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Reducing Operating Expenses

2009 | Jan 28 in Business Development , Home Page News , Systems , Money , Management

By E-Myth Business Coach,

BudgetingIn 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.

  1. Demand in the market has dropped off, causing an unacceptable decline in profitability
  2. The business is losing money and needs to return to profitability
  3. 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 E-Myth Point of View, operating cost-reduction (or for that matter, any business decision) requires a well thought-through strategy. There are two very important ideas here:

  1. A strategy requires you to take a step back, put things in perspective, and look at the big picture
  2. 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 E-Myth 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 E-Myth 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 E-Myth Point of View, 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 E-Myth 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.

Further Reading

The Three Business Personalities

Cash Flow Q & A with an E-Myth Business Coach

Comments

  1. .Saidu A. says:

    Wow, this is truly a great read! The slash and burn action is something most Entreprenuers this year will have to constantly remind themselves not to carry out! The unfortunate thing is that it is already happening everywhere one goes. Here in Nigeria, Financial Institution (who are the largest employers of labour in the country) are reducing headcount. The question for me is "Why isn't it obvious to Management that reducing headcount is not the answer?"

    Management apart from asking the strategic questions in the writeup must be able to look at the major blocks that make up their overheads. While in most organizations, Payroll accounts for anything from 30% to as much as 50% or more, the fact remains that when this % is broken down further, the bulk of it is in Management Remuneration!

    Instead of slashing and burning, management needs to look at how to further improve efficiency, if the target was 80% before, increase it to 100%. You'd be amazed at what people can do if stretched properly. Take a closer look at those costs, what are the underlying processes? Set targets for improvements within the processes, set targets for reduction of any waste. Set targets for reduction of Telephone bills, you can have a No Email Day or No Telephone Day in your organization. 

    I believe the key to surving is thinking out of the box and one thing management is not good at doing at times like this is asking the right people (Your Employees) what they think can be done! Employees have all the answers and all management needs to do is provide the strategic leadership by setting the targets which ofcourse need to emphasis those organizational values that can't be allowed to diminish, the rest can be mapped out by Employees! They are the ones that stand to loose their jobs and that is motivation to think out of the box!

    Submitted Jan 29, 2009 3:07 AM

  2. .Mark R. says:

    In reading this article I am reminded of all the marketing and advertising that is cut during a business slow down. Are you sending the wrong message to your customers and prospects when you no longet "tell" them about your company or product?  If marketing is slashed, what do you tell your future clients? If you cannot take care of the customer now, why should they stick with you when things are better.

    There is an old adage that goes something like, "it doesnn't matter how many times you are knocked down, what counts is how many times you get up". I believe this is also true when looking at the current reality. If you cut costs in an irrational manner, will they be the cuts that prevent you from future growth? Any strategic decision must be made looking forward, the past is gone, you may pay for your mistakes, but you can learn to not repeat them.

    Make the decision that is best long term, whether in costs, programs, employee relations or marketing. But make the decision realizing the long term implications for success.

    POWER ON--Mark

    www.atomicpenny.com

    Submitted Jan 29, 2009 8:53 AM

  3. .Glen T. says:

    Great Article!

    "...reducing operating expenses has emerged as the number one objective for business owners everywhere."

    What I am not hearing "out there" is the question, "Why are these operating expenses here in the first place?" We need to put serious, proactive thought into whether we even need this expense, or is it just a short cut or bandage?

    Too often during good times, managers get into the habit of throwing money at the problem. We do this by spending more, adding positions, expanding facilities, etc.

    Whenever we add a position, or create a job to fill a gap in our system, we create a long-term addition to our operating expenses. Perhaps a better solution would be to review our procedures, find the hole, and fill it systemically. Or, if we need a new position, is there a way to do it temporarily? Could it be outsourced? Could it be automated?

    I agree that we must look at the big picture right now and think strategically about where and how we cut expenses. Entrepreneurs should learn from this lesson and think strategically when we want to add expenses.

