Cost Reduction for any business is a challenge but more so in turbulent times
A Black Swan event is a rare event with severe consequences. It can not be predicted but of course, hindsight is always 20-20.
While Businesses can’t control the environment in which they operate, they can certainly control how they react to events like this.
Whenever a business is in turbulent times, they look at cost reduction across the board, also referred to as “tightening the belt”.
Headcount reduction as well as cutting discretionary spend is of course measures which can deliver immediate results but they also have a significant downside if they are purely done for short term gains.
For example, you can reduce the cost by cutting headcounts but what happens when the business picks up again? You need to then hire those resources again and the cost comes back to you.
And then you are training those employees again to perform the job.
In short, that is a loss of momentum and which makes the recovery even more painful.
What we hope to provide is a framework that companies can leverage to reduce the cost in a more sustainable fashion.
As you would notice, we are not suggesting headcount reduction, you already know that!
We are recommending a set of strategies which can help you cut cost in a more sustainable manner and not make you lose momentum when business picks back up again.
You should be able to see anywhere between 9 – 15% in cost reduction by following these simple strategies. The number is just a recommendation based on what we have seen in our experience.
This article is intended for owners, operators and finance professionals to help them take action today
Let’s get started
1. Set up a Cost Control Process
By Cost control, we mean a set of processes that enable the budget owners to review the purchase before the spend actually happens.
A very typical scenario in companies is as follows
An invoice from a vendor shows up in Accounts payable inbox. The invoice is uploaded and then A/P is chasing the business owner (if the name is on the invoice) to seek approval on whether this should be paid or not.
What’s wrong with this picture?
There are a couple of issues with this approach
1. You don’t have any control over expenses. Even if you wanted to delay a specific expense, it has already happened and you are obligated to pay the invoice.
2. The finance team can not accrue expenses until the invoice shows up, which leads to a failure to accurately predict the cash flow requirements.
3. Most small companies do not have very favorable payment terms, so the invoice is due immediately or within 30 days. So now you have 30 days’ notice to ensure you have the cash to pay vendors.
So how can you overcome these challenges?
You can set up a cost control process so that all purchases are approved before the order is placed with the vendor.
By setting up a purchase approval process you can ensure that the authorized person is reviewing the purchase before the order is placed. The purchase order process can be based on the amount, type of purchase, department budget owners, etc.
You can implement this process through a manual email approval or through an automated purchasing system.
There are three advantages to this approach
1. You have the ability to approve the expense in advance which allows you to accrue the expense. That way you are able to better predict the workflow.
2. In turbulent times, you can also adopt cost avoidance measures by rejecting or delaying certain expenses.
3. If you want to tighten the belt, then you can always change the approval levels so that all purchases are reviewed by senior management of the staff. For example, all purchases over $1,000 need to be reviewed by the Chief Financial officer or owner of the company
This measure alone would help you to immediately avoid cost or delay costs.
2. Review Your Discretionary Spend
The next strategy is to review the discretionary spend so that you can identify areas where spending can be curtailed in the short term.
By definition, discretionary spending is the spend which a company can live without. For example, spend on ad campaigns is discretionary spend but the monthly utility bill is not.
In the short-term, you should look at reducing your discretionary spend by reducing the usage of services.
Now let’s look at some of the common categories for discretionary spend that you should review to understand usage as well as opportunities for short term cost reduction
Here are some examples of categories you should review for cost reduction
Marketing spends can be grouped into buckets.
These buckets could be brand awareness i.e activities related to building the brand, or it could be the money you spend on generating new leads for the business or any sort of brand-related activities in terms of brand building and so on.
Let’s look at the two main categories under marketing
If you have outsourced your brand/marketing related activities to an agency then you are likely paying them a monthly retainer fee.
If it is retainer-based, you should ask your partners to reduce the scope of activities they are managing and hence reducing your monthly cost.
If it is not retainer-based, then you might be able to get buy by reducing the scope of the work performed by the company.
For example, the agency develops a new ad campaign for you every quarter. You could probably skip a quarter or two and reduce the scope of services and hence the reduction in cost.
Advertising spend is typically the spend you have on media to promote your campaigns. There are of course different channels. For example, you might be spending money on online ads like Google or social media sites like Facebook and Twitter or you could be spending money on offline ads to purchases media in various trade Publications or magazines.
The spending on agency and advertising is related, so if you are reducing your agency work scope then that should have a direct impact on your advertising spend. Lesser the campaigns, lower the advertising spend.
