Cost Reduction

The quickest and surest way to improve profitability is to thoughtfully and effectively reduce costs in your business. I actually like to think of a cost reduction process as a profit finding process, because every dollar saved goes to your bottom line. The following example of a simplified P/L illustrates how much more cash can be generated for your business through cost reductions than can be generated by increasing sales. A 10% reduction in costs generates a 9% increase in profits (pre-tax). A 10% increase in sales provides only a 1% increase in profits (pre-tax).


In this oversimplified example COGS and general expenses were reduced 10% and the results are dramatic. These results could be smaller or greater depending on the exact structure of your expenses.

Reducing COGS is a combination of analyzing raw material supply chains and internal operations. Reducing general expenses is the process of reviewing both fixed and variable expenses. Adopting an “every penny counts” attitude is not as old fashioned as it sounds and should be adopted from top management on down.

COGS reduction is key in the cost reduction process. Raw material and labor costs are probably the largest expense in your company and should be constantly monitored. Suppliers of raw materials may have cut prices quite a bit in today’s environment, but may still be complacent with your business. Renegotiating or looking for alternative materials may be possible, but not at the price of sacrificing quality or service. Even if material costs are the lowest possible, new strategies may lower your overall material costs. Lower inventory levels, consolidation of inventories, and lower delivery costs are just some of the things to look at. Labor costs must also be considered. Indiscriminate layoffs are not the answer. Productivity is!

Opportunities to reduce general expenses are many and a comprehensive audit of your expenses will show any number of ways to increase your bottom line. Even fixed costs should be looked at. Many companies have consolidated operations, developed shared services programs and found numerous ways to cut fixed costs. All items should be looked at with a keen eye. Even the smallest expenses may be trimmed and the cumulative effect can be substantial.

In a recent survey it was reported that although most companies have taken cost reduction actions recently, a majority responded that the plans that they have in place today will not allow them to achieve their overall goals. Lack of resources, internal challenges, and lack of analytical capabilities were some of the reasons cited for not realizing or even recognizing cost reduction opportunities.

Cost reduction is no longer an option for most companies. It is required for a company to stay competitive in today’s business environment.