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Understanding cost-cutting and its role in running a business successfully
The secret ingredient to run a successful business is not always as rosy as it may seem. Let’s understand the difficult side of running a business.

what is cost cutting

We are living in uncertain times. The last five years have shown humans that nature can be unpredictable. As times evolve, everyone is adapting to their surroundings, and so are businesses. It is essential to understand that both controllable and uncontrollable factors influence businesses.

Non-controllable factors encompass situations like pandemics or declining sales, while controllable factors pertain to aspects such as business offerings, products, and expenditures. Business enterprises will try to bring changes in the elements they can manage, particularly for cost-cutting. In this blog, we will deep dive into the meaning of cost-cutting, exploring its motivations and delving into the potential risks associated with this practice.

What is cost-cutting?

Cost-cutting encompasses actions by a company to trim its expenditures and enhance its profitability. These cost-cutting steps are commonly put into practice, when a company faces financial challenges or operates in economically challenging times. They may be undertaken proactively by a company’s management when anticipating future profitability concerns, thereby incorporating cost-cutting into their overall business strategy.

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Different methods companies use to cut costs 

Cost-cutting in companies is an activity undertaken by management in periods when companies are not performing great, generally in the downswing of a business cycle. Cost reduction techniques include:

Layoffs:

Layoffs involve the reduction of a company’s workforce. This can be a challenging decision, often made in response to financial difficulties, a shift in business strategy, or the need to improve efficiency. Layoffs impact both employees and the organisation, as they can lead to reduced morale and loss of institutional knowledge.

Example: Many companies, especially a lot of tech companies laid off their employees post-COVID. One of the massive layoffs was by Amazon during the end of 2022, with over 18,000 employees being laid off.

Reducing employee pay/non-payment of bonuses:

Companies may opt to reduce employee salaries or withhold bonuses to control costs. While this helps in the short term, it can lead to decreased job satisfaction and retention challenges in the long run.

Reduction/elimination of outsourced services:

Businesses often outsource certain functions to save costs. Deciding to reduce or eliminate these outsourced services can bring processes back in-house but may require additional resources and expertise within the organisation.

Shutting down a facility:

Closing down a facility is a drastic cost-cutting measure. This can involve shutting down unprofitable branches, factories, or offices. While it reduces expenses, it can also result in job losses and potential logistical challenges.

Example: The COVID breakout has been harsh on every sector of the economy. Many suppliers of auto components shut down their facilities during COVID. Bharat Forge Ltd, Motherson Sumi Ltd, and Sundaram-Clayton Ltd are some examples.

Streamlining the supply chain:

Streamlining the supply chain involves optimising the process of sourcing, producing, and distributing goods. By eliminating inefficiencies and redundancies, a company can save money and improve its overall operations.

Implementing new technology to reduce human costs:

With the advent of tech solutions such as automation and artificial intelligence, companies can reduce the need for human labour. This can lead to greater efficiency, lower operational costs, and the ability to reallocate human resources to more strategic roles.

In all of these cost-cutting measures, businesses need to consider the short-term and long-term effects on their employees, customers, and overall business reputation. Balancing cost reduction has its advantages with maintaining the quality of products or services and the well-being of the workforce is a critical aspect of effective cost management.

Also read: What is gross profit? What does it indicate about a company’s financial position?

Strategising cost-cutting 

Before you go on to make any business decisions about cost-cutting, it’s imperative to have a plan in place for cost reduction. Having a plan will ensure that there is an optimised resource allocation.

Strategy 1: Categorise your expenses into different buckets: Good, bad, and best.

When devising a cost-cutting strategy, it’s imperative to develop a plan instead of making arbitrary reductions. Categorise your costs into three categories as per below: 

Good costs: These contribute to the company’s growth and align with its customer-focused approach, meeting customer needs effectively.

Bad costs: Bad costs are those that don’t align with the company’s growth strategy and result in resource wastage. Eliminating bad costs can free up resources for more productive purposes.

Best costs: These are associated with what makes a company unique, its differentiation from competitors, and the true value it provides to its customers.

Once a company classifies its costs into these categories, it becomes easier to target the reduction of bad costs while maximising the benefits of the best costs.

Strategy 2: Check for cost duplication 

If your company has two departments performing similar tasks, you may seek to merge the two departments for cost-cutting by restructuring their expenses and designing new outcomes. Consolidating and redefining work from time to time will lead to efficiency and reduce redundancy of the work.

Strategy 3: Consider the organisation’s long-term strategic goals.

When a company contemplates cost-cutting strategies, it must assess how these measures can align with its long-term objectives. For instance, the company’s goals might encompass expansion in the global market while scaling down operations in the domestic market. In this context, the strategic closure, divestment, or downsizing of facilities in the domestic area can prove to be an efficient way of cost reduction, facilitating the realisation of future growth ambitions.

It is worth noting that cost-cutting does not necessarily entail the complete elimination of expenses; it can also encompass optimisation and efficiency improvements. Enhancing productivity directly leads to cost reductions, making it crucial to measure productivity. Nowadays, there are various apps available that enable companies to monitor employee productivity and track time allocation for different tasks and projects.

Risks associated with cost-cutting 

While cost-cutting is essential for businesses to survive, it can come with its own set of challenges. If you are cutting costs too deep and too fast, it can result in the company’s image being tarnished as it can be in the news for all the wrong reasons. In recent times, we have witnessed the chaos that BYJUs has been surrounded by as the employees were being continuously laid off and many employees took to social media to display their frustration towards non-payment of bonuses, etc.

Apart from this, there are several hidden costs – reduced innovation, lower morale, and lower customer satisfaction. Before you go on the cost-cutting spree, you must consider these potential tradeoffs. It’s always beneficial to do cost-cutting most quietly and respectfully, as the company’s rapport is at a huge stake here. 

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Another prevalent mistake is neglecting human factors. This leads to resistance, mistrust, and demotivation among different stakeholders like employees, suppliers, etc. To avoid this, transparently communicate your cost reduction plan’s rationale. Communicating with stakeholders on a timely basis and at the same time rewarding team efforts is important.

Conclusion

Establishing a culture of continuous improvement is of utmost importance. This can be done by integrating cost-cutting into daily operations, continually evaluating outcomes, and aligning them with your strategic vision. This maintains cost consciousness and ensures long-term benefits while building stakeholder trust.

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StockGro Team

StockGro is India’s first and largest ‘Social Investment’ platform aimed at helping you master the art of “Trading & Investment”. Trade, Invest and get rewarded to Learn everything about ‘Investments’ the fun-filled way.

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