Essential guide to cost control

Cutting costs is the simplest way to improve your bottom line. Introducing a cost control system can bring immediate savings and make sure that you remain competitive in the longer term.

But cost control needs to be carefully managed. Whilst it clearly helps to cut wasteful activities, careless cost cutting can lead to falling quality and poor morale.

Your costs

Systematic cost control

Who is involved?

Easy savings

Opportunities to cut costs

Cost-cutting pitfalls

Cost-control consultants

1. Your costs

Cost control works best as part of your routine financial management. The first step is to look at your existing costs.

Identify your major cost centres

• Typically these might be purchasing, production, sales and marketing, financing, administration, premises, facilities management, and research and development (R&D).
• In a small business, a cost centre is usually the area one manager is responsible for.

Identify the major types of cost within each cost centre

These might include:

• raw materials and supplies;
• utility bills for energy and water;
• capital expenditure;
• other purchases (eg consultancy services and advertising space);
• staff;
• premises;
• communication;
• travel;
• transport;
• financing costs.

Choose the costs to focus on first

• Focus on costs that may offer easy savings and large costs that you may be able to change in the short term.
• Fixed costs (eg long-term fixed-rate loans or fixed-price contracts for raw materials) are hard to control in the short term.
• Some cost centres, such as R&D, make important but indirect contributions to your bottom line. You need to account for these contributions before deciding on cutting their budgets.

2. Systematic cost control

Start from your business objectives

• For example, you might aim to manufacture 1,000 units per month, or win ten new customers.
• What are your quality standards? For example, your customer service standards might require you to answer all enquiries within a specified time.

Establish your 'standard costs' for achieving your objectives

Standard costs are the costs you would have in an ideal world. You need to consider:

• What resources you need.
• How much of the resources you need. Standard costs are based on peak performance (eg no unnecessary wastage of raw materials or staff time).
• What the resources cost.

Set up realistic 'budgeted costs' based on your actual experience

• Budgeted costs will usually be higher than standard costs. For example, you might expect 2% of all production to be wastage, raising unit costs.
• Budgeted costs may sometimes be lower than standard costs. For example, if you have staff vacancies to fill.

Record your actual costs and compare them with the standard and budgeted costs

• It may be appropriate to compare unit costs (cost per unit produced) or total costs (including overheads such as premises).
• Costs that are higher than your budgeted costs may show opportunities to reduce costs in the short term. In general, the larger the cost overrun, the more scope there should be for savings.
• Costs that are higher than your standard costs usually indicate opportunities to reduce costs in the longer term.
• Lower costs may suggest good management, but might also reveal quality failings or impending problems.
• Using a spreadsheet or cost control package, it is easy to record and compare costs on a regular basis (eg monthly).

Regularly review what you are doing, how you are doing it and who you are using

• Benchmarking yourself against other organisations may show that your performance is sub-standard. For example, if your wastage levels are higher than the industry average.
• An internal review, or input from an external consultancy, may suggest alternatives. For example, standardising components to reduce design and manufacturing costs.
• Check that you are getting the best value from your suppliers. Checking price comparison sites quarterly or annually can reveal if other suppliers can offer you a better deal.

3. Who is involved?

Each cost centre is usually the responsibility of one manager

• Some costs can be easier to control if one manager is responsible for that cost throughout the organisation.

Involve employees in cost control

• Employees can suggest cost-saving ideas, especially if there is an incentive to do so. Ask what causes them problems or wastes their time or resources.
• Employees are more likely to co-operate with cost control initiatives if changes are explained to them.

Include your customers and suppliers

• Ask your customers if you are providing them with anything they do not need or which they consider unnecessary or wasteful. For example, excessive packaging.
• Your suppliers will know what other purchasing options are available that might suit your business.

External consultants can be a useful resource

• See cost-control consultants.

4. Easy savings

Some costs can be reduced with little risk of an adverse impact on quality and performance.

Checking supplier invoices may reveal overcharging

• Common examples are double billing, incorrect charges and missing discounts.

Remove unnecessary costs

• Get rid of obvious overcapacity (eg unused telephone lines).
• Cut out obvious waste (eg heating premises at night, or with windows open).
• Scrap useless processes (eg paperwork that is completed, filed and forgotten).

Crack down on excessive costs

• Use second class postage or email, unless only first class post will do.
• Find alternatives to highly priced suppliers or negotiate discounts.
• Avoid over-specifying (eg high-quality components for a low-quality product).
• Ban wasteful luxuries (eg full-fare business class flights). But cutting back on items employees see as 'benefits' or 'perks of the job' needs careful handling.

