by ProcureDeskLast Updated : Nov-27-2023
Cost reduction for any business is a challenge. But did you know this becomes a more pressing issue during turbulent times?
Take for instance the COVID-19 situation or any Black Swan event where businesses operated with a lot of uncertainty, economic downturns were just inevitable. This would cause any company to panic, given that they are without cost reduction strategies in the pipeline.
Although businesses can never control the environment in which they operate, it is possible to control how to reach events like these. All it takes are cost reduction strategies.
In this resource, we’ve gathered information, tips, and insights to help owners, operators, and finance professionals take action toward cost reduction strategies.
Our team aims to recommend a set of strategies that can help you cut costs in a more sustainable manner.
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.
Cost reduction refers to the process of identifying and eliminating excessive expenses that can reduce your company’s production processes, efficiency, and profitability.
There are quite a few strategies involved in cost reduction such as:
While cost reduction can be a difficult process in terms of identifying cost drivers, this is an important step to make sure that your business remains competitive in today’s global market.
There are a few resources out there to help your business improve and implement your cost reduction programme such as government programs, consulting firms, and even software solutions.
The primary goal of cost reduction is to minimize expenses, cost drivers, and increase efficiency in your company, which ultimately contributes to the financial health and sustainability of your business.
By implementing cost reduction strategies, your company can improve its profit margins, cash flow, and overall competitiveness in the market.
Other goals and objectives of cost reduction may also include the following:
All these strategies can help your business reduce production and operating costs to improve resource utilization and mitigate financial risks. This also prevents your business from spending too much on bad costs.
When your company continuously monitors and minimizes your expenses, you can make sure that you’re operating efficiently and effectively, positioning yourself for sustained success in the marketplace.
There are many reasons why your business might need a cost reduction strategy. Here are the most common reasons:
Cost reduction is one of the most effective cost cutting strategies for your operating costs.
By reducing expenses, your business can improve your cost structure, decrease your day expenses, increase your profits, and reinvent your funds in other areas of your business.
During recessions or other economic down turns, your business needs to increase your cost savings to survive.
With a well-developed cost reduction strategy, your business can identify and eliminate unnecessary expenses, which can free up your cash flow. You can even build better long-term relationships with your suppliers!
If your business plans to grow your business operations, you may need to reduce your costs to free up capital for your investment. Whether it’s improving your office spaces, deciding to get raw materials from other suppliers, or even adding business travels to your business plans, cost-saving opportunities can help your business eliminate wasteful spending.
Cost-saving opportunities can help improve efficiency. By exploring on different types of cost savings and other cost-cutting measures, your business can streamline your operations and save money.
Did you know that reducing operational costs and other unnecessary costs can help increase your shareholder value? When you improve your company’s profitability and decrease your administrative costs, you make your company more attractive to investors, which can lead to higher stock price.
A strategic cost reduction strategy can help your business gain a better understanding of your expenses, such as your labor costs, production costs, travel costs, etc. This can help you make more informed financial decisions.
Did you know involving your employees in your cost-reduction efforts can help boost employee morale? Doing away from bad costs and other expensive business expenses can increase employee engagement and productivity!
Having cost reduction strategies as part of your business practices will help you reduce maverick spend and even improve how you allocate resources for your company. This can lead to better overall business performance and long-term supplier relationships.
By setting up a cost reduction process, you enable employees with budget roles in your company to review the purchase before the spending happens.
A very typical scenario in companies is as follows
An invoice from a vendor shows up in the Accounts payable inbox. The invoice is uploaded, and then A/P chases the business owner (if the name is on the invoice) to seek approval on whether this should be paid.
However, there are a couple of issues with this approach
To overcome these challenges, you need to set up a cost control process to approve all purchases before the order is placed with the vendor.
By setting up a purchase approval process you can ensure that the authorized person reviews the purchase before placing the order.
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 an automated purchasing system.
Did you know that there are advantages when setting up a purchase order approval process with a purchasing system:
This measure alone would help you to avoid costs or delay costs immediately.
ProcureDesk has built-in budget tracking and controls to ensure you can effectively manage and adhere to your budgetary constraints.
Setting up the budget is straightforward, allowing for easy configuration or importation from sources such as spreadsheets or systems like QuickBooks Online.
Once the budget is established, employees can select the relevant budget for their purchase. The system then checks the available budget, assisting in maintaining cost control.
Users have the autonomy to determine the system’s response in case of insufficient budget. For instance, options include displaying a warning message when the budget is unavailable or preventing a purchase when funds are insufficient.
