Reduce costs and grow profits–that’s a goal that business owners at any level can get behind.
But no business can operate (or grow) without some expenses. At the very least, it needs to purchase inventory, run payroll, and pay to keep the lights on.
It doesn’t take much for a business’s spending habits to slowly creep up and start eating away at profits–especially as it scales and issues corporate cards to more employees.
You don’t have to be a massive corporation to engage in cost-reduction strategies. Chances are, there are a few things you can start doing immediately to save money.
Below, we’ll cover what a cost reduction strategy looks like, how to make a sustainable plan for your business, and some best practices for cutting costs without detracting from the quality of your products or services.
What is a cost reduction strategy?
As the term suggests, a cost reduction strategy is a plan to cut back on spending and improve profitability.
Cost reduction is crucial for businesses because it can help you grow your competitive advantage, remain nimble, and maintain a strong financial position.
Reducing costs allows you to grow your cash reserves and have the funds available to take advantage of new opportunities before they go away.
Plus, it gives you a safety net that makes it easier to navigate volatile market conditions when they arise. Even in a downturn, you can have the peace of mind that you have the ability to meet short-term obligations like paying your employees and utility bills.
As a small business, it might seem like every cost or expense is necessary to support your operations.
Thus, a cost reduction strategy may not always involve completely eliminating certain costs. Rather, it could require finding strategic ways to get discounts and secure deals on the goods and services you regularly purchase.
Common areas for cost reduction
Reducing costs doesn’t have to be an all-or-nothing strategy.
Even small changes can make a meaningful difference on your bottom line and foster a profit-minded business culture.
Here are some of the common strategies to help small and medium-sized businesses reduce costs:
Supply chain management
You might be able to derive cost savings from your supply chain.
Review current contracts with vendors and suppliers, especially those that are up for renewal, to see where you could negotiate better terms and pricing.
For proper vendor management, you don’t want them to feel like you’re trying to lowball them or devalue their goods or services.
However, given your loyalty and the continued business you bring to them, you may have some bargaining power in long-standing partnerships.
Technology investments
It may seem counterintuitive that investing in advanced technologies and software solutions can help reduce costs.
However, these programs often produce a positive ROI, even if they require an upfront investment.
Specifically, automated solutions can reduce reliance on manual, time-intensive tasks, thereby reducing labor costs.
The cost reduction process
When establishing a cost reduction strategy for your business, focus on implementing sustainable changes that support the long-term success of your organization.
It’s easy to cut costs if you’re not concerned about how it will impact your operations, employees, or customers.
For instance, you could save a lot of money by not renewing the lease on your office space. However, this isn’t a practical solution that would allow business to continue running as usual.
Thus, you must be strategic about reducing costs to ensure you maintain high-quality service or product delivery.
The process to establish an effective cost-reduction strategy includes the following:
- Assess and prioritize spending
First, review your accounting records and financial statements to thoroughly assess your current spending and how trends have changed over time.
Get a clear understanding of your main cost drivers, and identify potential areas where you could reduce spending–including overhead, labor, materials, and more.
Prioritize the costs that could have the greatest impact on profitability.
- Collaborate with stakeholders
Before moving forward, speak with key stakeholders to get their input.
Employees at different levels in the organization may have a unique perspective on where you could save money or reduce waste, given their hands-on experience in the business.
Encourage them to share their cost-reduction ideas, which will also help you face less resistance when it’s time to implement changes.
- Set clear objectives
At this point, you should set some clear goals for your cost-reduction efforts. For example, you should define a certain dollar amount or percentage that you’d like to reduce costs by, and the specific costs you’re targeting.
It’s important to set a concrete objective for your strategy; otherwise, it will be hard to gauge the success of your efforts.
Plus, if you just set out to simply “cut costs”, with no quantitative value attached, you might not make the meaningful impact on profitability that you were hoping to achieve.
- Take action
With the planning phase out of the way, you can begin to take action on your cost reduction strategy.
This step will vary depending on the type of costs you’re trying to reduce and by how much.
This might include streamlining certain processes, renegotiating procurement contracts, automating tasks, and investing in technology solutions to promote better efficiency.
- Monitor progress
After you’ve implemented your strategy and taken the appropriate steps to reduce spending, you will need to monitor your progress over time to see how well you’re meeting your objectives.
Make adjustments as needed to stay on track, and stay open to feedback from employees on how these changes have impacted their work.
Cost reduction mistakes to avoid
Reducing costs shouldn’t be done without a well-thought-out plan. When creating your strategy, here are some common mistakes to avoid:
Excessive cost-cutting
As we mentioned above, technically speaking, there are many things you can do to significantly cut costs.
However, these aren’t always practical solutions and will likely do more harm to operations than good.
Ideally, your cost-reducing strategy shouldn’t impact the customer experience.
Thus, you must strike a balance between cutting costs and maintaining the quality of your products or services.
Going for the easy cuts
On the other hand, it can be just as ineffective to cut costs that are minimal and don’t create a real impact on profitability.
Don’t cut costs just because they’re “easy”. Be more strategic and seek out changes that can drive sustainable savings for your business over time.
Focusing on short-term savings
Similarly, a common pitfall with cost reduction efforts is that companies can get caught in a trap of focusing on short-term savings that hurt their long-term growth.
The phrase “it takes money to make money” isn’t just a clever quip. It’s often the reality for most businesses.
Certain spending will produce a return on investment (ROI) and is a worthwhile use of the business's money.
This might include purchasing new equipment that will help them produce goods twice as fast or an automated software solution that will cut down on the manual labor hours spent on back-office operations.
Business leaders should understand the difference between an investment and a cost and build their strategy accordingly.
How to implement a cost reduction plan
Each business is completely unique, and its cost reduction strategy should reflect this uniqueness.
Even still, the following best practices are generally applicable across businesses of all sizes and industries:
Align with high-level objectives
Make sure that your cost reduction strategy supports your business’s overall objectives–whether that’s revenue growth, new market expansion, or other goals.
As we’ve mentioned throughout, growing your business requires a certain amount of spending and investing, so ensure that your cost-reduction plan doesn’t hamper your high-level goals.
Naturally, reducing costs directly supports better profitability. However, cutting back spending in other areas may indirectly impact your team’s ability to grow sales or expand business.
Engage team members
Similarly, you’ll want to engage with different employees and departments in your organization before implementing any cost reducing measures.
It’s important to collaborate with your team to ensure your strategy is practical and to get their unique perspective in case you’ve overlooked something about the plan.
In addition, any type of change can require some adjustments for your team. So, if you involve them in the decision-making process, they will be more likely to support your initiatives and improve the likelihood of your plan’s success.
Keep track of key metrics
Define and monitor key performance indicators (KPIs) and metrics related to your cost reduction strategy.
Doing so will give you an objective way to monitor your progress and ensure you stay on track with your plan.
Some common KPIs to track when reducing costs are your gross margin and operating margin to gauge overall profitability. However, you may choose other metrics specific to your strategy.
Enhance your cost reduction plan with an expense management tool
Reducing costs should be a holistic strategy focused on long-term sustainable changes that improve efficiency and profitability.
With BILL’s Spend & Expense management software, you can easily track expenses and monitor trends, helping you identify potential areas where you can reduce costs.
Our platform provides real-time visibility over your current spending and allows you to set budget controls and limits to right-size expenses and support your financial goals.
Try BILL Spend & Expense today to get better insights into your spending or request a demo.
