Cutting costs? 5 things you should do before you start

Avoid reducing value to your customer when cutting costs

OVERVIEW

You can improve a company s bottom line performance by either cutting costs or adding value via the sales mix. Sounds simple!

In this article, we shall look at cutting costs or more precisely, what you should do before you cut costs to make sure you make the right decisions.

Let s start with the obvious: costs are an input which, to add value to the business, should deliver outputs of greater value to the business than their input cost. The difference between outputs and inputs equates to the added value generated by incurring that cost. When I was a lad, Economics lecturers used to call this the concept of marginal return.

Now for a very simple but important observation which is often overlooked: Costs which add no value and/or which cannot be structured to create added value clearly need to be cut, particularly when a business is seeking to survive.

Why is this statement so important? The logic is this: to cut costs you save a dollar – this is a fixed benefit in perpetuity. However, if you can figure out a way to create added value from this cost, then you can end up receiving a benefit which is a really large multiple of the cost. And, if you communicate the benefits it brings, you might end up with a strategic advantage. (More on this below).

Which of these outcomes would you prefer?

Cutting costs can be quick and relatively easy. And, particularly with human capital which is often a major cost of most businesses, the result is almost immediately apparent on the bottom line. However, danger lurks with most cost cutting strategies as these strategies can undermine the core business value chain if they are not done with proper thought and structure.

Most turnarounds in the 80 s and 90 s were based on cutting costs, particularly human capital. However, many of these downsized businesses suffered from long term scarring and a question mark over their sustainable viability.

TABLE OF CONTENTS

  1. Understand where the cost fits into the value chain of your business. Read more >>>
  2. Determine who currently uses the cost within the business (employees and management) and for what purpose. Read more >>>
  3. Determine whether any external stakeholders benefit from the cost and whether they understand they are receiving a benefit provided by your business. Read more >>>
  4. If a cost is being retained, ensure it is adding the maximum value possible. Read more >>>
  5. When you cut a cost, make sure you have communicated it effectively before, during and after you cut it. Read more >>>

Let’s now go over each of these 5 areas in a bit more detail.

  1. Looking at a cost in isolation can result in misleading conclusions as to its value to the business.

    You need to understand the business value chain and where the cost fits in – which means mapping the value chain and the key processes which deliver value to the stakeholders (more often than not the key stakeholder group will be the business’ customers as they are the foundation of the business’ viability. In quite a few situations, however, the stakeholder group could be the business’ suppliers, employees or management who in turn add value for the customers).

    Example: as we discovered at Sugar Co.(see Case Study), freight is more than just a cost of delivering product from door to door. Although freight costs need to be competitive, freight is also about timeliness and reliability in terms of pick up and delivery, assisting when an emergency arises and ensuring the quality and quantity of the product does not deteriorate during transportation.

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  2. Some costs might appear to be surplus and of no value add to the business, particularly when the direct beneficiaries of the cost are not the customers.

    The fact that a cost is not used by customers does not invalidate the cost per se.

    Example: the value of a staff canteen in a factory has no direct external value for a customer. However, it does benefit employees and it can improve work conditions and the prospect of hiring better employees.

    Also, think laterally about the canteen space! Use the canteen as an information venue and/or a training venue before and after meal times, making it a value add space for the business. Put company products on display including new launches so employees can see what is happening in the business and perhaps they can promote the products to their family and friends.

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  3. Sometimes costs do not directly add value to the finished product but the external stakeholder receives a benefit from it in all sorts of extraneous ways.

    Example: in one of our assignments (see Case Study)., we had a cost issue with packaging material for our confectionery products. There were cheaper products available on the market but the colours we used on the packaging did not look as bright so the product would not stand out as well on the retail shelf. When you are competing with the big boys on supermarket shelves, every little thing counts.

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  4. Never stop looking for ways to extracting even more value from your costs.

    This is the equivalent of the sales strategy of squeezing the orange to extract as many benefits from a product s features as is humanly possible.

    Often costs are underutilised because no-one sees them as potential strategic advantages for your business. And, their benefits are often under-communicated both internally as well as externally.

    Example #1: more than a few years ago, a major food manufacturer of cordials had a dilemma. They used 25% fruit juice in its cordials. Fruit juice was expensive but it was considered necessary to give the cordial its flavour and consistency. However, consumers like you and me thought cordial contained sugar, water and some colours and flavours. They did not know cordial contained real fruit juice and therefore could not perceive any benefit from the use of this ingredient.

    The options for the manufacturer were to look for cheaper alternatives to fruit juice or communicate this feature to the consumers in a way that it was perceived as a benefit. They took the second path. Once this story of ‘25% real fruit juice’ was advertised, sales of their cordial took off – there is nothing like having the ‘first in market advantage’. Even though their competitors could have told this or a similar story to consumers, they didn’t – and they lost market share.

    Example #2: if you have a communication tool which you use with customers, distribute it to all your stakeholders internal and external and let them all know what you are doing and what you are up to. Encourage them to partner with you in developing new ideas for your customers as part of the communication channel and perhaps you can even get them to contribute to the cost if they are getting a benefit of recognition!

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  5. Follow up is the key.

    Communication of analyses that show a cost is not of benefit either directly or indirectly to the business is critical if a stakeholder group is used to receiving a benefit from the cost.

    Follow up with any stakeholders who may be affected and impacted by the decision. Make sure you explain the logic and how the cutting of this cost will not negatively impact the stakeholders in terms of their net benefit. Most importantly, be prepared to listen to responses and take on board opinions. It may be that despite your best analysis and research you got it wrong.

    After all, despite research and testing, New Coke did not succeed, nor did the Ford Edsel, so if two iconic companies can get it wrong despite a stack of testing, don t think you can t get it wrong either.

    Example: in one of our assignments (see Case Study)., we re-wrote all the employee contracts as we had employees working for the main company, a subsidiary as well as an outsourced agency – and some employees had contracts of employment, some did not. And, to make matters worse, there was no logic as to who worked for whom – particularly as all staff had originally worked for the main company and transfers to the ‘new employers’ had not been well documented. Oh, and we were about to embark on a new round of negotiations for the Enterprise Bargaining Agreement which had a ‘drop dead’ deadline which was about to expire.

    As you could imagine, this was an IR nightmare waiting to happen.

    To cut through the obvious problems and difficulties, we worked closely with the Union and we had numerous staff meetings to explain the changes we were about to embark on – pretty difficult in a business which was being subject to enormous restructuring and with its future viability in doubt.

    With our lawyers from Holding Redlich, we prepared new contracts for all staff which reflected more accurately the roles and responsbilities of the employees and the employers and ensured both parties knew what was required of each other going forward. No more searching for missing documents, no more incorrect details of start dates and no more figuring out which employer was responsible for which employee!

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