How the simplest cost-cutting programs can lead in the most unexpected directions

A funny thing happened on our way to preparing this article. We heard from one company owner after another that, in essence, we were barking up the wrong tree.

Our plan was to call around and get tips for lowering one line-item expense after another: phones, payroll, travel and entertainment -- you name it, we'd have it. And the timing seemed right. Almost everywhere we went people were talking about how their businesses (or businesses they knew of) were feeling a squeeze on growth and profits. So to get started, we invited a handful of chief executives over for lunch to talk about what they were doing to lower their break-even points and improve their bottom lines. We were looking for specifics. Which items did they scrutinize the most? Where did they find the most waste? And what sorts of things had they tried that didn't work at all?

Listening to our lunch guests (who ran everything from a $4-million environmental engineering firm to a $65-million food-service business), we did get ideas. But, they told us, the motivation to cut costs becomes a departure point for something much more far-reaching. It forces a CEO to reexamine the entire company, to rethink the way it is structured, what it does, even his or her own role in it. Their experience was confirmed time and again as we talked with dozens of company owners. And we realized that when people begin to ask basic questions about their companies, what they then decide to do often flies in the face of the usual cost-cutting guidelines.

Hold off doing anything right away. In theory, anyway, there's no art to cost cutting. First, you take a good look at how you spend money; then you figure out what you can do without. But what if the information you have doesn't give you enough detail to make these judgments? What if you're uncertain about what the effects on your business will be? Without the right information at your fingertips, you won't know whether you're carving muscle or fat.

When Paul Berg became CEO of Enterprise Builders Inc. in 1987, for example, it was plain to him that a lot of things at the company were out of whack. The three-year-old Avon, Conn., construction business was winning $200,000 to $300,000 contracts with ease. But once it had them ($6 million worth in 1987), it often frittered away its margins doing the work. One of Berg's first thoughts was to find places to cut. Payroll was the most obvious area, he thought, since it accounted for 20% to 25% of his expenses. But how would he conduct the business without project managers, crew, and office personnel? Unclear. Before making cuts he needed to know a lot more about individual projects and how they worked.

A big impediment to seeing problems, Berg realized, was the way financial information was generated and collected. Technically speaking, the company could crank out computerized cost reports every week. "But different project managers had different criteria and used different formats," he says. Without any consistency, it was tough to know when jobs were in trouble and where the difficulty lay. So Berg, an engineer by training, created systems to estimate jobs, to track costs, and to bill. Then he taught everyone how to follow them.

Berg says it took close to a year to get people doing things the same way. Now that the systems are up and running, he can spot most problems -- a cost overrun in a concrete foundation, for example -- a lot quicker than before. One big area he's become attuned to over the past year or so is the total cost of managing projects. Since a $200,000 job requires nearly as much management as a $1-million job, the company has started going after the bigger projects. Today about 80% of its projects are in excess of $1 million (compared with 30% three years ago), and once again the business is making money.

"The real eye-opener," says Berg, "was figuring out our break-even. We learned it takes about 100 small jobs to match the profit potential on 10 big jobs if we manage them correctly." Without the right numbers, he might never have realized this.

Forget about 10% across-the-board cuts. Many tough managers suggest that the first thing to do when your market dips is hit the brakes on spending. Pick a figure, any figure -- 10% is a common one -- and snip away. But for some businesses, this kind of advice is hooey. Not that there aren't places to cut. Usually, there are. But sometimes the most urgent challenge of all is to understand the underlying problem.

Take the case of Larry Bartlett, owner of Lube 'n Go Inc. Last year Bartlett, who had recently bought out his father and uncle, saw the profit margins on his business deteriorating badly. Operating nine rapid oil-change shops (total revenues: $2.2 million), the business was built on the idea of superior service and convenience to customers. Even though there were no appointments, people rarely had to wait long; the average car was in and out in 15 minutes. Lube 'n Go charged a premium for its service over local gas stations and most chains -- its average sale was $22 versus $12 to $15 for its competitors.

