How to Reduce Costs Without Destroying Your Business
When times are tough, reducing costs are an essential part of business survival. The problem is many executives adopt a “slash and burn” approach to reducing costs that can help in the short term, but reap significant long term damage on the ability of the business to prosper.
There is an alternative. A strategic approach to Cost Reduction that responds quickly to the short term need to reduce costs and survive, yet also benefits the longer term position of the company to prosper and thrive.
This article outlines this approach.
The Starting Point
First, make sure your problem is cost. It’s not uncommon for business owners and managers to jump to the conclusion that their problem is cost. Typically, cost reduction initiatives are driven by poor profitability or cash flow. It’s wise to remember that there are three and only three ways to improve profitability:-
- Increase Selling Prices.
- Increase Sales Volume.
- Reduce Cost.
If poor profitability is your issue think about what you can do with the first two items in the list as well as cost. Assuming you’ve concluded Cost is the issue, rather than recklessly attempting to come up with a cost cutting solution simply on the basis of experience or intuition, the strategic thinker would take a more analytical approach.
The strategic approach to cost reduction has to consider the particular circumstances of your own business and the resultant implications on that business before assigning actions. Any other approach is likely to result in as many problems as you solve. How do you do this?
The Issue Diagram
You start with a blank sheet of paper and draw up an issue diagram based on your key question:
How Can my Costs be Reduced?
Below is an illustrative approach to what your Issue Diagram might look like. I’ve assumed here you are a manufacturing business that produces a range of products in your domestic market. If your business has other characteristics, get out your own blank sheet of paper and create your own diagram to highlight your own Strategic Cost Reduction Actions.
The key to coming up with the best solution is to continually ask the right questions as you progress down the levels, before you finally settle on Actions.
What a Cost Reduction Issue Diagram might look like:-
The First thing to consider in our example company is the design costs of products. Are they too expensive? In which case these products would be classic candidates for Value Analysis or Value Engineering. However, it may be that the market is prepared to pay for this quality, in which case cost reduction isn’t your answer, and marketing activities may be able to position these products for higher pricing. Companies like Ferrari and Porsche have adopted this approach successfully over many years.
Variable Costs of Production are primarily a function of materials and labour used to make the product and the processes used through the factory. Improved purchasing methods, replacement of higher cost suppliers, improved production control, tightened quality control, improved maintenance and sometimes replacement staff can all reduce cost. Your own specific cost reduction actions will depend on the answers to each question you ask.
Finally, your Fixed Costs may also be too high. Typically Fixed Costs will relate to people, and you have to make an assessment here on the effectiveness of what they are doing and the benefits they are delivering to the organisation. Your key question here is what’s essential to your business and what’s nice to have.
And Finally …
Each type of Strategic Cost Reduction Analysis requires considerable skill and experience to deliver immediate cost reduction benefits that do not destroy longer term financial success. All CFO Centre CFOs have been trained in the details of Strategic Cost reduction Analysis and all have considerable experience in delivering real business benefits that can help survival in the short term and provide the base for a thriving business over the longer term.
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