If you run a business, of course you want to run it at the lowest possible cost relative to the income you receive. That way the difference between the two – your profits – is as high as possible.
As an objective, that’s fair enough. But you’ve got to know what you’re doing because it isn’t as simple as it sounds.
That’s because too many people focus on just one element of the picture and ignore their real purpose.
You see, the objective of any business is not to reduce their costs as low as possible.
It’s to make as much profit as possible.
They sound like the same thing, but they’re not. There’s a false equivalence at work here.
So if you want to know how to put as much profit as possible on your bottom line, keep reading. I’ll share some of the common misconceptions and show you a better way of getting the results you want.
Cheap
I guess we’ve all worked for cheapskates at one time or another. I certainly have.
But let me ask you this – how come none of the cheapskates you worked for have built a multi-billion dollar business?
Sometimes you find cheapskates running multi-billion dollar businesses once they get to that size. But it’s rarely how someone builds a multi-billion dollar business.
Once you have a multi-billion dollar business, there can be an argument for chasing down the efficiencies that open up due to economies of scale kicking in, or volume discounts for buying larger amounts of goods and services. But that’s very different from building a business through being a cheapskate.
There are a couple of reasons for this.
1 – Your customers
Ask your customers if they want cheaper prices or not, and they’re likely to say yes.
However, unless you’re selling to cheapskates – which, by and large, is a terrible economic model – that’s not what they really want. What they want is good value, not necessarily the lowest price.
Putting any other consideration aside, though, training your customers to always buy the cheapest isn’t all that smart, because one day the cheapest provider won’t be you. But if you’ve been trumpeting about how cheap you are, all you’ve really done is lay the groundwork for someone else to sweep in to undercut you.
Focusing purely on reducing your costs, and passing on those savings to your customers to win their business, also limits you to the 10-20% of any market who are dyed-in-the-wool cheapskates who will always buy the cheapest, no matter what.
The other 80%+ of the market won’t come near you with a bargepole.
And sure, some people cycle into being cheapskates and cycle back out again so there’s churn which can give the impression of more people buying from your business. But over time, you’re limiting your target market if being the cheapest is all you’re trying to do.
That’s because, once you’ve been around for a while, you get tired of buying cheap things that break and trade up-market as and when you can afford it.
And customers can smell a cheap operator out dead easy.
In my career, I’ve found that any firm which has a reception area about as welcoming as the visiting room at a maximum security prison is almost certainly cutting corners in their production in order to be the cheapest, without thinking that I might want something else as well, like product quality, longevity, or reliable after-sales service.
To confirm my opinion, I usually ask to visit the gents. If that also looks like what you find in a maximum security prison, I’m very unlikely to buy from you. If you treat your staff that badly, it’s too a big stretch for me to believe that you’re likely to look after me and my business any better.
Sending out messages like “we’re cheap as chips” to your customers – either explicitly in your marketing or implicitly in the state of your factory toilets – is something only a minority of customers want. And even those are fickle – off like a shot if they can find someone to do something similar for a penny cheaper.
2 – Your bottom line
There’s an old saying “buy cheap, buy twice”. There’s usually nothing more expensive than buying cheaply, and sooner or later, most people work that out for themselves.
Rather than buying a quality product that last 5 years, some people buy a product at half the price that stops working the minute the 12-month guarantee period runs out. So you need to buy another one, and so on.
By “buying cheap” at the start you’ve spent 2-and-a-half times more over that 5 year period than you would have spent by purchasing the higher quality product.
As an aside, this is one reason government spending is so wasteful. It’s not actually because they’re deliberately wasting money (at least not most of the time). It’s because they’re spending 2.5x the amount of money they need to spend over 5 years because their only purchasing decision has been “who’s the cheapest?”
Yet, many businesses fall into the same trap, falsely equating “low price” with “good value” when it’s often the exact opposite.
That’s why every cheapskate business I’ve come across has to pedal twice as hard to keep the show on the road as other businesses in the same sector. They’re always the people who pay their VAT late and worry about making payroll this week.
It takes a lot of time, nervous energy, and (ironically) money to run a cheap business, even though purveyors of more simplistic business strategies would have you think otherwise.
Even if the product you sell is nominally cheaper per unit to produce, you need a bigger complaints handling team because your low-quality products break more often, you’re probably sending out more rush order replacements for products which don’t work as intended because corners were cut in the manufacturing process, and your accounts team is larger than it needs to be because of all the credits and reinvoicing they have to do.
The hidden costs of being cheap are considerable.
