Business And Leadership, Ireland's Business News Service

When looking at cost cutting it is important to take a structured approach. Too often, businesses tackle costs by measures such as  arbitrary budget cuts, salary freezes and bans on recruitment. While this approach can, of course, deliver savings, it is likely to be unsustainable and could harm not only morale, but the business as a whole.

Successful cost-reduction programmes are always sponsored by and driven from the top. To achieve cost optimisation requires a relentless, ongoing focus and determination from the owner manager. Given the size and scale of the challenge, organisations cannot afford to have any confusion about roles and responsibilities.

While led from the top, cost-cutting initiatives must be properly communicated throughout the organisation. Focus on cash and develop a culture where the whole team thinks before incurring costs of any kind. This is no mean challenge, but if met can result in a sustained reduction in the cost base and an attitude by all to continually be on the look-out for further cost-saving opportunities.

The starting point for delivery of any sustainable cost reduction is to gain a clear understanding and visibility of all costs within the business and the drivers of those costs. This will include scrutiny not only of the absolute level of costs, but also of key metrics used within the business. Measurement of key performance indicators such as productivity, cost per unit and product- profitability analysis can highlight high cost or poorly performing parts of the business, which should be tackled immediately.

It is generally quicker to cut variable costs, such as salaries and wages, advertising, travel and other overheads, and these are often addressed first. Achieving reduction in fixed costs such as equipment and rent costs is generally more difficult, and it will usually take longer for the benefits to be seen. Exiting a lease, for example, may require up-front payments, with the benefits coming through over a longer period.

The most effective way to cut costs is to review each and every cost within the business and ask yourself whether or not it is necessary, and what value it adds to the business. If a cost item is necessary, ask yourself if the cost can be reduced rather than cut. An example might be reducing purchase quantities, or finding a cheaper alternative supplier. Review all purchasing procedures within the business as well as authority limits, but ensure the latter are adequate for efficient operations.

Many businesses continue to produce goods or services that destroy value in the business. Product-profitability analysis should be used to identify which products or services are most cost-effective and which contribute the most to central overheads. Those that destroy value should be cut unless strategic reasons exist to retain them (for example, as loss-leaders). The savings achieved can then be invested in the most profitable products and services.

Labour will be the largest cost for most businesses, and serious focus should therefore be given to reducing these costs. Productivity analysis should be monitored and actions taken to improve areas with low productivity. Consider reorganising shift patterns, restructuring teams, and reviewing production processes and flows. Simple changes to floor layout in manufacturing plants, for example, can lead to significant savings and a better work environment for employees.

Poorly performing employees should be performance-managed out of the business. Proper processes and procedures must be followed and it may take some time to deliver the cash savings, but other benefits can often result sooner, for example, from increased motivation and productivity from fellow workers.

Other areas where labour cost savings can be delivered include:

• Restructuring of benefits, for example, by offering flexible pay and benefit packages
• Reducing overtime through increased productivity during normal time and implementation of more stringent processes for authorisation of overtime to be worked
• Reducing training for areas with high staff turnover.

Review the levels of buffer stocks held throughout the business. Cultures of ordering extra stock as a ‘just-in-case’ need to be changed. This applies not only to manufacturing but equally to other areas of the business, where, for example, excess stationery and supplies are often held.

Many businesses hold significant obsolete stocks that should be realised both to generate cash but also to reduce stock-holding or warehousing costs.

Occupancy (premises-related) costs will normally be one of the highest costs to the business. Review occupancy requirements when downsizing operations.

• Seek to renegotiate lease terms, including downward revision of rents and revision of payment terms
• Review facilities management (FM) costs. Consider outsourcing to a specialist FM provider if necessary.

Today, IT is a critical area for business, so think long and hard before tackling cost cuts in this area. While it is possible to achieve savings, any cost-cutting plans here need to be thoroughly researched before being implemented. It is vital to ensure there will be no adverse impact on the business, as the implications of changes of IT systems can include issues with access to management information, as well as customer and supplier records.

Resolution of issues resulting from a poorly thought-out plan can be time consuming and costly. Listen to your experts in this area.

There are opportunities too for cost cutting in your fixed assets. You might consider deferring capital expenditure plans, and perhaps wait another year for the new car or replacement PCs. Equipment sale and leaseback is another effective way to release cash and reduce costs. When you are buying new assets, consider leasing from the beginning rather than buying. There are opportunities at the moment to look at purchasing second-hand assets if appropriate to your business requirements.

Opportunities may exist to drive significant savings from resource utilisation too. Look closely at areas like energy, packaging, water, and transport and distribution activities.

The current economic climate presents opportunities for business tie-ups, either through acquisition or collaboration, which can deliver cost savings by eliminating duplication of roles and functions.

Outsourcing part of the business can deliver cost savings too. However, great care should be taken here to fully assess the implications of undertaking such a process change, as bringing outsourced services back in-house can be difficult and expensive.

Overall, in order to achieve sustainable cost reduction, it is vital to first understand the cost base of your business and the cost drivers. Then you can tackle each cost area by measurement, so as to ensure the targeted savings are achieved and that other opportunities for cost cutting are identified.

Simple cost-reduction techniques

Some simple techniques to deliver cost reduction across the business include:

• Close scrutiny of all purchase orders. Questioning whether purchases are essential and whether goods or services can be obtained from alternative sources more cheaply may seem simple, but experience shows that significant savings can be achieved. Don’t just accept the answer given – probe and challenge
• Reviewing your procurement process. Is it centralised? Do you have too many suppliers? By consolidating down to a smaller number of more important suppliers you may be able to secure better deals both on price and service
• Reviewing and redesigning customer-service techniques to get things done right the first time. Less time spent responding to customer complaints allows greater productivity and reduced staffing levels
• Restructuring the organisation to remove surplus layers of management and to streamline it
• Freeing up excess infrastructure, through redesign of manufacturing processes or warehousing activities. Blockages or bottlenecks throughout the organisational structure can significantly increase costs and reduce throughput. A focused review of all operations of an organisation can result in significant improvements in performance, allowing businesses to focus on strategic decision-making while simultaneously reducing costs.

Alan Morris is head of KPMG’s Cash Management team in Ireland.