Tuesday, 30 July 2013

Managing Costs

A formerly profitable local business had started to lose money.  The owner was at her wits’ end.  The business had lots of good customers – in fact turnover had grown over the last year – but the losses kept growing.
She had tried various marketing initiatives and had even laid off some loyal staff but nothing seemed to help.  She was on the point of closing the business but first of all decided to take further professional advice.

The main problem was identified to be her reduced gross margin.  It became clear that in expanding the business she had lost touch with purchasing and pricing, which were now done by employees.  Installing new processes, controls and performance measurements meant her staff could run the business profitably.
In a nutshell, what was lacking was cost control.

Why is cost control critical to business success?

- Reducing costs is the easiest way to improve profitability
  • Assume 40% gross margin and 10% net margin: to grow net profits by £1 requires £2.50 of additional sales – but only £1 of cost savings. Cost savings go straight to the bottom line
- Constantly focusing on sustainable cost reduction forces innovative efficiency measures. If you aren’t doing this you may be being left behind by your competitors. If they aren’t then you will build a competitive advantage

 How do you control costs?

- The start point is a budget which sets out what you expect to spend on any line item

- Individual budget holders must have achieving budget near the top of their annual objectives

- This budget must form the basis of your monthly management review, where actual expenditure is compared to planned

- Overspends must be identified and explained, with appropriate remedial action initiated

- Annual budgeting (or a decrease in profitability) should be used to review key cost drivers and identify steps to reduce them
  • Productivity
  • Utilisation
  • Supplier choice, terms and management
  • Product or service design
  • Organisational structure
  • Automation and processes
  • Outsourcing
  • Standardisation and off-catalogue purchasing
  • Customer, product or market profitability
- Build a culture of cost control and commercial awareness

 A word of caution

- Relentless attention to costs is a good thing but it must match your wider strategy
  • If you compete on stock availability and breadth of supply then you would need to exercise caution when reducing stockholdings
  • If you compete on product quality you would be foolish to continually source the cheapest components

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