Cheaper
If you find a thoughtful analyst or two…or have a (ahem!) superstar CFO…you can work out the areas where being cheap is costing you money and take some different decisions.
That probably won’t give you all the upside, but at least it will stop the downside leakage for your bottom line of having to express-ship replacement products which broke in transit due to someone deciding to save 3p on the bubble wrap which used to protect your products inside their shipping boxes.
For the upside, though, you need insightful managers who can join the dots in a way that most managers can’t.
Most managers have a very narrow focus on their metrics and don’t much care what happens as long as they hit their sales targets or their production quotas.
At some level this is understandable, but let’s face it – your business runs on bottom line profits and cash flow. Whether or not the operations director has met their production quota is an irrelevance.
Tractor factories in Soviet Russia always met their production quotas and their economy still collapsed.
However you, as the leader, need to be comfortable with the trade-offs required to make this work.
If you continually hammer your production director for not meeting their quota, when the reason is that they had to stop the machines and make urgent repairs to save the next batch being made for your biggest customer being returned as sub-standard, then don’t expect them to manage the bottom line for you. They’ll focus on their quota to the exclusion of everything else, including your bottom line.
Some people take to this style of management better than others. By and large, people from a large company “managing by the numbers” background find this difficult, even though being able to make intelligent trade-offs is one of the most important ways someone in a management role can add value to the business.
While they won’t always make the right calls, if the company mindset is that you expect managers to make intelligent trade-offs – or at least trade-offs that appeared smart and thoughtful at the time the judgement was made, irrespective of whether or not it ultimately turned out as intended – then your wins will far outpace your losses over time.
Your managers will make “best value” decisions, not “lowest cost” decisions.
Your customers will probably pay more for better quality and more reliable products.
You won’t be funding the cost of failure any more (eg returned products and customer service complaints) – those savings flow straight to the bottom line, outpacing any additional costs you incur usually.
There is an art to this though. In the same way as buying something cheap can be a very expensive decision, so can buying something expensive, if it’s only really a shoddy product with a fancy price tag.
And occasionally the increased cost isn’t worth it. If a product lasts 10% longer than others in its industry, but costs twice as much, all things being equal, that isn’t a good value decision.
That’s why you need smart people who can make the trade-offs necessary to add to the bottom line, not just plough their own furrow to the exclusion of any other consideration…even if that isn’t in the company’s best interests.
And it’s also why you need to support those smart decisions, even the ones that don’t work out (as long as they were smart at the time the decision was made) or people will drift back to just looking after their own furrow and not come out again for a long time.
Cheapest
While the cheaper/best value strategy is better for your bottom line than the cheap/lowest cost, there’s another way of running your business which is often even better.
That’s because in the “cheaper” strategy nobody in the business, apart from the managers, is doing anything different to the “cheap” strategy. If I’m running a machine or making sales calls from the call centre, I’m just doing whatever I was doing before. It’s just that, now and again, my manager tells me to start doing this or stop doing that.
But that usually comes with a significant management cost.
Now, when this is done well, the extra management cost saves the organisation more than the cost of employing the managers, so there is plenty of upside for the business. But that’s not always the case, so you need to remain vigilant.
There is another way to run your business, though. When this works well, it’s the cheapest way of all to run your business, but it does require you to employ high-calibre people – not necessarily outrageously expensive people, just people to the middle-to-top end of the market rate salary bracket for the job your hiring for.
Here’s what you need to do:
1 – Structure = cost
Every time you see a management structure, you need to see cost. While the focus in most businesses is on line-worker productivity, you need to think about your management team in the same way.
It’s not a cast-iron rule, but I’ve seen a lot of businesses which could operate with half the managers they have and be no worse off than they are today, pocketing the saving in extra cash on their bottom line along the way.
However businesses think that when they get to a certain size, they need to employ an HR Manager or a Quality Assurance Manager or a Finance Director.
There are times when all those decisions can be good decisions, but they can also be bad decisions. One of my proudest moments as a CFO advising a growing business was talking them out of hiring an HR Manager for their 10-person start-up and hiring another salesperson instead, at a higher salary than they were prepared to pay for an HR Manager.
Now, these were lovely people, and their hearts were in the right place. They’d read all those articles in business magazines about the importance of people development in any successful business and thought they should do the same “because of the amount of time we spend on people”.
The reality was they just needed to get rid of a particularly difficult member of staff and “the amount of time we spend on people stuff” reduced to almost nothing in just a couple of weeks.
When you think about bringing in more management resources, you need to ask yourself if you’re just papering over a problem – in this case employing someone to spend their working day having someone moan at them constantly, instead of the bosses having to do it – or if you’re really taking the business forward.
