June 9, 2014

The No Nonsense Guide to Cost Reduction for Clever Business Leaders

In order to reduce or just control your costs you’ll need to start with knowing what they are. This sounds easy, but actually there are certain important things that are often not measured. Here’s a practical list to help you:

What you need to measure

  1. Money

    A Pareto Analysis of where the money is being spent. 80% of your cost goes on the top 20% of costs, so after people and materials, what else is taking your money? And within materials, again what is the top 20%. Savings made on these top 20% will give you the biggest benefit, and investigating, negotiating, shopping around on these will be worth your time. Banning biscuits and post-its will not give you anything like such a big payback, and will only demotivate people and make them less productive!
  2. Productivity

    Productivity of people is something that you would ideally measure. If you could compare one against another you could work out WHY some people are producing more (remember it may not be their fault!) as well as taking action in focused problem areas, rather than having blanket reorganizations which tend to only make the good people leave. And remember that measuring the hours people work doesn’t help much: productivity is not at all the same as hours worked – in fact it’s the inverse because people who work shorter hours to produce the same outcome are more productive.
  3. Time

    Percentage of time wasted, and on what. Since people are probably your biggest cost, and this money only gets you their time, it follows that their time is your most valuable asset. And I expect most people would say that they waste 20% of their day, maybe more, mostly because of systems, communication, information and equipment not being as efficient as they could be. If you had facts you could work out whether investment in equipment or management time was worthwhile.
  4. Efficiency

    Hours spent on tendering, meetings, IT problems, managing queues, duff information, etc. These categories aren’t exactly waste, but they can often represent inefficiency. So if you were able to measure the actual time spent on writing tender documents and then reviewing incoming tenders, for example, you could work out whether this was costing you more than you save, or not. Similarly, if you (and the participants) knew the actual cost of a meeting they might be inclined to reduce the number and duration of some of them. Managing queues is often more expensive than getting the extra resource needed to get rid of them – you have to progress chase some of the queued jobs, apologise to waiting customers, etc. And tracking down duff information in the system and putting it right takes a bit of time but probably saves you time in the end – but it’s never measured.
  5. Key Resources

    Cost of key resources per hour, and their utilization. The idea here is to measure the utilization of expensive pieces of equipment (machinery, fork lifts, vehicles), rooms (operating theatres, testing labs, IT training rooms, etc), and maybe even people, so that you can make the right decision about whether you need to get more of them – or less of them, or hire them out to others. Utilisation (the proportion of time spent actually being used) is often not measured, and yet it’s vital to know.
  6. Subcontractors

    Subcontractors. Before you know it you have regular contractors working in your business, and they can be under the radar despite having a much higher cost than regular employees. They don’t appear as a fixed cost or on the head count, and they might be paid for out of a number of different budgets. They might be great value (e.g. training from me!) but they need to be monitored in case full time employees, or overtime, or cancellation of the work, would be better options.
  7. Turnover

    The effect of pricing on turnover – it would be great to measure this! How much more would you sell if you cut your prices? …and more importantly how much less if you increased your prices? One of my clients worked out that their smaller accounts were not actually profitable when you included the time to manage them, so they put their prices up by 12%, and they only lost 2% of their business. They should have done that years before! The way to test this scientifically is to experiment with your pricing so that you can measure the effects, and therefore really understand the elasticity of your market.
  8. Department Income

    Income generation per department: often we focus only on the costs of departments, and then try to reduce this - but maybe some are generating money as well, and maybe others could generate some too, or generate more. Some parts of your business will always be a net cost, but at least they could be less of a cost. It would be interesting to analyse each department as a mini-business. And remember, what gets measured gets improved.
  9. Savings

    Savings we’d make if we invested / Cost which we’d pay longer term if we cut. This follows from the above, and the point is that most companies who cut costs end up losing more than they gain. Ideally you would measure the effect of cuts, rather than just cutting and walking away. In fact, predicting the effect, and then seeing if that is indeed what happens, would be the best way. What cuts are you planning to make, and how will you measure whether you really get the benefit of them, without effects on other areas of income?
  10. Failure

    Failure costs due to poor quality. Finally, a critically important measure is failure costs. We all measure prevention costs – training, IT development, auditing, quality department, supervision, preventative maintenance, etc. But the flip side gets forgotten: the cost of handling complaints, lost business, rework, warranties, management time sorting out problems. The numbers for these are always going to be approximate, but that’s OK; the main thing is that you can make more informed decisions if you know that you are currently handling 10 complaints a week and each one costs you £400. You can work out what it would cost to reduce the numbers, make the change, and then monitor if that really happens.

What you can do next?

Here is a short summary of the top 10 actions to take.

1. Measurement before you do anything else – know for sure why you’re making the change, and know whether it has had the desired effect.

2. Do a Pareto Analysis and focus on the big areas not the biscuits.

3. Publicise the costs of everything, including time, so that everyone becomes more cost aware and everyone can suggest ideas for reducing waste.

4. Engage employees in the process of cost reduction – set up project teams and involve as many people as you can at all levels.

5. Make sure you have a strong HR department who aren’t afraid to confront problems – and get rid of the right people.
6. Cost of sickness – measure it and reduce it. It is often a huge cost when you work it out, and much of it is preventable by the right management.

7. Good purchasing. And this may well not be the same as a centralized purchasing department who don’t really understand what they are buying. This means the right things being bought by the right people, using good negotiation skills, and good processes.

8. Cost benefit analysis rather than just measuring costs. What do we lose if we cut something, both now, and in the future, and in other areas of the organization?

9. Measure and improve utilisation of all resources.

10. Optimise quality rather than just cut or raise it. Aiming for 100% perfect is probably too expensive for the small added benefit, while cutting corners is false economy. There is an optimal point, usually at the point where your prevention costs are twice your failure costs (ask Taguchi) and you need to find this.

Well, I didn’t say it would be easy!

Do you have any suggestions? Want to share your experience? Add your comments below.

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