Cutting costs is a key priority for any business struggling to maintain strong profit margins. It may sound counter intuitive, but taking a ‘slash and burn’ approach to lowering costs can ultimately lower profits.
If a business is not strategic about implementing cost reduction measures, and recklessly downsizes its product offerings or processes, it could damage relationships with clients, reduce productivity and drive down revenue.
Most businesses can, however, improve profit margins without having an adverse effect on the business, through focusing on operating efficiency, reducing unused capacity and getting rid of services that customers don’t value.
Improving operating efficiency
In order to reduce operation costs without damaging a business, Pitcher Partners partner David Knowles says managers must have an “end-to-end” understanding of their business processes. He recommends walking through every step of interaction with a client – from attaining a prospect, to getting an order, delivering a product or service and receiving a payment.
Then, Knowles says, it’s about “drilling into the bits that are necessary.”
“Which bits are adding value to the customer along the way? And which bits can you do without?”
For example, he says, implementing an online third-party payment system like Westpac’s Pay Way, rather than sending an invoice, could allow a business to collect debtors faster, without having to devote time to chasing up payments.
Understanding the potential of recent technological advancements is another key way to reduce operating costs, according to KnowledgEquity Strategic Projects and Finance Manager Steve Piening. In particular, cloud computing can allow businesses to improve efficiency at very little cost.
“When properly utilised, these solutions can help the business to operate efficiently and allow for the capture of more data than ever about their businesses, its customers and staff,” says Piening.
Reducing unused capacity
Excess capacity, where equipment or staff have the ability to produce more than they currently are , can result in wasted profit. Knowles says there are many examples of companies who have learnt to make use of what would normally be thought of as “excess” capacity.
“All those things are about saying: ‘We’ve got assets that are productive 10% of the time, how do we get them occupied the other 90% of the time?’
“The same is very true for productive assets in businesses, where the key machine might sit idle,” explains Knowles. He says managers and business owners should ask themselves, “Should I own this? Do I need to control this asset?”
While reducing excess capacity can be as simple as selling off an unused machine, it may also require a more considered, long-term strategy, due to fixed contracts. As such, KnowledgEquity director Courtney Clowes says cutting unused capacity may not always be directly connected to a typical single year budget cycle.
“For example, reducing office space can be linked to changing the organisation structure to involve more virtual teams and teleworking,” says Clowes.
“But, these new structures must first be implemented carefully, and then rental negotiations need to take place. So, it is likely to be a three year cost reduction strategy – which, if done poorly, can cause more harm than good, with frustrated and annoyed employees.”
Cutting services, products and processes customers don’t value
Customers can often offer the best insight into areas that are unnecessary costs to the business, such as services they value less than others, or products that are not popular. Businesses should be in regular contact with customers, and speak to them directly about their experiences.
“Start with your most valued customers,” Knowles recommends.
“Why do they do business with you? What’s the value that you add? Think about whether you’re geared up to provide that value, or is it incidental?”
Customers can also provide advice on how to improve services in ways that may be cost effective – for example, communicating with the business online may save customers time, while reducing administrative costs. However, Clowes cautions business owners to remember that customers may not understand all the necessary processes.
“Be careful here, because there are often internal controls (such as independent verification of activities or transactions) that look like duplication of effort, but these should not be eliminated as they protect assets and help avoid mistakes, waste and fraud,” says Clowes.
If all cost-cutting measures are exhausted and margins are still unsustainably low, businesses may have to resort to increasing prices. Many business owners are understandably reluctant to raise prices, particularly if competitors are able to offer their products for a lower price.
“Prices are a real challenge,” says Knowles. “You’re not just competing with the guy down the road, it’s a real global marketplace.” While costs such as labour or transport may be high for one producer, local conditions may make them lower for a competitor.
When customers are able to access cheaper alternatives, Knowles says it’s important for businesses to differentiate their products and show they are adding value. By adding extra features, delivering products or services with more speed or even changing the colour of their product, a business can avoid customers making a direct comparison between their prices and those offered by a competitor.
Both Clowes and Knowles believe customers value the quality of their experience with a business, to the point where they may be willing to overlook a difference in price.
“Rather than selling the product, you can sell the experience,” says Knowles. “People don’t’ remember what you did for them, they remember how you made them feel.”
When a customer values their relationship with a business and the product they offer, businesses should be able to maintain healthy margins without resorting to the slash and burn approach.
This post originally appeared in Business Focus.
Written by: Jessie Richardson