In this case the additional cost of the additional management structure was taking away from the bottom line, not adding to it.
That’s because management structure equals cost – unless you can see an RoI on that cost, you’re probably better off not employing someone in the first place.
2 – Process = cost
In the same way as management structures increase costs, so do business processes.
Now, I know what you’re probably thinking – but we implement business processes for increased visibility, transparency, and efficiency.
And that’s what people who obsess about business process management will tell you.
Sometimes it’s true, but more often it isn’t.
What you actually do every time you implement a business process is that you set a “floor price” that whatever you’re doing can’t fall through.
Which is bizarre, because you’re trying to add to your bottom line, so the last thing you want to do is set a floor price which ensures you can, beyond a point, never do an activity at a lower price than you do now.
When I ran a 1,000 person call centre operation, we discovered that when we asked all the questions we needed from a caller in a certain structured process, calls took significantly longer than when we just let the caller talk in any sequence they wanted and just noted down what they said in the relevant part of the online form the call centre agent filled in.
With a structured process, calls took about 3 minutes.
When customers gave us the information in the order which suited them best, calls were often less than half that amount of time. (Full disclosure: sometimes calls were longer too, but they were much rarer than the shorter calls, which meant we were net winners overall.)
If you want to run a business at the lowest possible cost, you might need to give up some of the processes you currently use as they are effectively “inking in” a minimum level of cost you will never be able to go below.
3 – Decisions = cost
Every time something has to go to another person for a decision, you’re building in cost.
At the very least, there’s the time your staff member spends explaining the issues to whoever needs to make the decision. Sometimes there’s some negotiation, a bit of to-ing and fro-ing as well, some additional information required, and so on. All of which increases the time spent, and therefore the cost, of that decision.
There’s another cost too. If your customer is waiting an extended period of time for a decision, the likelihood is they’ll probably shop elsewhere next time they need whatever you’re selling.
Life is too short for someone to wait 48 hours to find out if they can have something you sell in blue instead of green.
So you want as few touchpoints as possible beyond the first person who encounters an issue in your business. You need to give your people some leeway to make decisions so they don’t need to refer on to someone else to get an answer.
That’s especially true when the answer is obvious or largely predetermined.
Back in my days running a call centre, we did a study and found out that (based on their salary costs) if we let a call centre agent give a customer an answer that cost us about 50p. If they referred the decision to their manager, that cost £5. And if the manager referred it to a director that cost £50.
It might not surprise you to learn that the vast majority of the time, the decision a director took to rubber stamp something was the same “obvious” or “predetermined” decision a call centre agent could have given. We just spent £50 making that decision instead of 50p.
I don’t know about you, but spending 100x the cost to get to the same answer doesn’t immediately sound like the best strategy for building the bottom line of any business.
So we gave call centre agents much wider parameters for making decisions on the spot which saved up the majority of the extra £5s and £50s we had been spending previously.
The parameters are key, of course. We didn’t want a call centre agent committing the business to a £1million refurbishment of a customer’s warehouse just because one of our truck drivers had scuffed some brickwork while reversing into the customer’s loading dock.
However, could the call centre agent process a refund because the goods hadn’t turned up as promised without referring that decision up the line? Of course – what was the director going to do, tell the call centre agent that Mrs Smith was lying about the late delivery even though they had never met or spoken to Mrs Smith?
And did we have a few Mrs Smiths who called up a little too often to complain about a late delivery in the hope of getting a refund. Of course we did, but when the call centre agent fired up the customer record, anyone who had a history of multiple refunds was quizzed much more closely than someone who previously had a “zero refund” customer record.
In either scenario, we relied on the call centre agent’s judgement, using their 1:1 conversation with the customer and their customer record to guide their decision. However no better decision was likely to be taken if the manager (£5) took it or the director (£50) took it, instead of the call centre agent (50p) taking it.
If you put your mind to it, there are a remarkably large number of activities in your business that don’t need expensive organisational structures, rigid processes, or drawn-out decision-making criteria.
Every single one of those adds cost to your business.
Throw together a penchant for always buying the cheapest, irrespective of quality, and thinking that an increase in management, rigid processes, and complex decision-making criteria will always have a positive RoI, I’m here to tell you that’s almost never the case.
Control freaks can’t run businesses with a minimum of management, processes, and decision-making, but you need to ask yourself – would you rather be a control freak or would you rather run a highly profitable business?
The odds of anyone doing both of those at the same time are vanishingly small.
The choice is yours.