For his newer locations, which were staffed with three mechanics, Bartlett had to service 35 cars a day on average just to break even. At various times during the week -- and he couldn't always predict when -- things got backed up; and if more than two cars were waiting, people drove off. "Some of them came back," Barlett says, "but a lot of them didn't." When you're trying to cover overhead, every lost customer hurts.

Bartlett conscientiously investigated opportunities for cutting costs. Rent and utilities were fixed, so he couldn't do much about them. And people? Well, he had a hard time seeing how he could maintain service quality with fewer than three employees per location. "We had recently reorganized the layout of the shops to make them more efficient." The only place where he felt he could cut was the $9,000-a-month advertising budget. But as he was looking for ideas, his father (and ex-partner) posed a simple question: What was the best strategy for maximizing profits? "It's a very different question from 'How do I minimize operating costs?' " notes Bartlett. In answering his father's question, he concluded that cutting costs wouldn't be nearly as lucrative as creating more capacity. So last summer he decided to spend money -- to increase staffing at the shops from three people to five on weekdays and from five to seven on Saturdays.

So far, so good. By having extra mechanics on duty, Bartlett has been able to cut the waiting time and service more cars with greater efficiency. Currently, he says, the average Lube 'n Go shop handles 42 cars a day -- 5 more than last year. Moreover, the average sale is up nearly 20%, to $26. The extra revenue of almost $300 a day per shop more than pays for the additional labor. And there are other benefits to this approach. Now that things are running smoother, Bartlett has been able to get away with less advertising (the ad budget is half what it used to be) and rely on word of mouth.

In the year since he made the changes, pretax profits have gone from less than 1% to around 6%. "Essentially," Bartlett says, "we figured out what was really important to our customers. They wanted good service and didn't want to wait. We had to be able to handle the volume when it was there."

Don't be sentimental about any parts of your operation. One of the hardest things for a business owner to do is to take a clear-eyed look at his or her own company. Especially after investing lots of time and money in a product -- and so much of yourself -- it's natural to think that problems are fixable. Truth is, however, that your emotions may be getting in the way.

About 18 months ago Andy Plata, CEO of Computer Output Printing Inc., was having trouble sorting out some of the recent reversals in his business. For almost a decade Houston-based COPI had been involved in virtually all aspects of computer printing -- everything from $300,000 printer sales to $200 printing jobs and supply sales. For a long time, this comprehensive approach seemed to work; in 1987 the business earned 15% on sales of $4.2 million. But more recently those margins had all but vanished. On secondhand-equipment sales, which had been a major profit center, "we were running into all kinds of pressure on pricing," Plata says. He and his managers had always thought serving customers, no matter what size, was the basis of the company's success. But the evidence suggested they were wrong.

Different managers had different theories about what needed to done. Some said it was time to develop new high-value services; others thought they should simply hire some commissioned salespeople and promote their current services. To get an outside view, the company hired consultants to analyze the business. "We really wanted somebody who would challenge our thinking," Plata says.

For a month he and his seven managers kept track of virtually every minute of their working day. They compared where individuals spent time with where the business made money. The results confirmed some of their suspicions. A lot of time and effort went into selling low-profit items like envelopes, for example, which accounted for just 1% of total sales. "And most of those sales didn't lead to anything else," Plata says. Similar mismatches came to light in other parts of the business. "The phrase we used around here was that we were majoring in minors."

As might be expected, these discoveries were a bit unsettling for a lot of people. Plata, for his part, felt that COPI needed to create major new profit centers fast, even if it meant walking away from some of its existing core business. But not everyone agreed. One vice-president, for example, argued that the changes needed to be gradual so as not to exclude short-term opportunities. Employees, some of whom feared for their jobs, expressed their own concerns; to open up discussion, COPI set up a special computer message system where people could ask questions and make comments anonymously.

It hasn't been easy by any means, says Plata, but over the past year the company has taken a series of big steps. "We've had to really sell people on the idea that we could no longer afford to do business as we were," he says. Using every available source of money (internal cash flow, credit lines, and so on), COPI bought $150,000 worth of new computers and hired five new people with specialized software experience. Meanwhile, it let six employees go who couldn't -- or didn't want to -- develop the necessary skills the business needed. (Plata helped each of them find new jobs.)