    Thank you again for another great article! I look forward to your tactical ideas in the next one.

    Glen

    www.ebsystemsltd.com

    Submitted Jan 29, 2009 9:26 AM

  4. .Deborah M. says:

    Thank you.  I am a one and a half person (temporary employee) business.  I am the owner, and I figured out that my one huge inefficiency is filing, (sooo overwhelming, and so much of it when I have too many other things to do) so i asked a friend if she would be interested for one price for the day, I guess it would be called a block price.  She did a fairly bang-up job it looks like, and we had a nice time.  I am asking her back, after I review her work to make sure of her efficiency.  I know it is a little extra money when I need every dollar, but she is helping me increase MY efficiency.  Which I believe is the whole point of E-Myth, thinking about the value of spending a little money to build cost-effectiveness vs. cutting everything, like my temporary employee friend.  Thanks E-Myth.

    Submitted Jan 29, 2009 10:09 AM

  5. .Jennifer R. says:

    Michael, very well put. start with the end in mind. I have decided to change my own economy. While others are firing people I am hiring people. I have decided to create a powerful team and stop working like the Technician. The team is working with the company Purpose Vision and Goals we have created collectively. We are building an organisation that is clearly going to achieve remarkable success. All are aligned to the Purpose, We see, feel, touch breath abdundance. Our strategy is to work from Possiblity and to create our own economy. We have clearly defined what our goals are for this year and all members of the team are gearing for the targets that have been set. Client Servicing is of Prime importance and engagement is the way forward. Thanks Michael and the E-Myth team that was an awesome and inspiring write up and came at the perfect timing.

    Submitted Jan 29, 2009 10:36 AM

  6. .Rob B. says:

    This is a great topic.

    I operate a recreational sales and service business and until this past fall we were a company of 23 people. This year has been easily the most interesting to date.

    I most appreciate the comment; "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;" I look at my staff as an investment and not an expense, although at some point you have to make the tough decisions if you are going to survive.

    For the first time in twelve years of ownership I had to expedite a round of non-voluntary layoffs. We just plain did not have the billable hours available to keep staffing at the level we were at. I listed my employees on a sheet and after much consideration circled the people that I had to cut. If you have ever been faced with this task, you know the difficulty involved.

    At some point you have to do what is right for the crew that remain. No matter how well thought out and carried out, it's bound to have an effect on those that remain. Not by rule are the effects always negative. 

    Being as small a company as we are it was easy to have very candid conversation with my remaining staff. We talked about exactly what brought me to the decision, (no one was all that surprised) and at that same time, "we" laid out an action plan going forward.

    I am seeing a rededication to company. Folks are wearing hats they thought they never might or ever really wanted to.

    Like it or not we have a shake out going on right now. As the leader you only can hope that you make the right decisions at the right times. As an employee, survival at your current position may depend upon how many hats you are willing to make fit.  

    Submitted Jan 29, 2009 10:41 AM

  7. .Saidu A. says:

    Well saidu Rob. I know how difficult the act itself is. I guess the message is that as Leaders of our organizations, we need to ensure that we are always "thinking" and working on our biz as the decisions we have affect not only our bottom line but all those employeed directly and indirectly by us. As long as entrepreneurs focus on the right things, I believe we'll make the right decision most times and like you've said Rob, it might mean having to let people go! If this is the case however, Leaders and their organizations come out on top because all those left behind rally round to ensure success.

    Saidu

    www.buzznetz.com

    Submitted Jan 29, 2009 11:16 AM

  8. .Neil O. says:

    Reading the comments above was very insightful. A common theme seems to be 'how can you cut costs, including staff, and ensure that the business is not hurt long-term'.

    One way of doing this right is through an Activity Based Costing (ABC) project. 10 years ago when I was working as an Accountant with Pfizer in Ireland, I introduced an ABC project in 3 manufacturing plants. It involves going into every department, measure what people are doing and you classify everything as value added or non-value added. Studies have shown that one-third of people's tasks are non-value which means that they can be removed and it will have no impact on your product or service.