First, you need to review the discretionary spending to identify areas where spending can be curtailed in the short term.
By definition, discretionary spending is the spending that a company can live without. For example, ad campaign spending is discretionary, but the monthly utility bill is not.
In the short term, you should reduce your discretionary spending by reducing the usage of services.
Now let’s look at some of the common categories for discretionary spending 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 spending can be grouped into buckets.
These buckets could be brand awareness, i.e., activities related to building the brand, the money you spend on generating new leads for the business, or any brand-related activities regarding brand building and so on.
Here are two main categories in marketing:
If you have outsourced your brand/marketing-related activities to an agency, you will likely pay them a monthly retainer fee.
If it is retainer-based, you should ask your partners to reduce the scope of activities they are managing, reducing your monthly cost.
If it is not retainer-based, you might get bought 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 cost reduction.
Advertising spend is typically your spend 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 purchase media in various trade Publications or magazines.
The spending on agency and advertising is related, so if you are reducing your agency work scope, that should directly impact your advertising spend. The fewer the campaigns, the 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 on offline ads.
Sometimes, offline ads are more economical and have a more broad reach.
However, It depends from industry to industry, so it’s hard to generalize the strategy.
It would be best if you looked at what channels are effective and not effective and then decide on cost-cutting or consolidating spend to specific channels.
Another category for the review is software subscription.
Since everything is moving to Cloud nowadays, it’s not inconceivable that companies spend a lot of money on software subscriptions.
It could be your software subscription-like your Microsoft 365 license or the CRM.
The way to reduce expenses on software subscriptions is to divide your current software subscriptions into critical and non-critical categories.
For example, Microsoft 365 is critical software because you cannot send emails or create documents like spreadsheets without that.
However, an online project management system could be categorized as non-critical software.
Once you have the classification of your software subscriptions into critical and non-critical categories, you should then review your software spending for the following
The third category you should look at is expenses related to sales. Some of the common sales expenses are
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 it on a case-to-case basis. For example, you can delay the management commissions without impacting the commission’s payout for the front-line team.
Customer entertainment spend
This is the money spent on entertaining clients. 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.
Review the training spend related to sales and see if you can delay the training, reducing the spending in the short term.
You might have noticed that in the sales category, we rely 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 cautious about reducing spending but review for timing and ROI.
Companies generally review their contracts when they are up for renewal.
Your company might be reactive, and you only look at renewal when the renewal invoice appears.
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
2. Now, if you don’t have a contract management system you likely will not have all the contacts in one place.
That is fine, don’t stress if you don’t have all the contracts. You are probably OK if you cover 80% of your spending on the first go.
3. Once you have the contracts, set up a review meeting with your stakeholders to review whether you need a service.
4. If the contract is not required at all and the vendor allows you to terminate the contract for convenience, without charge, then 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 can still contact vendors and see if they can help you with short-term cost reduction instead 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 instead of a 3-year renewal.
There might be cases where you have a contract, but you can live 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 but want to suspend the service.
The contract review should provide you with a list of such opportunities.
So contact your vendors and see if they will suspend the services for 3-6 months.
Most 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 facility.
If 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 do the cleaning less frequently.
These are mere suggestions; this might or might not work for your situation.
A hiring freeze is one of the first things that happens in uncertain times. If you have training services for new hires or certifications, then it would make sense to review those and see if you still need them.
If you regularly conduct employee training as part of personal development, it could make sense to suspend those services temporarily.
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, you probably do not need proactive maintenance that often.
So, it would be best to ask the vendor for cost reduction since they are not incurring a cost to service the printers.
If you have outsourced your IT support (most small and medium-sized businesses do), 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 your services’ price, but it is worth looking at.
If your business slows down and you have reduced staffing needs, that will influence the variables that determine the cost of the service.
These are just examples; review your spending to identify relevant opportunities in your company.
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 fast-moving and slow-moving inventory.
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:
For example, an item has a 10-unit safety level set up 1 year back. Have 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 to 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 can provide such services.
This increases efficiency and frees 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 is transferred to your books when the inventory is issued.
In case vendor 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, 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 can plan better, they can ship the product faster.
3. Talk to your vendors to see 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 the customer’s and supplier’s 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 if you don’t need them sooner. If you encounter a temporary downturn in business, you will still need that inventory when things pick back up again.
b) If you have a volume commitment and don’t need 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.
Here’s a cost reduction programme that you can implement:
1. Identify High-Cost Categories
The first step is identifying the categories where you spend the most money. This can be done by reviewing your financial statements or using a budgeting app. Once you know where your money is going, you can develop strategies to reduce spending in those areas and experience cost improvement.
