Cutting costs may not improve profitability

When faced with a demand by the chief executive officer (CEO) to cut costs, what should the head of corporate income do? Whenever profits are reduced, or the business makes a loss, one of the initial actions is to “cut costs”. While this is understandable, this demand can frequently be taken without thought, other than that reducing expenditure might improve profitability.

Hurried and simplistic actions across a company, in response to reduced income and profits may have other unforeseen consequences, which may not be beneficial. If income is down, a panic response of cutting costs can often ignore the real reasons which may be revealed by asking the questions; has the market changed, what is effecting demand, is there a problem with the product, and is the sales strategy and operation effective?

Executives responsible for the production of corporate income should be assessed on the amount of profitable income they produce and the efficiency with which they produce it. Therefore, the objective of these executives should always be to maximize profitable income while minimizing costs and the use of assets.

Before initiating cuts in expenditure, it is essential to understand where costs and investments are incurred and how they contribute to producing profitable income. Businesses may consider themselves to be lean and efficient, but expenditure tends to increase over time for no apparent growth in contribution to profitable income. For this reason, all expenditure should be continually monitored, and closely managed to ensure that all costs and investments are used efficiently, in order to maximise profitable income.

If you believe that your organisation is as “lean and efficient” as possible, – then how do you know? Can you prove it? Continual performance measurement is essential if management decisions are to be made on factual information, rather than “gut feel” or assumptions.

All activities involved in getting and retaining business should be continually monitored regarding their costs, benefits and contribution, in order that they might be effectively managed, but the question is – are they? Is there a clear understanding of all those activities which although they do not in themselves produce income, such as advertising and promotions, are important contributors to its production, by the anticipation and satisfaction of customer requirements?

Here is why this is important:

* Without a clear understanding of where costs and investments have to be made, it is difficult to develop a functional  strategic plan
* Without a functioning strategic plan, it will be increasingly difficult for managers to make the right decisions
* When managers cannot make sound decisions, production efforts can become disjointed and not-effective
* Production efforts that are disjointed and not-effective will increase costs and reduce profits
* Therefore, it makes sense to have a clear understanding of the costs and investments associated with all the activities involved in anticipating and particularly satisfying customer requirements.

With this information, the head of corporate income is in a position to identify and make cost savings from where there is waste or inefficiency in the system. Having a lean and efficient operation for producing profitable income for the long term, they are in a position to make a detailed account of how costs and investments are used and to what effect. Thus they are able to show precisely how cuts to expenditure and investment will effect the production of income and the potential consequences that will result.

Performance measurement is an essential tool of management, by enabling decision making to be based on quantified rather than qualitative information. Ultimately, the CEO may insist that cuts are made to costs and investment, so that the head of corporate income has no option but to comply. However, in such a position the executive should be able to outline the consequences of such actions, so that senior management are under no illusion of the consequences of their decisions, particularly as to how they affect the ability to produce the required level of sustainable profitable income for the long term future of the business.

The call to cut costs may be justified, but is often a simplistic answer to more complex problems that are manifested by falling profits. Rising costs may result from a weak control of expenditure, or increased inefficiency through poor management which reduces profitability. But when falling profit results from falling sales, a reappraisal of the business strategy and operations is the right approach rather than a panic call to cut costs. Continual performance measurement of all related activates should ensure the head of corporate income is always able to justify expenditure and to show how its reduction is likely to affect income production.

© N.C.Watkis, Contract Marketing Service 24 Aug 12
Contract Marketing Service, (Profit Development Specialists)

September 3, 2012  Tags: , , , , , , , , , , ,   Posted in: business development, business efficiency, Business Marketing, business performance improvement, business performance indicators, business performance management, business performance measurement, Uncategorized

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