reduce costs. Lower costs may indicate good management, but might also reflect a drop in quality or potential problems. A spreadsheet or cost-control package will make it easier for you to record and compare costs on a regular basis. We recommend you do this monthly.
Periodically review what you are doing and how you are doing it. Benchmarking your business against other similar businesses may show that your performance is sub-standard. For example, your wastage levels might be higher than the industry average. This is an opportunity to implement cost-saving solutions and to set goals, such as standardising components to reduce design and manufacturing costs by 10%.
Who is involved?
If possible, make each cost the responsibility of one person or manager. Some costs will be easier to control if one person is responsible for that cost throughout the business.
Get your employees involved in cost control. Give them an incentive to suggest cost-saving ideas (such as a monthly competition for the best idea), and ask what causes them problems or wastes their time.
Employees are more likely to co-operate with cost-control initiatives if changes are explained to them and they understand the benefits to the business (for example, improved job security if the business becomes more profitable).
Include your customers and suppliers. Once suppliers are aware you are watching costs, they may start sharpening their pencils, especially if they know the other purchasing options available to you. Try asking your customers if you are providing them with anything they don’t need. You may be able to save costs by eliminating unnecessary features or frills.
Easy savings
Some costs can be reduced with little risk of an adverse impact on quality and performance. Some quick savings can be found by:
- Check supplier invoices for overcharging. Common examples are double billing, incorrect charges and missing discounts.
- Eliminate unnecessary costs. Get rid of obvious overcapacity such as unused telephone lines. Cut out blatant waste such as heating premises at night, or leaving lights and computers on after hours.
- Scrap useless processes such as paperwork that is completed, filed and forgotten.
- Crack down on excessive costs. Mobile phone usage can easily fall into this category.
- Find alternatives to high-priced suppliers, or negotiate discounts and better payment terms.
- Avoid over-specifying, such as high-quality components for a low-quality product.
- Ban wasteful luxuries such as full-fare flights; book ahead to take advantage of cheaper flights.
- Root out inefficiency. Identify manual, paper-based systems that could be computerised.
- Avoid frequent small orders. They waste time and may mean you lose discounts.
However, be careful about cutting back on items employees see as ‘benefits’ or ‘perks of the job’. This needs careful handling. Remember that it is easy to give perks when times are good, but much harder to take them away without causing resentment.
Other saving opportunities
Taking a systematic approach to all your costs should highlight other opportunities to control costs with little risk. In many cases, reducing costs will require you to change the way you do things.
Some of the most common opportunities are listed below, but in every case, be aware of the potential to damage your core business activities.
- Reduce your payroll costs by outsourcing non-core activities.
- Redesign processes to eliminate duplication of effort and to cut out time wastage.
- Make more use of technology and automation.
- Consolidate purchasing with fewer suppliers to get better discounts.
- Agree to long-term supply contracts or guarantee minimum annual purchase volumes in return for lower prices.
- Build personal relationships with suppliers to encourage preferential treatment.
- Form strategic buying alliances with businesses in your trade or area to buy larger volumes and share the savings.
- Trim back your product range and increase production runs.
- Focus on quality control to cut rejection rates and reworking costs.
- Meet with your bank manager to review your finances to reduce interest costs.
- Cut back on the need for working capital through just-in-time purchasing, better credit control and negotiating longer payment terms with your suppliers.
- Get the most out of your premises by sub-letting spare space.
- Introduce home working or ‘hot desking’ to cut space requirements (and travel costs).
- Cut the cost of communications by using email or Internet calls (such as Skype) whenever possible.
Pitfalls
Reducing costs can have a negative effect, so before you make changes check that your standards will not be compromised, and that your ability to meet objectives will not be harmed.
Almost every cost saving has a potential downside. For example:
- Over-dependence on one supplier puts you at risk if the supplier fails.
- Production and marketing plans driven by cost-cutting considerations are unlikely to be responsive to customer requirements.
- Tighter control of financing may leave you with no safety margin when cash flow is unexpectedly poor.
- Cutting short-term ‘investment’ costs (such as training, advertising, equipment or new product development) can lead to long-term weaknesses.
Employee costs
Reducing costs that directly impact on employees is fraught with difficulty. For instance, reducing costs such as training and meeting times is often counterproductive in the longer term. Poor work conditions, pay and benefits will also not attract and retain good employees and will de-motivate employees who stay.
Changing an existing employee’s terms and conditions, to the employee’s detriment, can be a breach of the employment agreement, so get expert advice first. Making employees redundant brings short-term costs and the risk of possible employment proceedings or a personal grievance case. It may also damage long-term morale. On the other hand, introducing improved procedures can be difficult and expensive. Employees may be resistant to change, and may need extra training.
Advisers
Finally, remember to include your business advisers and especially your accountant in your cost-control programme. Accountants typically deal with many businesses and are therefore in a strong position to help you identify and monitor ‘cost culprits’ and suggest ways to lower costs and improve business profits.
Next steps
- Set a staff meeting to review your costs and delay or eliminate plans to purchase items that are not essential.
- Commit to an ongoing cost-control and monitoring process and delegate key staff to manage the process and oversee specific cost centres.
- Ask your accountant if they subscribe to the NZ Benchmarking Survey to see if your costs are in line with similar businesses.
- Use the free Business Assessment Tool to help identify areas where you could save on costs.
Content provided by The Small Business Company
