Every business will hit a financial pothole, with the first response being to cut costs and cut them quickly. This makes sense, but cutting costs too dramatically puts you at risk of not having a viable business when the crisis is over. All too often businesses become obsessed with cutting costs at the expense of actually doing business and this causes far more grief than the issue that instigated the cost cutting the first place.

A construction company I had worked with for many years got into financial difficulties and a moratorium was placed on all spending. Now this company made its money by winning tenders. The industry is highly competitive and cutthroat in every way. To me the value of having the very best tender documents and proposals seems obvious, yet one of the areas where spending was to be cut was on the development of a more professional-looking cover and format for the submission documents. This would have resulted in an annual cost of around $2500.

Given that the company sends out about 250 tenders per year, the cost per tender would have been about $10. This business turns over well in excess of $100 million per year surely this is false economy?

Surely in tough times you want any competitive advantage you can get. And while I don't doubt that a flash-looking document alone is not going to win a tender, it is going to say a lot about the professionalism of the business.

The reason this sort of thing can happen is that the person doing the cost cutting doesn't understand marketing or see value in the proposed spending. And this is the danger. Every cost cut has ramifications and these need to be considered fully. All too often the tangible cuts, such as sacking staff, are clear, but the less tangible cuts, such as reducing meal sizes in a restaurant, are less apparent. However, the end results are the same - customers get disgruntled and head elsewhere.

There are many ways to cut costs when times demand it, but if cutting particular costs has the potential to impact on your ability to make an income, my belief is that these cuts must come last and only when you are truly in a state of desperation. The phrase 'cut costs however you can' can be a very dangerous directive. I saw an example of this when I was working for a subsidiary of a large shipping company. One day head office sent a fax to the CEO of our company, saying simply that all costs must be cut by 10 per cent. We had a big pow wow, looked at how we could make this happen and eventually worked out a plan of attack.

During the next month we did actually cut our costs by the required 10 per cent. A couple of months later, our CEO got another fax from head office, again asking him to cut costs by a further 10 per cent. So again we set about figuring out how on earth we could do this. We made some very silly moves that ultimately cost the company a lot of money, but we achieved the 10 per cent cut and head office was advised.

We lost staff, we did less marketing, we stopped servicing equipment as often as we should have, we didn't replace uniforms, we cut back on cleaning services and we stopped doing many other things. Of course, this meant that our level of service dropped, the boats became grubby and less reliable, we lost business because we had cut back our marketing dramatically and staff morale went through the floor.

Several months later we got another fax, asking that yet another 10 per cent be cut from our operating budget. The CEO flew into a rage and sent a heated fax to head office about the ridiculous nature of cost cutting and how we couldn't possibly cut costs any more and be left with a viable business. The response from head office was simple. They said okay. An interesting little exercise. Head office just wanted to see how much we could reduce costs and we were driven by fear to do what they asked. The business never recovered from these cost cuts and it eventually faded into oblivion.

The moral of this story is that, yes, we have to cut costs, but we have to do it in a smart way not in a panicked or illogical way. If we cut too deep, we may actually destroy our business.