Managing costs Featured

7:00pm EDT February 23, 2010

Decreasing costs in the first phase of an economic slump is easy because people tend to lose focus on doing so when business is booming. As a result, finding ways to contain costs when the economy contracts is not that difficult.

In contrast, generating profit improvement during a mild recovery can be extremely challenging because management teams have already addressed the most obvious inefficiencies in their businesses, says Mark G. Metzler, CPA, director at Kreischer Miller.

“A company’s financial viability depends not only upon its revenue but also on effective management of costs and expenses,” Metzler says. “During these challenging times, managing costs has become a top priority for business owners.”

Smart Business spoke with Metzler about how to approach sustainable cost management in a challenging economy.

What makes managing costs in this economy more challenging?

Too often, companies focus on increasing revenue without fully understanding what is happening to the cost side of the business equation. Many organizations lose sight of the true cost when they are expanding their product lines or service offerings to meet customer requests. Companies need to analyze their cost structure to identify all of the costs associated with providing each product or service. Once the true costs are identified, it is often easier for the business owner or manager to effectively allocate resources to the work that is most profitable and eliminate those that are determined to be too costly.

While it may seem counterintuitive in a stagnant sales-growth environment, sometimes enhancing profits means cutting sales efforts. The Pareto Principle tells us that 80 percent of profits are generated by 20 percent of your customers. But do you know which customers are in your top 20 percent?

By performing a critical analysis of customers or products, management might find that cutting sales efforts in less profitable areas of the business and shifting resources to the most profitable areas can increase overall profitability levels.

Top-line growth without bottom-line improvement can be disastrous. The goal should be to work smarter, not necessarily harder.

What can business owners do to get a better handle on their costs?

What you can measure, you can manage. Organizations that actively monitor operations are in a better position to uncover costly problems before they impact the bottom line. Successful companies recognize that it’s not about accumulating volumes of financial data but rather using ‘information dashboards’ that compile key performance indicators for any business function that managers want to track. Dashboard information is provided in real time, enabling the CEO or owner to take the pulse of the entire business at any time.

What areas of an organization are the best places to audit?

Payroll and benefits are typically the largest expenses, and reductions in work force to match associated revenue can result in significant savings. However, before taking this route, many organizations look at other alternatives, such as shortened workweeks, unpaid leaves of absence, temporary salary reductions, or revamping or suspending benefit packages to reduce payroll costs without losing valuable employees. They recognize that the costs, including recruiting and training, to replace an experienced employee when the economy improves may be far greater than the cost to carry the employee on the payroll.

Additionally, companies may not be too quick to hire a replacement for an employee who leaves. Rather, they rethink how work is being performed and look to reallocate the individual’s duties to existing employees.

Another option that shouldn’t be overlooked is outsourcing, which can turn a fixed cost into a variable cost — and it’s the fixed costs that are challenging to cover in a difficult economy. Continued technological advances have made it possible to outsource a wide range of functions, including HR, customer service and IT. For example, software-as-a-service is now a thriving sector, allowing companies to dramatically decrease their IT infrastructure and the internal resources necessary to support it, and gain enhanced customer service and application availability.

Lastly, companies should examine each expense item on the income statement to determine what they can live without. Multiple small-dollar savings, whether attributable to unnecessary subscriptions or services, can result in substantial bottom-line improvements.

How can a business strategically and rationally look at these areas for ways to improve them?

In the simplest terms, business owners need to look at their operations to identify what is adding value. Successful businesses look for ways to streamline their operations and shorten the number of steps in the delivery process. Owners who think in these terms find it easier to determine what costs can be cut without harming the business. The focus is on serving the customer in the most efficient and cost-effective manner.

What mistakes do businesses make when trying to manage costs?

One of the fundamental mistakes that businesses make is failing to recognize that, in order to improve, change is inevitable. Tom Peters, who is often referred to as the father of branding, said, ‘Excellent firms don’t believe in excellence, only in constant improvement and constant change.’ Leaders of organizations must embrace change and not allow those who oppose change to derail the organization’s goals and objectives. If the tone at the top of an organization does not support an initiative, then the initiative is doomed to fail.

Business owners who are successful surround themselves with the brightest people and solicit their input.

Mark G. Metzler, CPA, is a director at Kreischer Miller. Reach him at (215) 441-4600 or mmetzler@kmco.com.