Improving performance - is cutting costs the answer?

Business managers and owners often resort to cost cutting performance is below target or cash / profits are being squeezed, but is this the answer?

Having seen and implemented many cost cutting projects for businesses, I have seen both the successes and the failures of such measures. In the best cases, cost cutting can free up cash flow and improve profits to enable better future returns. It can also lead to improvements in processes, and lift energy levels across the business resulting from employing good working practices or feelings of achievement and positive expectations surrounding future potential. In the worst cases, it can lead product / service deterioration, lost opportunity, or short term savings that are then eroded by a need for future spending that is often higher than the initial savings. Further, it can significantly impact employee morale and lead to backlogs in work and corners being cut.

So when should we cut costs? The very word 'cost' creates an instant problem as it has negative connotations. That is where understanding your business performance is critical. Cost analysis to separate direct and indirect costs is a great starting point. From there, we can then recognise 'investments' vs costs. Remember, an investment is simply any spend on an item or asset that it will generate income or appreciate in value in the future, or in fact enhance value through future cost savings (in broader terms it may generate other benefits that may form strategic goals). So labour, equipment, premises, stock, systems, patents, marketing etc can all be considered investments). With that determination, we can establish where investments are yielding or expected to yield value. If value is being created or is expected in the future, then the investment is probably worth maintaining (subject to whether there are better investment opportunities available, for the given resource constraints). Cutting indirect costs is of course desirable where the level of business support that is provided by indirect resource is not impacted (or where the impact has been assessed and accepted).

There may be some 'easy wins' where costs can be reduced without impacting the business operation at all, such as improved supply chain deals. These are likely to be the first stages of cost reduction and can be very effective but care should still be taken when undertaking any such exercise.

Cost reduction programs can be targeted where you have identified resources that are not generating sufficient value (or are not expected to in the future), or where there has not been any identification of the value created from specific resources, then some managers may opt to cut costs more aggressively and wait to see if there is any operational impact. The danger of the latter approach is the risk in impacting operational & support output, and in reporting savings that are later eroded as discussed above.

#costefficiency #returns