    Ireland has been hit very bad by the recession and with many businesses suffereing a 20% or more drop in sales there is only one option and that is cut costs, including staff. It's survival of the fittest.

    Submitted Jan 29, 2009 11:27 AM

  9. .Mike L. says:

    Thus far, during the past six months, we have taken several strong measures to reduce our costs. 

    1. We renegotiated our current lease a year early in order to take advantage of the fact that our landlords had a fairly empty building.  Local rents are at a low right now and the landlord was happy to renew us at a reduced rate.

    2.  We cut our health care expenses on a monthly basis by 33% simply by changing plans from a full-coverage to a 'major medical' plan.  The plan really doesn't alter employee costs because we do guarantee 50% of the deductible but overall costs will be far lower and the plan is designed so that it pays all preventive care AND co-pays drug costs.  Sweet deal all around for us.

    3.  We've started re-using supplies that were normally disposed-of and require that employees continue to conserve where possible.  In fact, it is now part of the review process.

    4.  We are reviewing our current SBA loan with our bank and are requesting a delay in payments in order to accumulate some cash reserves at the moment.  We realize that this isn't entirely cost-cutting but the SBA is allowing banks to defer payments for as long as necessary without prior approval and we figured that we should take advantage of the option.  Interest-only for a few months doesn't hurt in the current economy.

    5.  We ultimately have cut staff, but mainly by normal procedures.  We have also engineered programs that would help remaining staff to improve productivity, something that we've never actually been able to do in the past.  Our hiring procedures have changed significantly as well, and we are able to take advantage of current unemployment to hire much more intelligent and quality people.  We pay a little more, expect a lot more and ultimately are rewarded with extra productivity.

    Seems like some of this is working.  We're still in business.

    Submitted Jan 29, 2009 1:08 PM

  10. .Emery C. says:

    The guideline I advise all the owners I work with is do not cut anything that affects the direct connections to the customer. Reducing sales help is one of the worst things a retailer can do but perhaps the drivers and mechanics can be reduced. Also, I found an interesting survey done by McGraw-Hill. They analyzed the last major recession (early '80s) and found something that was astonishing. They tracked the retailers who survived for five years after the recession. The folks that cut expenses, cut advertising and literally hung on and survived, saw an increase of an average of 19% in the next five years - not too bad. Contrast, however, with the retailers who kept sales help and advertising and managed through the recession - 275% increase over the next five years. The did that by killing off the weak operators.

    I guess the question you have to ask yourself - Are you going to Survive or Thrive?

    Submitted Jan 29, 2009 4:36 PM

  11. .Aaron P. says:

    Working in retail the three biggest costs are rent (we're in a Westfield shopping centre), stock and wages (in that order). The problem we face is that if you don't pay rent you get shut down (with all the expenses that entails), you don't buy stock you have nothing to sell. Which leaves wages. This is the most difficult area from which to make cuts and I agree wholeheartedly with the article in this respect. I have spent a lot of time, money and grief getting the team that I currently have and I would be very reluctant to part with any of them. The culture in the store is fantastic and is more conducive to sales than it was when I first purchased the business.

    Our main avenue for cost reduction is stock. Our limited demographic research indicates that price is the key motivator for our market rather than quality. This means that quality products that are more expensive sit on the shelves while we sell out of similar products that are cheaper (and therefore poorer quality). Sourcing cheaper product is proving more difficult than we first imagined. Australia has a limited manufacturing base meaning almost 99% of my stock is imported from China. Production and freight costs have soared with the rise in oil prices and the fall of the Aussie dollar - so we get hit twice. There is also a fine line to be walked between quality and price for us. A too big drop in quality cheapens the image of the shop and changes the customer experience. Challenging times and I look forward to part two.

    Submitted Jan 29, 2009 5:01 PM

  12. .Patrick F. says:

    I am a small personal injury law firm.  I have just cut salaries in 2 of my 3 employees.  I am wondering if I am doing the right thing but fee confident that I am.  What I have done, however, seems to go against a few tenets in E-Myth.

