Cost Cutting

Cost cutting is a strategy organizations employ to reduce expenses when they experience a decline in profitability metrics. For example, reduced travel and a focus on energy-efficient procedures are two of the many ways frequently used to save costs. They are measures or activities undertaken, especially during times of distress.

Cutting costs always sends a message to customers, employees, or both. It is a way out when revenue falls due to an ongoing economic downturn or a shift in market reality. Another possible reason could be that the organization is under pressure from investors to deliver higher profits within a shorter period.

• Cost cutting is lowering a company's expenses to increase profits. It entails both process optimization to increase productivity and identifying and eliminating expenses that do not create customer value.
• Cost reduction often concentrates on producing immediate savings.
• The measures include various actions, from downsizing an office space to layoffs or outsourcing at a lower cost. In addition, it entails reducing staff size or adjusting cost per employee (pay cuts), checking for cost duplication, benefits reductions, and so on.
• Companies are better equipped to transform their expense reduction strategy into a growth strategy when they can identify their organization's good, bad and best costs.

Cost cutting often means minimizing exposure to undesirable costs and boosting investment in desirable costs. This is crucial in unpredictable times because it helps organizations build a more sustainable growth strategy. Forward-thinking businesses adopt cost-cutting measures to further match their costs with their business strategy during difficult times. Strategic cost reduction can reduce the cost structure, but proactive cost reduction enables a firm to be ready for expansion. While freeing up resources to pay for change and future growth, it concentrates on the controllable areas of the business.

Identifying and comprehending the differences between bad, good, and best costs is one of the first steps toward smarter, more purposeful cost cutting. Costs that do not align with the company's overall growth strategy are called "bad costs." Conversely, the first costs to be cut in good companies are wasteful, and it is better to redirect these resources to more productive uses.

Good costs fuel programs, initiatives, and strategies supporting the organization's overall growth objectives. The company can find them by understanding the client and consumer preferences and connecting them with its activities. The best costs are those that help a business develop and broaden its truly unique expertise. These are the limited abilities that distinguish a business and increase its worth. These skills stand out as genuine differentiators that are challenging and hard to imitate.

Before making drastic cuts, it's important to know how each item affects the firm's overall business strategy. For example, what may be a terrible cost for one company may be a favorable cost for another. Companies can transform their expense reduction strategy into a growth strategy by identifying their organization's bad, good, and best costs and understanding how they coincide with customers' wants.

Strategies can differ according to the size and nature of the organization, among other factors. Considering an organization's long-term goals forms one of the base points here. Any reduction strategy should be formulated only after an evaluation based on it. Searching for duplication should also be one of the priorities. If different departments perform similar functions, they could be consolidated to save money. Similar is the case for workforces: where there is duplication of work, it can be avoided.

If there are outdated technologies used in the process and if replacing them with new technology increases efficiency, it has to be done. The process may require higher costs initially, but it will pay off in the long run. Furthermore, automation aids in the reduction of labor costs.

Another way is to explore innovative marketing solutions that can propel growth. The world is moving away from traditional forms of marketing, such as newspaper and radio advertisements, and toward digital platforms like Instagram and Twitter. They may be much more cost effective than traditional marketing outlets. Evaluating small costs can also be a major factor in the cost-cutting process. For example, if important communications can be sent through the mail, printing them can be avoided.

Similarly, companies can cut off unnecessary subscriptions. Food, water, and electricity can be checked for waste. Opting for teleconferencing instead of in-person meetings can save on venue and travel costs. Cost-cutting strategies include:

• Vendor management (negotiating discounts and better terms).
• Outsourcing at a lesser cost.
• Reducing staff size.
• Adjusting cost per employee (pay cuts).
• Benefit reductions.
• Including raising the prices of goods and services and reducing real estate costs.

Let us check out these examples to gain an understanding of cost-cutting:

Example #1

Dan is a small business owner who has a clothing brand. He had rented a big property to accommodate his brand production, twice the size he needed. Unfortunately, his sales had dropped, and he had been experiencing financial difficulties for several months. He had to save money to keep his business running, so he chose to rent a smaller property and shift production there. Dan was able to save money by cutting costs with this move.

Example #2

News reports of an upcoming recession after a dull pandemic have put a lot of companies in a tough spot. Even giant companies like Twitter and Meta are opting for mass layoffs. Twitter, however, made early headlines. Elon Musk, a businessman and a billionaire, acquired stakes in Twitter.

The American company owns a microblogging and social networking platform by the same name and decided to lay off four key executives. It also revealed that there were further layoffs in the pipeline. The company had to do so as there was mounting pressure from investors. They also revealed the plan to implement a $20 monthly charge for high-profile users to keep their "blue checkmark" but recalled it after backlash.

Pressure from investors, layoffs, and price increases (introduction here) were all indicators of the company trying desperately to cut costs and maximize profits during a downturn.

Here are the main advantages and disadvantages of cost cutting:

Advantages

• Companies can save costs in the short run and save the business from loss or closure.
• If done thoughtfully, slowly, and practically, it could be sustainable. e.g., checking water, food, and power wastage.
• It leads to more efficient business processes and management.

Disadvantages

• Layoffs are often the go-to strategy that companies choose. However, there may be two issues arising out of it. The first is wrongful termination issues, related lawsuits, and payment of dues. The second factor is the overburdening of existing employees. They have to work extra for the same pay. Eventually, they might leave, and the company would incur hiring costs.
• Similarly, layoffs can be an issue if there is a sudden change in the atmosphere and a surge in orders.
• If not done properly, it can tarnish the company's image. As a result, it can further hurt the chance of recovery from the downturn.

Though similar, cost cutting and cost optimization have some key differentiating factors. Let us look at them in the following table -

This article has been a guide to Cost Cutting and its meaning. We explain its strategies, examples, advantages, disadvantages, and comparison with cost optimization. You may also find some useful articles here -

• Cost Efficiency
• Avoidable Cost
• Objectives of Cost Accounting