What to cut?

During recessionary times many companies work hard to cut costs. The problem is that businesses spend money to make money business is an investment. Therefore, if you spend less, it follows that there is a risk that you will earn less. The question therefore is how do you reduce costs without damaging the business?

I first saw the impact of this in the 1980’s recession when working in the IT industry.  Although the UK business was profitable, the company was struggling globally so we were all directed to cut headcount and reduce costs.  In the UK we found that every time we reduced our costs, our revenue fell shortly afterwards.  The net results were entirely negative – we ended up a smaller company with lower market share, poorer economies of scale and a demoralised workforce.

We had made the mistake of focusing on costs rather than on efficiency and productivity. 

The sad thing is that I can see exactly the same thing happening in other companies today.  For example, I recently attended a seminar where one of the speakers explained how they had “taken $500m of costs out of their company” by banning international travel and using video-conferencing instead.  It sounds impressive but it left me wondering what the impact of this change would be?  In my own business I regularly travel hundreds of miles to meetings to have conversations which I could just as well have had over the phone, yet I gladly spend my own time and money because I see value in the face-to-face contact.  It is impossible to put a figure on this value, but I am certain my business would suffer if I told all my customers that I would only speak to them by phone or video link from now on.

I believe the problem is that many managers are obsessed with reports and financial statements and do not fully understand the processes of their organisations.

For example, another company I worked with provided all of its managers with a monthly financial pack.  At about a centimetre thick it was an impressive document that contained details of their running costs, premises costs, income, headcount, graphs that compared this year to last year, the current month to previous months and so on.  After the monthly packs had been issued there would be a flurry of emails as the managers wrote to their people seeking clarification and further information on the underlying reasons for the movements in costs and income. 

I never really understood why they put so much effort into this process as all the reports showed was what had happened in the past and, in my opinion, the role of management is to focus on the future.  What’s done is done – get over it! 

Moreover, the cost of the process itself was frightening, since the cost did not just include the time and money taken to gather, collate and circulate the information, but included the time numerous people spent in studying the reports, writing supplemental reports and the opportunity cost of being distracted from driving the business forward.

The solution is to focus people on value-based management.  This is an approach which recognises that costs and income are linked such that when managers are considering whether to invest or cut costs, they do not simply concentrate on the “top” or “bottom “ line, but on the dynamics of the relationship between cost and income.  For example, a friend of mine who runs a tool-hire business finds that his largest customers push for the keenest prices and only ever pay on account, whereas his smallest customers rarely haggle over the price and pay cash on delivery.  Both sets of customers are important to his business and by understanding the balance between the two he has been able to optimise his cost base and maximise his profits.  

The lessons are simple:

  1. When looking to cut costs, make sure that you understand the full implications of your actions.
  2. Cutting costs by edict (e.g. “international travel is banned”) should only be used as a last resort as it is tantamount to telling your people that you do not trust their judgement.  It may save money in the short-term but it will certainly damage morale.
  3. Everyone should be focused on efficiency and productivity rather than purely cost and income.

About the Author
Alistair Schofield is Managing Director of Extensor Limited.

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