It's too early to know how long the changes will sustain the company, but people are encouraged by recent progress. "We've been winning consulting contracts several times larger than the ones we used to get," Plata says. The new business is enabling COPI to generate profits and pay down loans. And in the process, Plata adds, everyone has learned something. "Unless you're finding ways to generate profitable business," he explains, "you put everything in jeopardy."

Cash worries are best left to management, right? Wrong. A lot of well-meaning company owners don't like to go into detail about cost-related problems. A common concern is that employees will panic about the future of the company, maybe even jump ship. But many others have found that when employees are informed about what's going on, they're willing to help out. If you set up credible channels for expressing ideas -- meetings, suggestion boxes, whatever -- employees will come through.

Early in 1989 George and Jim De Marco, two brothers who own the Greater Alarm Co., in Huntington Beach, Calif., saw their cash become so tight that they had to borrow against their credit line. Bloated inventory -- parts that wouldn't be used for several weeks -- was responsible for some of the problem. But a bigger worry was the amount of overtime they paid employees who installed their security systems. Based on information from their own installers, they bid jobs with a set number of labor hours. But it wasn't unusual for the experienced technicians (who earned $12 to $15 an hour, plus benefits) to go over. And not by a little. "It was often 50% over," says George De Marco. Needless to say, overtime was digging into profits. He and his brother decided to confront the issue head on.

At a dinner meeting last fall, the De Marcos brought up the problem to their employees. They wanted to control labor expenses, they said, but not by compromising the quality of the work. They'd considered turning jobs over to independent contractors and paying them flat rates. But for a few reasons -- quality for one -- they wanted a better solution. They asked employees for ideas, and two installers proposed an approach the De Marcos liked so much that they adopted it with only minor modifications.

Essentially, it works like this: instead of paying installers hourly for however long the job takes, they give them a labor budget for every job. If they're budgeted for 20 hours and they finish in 12 or 15 (as many do), they're paid for the full amount. If they need more time, they don't get any more money. Once installers have completed a job, they can go right to the next, so the system provides an opportunity for the most efficient people to earn more. And Greater Alarm gets to fix its labor costs. "The great thing about it," De Marco says, "is that it's self-motivating." To keep installers from compromising quality, it's up to them to fix problems on their own time.

In effect since February, the new system is making a considerable difference in how people operate. "Many employees who used to handle two installations a week are now doing three," says George De Marco. To inject a little competition, $4-million Greater Alarm posts a chart on a big board that compares all 24 installers on a monthly basis. It tracks their budgeted versus actual time and shows the percentages over or under.

And what has it meant for the company? For one, it means that Greater Alarm has been able to operate with fewer employees; 10 installers have left, and they haven't been replaced. The company has cut about 15% from its labor costs. In March, for instance, the labor expense was $68,000, compared with $80,000 the year before. "And the savings," De Marco says, "go right into our profit."

Just because you've lowered your break-even, don't breathe a sigh of relief yet. You don't have to wait until you feel a pinch to investigate opportunities to improve profits. Some of the most successful managers we know would argue that if you aren't looking at the numbers constantly, you're missing the boat. Executives like Ron Shaich, co-CEO of Au Bon Pain Inc., an 80-unit chain of French bakery cafés, for instance, don't take anything for granted. Monthly numbers, Shaich thinks, are too old by the time you see them. His are weekly, which means that he can check each store's performance by Tuesday of the following week. "If you wait too long," he explains, "the market has already changed on you." His way, adjustments can be made -- resources increased or decreased -- as they're needed.

Certainly, it takes discipline. But with so many variables shifting at once -- technology, the expectations of customers, the capabilities of competitors -- it may be your only hope of protecting your profits in today's environment.

"I spend about a third of my time figuring out how to lower my costs," notes Bob Luddy, founder and CEO of Captive-Aire Systems Inc., a $16-million company that makes commercial kitchen-ventilation systems. Late last year, for instance, he saw delivery dates for his products extending from their normal two weeks to nearly four. Orders were up by 40%, so the delay was easy to explain. His response, though, was to eliminate the bottleneck. Over a period of three months, he shifted 15 out of 35 employees from the corporate office to plants or sales offices. With the help of new computers, these former middle managers can now take orders faster and get them into the production cycle one week quicker than before. "We changed the way we did business." Since then, Luddy has moved on. Late last spring, for instance, he was reviewing every line item in his overhead budget and reevaluating the goals of his company to make sure they were still in line with what customers wanted. "As we develop new information," he explains, "light bulbs come on, and we tweak things. We keep trying to get better at what we do."

