The balancing act between cost optimization and investing in growth can be delicate. Inflation is currently slowing, but businesses still feel the financial squeeze. In times of financial pressure, it can be tempting to maximize profit by cutting costs. But “you can’t cost cut your way to prosperity,” says CFO Gabriela R., who tells businesses that while no costs should be off the chopping block, the wrong cuts can be counterproductive to growth.
Cost reduction strategies require careful planning, but Gabriela outlines her most important advice to businesses who want to grow more cost-effectively.
Without a Strategy, Cuts Are Arbitrary and Risky
The first priority, says Gabriela, is to thoroughly understand your reasons. “Make sure you understand why you’re cutting costs. Is it to weather a particular storm? Or because you want to compete on price?” The end result may be similar, but the process will likely be different.
In either case, a thorough evaluation of expenses is in order. “Nothing is off limits,” says Gabriela. “Which doesn’t mean you’ll cut everything. It just means you must examine all of your expenses. Obviously, you’ll give your largest buckets the most attention.”
Why Across-the-Board Cost Cutting Often Backfires
There is no one-size-fits all solution to cost cutting. The size and circumstances of each business matter. How do you cut 10% of a department that has one person, for example? Instead of a broad application, businesses must investigate each expense for both short- and long-term utility.
When it comes to cost optimization, many companies tend to make more aggressive cuts to overhead. But not all overhead is created equal. Beyond the employees who create and sell, businesses must understand that profit can also come from the back end.
“You can’t save money by not purchasing certain assets,” Gabriela explains. “Especially those that help you collect and analyze data. The last thing you need is to make cuts so deep that you lose the ability to understand what works and what doesn’t. Or worse, that you cannot be compliant. That will generate a whole set of issues and expenses down the road.”
Avoid ‘Halfway’ Measures
Strategically assessing all expenses is key to balancing cost with profitability. Similar to across-the-board cuts, businesses sometimes make the mistake of ‘halfway’ cuts. These ‘halfway’ cost cuts, according to Gabriela, are partial cuts to avoid making tough commitments towards more strategic cuts. Staff reductions, for instance, may reduce immediate expenses but can have a profound effect on future profit.
“Say you have 10 engineers. The cost of the department is reasonably fixed, though revenue they are responsible for generating will vary due to the size and timing of projects. If you decide to cut down to seven engineers, you end up destroying the ability to generate revenue all together and still have the expense of three engineers. That’s going halfway,” says Gabriela.
Instead of cutting partially and leaving every department short-staffed or struggling, Gabriela advises businesses to make tough but decisive choices. For example, completely eliminating certain products, divisions or services rather than providing them with insufficient resources. Businesses need to have the courage to fully cut areas that no longer make sense, rather than put remaining employees in impossible positions.
Only going halfway through cost reduction analysis can have suboptimal long-term consequences. “Seven engineers can’t do the work of 10, which hurts your future revenue. You might not hurt your revenue by 30%—you might hurt it 50%. If you restructure for the purposes of cost cutting, you must commit to everything the restructuring entails. You can’t do it halfway.”
Understand Your Data and Limitations
Knowing how and where to cut costs requires information. As a CFO, acquiring data is Gabriela’s first step. “To assess and optimize your costs, you have to understand what kind of data you have. That will help you make courageous choices on what to cut and what to keep.”
The next step is to apply your business model. “What is your appeal to the market? Are you creating something original? Or are you just selling the widget?” In the case of the 10 engineers, “those engineers are the reason the company is successful—because they work directly with clients to develop customized, highly engineered solutions. Cutting the engineers [to reduce costs] is not in your company’s best interest.”
Consider Alternatives in Cost Optimization
While often an easy choice, layoffs are far from the only solution. Automation, expense audits and reallocation are other cost cutting strategies. But whatever strategy you choose, it’s also crucial to share the obligation equally—not only horizontally, but also vertically.
Leading by example is not just important for staff morale, it’s also good business. “We’ve all seen the headlines about companies that cut thousands of jobs while the CEO gets millions in bonuses,” says Gabriela. Trust is an invaluable commodity, which, once broken, is costly and difficult to regain. “The people at the top also need to tighten their belts.”
In addition, when employees are substantially impeded by budget cuts, your business may run the risk of losing its best talent. When making cuts, keep in mind how that can impact your talent’s ability to feel supported in their role.
Incentivize Win-Wins, Not Trade-offs
Sometimes, cost optimization is about reframing a challenge or adapting a metric to align all stakeholders rather than eliminating a factor.
A manufacturing client that seeked Gabriela’s expertise was having difficulties improving their profitability. The manufacturer had an engineering manager, a quality manager and a production manager. “They were the three people who made everything work.” But the company’s cost-reduction strategies put the three managers in direct conflict. Lowering the quality percentage goal of the product to save money, for example, hindered the role of the quality manager. “They were not working with each other but against one another,” says Gabriela.
She proposed the company base their cost-cutting measures on a different metric. “Instead of choosing the quality percentage or the efficiency percentage, we assigned an overall growth margin instead.” Then the three people ‘who made everything work’ could work together for the betterment of all.
Getting buy-in from key staff is crucial, according to Gabriela. The best way to obtain that buy-in is to share information. “You need to explain measures in a way that makes sense, for the individuals and for the business.”
Think Cost Optimization Rather Than Cost Cutting
When cash flow is tight, cutting costs can feel necessary. But there are cash flow strategies beyond cost cutting to help navigate those temporarily straitened circumstances.
When performed strategically, cost optimization unlocks resources for growth.
“Rather than choosing what to cut to maximize profit, the balance might be between investing in a new tool versus a new trainee,” says Gabriela. With the right approach, companies can cut costs and invest in the future.
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