Root out inefficiency

• Identify manual, paper-based systems that could be computerised.
• Avoid frequent small orders. They waste time and may mean you lose discounts.
• Think about switching to single monthly invoicing to cut processing and costs.

5. Opportunities

Effective use of a systematic approach will highlight opportunities to control costs with little risk. In some cases, there will be easy savings such as cutting the cost of supplies.

In others, cost reduction will require changing the way you do things. Some of the most common opportunities are listed below.

Reduce your payroll costs

• Outsource non-core activities.
• Use consultants, freelances or part-time employees, instead of full-time employees.
• Redesign processes to prevent duplication of effort and to cut out time wasting.
• Make more use of technology and automation.
• Do not overpay when recruiting new employees.

Improve your purchasing

• Switch to cheaper suppliers, or negotiate price reductions or higher discounts for early payment.
• Consolidate purchasing with fewer suppliers to get better discounts or place fewer, larger orders to avoid multiple delivery charges.
• Agree long-term supply contracts or guarantee minimum annual purchase volumes in return for lower prices.
• Build personal relationships with suppliers to encourage preferential treatment.
• Simplify or automate purchasing procedures to reduce your costs, and those of your suppliers.
• Form strategic buying alliances (eg purchasing consortia) with businesses in your area or trade to buy larger volumes.
• Give individual employees purchasing limits to reduce administration and ask your bank about purchasing cards.

Find ways to make production more efficient

• Trim back your product range eliminating non-profitable lines and increase production runs.
• Use standard components to lower design, purchasing and manufacturing costs.
• Change processes to keep wastage of raw materials and energy as low as possible.
• Consider if there are ways to repurpose or reuse your wastage.
• Improve quality control to cut rejection rates and reworking costs.

Review your finances

• Finance fixed requirements using loans, instead of overdrafts.
• Reduce unnecessary overdraft and loan facilities.
• Cut back on working capital through just-in-time purchasing, better credit control and agreeing longer payment terms with your suppliers.
• Apply for grants and subsidised loans.

Get the most out of your premises

• Introduce homeworking or hot-desking to cut space requirements and travel costs.
• Rearrange existing premises and workflows to minimise wasted time and space.
• Sub-let spare space.
• Control utility costs.

Cut the cost of communications

• Use email whenever possible.
• Use an intranet to reduce duplication of information and unnecessary meetings.
• Use cheaper communication facilities (eg alternative suppliers, leased lines or VoIP to make calls).

6. Pitfalls

Reducing costs can be damaging. Before making changes, check that your standards will not be compromised and that your ability to meet objectives will not be harmed.

Reducing costs which directly affect employees is extremely difficult

• Employees are not machines. The work performance suggested by time and motion studies is unlikely to reflect people's actual behaviour.
• Reducing costs such as training and meeting times is often counterproductive in the longer term.
• Introducing improved procedures can be difficult and expensive. Employees may resist change, and may need extra training.
• Poor conditions, pay and benefits will not attract and retain good employees.
• Changing an existing employee's terms and conditions, to the employee's disadvantage, can be a breach of contract.
• Making employees redundant may increase short-term costs and the risk of possible employment tribunal proceedings. It may also damage long-term morale.

Almost every cost saving has a potential downside

For example:

• over-dependence on one supplier puts you at risk if the supplier fails;
• production and marketing plans driven by cost-cutting considerations are unlikely to meet customer requirements;
• tighter control of financing may leave you with no safety margin when cash flow is unexpectedly poor;
• cutting short-term 'investment' costs (eg training, advertising, equipment or new product development) can lead to long-term weakness;
• attempting to control fixed costs is itself a wasteful process.

7. Consultants

External consultants can offer an advantage over purely internal cost control

• Consultants may have up-to-date, specialist knowledge. For example, they may be acquainted with up-to-date benchmarks for your industry and current market conditions for utilities and other suppliers.
• A consultant's thinking is unlikely to be influenced by vested interests and historical preferences within your company.

Select a consultant carefully

• Look for membership of an established and appropriate professional body, with a published code of conduct. For example, the Chartered Institute of Procurement & Supply.
• Check references and look for evidence of a good track record, working with businesses similar to yours.
• Find out about the consultant's financial standing and check that there is indemnity insurance cover in place.

Negotiate a clear, written contract

• Agree what you will pay. If fees are to be based on a percentage of savings, agree how these savings will be calculated.
• Arrange when you will pay. Avoid having to make upfront payments, before you can see the results of a consultant's work.
• Insist that the consultant signs a formal confidentiality agreement.