Controlling Costs Effectively
Cost control is not perhaps the most exciting task in the world (especially if we have to spend many hours doing it every week) but if we don’t perform this job well, the effects can be both quick and direct in terms of its impact and we may then have to commit almost all of our time and energy to it. It’s therefore a good idea to spend quality time on developing and maintaining an effective cost control system which can help us to keep on top of our own or the team’s expenses, well before these get out of control.
Costs are the direct and indirect costs of earning revenue. We match the revenue earned with the expenses of earning that revenue to calculate the profit. This “margin” can be calculated for the overall enterprise or for an individual department where it is run as a profit center. Even where a department is only a cost-center (and profit is not as easily calculable) it must still “add value” by being less expensive than buying that same service in from external suppliers.
It is easy to see that certain “core” costs or expenses are inevitable because they are always fixed or visible to all (and therefore may be harder to quickly change or adjust downwards). A good example here would be having paid rent the next 12 months. This can’t be changed until next year. However, there are also a number of more “hidden” or occasional costs that also need scrutiny, and these can often be reduced quite quickly and with less “pain”. Whether a cost is direct or indirect, clear to see or hidden, the point is that, almost invariably, attention to any cost leads to ways of potentially reducing it.
The basic profit calculation formula for any commercial business is Profit=Revenue less expenses. As a result, at its most simple level, reduction in costs or expenses will increase profit. However, there is more to reducing costs than switching off the lights when you leave the room or asking the sales staff to stay in cheaper accommodation when they travel. The major reductions in costs are much more likely to come from strategic approaches, such as investing in new processes or equipment, adopting new technology, or redesigning the way that in which products or services are provided to customers.
How should cost-control be done in practical terms?
Managing the reduction of costs is often a very complex business because there are typically many previously unseen implications of cost reduction, which only become apparent after the analysis process has commenced. Many organizations that have ‘down-sized’ in recent years have now realized this. People therefore now often talk about cost reduction as a prime strategic goal for all departments to be done slowly and on an on-going basis. Whilst this is a laudable ambition, it has many risks to the enterprise, if it is not well-understood and the implications of any cutting carefully considered.
In process terms, costs should be analyzed and questioned in detail before changes are made in the most significant areas. Traditional cost-cutting strategies may only get you a little way towards your goal. These might be to reduce the marketing or advertising budget for example, which may save money in the short-term but hurt the revenue line in the longer term. As such, a more strategic approach is needed in which any initiatives are carefully evaluated for their potential long-term savings contribution.
In summary, they are four general principles to be followed when seeking cost reductions:
- Cost control starts with a solid budget and cost reporting system. If this is weak or difficult to use, mistakes will be made. After all, we cannot manage what we can’t measure.
- Non value-added costs should be eliminated as quickly and as fully as possible. However, this may require some process redesign, job restructuring or even re-negotiation with suppliers.
- Strategic cost reduction is likely to be more effective than traditional methods of cost reduction. This is cost reduction that arises out of making big changes to processes or introducing new technology for instance. It is likely to take longer but have a much bigger impact if done well.
- Review and change must be ongoing (this is never a once-off exercise).
In the final analysis it always needs to be remembered that cost reduction and control is a difficult and on-going management task that needs almost endless persistence to reach a satisfactory position.