Archive for January, 2007

You will not cut yourself to greatness

January 17th, 2007

There are two ways to view an expense. One is to consider it as a cost and the other is to see it as an investment in a resource that contributes directly or indirectly to the revenue your business generates.

The cost perspective tends to invite us to think “reduction” whereas the investment perspective invites us to immediately ask the following questions: What is the return I’m getting for this resource – that is, how does it contribute to revenue directly or indirectly? What can I do to get better value from this resource? Should I be considering increasing my investment here? Is this a long term investment or can I expect to see a return in the short term? How is the effectiveness of our other resources impacted by this one? It is important to think of cost control not simply as cost reduction, but as resource utilization management.

No business can cut itself to greatness. Typically when people look at cost reduction as a basis for profit improvement, they quickly discover that there are relatively few things they can do other than look to deal with a lower cost supplier. The saying “you get what you pay for” is true and unless alternative vendors can match the total service you now receive, switching needs to be considered with caution.

One of the main reasons cost-cutting exercises rarely achieve the desired results over the long term is that the wrong criteria are used to determine what costs to cut. If you look at each line item on a P&L you should be able to classify each expense as “discretionary” or “non-discretionary”. Discretionary expenses are those that you can actually eliminate or reduce by means of a management decision in the short term. Non-discretionary expenses are those that you are contractually tied to or which simply can’t be reduced unless you closed your doors.

If you take a closer look at these expenses you’ll find that the non-discretionary expenses are the ones you must incur to produce this year’s revenue whereas the non-discretionary expenses are the ones you need to grow your business, that is, produce next year’s revenue.

When you cut expenses, more often than not you are limiting your future. To put that another way, a focus on cost cutting is going to keep you where you are and over time you’ll find you’re left behind by your competitors. The key is not to cut costs but to continuously perform a return on expense analysis (ROEA) and to implement process improvement initiatives to ensure that the get the most out of the resources your expenses are giving you.

This type of analysis, by the way, is an invaluable service you can provide for your clients.

The biggest cost of all. This is related to the above comments on cutting costs. The cost of the lost opportunity is by far the biggest cost incurred by most businesses, and because it is rarely associated with a transaction its impact is never known.

For example, the value to the firm of a client who left because a phone call wasn’t returned, the prospective client who never signed on because your firm did not appear to be any different to the rest of the pack, the team member who left because the firm didn’t listen to a grievance. You won’t find the cost of these sitting neatly on your P&L Statement. They will be hidden in the revenue that was never earned, in the write-offs that you have suffered and in lower levels of resource productivity across the board.