Another alternative here is to consider the channel efficiency and move from one channel to another effective channel.
For example, if online ads are not an effective channel anymore maybe you want to stop spending money on online ads and consolidate spend to offline ads.
Sometimes offline ads are more economical and have a more broad reach.
However, It depends upon industry to industry so it’s hard to generalize the strategy.
You should definitely look at what channels are effective and what is not effective and then decide on cost-cutting or consolidating spend to specific channels.
2.2 Software subscriptions
Another category for the review is software subscription.
Since everything moving to Cloud nowadays it’s not inconceivable that companies are spending a lot of money on software subscriptions.
It could be your software subscription-like your Microsoft 365 license or could be the CRM and so on.
The way to reduce expenses on software subscription is to divide your current software subscriptions into critical and non-critical categories.
For example, Microsoft 365 is critical software because without that you cannot send emails or create documents like spreadsheets.
However, an online project management system could be categorized as a non-critical software category.
Once you have the classification of your software subscriptions into critical and non-critical categories you should then review your software spend for following
- If you paying certain vendors on a monthly basis, can you terminate the contracts wherever you don’t need the service?
- If the software is a monthly fee that is paid based on the total number of users using the application, then can you reduce the number of users using the system?
2.3 Sales expenses
The third category you should look at is expenses related to sales. Some of the common sales expenses are
Commissions: These are sales commissions. We are not advising on cutting the commissions, because that is detrimental to sales morale.
What we are recommending is that you should look at deferring the commission’s payout if at all possible. You might be able to do on a case to case basis. For example, you can delay the management commissions without impacting the commission’s payout for front line team
Customer entertainment spend: This is the money spent on entertaining clients. Now we are not saying that you should entertain your customers, however, this is always an area where some discretion can go a long way in managing the expense more responsibly.
Training: Review the training spend related to sales and see if you can delay the training and hence reduce the spending in the short term.
You might have noticed that in the sales category, we are relying on deferring the expenses and not cutting the expenses at all. In the end, the Sales department is driving the revenue growth so you should be very cautious about reducing spend but nonetheless review for timing and ROI.
3. Review Current Contracts
Companies generally review their contracts when they are up for renewal.
Your company might be in a reactive mode and you only look at renewal when the renewal invoice shows up.
That might be too late and you probably don’t have any opportunity to cancel the product or service.
What we are recommending is a proactive review of all contracts to identify opportunities for cost reduction.
Here are the steps we recommend for the contract review.
1. First, create an inventory of all the vendor contracts with the following details
- Contract Name
- Vendor name
- Brief description of the product or service
- Department owner: For example CIO, CFO, CMO, etc. You might have a VP of IT, VP of Finance or VP of marketing.
- Effective start date and end date.
- The severity of the service: Whether it is a critical service or not.
- Termination for convenience – Yes or no. Whether you can cancel a contract before the contract end term.
- Termination charges – Whether you have to pay a fee to terminate the contract. Some vendors might allow you to terminate the contract but you have to pay a fee for it.
2. Now if you don’t have a contract management system you likely are not going to have all the contacts in one single place.
That is fine, don’t stress if you don’t have all the contracts. You are probably ok If you are covering 80% of your spend at the first go.
3. Once you have the contracts, set up a review meeting with your stakeholders to review whether you need a service or not.
4. If the contract is not required at all and the vendor allows you to terminate the contract for convenience, without charge, then go ahead and cancel the service.
5. If the product/service is not required but the vendor doesn’t allow you to terminate the contract without a termination charge, then reach out to the vendor and see if you can negotiate out of the current situation.
Most vendors want to do right by their customers and would do everything possible to accommodate such requests.
6. If the product/service is required, you still can reach out to vendors and see if they can help you with short term cost reduction in lieu of a longer-term commitment.
For example, if your contract is up for renewal in 6 months, you can reach out now and see if they can reduce costs in lieu of a 3-year renewal.
4. Suspend Services Wherever Possible
There might be cases where you have a contract but you can live by without those services in the short term.
For example, you are going through a tough time and don’t have a use for such a service.
You probably don’t want to cancel the services altogether but want to suspend the service.
The contract review should provide with you a list of such opportunities.
So reach out to your vendors and see if they are willing to suspend the services for 3-6 months.
Most of the vendors would be able to accommodate that request unless they have dedicated resources assigned to your account and they can’t temporarily relocate those resources to another customer.
So let’s look at some examples of potential opportunities in this area
Cleaning services are generally scope based and the vendor might be charging you a fixed price based on the type of the facility.
