Cost Reduction Strategies
While it is obviously better (and often less painful and easier) if you can increase your revenue levels, this is usually very hard to do, particularly over a short time frame. As a result, a commercially aware organization will pay a considerable amount of attention to its costs or its expenses and identifying ways in which they may be cut or reduced without affecting the core service being provided.
Some cost reduction focused efforts focus simply on switching off the lights in empty rooms, putting sheets of newspaper into the toilets for people to use and turning the heating or air conditioning down in the last two hours of the day. Although it is still true that all of these savings add up, most organizations now recognize that costs are best controlled using a more strategic cost-cutting approach. An effective cost management strategy will therefore typically:
- Fit in with the overall corporate and business strategy
- Establish clear long-run and short-term goals for cost reduction
- Balance human, capital and technology inputs into cost reduction
- Identify and aim at reducing the important costs, even if they are hard to measure
- Recognize high costs of capital when it is used as a cost-cutting source
- Generate a sense of enthusiasm and challenge for the participants
- Continually reduce costs in real terms
- Reward the people who make it happen
- Recognize that communication is essential to discuss and agree likely areas to target
- Provide a clear competitive advantage over organizations of a similar size or type.
With a strategic approach, there are five primary ways in which strategic expense management can reduce costs: We’ll look at each of these areas below.
1. Investing in new equipment or processes. Before investing in new equipment or new ways of doing things (processes) the organization must assess the likely cost savings and improved productivity of the proposed investment. This appraisal must be rigorous and unbiased, otherwise the new approach may make the situation worse rather than better. Many organizations have brought in new technology, or recommended ideas and methods, without sufficient analysis of future needs. This can lead to a significant wastage of funds, and having to go back to “square one”, if you are not careful.
2. Economies of scale. As the volume of “units” sold and corresponding sales are increased the organization may benefit from economies of scale. This means that the fixed costs are spread over more units. For example, when a manufacturer buys materials or components, there are often quantity discounts available for large orders. These days, it is often possible to make these large orders but arrange for staggered delivery and payment so that inventory levels are kept down. Even in a service business, items like stationery may be purchased in larger quantities earning bigger discounts, or buying in bulk from supermarkets or shops (where sometimes you can save as much as 100%). However, don’t forget, the success of this approach requires that there be a market for the additional goods or services produced.
3. New technology or systems. Usually the enterprise that moves early into successful new technology gains a competitive advantage. The difficulty is that sometimes the new technology turns out to be more expensive than anticipated, particularly at first.
Currently, in the world-wide banking market, the development of internet and telephone banking and the provision of point of many different point of sale (POS) terminals has increased costs but as their use grows the relative costs per transaction will decline.
4. Consolidating learning gains. As employees become more used to doing something, whether it is providing investment advice, building boats, fixing computers or doing clients’ taxation returns, they become more efficient. So, putting resources into training and taking advantage of this improved productivity provides cost savings.
Some management writers, so-called “gurus” and consultants are now commonly suggesting that “knowledge management” and “developing a learning organization” are the key commercial strategies that every enterprise should adopt if they are to compete and win in the 21st century. Investing in every individual’s learning about how your organization “ticks” commercially would therefore seem to be a very wise decision to take for the long term.
5. Simplification. As organizations grow, their systems, their products and services and the methods they use become more complex. Often, there are considerable cost savings to be had by simplifying the organization, operations, products, services and processes used. This might involve redesigning forms and procedures at the most basic level, to flattening the organizational reporting structures or looking at possible commercial alliances and partnerships to simplify systems at the more sophisticated level. For example, a major international airline managed to offload its complex and largely unprofitable businesses in local markets by partnering with smaller alliance partners and passing business that they could make profitable to them for example.
At one level cost reduction is a simple affair in which budgets and expenses are cut or frozen for a period so that money can be saved. While such approaches can work, a better approach is to think about cost reduction in a more strategic way and use the five categories above to guide your efforts.