    In addition to me, I have a nurse lawyer who is talented but very difficult to deal with -- she has quit 10 times and I feel like a fool have ing taken her back so often.  I also have a "paralegal" who dealts with insurance companies and settles routine personal injury cases. He frankly loafs quite a bit and works very irregular hours.  I sort of inherited him from when I joined this firm and then my partner left leaving everything to me.  Nonetheless he brings home the bacon from time to time, usually just before I'm about to fire him.  Finally I have a hard-working, knowledgeable paralegal-admin type who does a great job and turns things around very fast.  Her problem is that she more or less does what she wants to do, sets her own priorities, and if per chance my priorities intersect with hers then that's Great!

    I see the wisdom in not canning key people.  On the other hand I have terrible cash shortage right now.  Also when I ask the E-Myth questions: Am I running the type of business I want to? I feel I am like a pinball reacting to these people instead of leading.  The emotional toll of cash flow pressures (last year by the way I had a phenomenal year, best yet) and difficult, crazy personalities makes me feel lousy when I -- the boss -- arrive at work each morning.

    I read in E-Myth where cutting back is not the solution but I am hoping to cut back, save money and rebuild. 

    Any help, advice insight greatly appreciated!

    Submitted Jan 30, 2009 8:58 AM

  13. .Rob B. says:

    It's nice to be involved in such a vibrant discussion.

    Prior to reducing staff we had gone through many rounds of cost-lowering alterations with varying success. From the simple shutting off lights, grouping "on the road tasks" to save fuel, we pulled rental uniforms and went to a supplemental clothing allowance, to even purchasing wall thermostats that allowed us to lower the heat an additional 5 degrees overnight. (and yes, during the day too) these are just a few of many adjustments.

    The thought process when being put in position to expediting a curtailment of staff included, "who could do what?" as well as "who would do what?' There is a big difference between the two questions. I made cuts based on who I felt would help me move my company forward most successfully. 

    I met with each person casually prior to laying off and just asked a few simple questions of folks to feel them out. Those that posed solutions, had an upbeat opinion of our opportunities, and had no issue trying "something new" had an impact on me.

    True technicians have an ingrained passion for what they do. Like me, I am a true technician that has, through kicking and screaming all the way, forced myself into being the entrepreneur. I am still most comfortable in the shop with a piston in my hand, but you know, there is great fun in steering the bus too! 

    Guess who were my most positive folks? Technicians please step forward.

    In the end, I did not release any hands on people. I cut negative, I cut inflexible. I cut assistant positions. I did not take seniority into account

    True technicians are a much harder find. Consequently, folks are getting more use to sharing housekeeping duties. Grabbing the phone where they did not before. Everyone is working outside their once defined zone but not their willing zone.

    Submitted Jan 30, 2009 4:41 PM

  14. .Arlene R. says:

    I very much appreciate the article. SomethinginEmery C's comment stuck me...Do we want to survive or THRIVE. I plan to market more instead of less, and also more sensibly rather than spending alot on general 'advertising'.  It may be a good idea to be selective about reaching our target markets in a more specific way based on our demographic data...who are our clients? where do they come from? where do they go? what do they do before coming to us?...After coming to us? How can we re-excite old clients, and get them to spend more...can we take payments in installments...these are questions I am now asking myself before thinking of cutbacks...but if I'm forced to...I will.

    Submitted Feb 1, 2009 8:07 AM

  15. .Raphael W. says:

    It's these times that separate the men from the boys. Thinking of innovative ways to market yourself without breaking the bank is critical. Grass roots marketing is something my team and I have been working on. I run a landscape business and I am currently joining local PTA's, and offering gardening classes for free to locals in more affluent ares. It's a great opportunity to specifically target my target market, by mentioning our company during sessions, and handing out our business card. It's a great way to get involved with the community and make a name for ourselves at the same time. The best part is, it only costs me a few extra hours a week. Eventually, I will have sales associates who will take this role, but they have a little ways to go. Be creative, focus on what costs are important to cut, and try not to let go of anyone, especially when considering how much time it takes to find good people.