Call it cost cutting, call it what you will. Mostly, it's just good, sound, old-fashioned management.


COMPANIES ON THE VERGE OF A NERVOUS BREAKDOWN

How can you tell if you're headed for real trouble? Chances are you can't, says David Ferrari. You're probably "too arrogant and egotistical" to see it yourself or hear it from your colleagues. Ferrari, president of Argus Management Corp., in Natick, Mass., spoke with INC. staff writer Leslie Brokaw and senior writer Bruce G. Posner about his observations of CEOs who are showing all the symptoms of being in trouble without knowing it.

On misplaced confidence

They think everything they're going to do is right. Especially if they've been successful with the first couple of things they've done. If their first decisions were successful, then they think everything they're going to do from now on will be successful.

On deflecting the blame

I love to ask the managers, "Why are you in trouble?" They'll say, "I'm in trouble because of the bank." The bank . . . what'd the bank do? Did the bank lend you money? And now it wants to get paid back? That seems reasonable to me. Did the bank tell you to buy the excess inventory? Did the bank tell you to rent the cars? Did the bank tell you to take a trip to Bangkok? It told you to run the business. And you didn't run the business right. The bank's not the problem.

On misperceptions

In really tough times, management can't cut costs because they don't look at them in the right way. Classic example: we went into a company once and the manager said, "We've put together a list of things we're going to cut costs on." And you look at the list, it's a joke. It was things like beepers. No hard-core costs, while out in the parking lot everybody has a leased car. I said, What are you guys, blind? The reason you're in trouble is because there are too many of you, that's the first reason. The second reason is you've got all these goddamn leased cars. Don't tell me the beepers are the problem.

On avoidance

You can visit companies in real trouble and the president'll be out in the plant. And you go out to see him and he's harried, working like hell, and says, "How much more can I do, I'm doing everything?" But he's doing the wrong thing. He's avoiding the problem. The whole company's the problem and he can't deal with it, so he's out dealing with something that he can handle. The people who I've seen who are good managers manage the people under them, as opposed to doing a lot of different things themselves.

On doing it the old way

We'll look at every single item of cost -- everything on the P&L -- and we'll ask management, "Why do you do it that way?" I love the answer I usually get: "We've always done it that way." When a guy tells me that, I know we're doomed.

On too much optimism

One of the mistakes that management makes and why people like us have to come in at a later point is that they procrastinate. They sense that the thing is not going right, all the numbers aren't going right, but still they refuse to believe it. It's always tomorrow. Tomorrow we're going to get an order. Tomorrow the market is going to turn. My sales guy tells me that if I just hang in there another two months, the sales will be there. Meanwhile, I'm pumping money into this thing and bingo, all of a sudden I'm going to find myself in a problem situation.

On secrecy

See, when you get into a company you find out that most everybody knows everything about the company. People think there are secrets in companies. There are no secrets. Employees know the salary of the president. They know everything all the way down. There may be a reluctance on the part of management to share information, but my opinion is it's already been shared.

On setting an example

You can't cut costs when you're sitting there driving your leased Mercedes from your palatial home. You've got to come back down to reality and become part of the troops. An example setter. Hell, how can they take you seriously if you're off playing golf or at the country club? You've got to be in the meetings, doing something every day, focusing on keeping people calm when you're working hard.

On why it's so hard

One of the problems in a smaller company -- this is a real important thing -- is that the management has nobody to talk to. People don't realize how often you go into a company and the guy says, Geez, I have nobody to talk to. I can't talk to the secretary. If I talk to my staff, they all nod and say anything you do is right because we're all working for you. The banker doesn't know anything. The attorney is useless. The accountant is next to useless. They don't have anybody to stand up to them. They fail to have a strong board of directors. They have nobody to bounce ideas off of.