2. Implement Cost-Reduction Strategies
There are several cost-reduction strategies that you can implement, depending on the category of expense. For example, if you are spending a lot of money on rent, you could try to negotiate a lower rent with your landlord or relocate to a less expensive office space. If you are spending a lot of money on salaries, you could evaluate employee performance and identify opportunities for salary adjustments.
3. Track Your Progress
It is important to track your progress to see how effective your cost-reduction efforts are. This will help you to stay motivated and make adjustments as needed.
4. Do A Spend Analysis
To reduce your expenses, you could consider the following when you work on y our cost reduction analysis
Implementing these cost-reduction strategies can improve your profitability, financial stability, and even improve your supply chain.
Travel and entertainment expenses are on the list when discussing reducing discretionary spending.
The problem, however, is that when you are looking at reducing T&E costs, you are usually behind the process by one step.
Most companies have cost controls in place, requiring the expenses to be approved before reimbursing the employee.
But by then, the expense had already happened.
So unless the employee is spending on items where they shouldn’t spend, you are obligated to spend that.
When controlling T&E expenses, you can’t drive forward by looking in the backview mirror.
However, you can use the last 12 months’ data to understand areas where you can reduce costs and change controls to control spending.
Do you have corporate credit cards that employees use to purchase supplies or other items from office supply vendors or Amazon.com?
If yes, you might want to move that spend to a purchase order.
With a purchase order, the spend is authorized before the order is placed. So you can control spending.
You don’t have this ability to control that in credit cards because, by the time you see the statement, the spending has already happened.
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 the 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/to total expenses filed by the salesperson.
Let’s call this the Sales Expense Effectiveness Ratio (SEER for short)
So higher the SEER, the better it is.
You can probably calculate this ratio for the entire sales team and sort it in descending order.
You can then look at the bottom 20% of performers and see if the spending can be curtailed for those resources.
You can implement a pre-authorization process to ensure that you can avoid unwanted travel spending.
There are a few considerations here
It would be best if you strived 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, it will create a huge backlog of approvals. The CFO has better things to do than approve each travel request.
On the other hand, if the department manager is approving the expense, then the approval process might not be effective.
A more balanced approach would be to approve expenses at the department VP level so that they can vet whether the travel is required.
It might make sense to implement pre-approval only for certain types of travel. For example, if you have to approve 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.
In the entertainment category, you have other expenses like meeting meals, etc. These are generally unrelated 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 on how much you spend on meals, etc.
However, if you still decide to continue these expenses, you should have a pre-approval process.
For example, a manager must pre-approve the expense.
Remote work or work from home are not interchangeable, at least from our point of view.
Remote work is generally referred to for companies where certain teams are fully or partially remote employees. This is by design and generally done to take advantage of the geographically spread of the talent.
In our view, work from home refers to the flexibility the company offers employees so that they can work from home once a week or more.
The idea is to offer this as a perk so employees can have a better work/life balance.
As more and more startups are intentionally remote, it is worthwhile to consider this 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, 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 environmental impact for you is the reduction of real estate and employee costs..
You can take a mix of the following actions
Move To A Permanent Work From Home Model
You can move certain teams to a fully remote work model in this approach. 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 in-house software development and other digital resources, that team can work remotely.
Irrespective of whether the teams can work remotely, 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 that the teams can use in the office.
The other alternative is not to move the teams permanently to work from home but to offer the flexibility to work from home a few days a week.
The big question is whether they still have the allocated space in the office. If that is the case, you can’t free up real estate.
The other alternative for this is to create certain cubicles that can only be used by these employees.
They are not assigned to individuals, so they can be used by anyone who happens to be in office.
The trade-off for employees working from home is that they give up their allocated space instead of flexibility from working from home.
With the above two measures, you can 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 sublease if allowed under your contract.
Please note that 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 work-from-home environment.
Calculating cost reduction opportunities involves determining the difference between the original cost and the new, reduced cost. This can be done using a simple formula:
Cost reduction = Original cost – New cost
For example, if a company originally spent $100 on a product but could negotiate a new price of $80, the cost reduction would be $20.
Cost reduction percentage = (Cost reduction / Original cost) x 100%
Using the same example, the cost reduction percentage would be 20%.
In addition to this simple formula, several more complex methods for calculating cost reduction exist. These methods can consider factors such as inflation, volume discounts, and the time value of company money.
