Just as the Reserve Bank is using the power of interest rate rises to stymie inflation, an increasing number of companies are looking more closely at their own budgets in readiness for what may lie ahead. With financial reporting season just around the corner, the expectation is for cost-cutting to be an increasing focus for businesses grappling with the economic fallout of the war in Ukraine, supply chain issues, soaring inflation and the lingering impact of the global pandemic.
Examples of cost-cutting plans abound. Telstra has declared it wants to reduce its net fixed costs by $500 million between FY23 and FY25. The Qantas Group has gone even further by setting a target of reducing costs by $1 billion annually from the end of FY23, when compared to FY19. Needless to say, similar conversations are happening inside businesses of all shapes and sizes as FY22/23 kicks into gear.
Amid all that talk though, it is important to remember there is a big difference between sweeping cuts and strategic cost-cutting. Look no further than a McKinsey Quarterly survey conducted at the height of the Global Financial Crisis that showed 79% of all companies cut costs in response to the economic turmoil – but only 53% of executives thought that doing so helped their companies weather the storm.
As McKinsey’s expert commentators wrote: “Cost reductions often go wrong … cutting all parts of a company equally may seem fair but it doesn’t make sense. Targeted cuts and efforts to build capabilities do.”
With that in mind, let us shine a spotlight on the concept of good costs, the dangers of bad costs and how to ensure the best cost-cutting strategy for your company.
In its simplest form, cost costing refers to measures implemented by a company to reduce its expenses and profitability. Such measures are normally enacted in periods of financial stress for the company itself, during economic downturns or, as is the current situation, when dark clouds are on the horizon. Cutting costs can be a strategic decision when management fears future profitability issues but it is crucial not to over cut as it can leave an organisation unprepared when demand returns and potentially facing even more costs.
When developing a cost reduction strategy, it is essential to focus on areas that can deliver the best financial return rather than simply making sweeping cuts. An excellent starting point to achieve this is by differentiating between a company’s good costs and bad costs.
Good costs are aligned to a company’s growth and, in particular, its customers and how to meet their needs. They are the costs that are needed to drive profit and often differentiate one’s business from its competitors and enable it to develop new value propositions.
Meanwhile, bad costs are non-essential areas of spending that do not gel with a company’s growth strategy. Inefficient processes and low-performing systems are high on the list of bad costs and can often be identified for overhaul or elimination during a cost-cutting regime. Cutting such bad costs allows resources to be freed and used in a more productive – and profitable – manner.
A quality cost-cutting strategy is built on quality analysis. Take the time to allocate individual costs into one of those categories – good costs and bad costs – as it will make it easier to identify what areas to consider putting on the chopping block. It is also worth noting that cost-cutting does not need to mean completely cutting a cost. Instead, mitigating the impact of a ‘bad cost’ may be better served by placing a renewed focus on optimising productivity or increasing efficiency.
Reducing costs requires more than a willingness to rule red lines through line items on a spreadsheet. Getting the right balance is not only critical to maintaining a strong company culture but ensuring that today’s cuts do not create tomorrow’s headaches. To help guide your cost-cutting strategy, here are four proven ways to cut costs in business.
This should go without saying but it is surprising how many businesses fail to adequately track expenses. Any cost-cutting strategy should quickly identify where money is being spent, from big-ticket items such as office infrastructure, software licences and travel expenses to smaller costs that can become large costs over time (eg: coffee, stationery). Evaluate every expense for its return on investment and if it does not come up positively, stop spending good money over bad. Also, work to create a workplace culture based on the long-term benefits of being part of a lean and profitable company.
For a great example of a ‘good cost’, look no further than investing in technology. While there may be substantial financial outlays at the start, the implementation of modern technology solutions can deliver long-term savings by increasing the efficiency of operations and improving productivity. From cloud computing to intelligent automation, there is no excuse for failing to explore how cutting-edge technology is paving the way for organisations across all industries to reduce capital costs and enhance profitability.
The most significant cost almost any business faces is employing staff but a common mistake many executives make when tough times hit is to dramatically reduce their workforce. Along with bearing the financial toll of payouts, rushing to lay off staff puts companies at risk of future labour shortages and being unable to meet production demands when the market improves. A smarter way to manage workforce resourcing without impacting long-term goals is to partner with an outsourcing provider that can recruit, train and nurture quality staff at a fraction of the cost of doing so in-house. Indeed, the cost of living in outsourcing hot spots such as the Philippines means companies can save up to 70% on fixed costs such as wages, technology and infrastructure.
The start of a new financial year is an ideal time to talk to one’s suppliers about brokering an improved deal. Many businesses, particularly those smaller in nature, have high operating expenses because of the costs associated with procuring raw materials and developing the ability to negotiate better terms should be a key priority for any management team. Strive to convince suppliers that it is in their best interests to build a long-term relationship with your company as it will help improve your cashflow and profitability and, in turn, theirs.
Rather than viewing the current economic climate as something to fear, companies should consider it an opportunity. Developing and deploying a cost-cutting strategy is a chance to identify where improvements can be made and ultimately lay a foundation for long-term sustainability. Whether weighing up good costs versus bad costs or pinpointing business functions that would benefit from outsourcing, it is all about doing what needs to be done to make FY22/23 a financial year to remember.
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