It is one thing to cut costs to improve the bottom line. It is another to cut costs to remove unnecessary complexity, bureaucracy and wastage. Either way, both motivations for cost cutting should result in an organisation becoming more flexible in its operations and more responsive to both customers and stakeholders.
Out of the pandemic crisis we have learned that decisions can be made and acted on quickly, complex procedures and policies sometimes have to be abandoned to ensure a rapid response, and those organisations that have and will emerge from the inevitable economic downturn will be leaner.
The set of insights that follows suggests some simple ways in which organisations, through careful cost cutting, can become more agile.
- Make your costs as variable as possible. Achieving greater profits from a smaller volume of output means a lower break-even point. The break-even volume (the minimum demand required for the organisation not to make a loss) is determined by the level of the organisation’s fixed costs, variable costs and price per unit. Cutting fixed costs is the most common strategy for bringing down the break-even point. You might choose to bring fixed costs down but remain flexible by ‘moth-balling’ temporarily.
- Go easy on the fixed costs required to meet your organisation’s strategic goals. Do not eliminate the fixed costs required to meet the organisation’s strategic goals. Cost reductions, if not undertaken with care, can damage an organisation’s reputation. Service levels offered to customers are a prime example. General management must be aware of critical cost-cutting decisions and lower level managers must understand the company’s mission.
- ‘Disintegrate’ where possible. In good times vertical integration and greater control of upstream or downstream activities is often seen as attractive. However, in a downturn not all of that capacity can be used, leading to excess costs in-house. Farming out activities to outside contractors (for example, by more efficient, entrepreneurial organisations taking on some of your activities or by utilising the specialised skills and capacity of an outside firm) can lead to real cost advantages. Resorting to subcontracting also brings the benefits of not tying up so much cash and generating a higher return on capital employed.
- Look to use current staff more effectively. Look to increase multi-skilling of staff or focus on developing more effective and productive teams. These options can be more useful to an organisation over the long term than cutting wages and salaries. A downturn may also give you the opportunity to negotiate a labour cost advantage that remains in place through the next cycle.
- Downsize if you must but act decisively. Think twice before laying people off. The expense and difficulty of hiring people in an upturn, and the waste of the investment in training and knowledge must be taken into account. Winston Churchill once wrote ‘The only way to swallow a bitter mixture is to swallow it in a single gulp’. Senior managers are most often considered the culprits for getting the organisation into a mess and are the first to be blamed for hesitating to take the necessary action. Ensure your actions correspond with what has been communicated to third parties such as unions and the media.
- Maintain R&D. Wherever possible push ahead with Research and Development programs despite the economic cycle. Most R&D programs have relatively long lead times. In markets where increasingly short product life cycles prevail, deferring a program for just 12 months could have a devastating effect on the long-term viability of your organisation.
The following topic in our Business Basics Series is Focus on the customer (Make the Most of Existing Customers and Improve Sales & Marketing Processes).