In case you have reduced staffing or no staff at your locations, you should revisit your contract and ask the vendor to charge less or suspend cleaning services where there is no staff.
Alternatively, you could change the scope and have the cleaning done less frequently.
These are mere suggestions, this might or might not work for your situation.
One of the first things which happen in uncertain times is hiring freeze. If you have training services for new hires or certifications and so on, then it would make sense to review those and see if you still need them.
If you regularly conduct training for your employees as part of personal development, it could make sense to temporarily suspend those services.
Managed Print Services
Managed print services include supplies and maintenance for printers. The service company charged a fixed monthly service for maintaining the printers and supplies are generally consumption-based.
If the business has slowed down and you are not using the printers that often, then you probably do not need to do proactive maintenance that often.
So you should ask the vendor for cost reduction since they are not incurring a cost to service the printers.
IT support services
If you have outsourced your IT support (most of the small and medium-sized businesses do), then this might be another area to look for cost reduction.
The IT support costs are generally priced based on the number of calls expected and the number of hardware points (servers, laptops, desktops) the provider needs to support.
This might be a little oversimplification of how your services are priced but it is worth having a look.
If your business slows down and you have reduced staffing needs, then that is going to influence the variables that determine the cost of the service.
These are just examples, review your spending to identify relevant opportunities in your company.
5. Review Inventory and Working Capital
Do you carry inventory? If yes, you might be using that for reselling that to your customers or using that to service your customers.
Higher inventory means higher working capital!
To reduce the working capital, you need to reduce the inventory. Here are some basic techniques you can apply to reduce the inventory.
Classify your inventory into Critical and noncritical inventory. You could use a typical ABC analysis to categorize inventory that is fast-moving and inventory that is slow-moving.
Once you have identified that, the next step is to see if you can implement a JIT (Just in time) inventory mechanism.
Typically companies carry more inventory than needed because of the following reasons
1. The lead times are higher, they need a cushion upfront so that they don’t run out of inventory when needed.
2. You are not continuously reviewing the safety keep levels for the inventory items.
For example, an item has a 10 unit safety level but that was set up 1 year back. Has your demand patterns changed now?
If the demand patterns have changed, you probably need to carry less inventory.
These are just two examples, there could be more reasons why you are carrying excess inventory. So thoroughly review your business and inventory requirements so that you can calculate the inventory you need to carry.
Once you have that analysis done, you can do the following
1. You can work with a partner to implement a VMI (Vendor managed Inventory) model. In a VMI model, the vendor takes over inventory management and is responsible for ensuring that you have the right inventory levels based on your demand patterns.
This works very well if you purchase your products from distributors. Most of the good distributors have the ability to provide such services.
This not only increases efficiency but also free up working capital because the vendors generally carry the inventory on their books until it is issued to you.
2. You can implement a consignment model where the vendor keeps the inventory in your warehouse but it is transferred to your books when the inventory is issued to you.
In case vendor managed inventory or consignment model is not a good fit for you, you can do the following
1. Talk to your vendors to see if you can reduce the lead times. If your overall sector is slowing down, then the vendors might be sitting on excess inventory and they could reduce the lead times or even better, offer you discounts.
2. The vendors might be able to decrease the lead times if you offer a better demand forecast. Since they are able to plan better, they can ship the product faster.
3. Talk to your vendors if you can implement a Just in time in inventory. It is easier said than done because it needs disciplined planning and execution on both customer and supplier behalf.
If you are in a situation where you have long term contracts in place and you are committed to a volume purchase, then you can do the following
a) You can take a delayed delivery of the products, in case you don’t need them sooner. If you encounter a temporary downturn in business, you would still need that inventory when things pick back up again.
b) In case you have a volume commitment and you don’t have the need for the committed volume anymore, you can ask your vendors if they can sell the inventory to some other customer. Better, provide them with some customer referrals if you can.
6. Travel & Entertainment Expenses
When we talk about reducing discretionary spending, travel and entertainment expenses st is definitely on the top of the list.
The problem, however, is that when you are looking at reducing T&E cost, you are usually behind the process by one step.
Most of the companies have cost controls in place which requires the expenses to be approved before the employee can be reimbursed.
But by then the expense has already happened.
So unless the employee is spending on items where they shouldn’t spend, you are obligated to that spend.
When it comes to controlling T&E expenses, you can’t drive forward by looking in the back view mirror.
However, you can use the last 12 months’ data to understand areas where you can reduce cost and change controls to curtain the spending.
