Thursday, November 18, 2010

You Can't Cut Your Way to the Bottom Line

by Rick Leibowitz

With all the talk about the economic slowdown in the news, businesses are scrambling to find the best strategies to deal with the challenges of increases operating costs (mostly due to inflation in the energy & commodities markets) and anticipated decreases in consumer spending. Business articles talk about how now is a good time for small business owners to tighten their belts and watch their discretionary spending.

I’ve personally read a number of articles that suggest cutting advertising budgets and hours of operation as a means to cost savings. However, I caution all small business owners to think carefully about the consequences of cost cutting before you take action.

Developing a contingency to deal with the economic slowdown is a very smart strategy for every small business owner, but the key to a good plan is to dedicate time to forecast the expected results of each decision. Another thing to keep in mind is that it is highly unlikely that your business can maintain profitability levels strictly through cost savings.

Unless you have been a completely inefficient manager of operations for your business, your expense lines are there for a purpose, which is mainly to help you generate revenue. You need to understand that the rash reactions of cutting expenses may result in cutting revenues that might have remained with your businesses had you not made those expense cuts.

To help highlight this point, there is a well-known story that relates to a chain of quick oil change services. It is said that a corporate financial officer noticed that an average service center spent $5,000/year on coffee and donuts for customers in the waiting area. The corporate officer sent a memo to all the retailers telling them to stop offering free coffee and donuts to give a quick $5,000 per year increase in their bottom line performance. The retailers who complied with this advice averaged about a 10% reduction in sales performance. Apparently some customers valued getting free coffee and donuts while waiting for their vehicles more than this financial officer thought and the customers either reduced the frequency of their visits or went to a competitor instead. With the average business unit doing $500,000/year in sales and making a 30% margin on sales, the average retailer would have realized a $10,000/year net loss in profit by following this advice.

I once served on an executive committee for a large corporation in the hospitality industry and we discussed similar cost savings strategies at our monthly forecasting meetings. As ideas for expense reductions were brought up, our wise general manager would always say, “You can’t cut your way to the bottom line.” She would always encourage us to be creative in looking for new revenue opportunities.

So as you proceed with a strategy to deal with the economic slow down, remember, there are only three things you can do to increase your bottom line performance:

• Decrease expenses

• Increase prices

• Increase volume

There are implications to applying each strategy, and the intelligent business owner will think about each opportunity.

I wish I could offer a catch-all strategy that would work for every small business, but life is just not that simple. Each enterprise has a unique business model that is affected differently by the changes in the economy.

The one common suggestion I can offer is to research customer spending habits, come up with a plan for your business and project expected outcomes before taking any action. And remember to think about adding to your revenues, not just decreasing your expenses.

As Winston Churchill once said, “Let our advanced worrying become advanced thinking and planning.”
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Originally published here on August 7, 2008, which just points out how long the economic slowdown has been going on.

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