If there’s one common denominator between businesses I’ve seen in trouble over the years, it’s this.
They see “increasing profits” and “reducing costs” as the same thing.
But, in general, they aren’t.
That doesn’t mean you should spend recklessly and not care about your cost base. Very occasionally I’ve seen that in organisations too, and the outcomes tend to be no prettier.
However, by far the bigger problem is those organisations who mistake “reducing costs” for “increasing profits”, and think they are the same thing.
One doesn’t necessarily lead to the other. In fact, it’s not uncommon for reducing costs to also reduce profits. The exact opposite outcome the theory suggests.
I say “theory” because it’s just that. An unproven concept which has nonetheless received a remarkable amount of traction in the business world. It’s about as evidence-based as the Flat Earth Society, and its adherents are no less evangelical.
Yet, when you stand back and look at the big picture, in the same way as the Earth is clearly a ball-shape, the “cutting costs = increasing profits” belief system is built on no less flaky a foundation.
Broadly, there are three main reasons for cutting that mental umbilical cord between the “cutting costs” and “increasing profits” concepts.
1 – Revenue is not fixed
For the vast majority of businesses, revenues are not, in fact, fixed. They might be fixed in your mind – “oh, we can’t charge more than £X, because that’s what our competitors charge” or “there is no way anyone would pay more than £X for a product like ours”, for example – but that doesn’t mean what you can charge for your products is actually fixed.
Unless you work for a regulated monopoly with a legal price capping mechanism, you can charge what you like for what you sell. That’s free enterprise, baby.
Everything you buy, I guarantee you, has a more expensive version of the same thing being sold very successfully by someone else.
You can have own-brand Value cornflakes. Or Kellogg’s version of the same thing. And there’s probably a Harrods version too. And maybe even a more expensive version than that, for all I know…whatever movie stars buy in Beverly Hills, probably.
They’re all cornflakes. They all have different price points.
There is a little mental flip you need to make, though.
It’s reasonably likely, albeit by no means certain, that you’re getting paid as much as someone might want to pay for whatever you sell now in the way you sell it now.
So if you want to get paid more, you’ll need to do something different in your business – build in more value, provide a better service, or increase some element in your product that customers would particularly value.
But it can be done.
Take Skoda cars. In the 1980s they were seen as about the worst car you could buy (assuming you couldn’t find a Lada). Yet now, they are incredibly smart-looking, well-made cars that sell for many times what an equivalent Skoda family saloon would have cost in the 1980s.
They worked out a way to be able to boost their revenues by doing things differently – very differently, in their case…helped, admittedly, by the takeover from Volkswagen – and look at them now!
I’ll admit that took them 30+ years. But if you focus more on your customers, more on delivering value, and more on improving your services, odds are you can make changes much faster.
Within 3-6 months, depending on your business, you should start to see things move in the way you want them.
And the great thing about working on the revenue side of the equation, is that the sky’s the limit in terms of your ability to boost your bottom line. Whereas it’s mathematically impossible to cut your costs below zero no matter how hard you try.
Given a choice between spending time working out how to increase revenues by 5% or cutting costs by 5%, the former is likely to impact your bottom line much more positively than the latter. And it won’t necessarily take longer or cost more.
2 – “Cost shifting”
I don’t know if that’s a proper term or not, but I use “cost shifting” to describe the impact of cutting costs in one place which results in increased costs somewhere else in your business, often outweighing the original savings made.
Consider this. It is possible to shave a few pennies off the cost of the parts you buy to make the products you sell?
Of course. Those savings are easy to see and simple to “bank”. No doubt someone gets a bonus or a pay rise for the great job they’ve done.
But what if that decision made your products even just a little bit less reliable?
Soon, you’ll find yourself giving your customers their money back more often than you used to.
Your customer service team will need to expand to deal with the increased volume of complaints.
Your factory will lose productive time because they’ll be remaking, for free, products which have failed at the customer end and thereby missing out on the opportunity to use that time to make more products to sell and generate incremental revenues.
Your customers will be less likely to buy from you again, your online ratings will probably decline, you’ll get fewer referrals, and you’ll probably come under price pressure as your customers start to balance off their costs and compensate themselves for the extra hassle of buying from a less reliable supplier.
Almost always, the downstream consequences of this pile of dominos toppling over are vastly greater than any supposed up-front savings. There are very few more expensive ways of running a business than that.
Same applies if you’re a service business. If the cheaper hairdresser you employed makes a right mess of one of your regular customers’ hair, the consequences are exactly the same.
None of those outcomes are good options for your bottom line.
3 – Sometimes, spending more increases profits
I know this is very counterintuitive, and I’ve met people with fancy degrees who can’t wrap their heads around the concept, but sometimes spending more increases your profits rather than reducing them.
Take the example above and reverse the chain. If you increased spending on that component to buy a higher-quality part that didn’t fail so often, you’d save the customer credits, customer service calls, re-work costs in the factory, negative impact on your company’s reputation and so much more.
I did exactly that earlier in my career to turn a loss-making business into a sector leader in profitability.
But that’s not the only way spending more increases profits.
In the same business, we had a bottleneck in production part-way through the manufacturing process which meant the factory as a whole wasn’t producing at maximum capacity. We could only produce to the maximum amount we could get through the bottleneck.
So we spent money on extra equipment so that all stages of the production process had a broadly similar hourly throughput.
At a stroke, that increased the productive capacity of the business as a whole by 20-30%, so we could sell about 20-30% more product.
However, because we were already paying everyone’s salaries, machine costs, energy costs and so on – apart from the relatively modest extra cost of that new equipment – we had no extra production costs. Everything was already paid for.
The most profitable work we did every day was to make the extra 20-30% we got “for free” that had previously been impossible to produce.
But there are many other examples, not even as dramatic as this. You’d be surprised what sprucing up your “front of house” can do if customers come to visit your business. Or upgrading your coffee machine for visitors. Or putting a friendly, empathetic person on your reception desk instead of a soulless tablet that asks you to put your name in to notify the person you’ve come to see that you’ve arrived.
In a business that’s making profits, increasing revenues by 5% will almost always add more value to the bottom line than cutting costs by the same percentage.
The mystery
Why so many businesses don’t seem to get this is beyond me.
I will grant you that teaching people methodologies for cutting costs is really simple. Armed with a spreadsheet and a copy of a case study from Bain or Boston Consulting, it’s relatively easy to teach this and understand it.
But this is like saying that because it’s easier for 4 year-olds to learn to write in block letters, we should never teach them to write in cursive.
I’ve absolutely no problem with people “learning the basics” when it comes to managing costs in a business.
The issue I’ve got is that this consumes 90-95%+ of all the thinking time in most businesses because the really good stuff – the ways you can boost revenues – is given hardly a passing mention in our education system and in our corporate boardrooms.
As Abraham Maslow (the Hierarchy of Needs fellow) said, “If the only tool you have is a hammer, it is tempting to treat everything as if it were a nail.”
Cutting costs to the exclusion of looking at ways to boost revenues is just a race to the bottom. However cheap you can do anything, I guarantee someone else can work out how to do it cheaper, even if they’re not unscrupulous cutters of corners.
Working out where it makes sense to spend more to increase revenues and build your bottom line that way instead is a lot harder, I grant you.
Not harder to do intellectually. Often it’s easier.
But harder because you’ve got to overcome all the conditioning you’ve had throughout your education years and your working life which says cheaper is always better for your bottom line.
There’s rarely a more expensive way to run any business than to try to run it as cheaply as possible.