As business terms go, 'cost reduction' doesn't sound too glamorous. It's hardly the most dynamic or innovative of concepts. That's OK though: business is business. It's not meant to be sexy.
Besides, what a cost reduction programme may lack in excitement, it more than makes up for in cold, quantifiable results. Cost reduction can dramatically improve the fortunes of a business, eliminating waste, improving efficiency and boosting profits. Who cares how drab it sounds? All that matters is the bottom line – and the bottom line is that cost reduction, when performed correctly, can deliver astonishing results.
How good are we talking?
Just a 5% reduction in operating costs has the same profit and loss impact as a 30% increase in sales.
Yeah, you can read that again if you like.
Profit v Cost
To increase profits, you essentially have two options: increase revenue or reduce costs.
To maximise profits, however, the obvious solution is to combine both methods, reducing expenses while working to identify new revenue streams and maximise your income from existing products.
It is a common assumption that boosting profits requires taking drastic steps to identify new revenue streams or expand into new markets.
Not so hasty. Start by looking closer to home: assess your products, production, pricing and accounting practices. Cost reduction can simplify things rather than adding layers of complexity.
The case for cost reduction
In the current economic climate, which business isn't under pressure to reduce costs? Departments; programmes; projects; entire organisations – no one and no project is safe from the threat of cuts.
A targeted cost reduction programme – one that has been based on a thorough business assessment – can yield the desired level of savings without incurring the sort of pain that is inevitable when budgets are top-sliced indiscriminately.
Cost reduction shouldn't be thought of as a reactive process however; something to call upon when a business is forced to make cuts. Rather, every company – whether expanding, stagnating or downsizing – should periodically conduct an organisational review to identify areas where savings can be made.
As any self-respecting FD knows, eliminating waste and increasing efficiency should be an ongoing process, not a sticking plaster to be applied when profits are down.
There are a myriad of ways in which a business can reduce its overheads – everything from the cost of office space to the type of biscuits served at boardroom meetings is potentially up for negotiation.
Biscuits and rent: one of these things costs an awful lot more than the other. So why are they being mentioned in the same breath?
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Rent may not be renegotiable.
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Biscuits almost certainly are.
Let's leave the custard creams alone however – if anything deserves to be ring-fenced, it's biscuits. Besides, the cheap brands never taste as good.
Consider instead another business expense, which will inevitably come under scrutiny as part of a cost reduction programme: stationery.
All the small things
On a per unit basis, most office supplies are relatively cheap. Haggling over whether your pens can be purchased for 10p or 8p a time isn't going to change much, is it?
Actually, you'd be surprised. It doesn't require a scientific calculator to deduce that a 20% saving on stationery across the board could run into thousands of pounds. Factor in office furnishings and peripherals as well and you can double that sum – and that's just for one office.
The trope about American Airlines removing an olive from each first class salad probably doesn't need retelling (OK, it happened in 1987 and they saved $40,000), but it illustrates the sort of thinking that every FD should have:
Looking at the bigger picture but focused on the details. Therein lie the savings to be made.
What to look out for
If you operate several offices, are supplies being ordered in bulk, or are individual managers left to source everyday sundries? Are items ordered on time, or is it common for the business to run out before being forced to purchase emergency essentials locally, possibly using petty cash?
Are you charged for delivery every time you order supplies? If your offices are situated within the same city or are frequently visited by a regional manager, could supplies be ordered centrally and then distributed in order to save on delivery costs?
Ordering items in bulk may work out cheaper, but overstocking will harm your cashflow.
How to conduct a cost reduction assessment
How do you go about assessing your business's profitability? Why, you look at the data. The numbers don't lie.
No skimping, no guesstimates and no ball park figures – just accurate data that can be crunched to reveal areas where savings can be made.
For example, how much does your business spend on office supplies in a year? Paper; sticky notes; printer ink – even teabags. Increasing the profitability of your business requires more than an ability to identify instant savings: you need to think long-term. Any resource your business consumes on an ongoing basis is a potential money-saver.
Identify areas of waste. Waste can happen due to poor planning, inefficient working practices or even overreach – trying to be too many things to too many people. Identify waste and eliminate it.
Increasing profits
What is the goal of cost reduction? Quite simply, it is a means of increasing profits – but it is by no means the only option. Cost reduction can be performed as part of an overall strategy geared around profit maximisation. For example:
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Product Line Simplification can reduce overheads by enabling a business to focus on making fewer products but to a higher standard. This in turn can justify increasing the price.
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Programme Slimming: Evaluate each area of a programme in turn. It's not simply about identifying your greatest costs – it's about identifying where savings can be made without impacting upon the service offered.
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Identify Cheaper Suppliers: First you determine your costs. Then you find out how to reduce them. If your current supplier can't provide a better price, find one who can.
Benefits of maximising profits
Profits fuel growth. Whether cutting costs or increasing revenue, the ultimate goal is to increase profits. As we've already identified, there are numerous ways to get there, be it by improving processes, increasing prices or reducing waste. The most important thing is that you do get there, using every tool at your disposal.
One-time savings, such as selling off excess car-parking space, can yield a lump sum, but ongoing savings will boost profitability month after month.
That's where a thorough cost reduction assessment proves invaluable. A no-stone-unturned business assessment will identify areas where savings can be made.
In some cases there will be profit barriers; areas where you simply can't squeeze any more. There will also be profit opportunities however.
Set financial targets and schedule periodic cost reviews. Analyse, assess and re-evaluate.
The result? A leaner, healthier business, greater control, increased profit and improved cashflow.
