How to Reduce Operating Costs

You might be short on cash, facing a demand reduction, or uncertain about future demand. The classic business playbook says these are good times to reduce operating costs. Before slashing your organization, consider the following strategies and tactics to avoid losing precious resources, cutting too little, or cutting too late.

Is a decrease in operating expenses good?

Lower expenses are not always a good thing. Just as businesses can experience “bad growth,” they can also experience bad expense reductions. Before choosing what to cut, determine your cost-reducing objective: efficiency improvements or capacity reductions.

Efficiency Improvements

Efficiency improvements boost productivity and scale. Examples include automation, standardization, cycle time reductions, and waste elimination. Efficiency improvements are expensive and take time to implement, but they bring short- and long-term benefits.

Capacity Reductions

Capacity reductions eliminate excess cost and overhead. For example, imagine a customer service department has three employees at 60% capacity. Eliminating one agent would shift the other two’s capacity to 90%. Capacity reduction is a prudent form of cost management and brings immediate cash savings. However, a capacity reduction can hurt long-term growth, especially if resources are challenging to replace.

Avoid the Downward Spiral

Cost management can be self-defeating when expense reductions create quality issues like long wait times, lower product quality, or slower processing. Quality problems may drive away customers, reducing revenues and demanding more capacity reductions – the dreaded Downward Spiral. Downward Spirals are challenging to stop and often require complete rebranding or recapitalization of the company.

Downward Spirals are the direct result of Spreadsheet Management, a form of decision-making based solely on financial targets, expense ratios, and payroll burden formulas. Spreadsheets are essential in planning cost reductions, but there should be other considerations. To avoid the Downward Spiral, collaborate with sales, marketing, and operations, not only finance.

When should I reduce operating costs?

Your sales funnel risk should dictate the timing of cost reductions. If you are a government contractor with long-term contracts, your sales risk will differ significantly from an e-commerce company with seasonal demand. The more predictable your revenue, the more time you have to plan operational spending reductions.

Timing will also depend on the agility of your labor, overhead, and suppliers. Companies can hire general laborers much faster than rocket scientists. Move quickly to cut resources that can be rapidly procured while preserving your hard-to-find employees, equipment, and materials.

Generally, the sooner you reduce operational spending, the longer your cash runway will last.

How to decrease operating expenses

Follow these steps to minimize expenses during uncertain periods.

1.      Measure sales volume regularly.

Keep top-of-the-funnel metrics in focus – website visits, inbound inquiries, booked meetings, calls placed, etc. Establish high-end and low-end financial targets. Low-end targets represent a danger zone where you should consider additional spending cuts. The high-end target indicates when to shift from defensive management to growth management.

2.      Use an operating forecast.

Analyze the financial results of expense reductions before executing them. Forecasting avoids cutting too little, too much, or ineffective restructuring.

3.      Collaborate with managers

A single person in a vacuum cannot plan effective operating cuts. Leverage your management team to challenge ideas and debate the best cost-reduction plan.

4.      Plan contingencies

Identify your assumptions and make backup plans. How quickly can you re-hire if sales volume returns?  Does it make sense to keep employees on furlough instead of complete layoffs? What does the next round of expense reductions look like, and what is the signal to contemplate such reductions?

Collaborate with a professional

Perhaps this is your first downturn, or you merely want a second set of eyes. In either case, you should always plan expense reductions in consultation with a CFO. Contact us to learn how a fractional CFO can help you navigate expense reductions and minimize risk.

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