    Submitted Feb 5, 2009 12:36 PM

  16. .Olivier M. says:

    I was working for a corp that hired about 200 employees during seasonal period. Seasonal means making sometimes new product for the year/season and also moving rapidly in decision making: As a result I often seen a boost of labor cost which could have been better managed.

    This boost of labor cost was used to manufacture in a "hurry" our product. This lead to hiring employee with incorrect qualification and in larger quantity that was really needed. 

    Training had to be done in a hurry.

    One reason of this high labor cost and hurry training was due to improperly plan the manufacturing process of our product.

    The product was done incorreclty and labor cost was really high.

    In the middle of the storm, CFO realized the overwhelming labor cost and fired too many employees.

    One important point is to really know what is the proper quantity of employee you need. Often too many employees on 1 project creates chaos.Therefore, a new product to be manufactured must be well thought out and experienced in small batch before full production starts.

    Submitted Feb 10, 2009 10:21 AM

  17. .Emem A. says:

    Cost Cutting Measures, a very daunting topic especially for businesses in developing economies. We are a consulting firm currently working with a client in the courier business in Nigeria, who are about the 6th in the Industry. Presently we have gotten to the implementation stage of the 5 year strategic plan we designed for them, and the MD is talking cost cutting. The idea of cost cutting that we seem to be passing on to the management of this highly bureaucratic PLC is laying of unproductive and stubborn staff. But when we return to our office and are discussing this firm, we always come to the conclusion that the management is still the problem. This we have communicated in the most diplomatic way we can. At our last meeting we discussed organization wide cost cutting measures, and we could clearly percieve that management understanding of cost cutting is just for junior level staff, as long as you dont triffle with managment comfort. It boils down to financial leadership. Its easy when you are a sole entrepreneur or a small coy, but for relatively large organizations its a maze of politics and insincerity.

    Submitted Feb 27, 2009 3:30 AM

  18. .Antonia H. says:

    Patrick F,

    I've just read your post of Jan 30 and wonder how things are going for you and your employees.

    Do you meet regularly one on one with your employees? Of all the things they could be doing, do they know which are the few things they should be doing? Employees need to take responsibility for their own performance - setting goals, reviewing successes etc - but as their boss, you can establish a simple routine of frequent, interactive meetings to focus them on the right outcomes. It's a worry if it's just by luck that your admin's priorities meet your own ... your paralegal who brings home the bacon from time to time may also benefit from clear targets to ensure sustained performance. Setting clear expectations is critical.  

    It can also be helpful to identify your employee's strengths and play to them rather than beating your head against a brick wall to get them to do things that are just not well suited to. Finding out what makes your nurse lawyer tick (how she thinks, how she relates to others, and what motivates her) and using this knowledge to your firm's advantage, by tailoring work to suit her style, may counter any effects of her difficult personality. Of course, this can be difficult to do in smaller businesses, as we all have to do things that don't stimulate us, but the goal is to do a bit more of what we're great at and a bit less of what we're not - the resulting increase in engagement and productivity speak for themselves.

    Good luck.

    www.bluedot.co.nz

    Submitted May 6, 2009 7:05 PM

  19. .Joseph S. says:

    There is a new way to reduce operating expenses by 20% or more by using IMPACTE's ABM management tool goes against all of the conventional wisdom of the management text books by defining quality as conformance to requirements in every function of an organization.  We have introduced IMPACTE to several of our small biotech companies.  Once seen in action, thier employees have embraced the technique and find they have more time to plan and strategize.  For more information on IMPACTE and the ABM management tool, feel free to contact me at ensign.pulver@comcast.net.  This tool is only for companies who are serious about thier business and not feint of heart.

    Submitted Jun 8, 2011 2:38 PM


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