AlastairThomson.com

Any idiot can cut costs. And plenty of idiots up and down the country, up and down the country, do exactly that.

There’s no great mystery to the process.

Someone fires up an Excel spreadsheet. Often an accountant. (Sorry…! Although by far the worst instance of this I’ve ever seen was done by an engineer.)

They slot in a much-reduced revenue number on the top line to reflect the downturn in business. Then they scale down all the costs by a fixed percentage until they get the profit number they want in the bottom right-hand corner of the spreadsheet.

Department managers are told to “work smarter, not harder” and “cut out the nice-to-haves and only leave the need-to-haves”, alongside a range of other patronising homilies. After all, it’s not like most managers haven’t been doing exactly that for a decade or more already.

Still, if you add in some draconian penalties for failing to meet a cost reduction target, you’ll probably get the costs down to something like the number you asked for.

Hurrah…time to break out the own-label cola to celebrate! (The champagne budget was cancelled back in 2005. And brand-name soft drinks in 2013.)

All is not what is seems

Scratch the surface a little, though, and you’ll almost certainly find that the financial target has only been met by taking some very short-term decisions.

·        Anything that didn’t absolutely need to happen to keep the factory producing gets cancelled.

·        All the experienced, long-serving, knowledgeable, relatively well-paid staff are eased out and replaced with trainees and juniors who mean well, but don’t really know what they’re doing.

·        Marketing budgets are slashed, along with training. And, naturally, the coffee and biscuit budget for your management meetings.

But, more likely than not, you’ll hit your target bottom line profit number the first year you try this.

However, you’re not out of the woods yet.

It’s just as likely revenues won’t bounce back as quickly as you thought (see above under “marketing budgets slashed”). So, as the months go by, it becomes increasingly clear you’ll have a similar problem next year to the one you thought you solved this year.

Out comes the spreadsheet to repeat last year’s winning strategy. Costs are reduced through the magic of Microsoft Excel again. Targets are set. The accountants (or engineers, sometimes) wait eagerly for last year’s success to be repeated.

But by month two of the new financial year, panic is flowing through the executive corridor. The “magic spreadsheet” isn’t working as well this year as it did last year.

It shouldn’t be a surprise…but often is…that once you fire your expensive staff and replace them with trainees on half the salary, you can’t fire the trainees the following year and replace them with someone on half the salary again.

That’s a one-time financial sleight-of-hand, not a sustainable solution.

An Excel spreadsheet makes contact with the real world

If, by some miracle, you nurse your machines through 12 months without any big repair costs, I can almost guarantee some big repair costs are just around the corner.

And if you haven’t been training your staff, your customers have probably noticed by now and are starting to try out some new suppliers to see if their quality is any better than yours.

As an extra bonus, it’s usually about now the organisation discovers that not all costs can be scaled down by 10% year after year.

The rent and property taxes on the factory stay the same irrespective of how much revenue you make. Microsoft are not going to give you a 10% reduction on their Microsoft Office licence fees. And, if you buy commodity products (steel, oil, aluminium, etc), good luck trying to get those at 10% off the current market price.

So what can you do instead?

The only sustainable answer is something I call Smarter Cost Cutting.

The 7 different types of cost in your business

Smarter Cost Cutting is a way of looking at your cost base as being made up of seven different types of cost, each of which needs handling differently to deliver the biggest bottom line impact.

Those seven different types of cost are:

·        Things you buy to sell on (cost of sales items)

·        Overheads to run your business (rent, utilities, etc)

·        Process costs

·        Framework costs

·        Outcome costs

·        Finance costs

·        Opportunity costs

In future articles, I’ll break this approach down a little bit further.

For now, though, the main takeaway is that dumb cost cutting – the sort of cost cutting people do with a spreadsheet and a “reduce by x%” formula – doesn’t work. Or at least not in anything other than the very short-term.

For long-term success, you need to look at your cost base through very different eyes.

And guess what? You probably save more money in the short-term with smarter cost cutting than with dumb cost cutting too.

What’s more, your “savings” won’t come back to haunt you next year when you need to fund a big repair bill in the factory or reactivate your long-neglected marketing campaigns.

We may live in uncertain economic times but, despite what the numbers might say in Microsoft Excel, short-term cost cutting strategies are unlikely to be your saviour.

This post originally appeared on LinkedIn