As a financial guy, I've always felt there's no time like the present to start cutting costs. When business is bad, cost cutting helps a company survive. When business is great, it helps a company take better advantage of the joyful time. But I've also found that mere penny-pinching measures won't do the job. At times, I've thought that my own tightfisted cost-control efforts are roughly equivalent to squeezing a fistful of mud. The harder I squeeze, the more I see slithering out from between my fingers.
So, in addition to encouraging financial discipline, I make it a practice to look for pockets of waste in a company. And I look for these among the "cost drivers" -- the activities that influence the spending of money. Often these activities not only stand in the way of success, they are simply irrelevant, and they should be eliminated. If you're interested in doing a search of your own, I've found the following areas a good place to start.
Number of transactions
In his book Managing for Results, Peter F. Drucker suggests taking a hard look at transactions within a company. Revenues are proportionate to volume, he points out, but costs are proportionate to the number of transactions.
In practical terms, this means that a very effective way to cut costs is to cut the number of transactions. In the early 1970s, for example, I was the chief financial officer of a cash-poor company that was purchased by Dana Corp. Suddenly, the accompanying cash infusion caused the number of our accounts-payable transactions to plummet. We had 30 days' worth of invoices to track and file, not 90 or more. One check could pay for dozens of invoices at a time, not just for one invoice as we found the cash. And the hours of telephone calls with angry vendors stopped when we started to pay on time. Suddenly, therefore, my accounts-payable costs plummeted as well.
A manager at one of Dana's divisions told me how a change in policy had affected its transactions in a different way. For years, he said, his division's direct-sales force had submitted detailed reports for each sales call. By actual survey, half of a peddler's working day was spent completing these call reports. But when the division simplified its reporting requirements, the sales force could spend nearly twice as much time selling. This change effectively doubled the size of the sales force and halved the cost per call.
When you look for waste among your transactions, therefore, you'll find at least two ways to eliminate it. First, you may find ways to reduce the number of transactions, and thus the overhead costs needed to process them. Second, you may find ways to make each transaction less time-consuming, allowing the same number of people to start performing a larger number of transactions.
Job positions and departments
Every position and department in a company, of course, is a cost driver. And some turn out to be unnecessary, or even a hindrance, to your company's success. To illustrate by a rather sad example, I once worked with a sleepy 2-person company that grew to 100 employees virtually overnight when its president invented a new product. The other of the 2 employees was a loyal bookkeeper with the title of vice-president of finance. But when the company took off, the bookkeeper was not qualified to manage its finances. In recognition of years of loyalty, however, the president gave his former bookkeeper the title of vice-president of planning. This person with a made-up job hired a staff, contracted for services, and wrote reports, which the company ignored. Only when the president left the company did the vice-president leave to find a productive job at another firm. Fast-growing companies are particularly vulnerable to leaving people behind -- but on the payroll.
Many companies pay for positions that were needed in the past but not in the present. Several years ago, for example, I was vice-president of finance for a small manufacturer in desperate need of a turn-around. To raise cash and cut costs, we sold our manufacturing plant and then purchased our product from private-label manufacturers. With only 10 employees remaining in the company, and no manufacturing plant, the firm didn't need a vice-president of finance. So I fired myself. Maybe you can depend on your employees to do the same, but a better tactic is to look at each manager objectively once in a while. Do the pay, position, and person match up profitably? If not, the answer may not be to fire that person but to redirect his or her efforts.
Products and product lines
It's often true that, as the old saying goes, 80% of the profits come from 20% of the products, and many of the nonperforming products are candidates for the trash pile. But deciding which ones to drop can be tricky because cost-accounting information often disguises the way that each product actually drives company costs.
For example, I once analyzed the cost structure of a multiproduct manufacturer with large losses. Like most companies, this one assigned manufacturing overhead costs to each product as a percentage of direct labor. But since little direct labor was used on average, $10 of overhead costs were applied to each dollar of direct labor. Consequently, a product with $10 of direct materials and $90 of direct labor would "cost" $1,000 ($10 + $90 + $900), while a product with $90 of material and $10 of labor would "cost" $200 ($90 + $10 + $100). And since the company's prices were set at twice its manufacturing costs, the products would be priced at $2,000 and $400, respectively.
Unfortunately, that massive overhead structure was dedicated to documenting, purchasing, scheduling, counting, and controlling the quality of the direct materials, while one lower-level manager supervised direct labor. Direct labor wasn't driving overhead costs, in other words; direct materials were. The company could have slashed its overhead costs by abandoning several products with high materials content while promoting products with high labor content. But its pricing structure, driven by the misleading information from its accounting department, encouraged customers to demand the very products that caused overhead to explode.
When it's time to drop products, you must ignore cost-accounting formulas and ask tough questions. Which products drive overhead and marketing costs? Which cause inventory to bloat? Do prices adequately cover these costs? If you drop the major cost drivers, would their overhead costs actually go away? Do you have more profitable products in which to invest your scarce resources?
More than any other cost driver, poor quality is a deadly virus that can infect an entire company. (Employees will occasionally emphasize the problem by posting editorial comments near their work areas. "There's never time to do it right," one sign reads, "but there's always time to do it over." Or, "We do it right the second time!") The obvious problem is the direct cost of failures: the product that must be scrapped, the error that must be corrected, or the job that takes twice the time that it should.
But soon, waste infects other parts of a company: more and more employees work full-time on problems -- making long-distance phone calls, supervising rework, expediting deliveries, processing corrected paperwork, and apologizing to customers. Soon, more and more managers work to "streamline" the error-correction process. And as the problems multiply, they become obvious to customers, who stop buying, and to vendors, who tighten credit terms in fear that the company won't last.
But the worst day-to-day effect of poor quality is that it takes the fun out of going to work. It just isn't satisfying to rework products, apologize to customers, make excuses to the sales force, and scrap bad material. Doing these things can destroy pride and cause ulcers. It's no wonder that poor quality means low productivity.
I've found that a false sense of thrift can also create waste. "We don't need this machine (or employee or building) yet," I've heard managers of fast-growing companies say, "but it's available now at a bargain. Let's get it." This attitude causes at least three problems. First, it consumes resources today that are needed in other areas to achieve a successful future. Second, when the resource is needed, last year's bargain often turns out to be the wrong size or an out-of-date model anyway. And third, the bargain purchase may never be needed in any case, and therefore becomes a total waste of money.
Another attitude that can create problems is when company owners and managers let early success go to their heads. "We're a big company now," they say, "and we can afford . . ." They waste millions on executive office buildings, strut-your-stuff advertising, and inflated staffs. I observed one midsize manufacturer who during a period of severe losses froze wages, eliminated bonuses, and required vice-presidential approval of every purchase. Meanwhile, the company's president continued to spend hundreds of company dollars nightly entertaining personal friends and hundreds weekly to keep his company-furnished Rolls-Royce in the company parking lot. Though these presidential perquisites cost relatively little, they made the other employees feel like galley slaves. Staffed with bitter, resentful employees, the company nearly failed before it finally turned around.
It's tough to succeed in business. The way I look at it, there's no need to make the job even tougher by carrying a heavy load of cost drivers.