Implementing Cost Reductions - a practical guide

A Practical Guide To Implementing Cost Reductions

In the aftermath of the global financial crises many businesses have faced declining sales and debt pressures.
To neglect costs is to jeopardise survival. 
This is so even in the aftermath of a commodities boom as we have experienced in Australia, as during these times businesses may have become complacent about managing costs.
Below are some approaches to implementing cost reduction.

Examine the three E's: economy, efficiency and effectiveness

Economy: Can we use less of the product or service by reducing waste or usage?
Efficiency: Can we lower the price by doing things right, better or more efficiently?
Effectiveness: Can we find a better way of achieving the aim by doing the right things?
e.g. selling costs could be reduced by visiting customers less often (economy), reducing per diem travel expenses (efficiency), or by using e-commerce (effectiveness).

A rigourous approach to the three questions may lead to quick savings. Economy and efficiency are the usual domain of the financial controllers where effectiveness may be more the domain of engineers or production managers.

Budgeting: zero based and priority based budgeting

Many businesses start their budgeting with an adjustment to last year's data. 
Zero based budgeting requires that every cost is examined from scratch. It is unfortunately usual for whole areas to continue because they existed historically but no longer serve any useful function.
A periodic examination of all costs can highlight target areas.

An alternative is to start with a goal of reducing overheads with a target of say 15 or 20%, which will make managers accountable to prioritise expenditure. The focus would initially be on the larger items of expenditure.
Even fixed costs such as rents with upward only reviews can be reduced in a competitive market.

Value engineering

Many businesses over-engineer their product or services offering features which customers do not really value. The test is whether customers are willing or not to pay for the extra features. The marketing department should have a good knowledge of customers' wants and needs. An example may be airline travel where do customers prefer to have sustenance on short flights or cheaper air fares?

Renegotiate contracts with suppliers

Putting contracts out to tender often results in substantially reducing costs. Businesses often are willing to accept lower margins rather than lose important customers or business.
Often, key raw materials are carefully negotiated, but important overheads such as IT and insurance are neglected. The internet has helped to provide price transparency, but at time specialist knowledge may be required to be sourced by consultants.

Labour costs

If labour costs are too high as a key performance indicator for your business, natural wastage, the least painful remedy rarely is sufficient.
Traditional perks and subsidies need to be reviewed. When labour costs are too high for whatever reason (e.g. falling sales). the volume of labour must decline accordingly through reduced work hours, redundancies or mandatory leave.
The use of independent contractors by out-sourcing labour in may instances is more efficient (use only when needed) and hence reduces your cost structure.

Implementing changing costs

Hasty, emergency action should be avoided as risks, particularly to service and quality must be carefully assessed.
Excuses to avoid cost reduction are all too common, based on smugness, cynicism or lethargy. Self protection and fear are the usual causes of inaction.
Many managers accustomed to constant business growth find difficulty in adjusting to changed circumstances.
The business' accountant should play a pivotal role since strong financial control is vital to running an efficient successful business.