In my last blog, (February 2017, http://localhost/osborne/the-bottom-line-on-product-pricing/) I discussed the impact of increasing prices and how much business would have to be lost to be less profitable than if prices had not been raised. For example, if your contribution margin or gross margin is 25% and you increase your prices by 12%, you would have to incur a 32% reduction in volume before profit is reduced to the previous level. In other words, you would have to lose over 30% of your volume.
In any business, for each dollar of sales, there is only a small percentage of the dollar that ends up as profit. However, if a business can reduce expenses and not affect quality or customer service the full amount of the reduced cost ends up as profit. In most businesses, there are so many factors that can have an impact on profits it is difficult to determine whether a major marketing thrust should be undertaken to improve sales and profits, or a concerted effort undertaken to reduce costs. A major marketing thrust could increase expenses more than the profit realized on the increased sales.
Reducing costs will increase profitability. But, management must ensure that the cost reductions do not impact the quality of their services or the quality of their products. Costs that reduce customer service or product quality can result in reduced sales volumes and then overall profitability.
All businesses should have a stringent cost-control system in place at all times. Costs that are not controlled will normally increase over time and before an entity realizes it, they have lost some of their competitiveness. Some manufacturing companies have an individual or a team constantly looking for ways to reduce costs.
Some approaches to cost control include:
- Budgets. Budgets that have carefully forecast each expense will reveal monthly costs that are above expectations. These expenses can be individually analyzed and appropriate actions taken.
- Policies. Policies that ensure two quotations for new supplies or repairs and maintenance can effectively control major expenditures. Quality is always problematic as it is difficult to determine ahead of time the quality of the service or product until it has been received or used. Repair parts from Asia, although cheaper, have often lacked the quality of locally produced parts.
- Benchmarking. Finding similar businesses and comparing costs can be very helpful, especially in areas of product wastage, electricity usage etc. E.g. a grocery store might have significantly more electrical and utility usage than a similar store depending on the many factors that can impact electrical, gas and water usage. Firms that specialize in energy conservation (Renteknik Group Inc., ECNG Energy, SHIFT Energy and SGS Canada, to name a few) can be contracted to analyze electrical and energy efficiencies and recommend and install cost saving devices or equipment upgrades. These companies have benchmarks for motor efficiencies and can identify where power is being wasted. Similarly, there are companies that can analyze your general administration expenses using their in-house benchmarks to determine where savings can be achieved. Firms such as Expense Reduction Analysts and Woodington Partners Cost Management will review your expenses and recommend ways to reduce costs. I have used these firms in the past and each time they were able to save the firm considerable monies. One firm realized an ongoing yearly cost savings of $250,000. They don’t charge for their services but contract a percentage of the cost savings.
- Eliminate duplication, over capacity, unused telephone lines and leaving computers on after hours.
In any organization cost control must be uppermost in managing for efficiency. Finding and eliminating waste is a constant battle.
John Alton
Financial Management
Visit osborne-group.com for other ideas and opinions from our Principals on a range of topics. Their views are their own and do not necessarily represent The Osborne Group’s perspective. The Osborne Group provides interim executive management, consulting and project support across all sectors and over a broad scope of service areas.
