Cutting Costs: Cut fat, not muscle

10 Dec 2012

I have seen several situations where management was of the view that costs could not be cut without considerably affecting the revenues or profitability of a company, but a new management team or a consultant showed otherwise, or where economic duress forced management to rethink what was possible.

In today’s day and age, having a competitive cost structure can be vital to survival. Those competitors who have more efficient cost structures, quite simply, will have more resources to compete, and therefore will tend, over time, to gain market share. While it is usually possible for many businesses to achieve major economies of scale simply by growing volume, this article talks only about the case of reducing costs in the case of stable or even falling revenues, that is to say, in recessionary times.

Allow me to provide two examples, both prior clients of mine:

Automotive company. Prior to the Lehman crisis, the company in question had over EUR 100 million revenues, but was barely breaking even. Waste was rampant; management was unaware. Staff were living the high life, driving fancy company cars, earning nice bonuses. They thought this was normal. In the year after Lehman, the company’s revenues dropped by over 30 million euros, and there were many millions of euros of losses. The company was in its death throes, with banks almost ready to pull the plug. A year later, thanks to a vigorous cost cutting program, the company was in the black again, despite a further 10 million euros decline in revenues.

Cement company. Corporate head office had performed international benchmarking, which showed that a local Central European subsidiary had a cost structure that was EUR 5 million higher than its sister companies, given its level of revenues. Local management claimed that costs were as lean as they could be. “There is only skin on the bones, no fat”, claimed local management. When head office insisted, local management replied “it could not be done”. At this point, headquarters hired my firm to “find” the missing five million, as headquarters said, “find fat, not muscle”, and help management implement the cost cuts. We did find and successfully cut EUR 5 million, almost to the penny.

The two situations were different, in that the automotive company “got religion” thanks the owner/CEO waking up to the inefficiencies. In the second instance, the cut was imposed from outside the local management team. (Local management was lucky not to lose their jobs!)

Yet, there were a number of things that the two situations had in common. They went about the cost cutting process in a rational way:

1. First, look at your income statement. It requires the simple discipline of someone going through the expense structure of the firm, line item by line item, drilling into great detail as to what is truly essential or non-essential to the firm’s operations. Hundreds of items, from newspaper and magazine subscriptions to access to databases, may be reclassified as “options” or “luxuries”, rather than “necessities”. The cost/benefit of every single expenditure must be weighed extremely carefully. It is remarkable how few companies really drill down and look at expenditures at this level of detail on a regular basis. It is elementary, yet so often neglected.

2. Staffing needs to be looked at very carefully. Can several positions be combined into fewer positions? Can certain tasks be outsourced at lesser cost? The same attention given to expense items, as per the previous paragraph, needs to be paid on the organization chart. Sometimes one or more layers of management may be removed entirely; there are times when this even enhances management performance, putting senior management closer in touch with staff on the front line, and to customers.

3. Utilities are generally worth looking at closely. There is an entire industry of consultants that have sprung up, who will look without charge at your telecom costs, energy costs, etc., provided you share a percentage of savings with the consultant. The cost savings found by these consultants are often substantial. Some companies simply do not take the time to review and shop their contracts every time they come up for renewal. Telephony costs, for example, have been falling rapidly for over a decade. Management can take the time to learn how to perform much of these savings; even if they do not have the expertise and are not willing to learn it, it would still pay to use the cost consultants. In fairness, sometimes it takes some capital expenditure to reap the benefit of these savings, but not always, and where capital is required, the payback periods are often very rapid.

4. Productivity and efficiency. Whether your firm is a service company or a manufacturer, it is almost always possible to enhance productivity and efficiency. Once again, some times this requires an investment in technology or IT, many times not. It usually pays to use experts.

I hope this article has given you some inspiration to cut fat. If management thinks it can’t be done, they will ultimately be right, this will become a self-fulfilling prophecy: they will not succeed in cutting costs. A better paradigm is to believe that everything can always be done better, and at lesser cost. And it is better to cut costs of your own volition, before any external parties force discipline on you, and to not just do it once, but to keep reviewing costs periodically.