Here are some additional tips for calculating cost reduction opportunities:
By following these tips, you can accurately calculate cost reduction and identify opportunities to save money for your business.
Cost reduction is an important aspect of business management for several reasons:
Improves Profitability: Cost reduction is a fundamental way to increase profitability. By reducing expenses, utility costs, employee costs, material costs, advertising costs, capital costs, and other business costs, businesses can boost their bottom line and generate more revenue for growth and investment.
Strengthens Competitive Position: In today’s competitive market, cost-effective operations have a crucial role for businesses to thrive. By reducing costs, companies can gain a competitive edge, enabling them to lower prices, offer better deals, and attract more customers while building systematic planning for the company.
Increases Liquidity: Reducing costs (such as employee costs and utility costs) can improve a company’s liquidity by meeting its short-term financial obligations. This is particularly important during economic downturns or periods of cash flow fluctuations which can improve business decisions.
Increases Efficiency: Cost reduction often leads to operational improvements and process streamlining. By identifying and eliminating wasteful spending, companies can streamline their operations, reduce redundancies, and enhance efficiency.
Boosts Employee Morale: When employees are involved in cost reduction initiatives and see the positive impact on the company’s bottom line, their morale and engagement can improve. This can lead to increased productivity and a more positive work environmental impact.
Protects Against Threats: By reducing costs (such as employee costs, overhead costs, etc), businesses can create a buffer against potential threats such as economic downturns, market fluctuations, or competitive pressures. This can help them maintain financial stability and weather the storm.
Enhances Long-Term Growth: Cost reduction is not just about immediate savings; it sets the stage for long-term growth and sustainability. By improving profitability, liquidity, and efficiency, businesses can reinvest in their operations, expand their offerings, and enhance their competitive advantage.
Cost reduction initiatives often fail due to a combination of factors, including:
1. Lack of Clear Goals and Objectives: Without clear goals and objectives, cost reduction efforts can be haphazard and ineffective. Businesses need to define what they want to achieve and set specific, measurable targets to track progress.
2. Short-Term Focus: When cost reduction focuses solely on immediate savings, it can lead to unsustainable practices that harm long-term growth. Businesses need to balance short-term savings with long-term investments in innovation and growth.
3. Inadequate Planning and Execution: Cost reduction initiatives require careful planning and execution. Businesses need to assess their current expenses, identify potential areas for savings, and develop a detailed plan to implement cost-saving measures.
4. Lack of Employee Engagement: Employees are often valuable sources of cost reduction ideas. When not involved in the process, they may feel disengaged and less likely to support the initiative.
5. Poor Communication and Transparency: Effective communication and transparency are crucial for successful cost reduction. Businesses must communicate the rationale behind the initiative, the targets, and the progress made to gain employee buy-in and support.
6. Failure to Address Root Causes: Cutting costs (example: employee costs, overhead costs, business costs) without addressing the underlying causes of expenses can lead to recurring problems. Businesses must identify the root causes of waste and inefficiency to implement sustainable cost reductions.
7. Neglecting Value Creation: Cost reduction should not solely focus on reducing expenses; it should also consider the value created by those expenses. Businesses must balance reducing costs and maintaining the value they deliver to customers.
8. Inflexibility and Resistance to Change: Cost reduction often requires changes in processes, procedures, and behavior. Businesses need to be flexible and adaptable to overcome resistance to change and implement cost-saving measures effectively.
9. Lack of Ongoing Monitoring and Evaluation: Cost reduction is an ongoing process and has a crucial role in your business. it is not a one-time event., not a one-time event. Businesses need to continuously monitor their expenses, evaluate the effectiveness of their cost-saving measures, and make adjustments as needed.
The distinction between good and bad costs is crucial in business management. While both types of costs represent expenses incurred by a company, they differ in their impact on its overall value and growth potential.
Good costs contribute directly to the company’s ability to generate revenue and increase its value. They are investments that enhance the company’s competitive position, improve efficiency, and support its growth strategy. Examples of good costs include:
By identifying and eliminating bad costs, companies can redirect resources towards good costs, enhancing their ability to generate revenue, improve efficiency, and achieve their long-term growth objectives.
Good costs are strategic investments and profitable ventures that drive value creation, while bad costs are expenses that provide little or no return on investment and may hinder growth. Distinguishing between good and bad costs is essential for effective cost management and maximizing the company’s financial performance.
Our intent with this article is to provide some immediate actions you can take to make a dent in your cost reduction targets to.
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 companies are using other strategies to reduce costs, so we encourage to you leave a comment and tell us what are you doing to reduce costs in turbulent times.
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