In this tumultuous economy, reducing operating expenses has emerged as the number one objective for business owners everywhere. So what are operating expenses? Operating expenses (also known as operational costs, fixed expenses, and indirect costs) comprise the expenditures that a business incurs as a result of performing its normal business operations. These expenses include rent, phone, utilities, fixtures, equipment, inventory, marketing budgets, insurance, payroll, professional services, etc.
Our objective in this blog is to look at operating-cost reduction from a very high level — strategically — rather than delve immediately into the details or tactics of this exercise, which we will do in a future entry.
So, from a strategic point of view, let's look at operating expenses and some of the reasons you may wish to reduce them.
- Demand in the market has dropped off, causing an unacceptable decline in profitability
- The business is losing money and needs to return to profitability
- The business is profitable, but management has profit objectives that require a better return at current revenue levels
Circumstances for cutting operating costs vary, but cutting some of them, or all of them, can be fraught with risk. So, to address the risks involved, you might ask yourself the following questions:
- Will you reduce your ability to compete effectively?
- Will you reduce the quality of your product?
- Will you reduce your clients' experience with your company?
- Will you reduce the goodwill you have worked so hard to build?
The point here is that you need to consider the company-wide and market-wide consequences of your cost-reduction decisions.
From the EMyth Perspective, operating cost-reduction (or for that matter, any business decision) requires a well thought-through strategy. There are two very important ideas here:
- A strategy requires you to take a step back, put things in perspective, and look at the big picture
- A strategy demands that you express clearly the result you intend to achieve
Consider the big picture
Let's examine more closely why looking at the big picture is so important. For starters, the big picture gives you a wider view of your market and your business.
In EMyth parlance, the Technician (who resides in all of us) has a narrow perspective and dwells in the "here and now." It's difficult for someone caught up in the daily to-do list to make strategic decisions that will impact the company. The detail-oriented perspective of the Technician, when used exclusively, can limit your ability to make sound decisions regarding the bigger picture. You are better served to bring the working perspective of the Manager in to play, to bring balance to this important decision-making process. By contrast, the EMyth Manager takes several steps back from the issues at hand and therefore has a much broader perspective. This broader perspective is a huge advantage that helps the Manager see the possibilities. It is from that range of possibilities that the Manager can make better, more informed decisions.
Michael Gerber expressed this idea well by saying, "How you think about your business is how you end up doing business." Think about that! If you spend your time looking for opportunities (instead of dwelling on your frustrations) you stand a very good chance of coming up with solutions that yield positive results.
Clearly, good strategies are critical to making good business decisions. Poorly conceived strategies can haunt you. For example, in bad times, strategies such as "slash and burn" are often proffered by so-called industry experts. But, be careful.
The slash and burn approach is short term. It is reactive in nature and characterized by the wholesale cutting of people and programs across the board, without much consideration of the consequences. The approach is reactive because it comes from no strategy at all, other than cutting costs. Hence, the tactic often achieves a positive short-term effect on earnings, but commonly leads to disastrous long-term results. Why? Because short-term cutbacks are, for the most part, unsustainable.
For example, the surviving employees of a cut-back have the same amount of work to do, but have fewer people with whom to do it. The end result is that the cost-savings come creeping back, owing to the inefficiencies created by the cutback. Slash and burn cuts also ignore the time and money invested in recruiting, hiring and training; they discount the demoralizing effect the cuts have on current staff; they disregard the impact cuts have on the total customer experience; and they typically overlook the inevitable rehiring costs.
Ten years ago, an executive named Al Dunlap, CEO of Sunbeam Corporation, was lauded by Wall Street as a slash and burn turn-around artist and given, smugly, the sobriquet, "Chainsaw Al." But, when his board finally woke up to the long-term results "Chainsaw Al" delivered, they asked for his resignation. To its credit, the board recognized the serious shortcomings of the slash and burn approach, an attitude now generally shared by businesses, large and small, throughout the nation today.
Know where you're going and write it down
And what about that second important idea, "A strategy demands that you express clearly the results you intend to achieve"? Two things are important here: a) Have the end result in mind before you start, and b) For clarity, quantify that end result.
From the EMyth Perspective, your strategy needs to be articulated into quantifiable results. With respect to cost reduction, ask yourself what level of profitability are you aiming for? Write it down and refer to it often.
Remember this: Cost reduction is only the means by which you increase profits. Cost reduction is not the end result you want; increasing profits is. So don't lose sight of this important distinction. It can have a major impact on the effectiveness of your strategy.
Finally, you must thoroughly understand the ramifications of your decisions, before you make them. This is what EMyth means by strategic work. Strategic work is what keeps you in business; it is planning and organizing the steps you need to take; it includes clearly defining, measuring, and tracking the results you want. These are the tools that allow you to work on your business instead of in your business. Strategic work transforms you from being the highest-paid employee in your business to being the business leader.
In the second part of this series (coming in February), we'll take a look at some of the tactical steps you can take once you've determined your overall strategy. Stay tuned!
Share your story
How have you approached cost-cutting measures lately? Have you been able to keep your "strategic hat" on? Tell us about it.