Traditionally, finance professionals use fixed costs to model the impact of increased sales or productivity (the “variables”) on overall financial performance. Technically, fixed costs should not change within the relevant period and more so, in the short term. However, in any downturn, we see businesses challenging the essence of this assumption. Any crisis raises the question of whether costs can be truly fixed.
What fixed costs can be reduced?
A recession is a great excuse to trim the fat that always creeps in during times of plenty. However, businesses that use a lens of value-add and customer service are much better positioned to determine what costs can be cut without harming the business.
Based on my experiences and observations of various organizations, I would like to share a few tips while challenging and reducing these fixed costs.
There are several expense categories that should be investigated further when thinking about reducing costs:
- Payroll and benefits
- Supplier relationships
- Cost of operations and value creation
Payroll and Benefits: alternative strategies and laying off decisions
These are typically one of the largest expenses, and reduction here to match associated revenue can result in significant savings.
Since cutting payrolls and benefits is a sensitive decision, organizations need to consider several alternatives such as
- shortened workweeks
- unpaid leave of absence
- temporary salary reductions
- revamping benefits or salary packages
- temporary economic unemployment especially in countries that have a strong social safety net.
Each of these alternatives has its own benefits and drawbacks. Also, they can be used in a combination. The main thing is that employees should feel that they still matter to the company and haven’t just been abandoned or forgotten about.
If neither of these alternatives is possible, organizations have to think carefully about permanent reduction in workforce. When having to make laying off decisions, several things should be kept in mind:
- consider market and organization dynamics that have a long-term impact on the business
- recognize that the cost of losing talent is much higher and replacing an experienced employee when the economy improves may be far greater than the cost to the current payroll
- when a decision is made, be generous. Celebrate your employees’ accomplishments and treat them well. They will be ambassadors for your company and their feelings about the person and company that laid them off matter.
Supplier Relationships: negotiate the contract terms
Building a good relationship with your suppliers should be an axiom to live by - especially when you are all in the same boat during a recession. However, there are also several recommendations that could be followed:
- do not neglect the importance of renegotiating contracts, resolving conflicts and protecting the future of both parties.
- do not get defensive – rather be curious, ask questions, and seek to understand what’s happening in their business. The more information you can gather, the faster you will be able to create a viable solution.
- renegotiate for the long term – try not to limit clauses by qualifying their validity.
Outsourcing: getting from fixed to variable costs
Continued technological advances have made it possible to outsource a wide range of functions including HR, customer service, and data analytics (much beyond the traditional outsourced functions of IT and Finance).
Outsourcing should not be overlooked. This can easily turn a fixed cost into a variable one.
Cost of Operations and Value Creation: main steps and considerations
Cost of operations and value creation are also an important part of the cost reduction strategy. There are a few recommendations that can be considered:
- ensure that you are making and buying the right products
- check if you are eliminating waste
- tailor your operations to end customer needs
- consolidate suppliers if this can help save cash and resources
- look for areas where value is being created or destroyed
- identify the true profitability of key products or product groups
- check for the reasons why the business is wasting money on some products
- optimize your manufacturing footprint to serve the global/regional market
- try to find ways to supply the customer at the lowest cost without compromising the service quality
Culture: cultivate the right mindset
This is the most important piece of cost management. I know of organizations where employees took ownership and pledged to reduce cost at their respective levels irrespective of their function. They responded as if they were running their own business. By approaching it from this grassroots level, costs were challenged at each step.
Is the organization culturally prepared and evolved to make a long-lasting positive impact on the business while pursuing these cost reduction measures? How can we develop an inclusive culture that shifts focus on cost optimization mindset at an individual level instead of just at the executive level?
The realization that every single employee controls some element of cost is the first step in creating that mindset. Organizations can implement programs around building this mindset and embedding it deep within the organization. I recall an instance where all the delegates to a big sales conference were asked to bring their own notebooks/pens. That single request saved the company thousands of dollars due to the differential rates the hotel was offering.
Even when focusing on extreme cost reductions, organizations need to relentlessly focus on growing and gaining market share, ring-fencing their strategic investment and keeping their people motivated.
I am sure organizations that look at fixed costs from this perspective will be more resilient and emerge stronger.
Note: The views and opinions expressed in this article are those of the author and do not represent those of the people or organization that the author may or may not be associated with in professional or personal capacity, unless explicitly stated.