Here are a few suggestions
Move more spend to purchase orders
Do you have corporate credit cards that are being used by employees to purchase supplies or other items from office supply vendors or Amazon.com?
If yes, then you might want to look at moving that spend to a purchase order.
With a purchase order, the spend is authorized before the order is placed. So you have the ability to control spend.
You don’t have this ability to control that in credit cards because, by the time you see the statement, the spend has already happened.
Review sales travel history and salesperson effectiveness
One of the major contributors to T&E spend is usually the sales department. And for obvious reasons.
You want your sales team in the field and not in the office.
However, not all salespeople are delivering the same amount of value. I.e closed sales vs amount spent on T&E.
An easy way to control spending is by looking at the ratio of sales closed in the last 6 months/ total expenses filed by the salesperson.
Let’s call this Sales Expense Effectiveness Ratio (SEER for short)
So higher the SEER, the better it is.
You probably can calculate this ratio for the entire sales team, sort it in the descending order.
You can then look at the bottom 20% of performers and see if the spending can be curtailed for those resources
Pre-authorization of travel
You can implement a pre-authorization process to ensure that you can avoid unwanted travel spending.
There are a few considerations here
Who should approve the expense?
You should strive for a balance so that the process is effective and not overly bureaucratic.
For example, if the CFO (Chief Financial Officer) needs to approve all travel then it is definitely going to create a huge backlog of approvals and honestly, CFO has better things to do then approving each travel request.
On the other hand, if the manager of the department is approving the expense, then the approval process might not be effective.
A more balanced approach would be to have expenses approved at the department VP level so that they can vet whether the travel is required or not.
What type of travel needs to be approved?
It might make sense to implement pre-approval only for certain types of travel. For example, if you have to approve each and every sales travel request, then it might cause a delay in the process.
It could even cost you more money due to last-minute bookings.
Pre-authorization of other expenses
In the entertainment category, you have other expenses like meals for meetings, etc. These are generally not related to travel and incurred in the regular course of the business.
It is completely up to you whether it makes sense to stop these expenses. After all, it depends upon how much you are spending on meals, etc.
However, if you still decide to continue with these types of expenses, then at least you should have a pre-approval process.
For example, a manager must pre-approved the expense.
7. Real Estate Cost Reduction / Remote Work
Remote work or work from home are not interchangeable, at least in our point of view.
Remote work is generally referred to for companies where certain teams are fully or partially remote. This is by design and generally done to take advantage of the geographically spread of the talent.
Work from home in our view refers to the flexibility the company offers to employees so that they can work from home once a week or more.
The idea is to offer this as a perk so that employees can have better work/life balance.
As more and more startups are intentionally being remote, it is worthwhile to consider this as an option.
Whether remote work can be effective or not is dependent on the nature of the work done by your organization.
If you are a manufacturing organization then remote manufacturing might not be possible for the operations team!
But it might be possible that certain teams can effectively work from home.
The long term impact for you is the reduction of real estate costs.
You can take a mix of the following actions
Move to a permanent work from home model
In this approach, you can completely move certain teams to a fully remote work model. For example, do the support teams need to be always in the office?
Another common example is the IT team. If you do a lot of inhouse software development then that team can work remotely.
Irrespective of whether the teams can work remotely or not, some individuals prefer to work in an office environment. So talk to your department heads to assess the possibility of working from home.
For occasional in-person meetings, you can create small huddle rooms which the teams can use that when they are in office.
Move to work from home for a few days a week.
The other alternative is not to move the teams permanently to work from home but offer the flexibility to work from home a few days a week.
The big question though is do they still the allocated space in the office. If that is the case, then you can’t free up real estate.
The other alternative for this is to create certain cubicles that can be only be used by these employees.
They are not assigned to individuals so it can be used anyone who happens to be in office.
The trade-off for employees working from home is that they give up their allocated space in lieu of flexibility from working from home.
With the above two measures, you should be able to free up real estate.
Now if you are leasing the space, see if you can get rid of the extra space you don’t need anymore. The other alternative would be to sub-lease if allowed under your contract.
Please note that either of the above changes might result in changes to the employment taxes paid to the city where you have your physical location.
So consult with Payroll on the implications of moving the employees from an office environment to work from home environment.
Our intent with this article is to provide some immediate actions you can take to make a dent in your cost reduction targets.
You would find that some of the suggestions work very well and some might not. It all depends on the context of your business and the industry in which you are.
We are also curious to see what other strategies are being used by companies to reduce costs, so we encourage to you leave a comment and tell us what are you doing to reduce costs in turbulent times.