The Highs and Lows of Cost Cutting for Businesses
Where to look, how to start, and when to outsource
Our survey of north central Ohio businesses, conducted in February, revealed key challenges faced during the Covid pandemic and identified the most pressing challenges that businesses would face in 2022 and beyond.
A quick recap:
Supply chain interruptions, lower demands for products and services, and government-mandated closures took a heavy toll on businesses during the pandemic. Keeping costs down became increasingly important in order to keep companies afloat, and many businesses turned to cost cutting measures in order to moderate the decrease in revenue.
According to businesses we surveyed, 28% reduced their expenses because of the Covid pandemic. The overwhelming priority for small- and micro-businesses was cost cutting, with 57% stating they had taken such measures, but all businesses prioritized it in some way. Forty-four percent of respondents delayed major business priorities including major capital projects, during the pandemic and, in 2022, twice as many respondents are planning to decrease spending rather than increasing it.
All told, the major areas of cost cutting respondents focused on included technology upgrades (37%), new hires (35%), employee pay and benefits (32%), equipment upgrades (30%), and marketing and sales (30%). As businesses continue to decrease spending into the future, considering the best areas to cut costs is vital to sustainability and future growth.
The effects of the pandemic forced most businesses to take a hard look at their operations and processes. Initially, this was for the purposes of findings savings, but it also uncovered potential efficiencies and changes to operating models that may bring long-term improvement beyond cost cutting. Before any cutting of overhead, such an examination is always prudent because it lessens the likelihood of cuts that have a damaging effect on the health of the business and its ability to recover.
What are the highest costs of small business?
The highest cost for most businesses is labor, and according to our survey, 25% of businesses cut staff during the pandemic. Including employee wages, benefits, payroll, and taxes, labor can account for 70% of total business costs (Paycor). Any expanded benefits you offer your employees can incur even higher costs, and the financial investment that goes into advertising positions, examining and interviewing candidates, and training new employees is also significant (AZ Central).
Many businesses were able to take advantage of the government’s PPP program to offset staff costs. (However, our survey showed that only 52% of those responding took part in the program, compared to 62% nationally.) For others, many had to take immediate and sweeping cuts to survive. In such circumstances, employers tend to make cuts across the board – either in personnel or pay or benefits. However, identifying those key team members and prioritizing their retention should always be the goal but, we recognize, hindsight is 20:20.
Post shutdown, many businesses are now facing labor challenges of a different sort, as demand exceeds supply in many areas. But lessons learned during the pandemic are proving valuable: 1) A focus on retaining key staff and reducing the expense of employee churn; 2) Viewing compensation and benefits in a different way to meet employee needs, such as offering more time off rather than higher salaries; 3) Auditing the cost of benefit programs to seek the most cost-effective option; 4) Encouraging alternative work arrangements, where possible, to lower expenses.
Though labor has the highest cost, there are other significant business expenses that should be considered.
The costs of inventory, materials, and supplies.
These can be huge investments for any business. Shipping and delivery often incur high costs, and businesses who manufacture their own products must pay for the equipment and materials to do so. The basis for cost-cutting strategies for logistics, regardless of company size, is knowing your costs. This immediately prioritizes areas of greatest potential savings.
For example: Excess inventory. The APQC’s benchmarking study has identified that companies who best manage inventory outperform others by $101 in inventory value per $1,000 in revenue – a significant number in any size business. Inventory tracking takes different forms, from spreadsheets in small firms to sophisticated inventory management software from companies like Wasp. But a key metric is to examine the sales of SKUs and/or products. Eliminating under performing SKUs or products – or simply limiting the inventory you carry for them – can have a significant impact on overall inventory expense.
Another logistics expense is transportation. On a larger scale, many logistics experts have suggested that companies review the geographical relationship between suppliers and the markets you want to serve. By using suppliers closer to your customers, significant savings can be achieved. Other opportunities for savings are: 1) Looking at delivery schedules for opportunities to consolidate shipments; 2) Reducing failed deliveries by asking customers to define preferred delivery windows and by confirming their availability prior to delivery; 3) Continued fleet maintenance, because the average cost of a breakdown is $760.
Internal processes and operations.
Many organizations used the impact of the pandemic to reexamine internal processes to find efficiencies and cost savings. Automation continues to be a major focus of larger manufacturing companies. But smaller companies have seen benefits, too, by simply taking a fresh look at internal processes and brainstorming ways in which tasks can be performed more efficiently.
Overhead and operating expenses.
Often a drain on funds, rent, utilities, marketing, and equipment are things most businesses must manage, and even office supplies can cost an unwelcome amount when they aren’t managed properly. Any equipment or real estate a business owns will need to receive some form of upkeep, and that likewise has the potential to incur fees.
Lastly, taxes and insurance, while highly variable among industry, are problems every business will have to contend with. Some of the biggest savings can come into play with proper insurance policies and insight into your expenses.
How do you start cutting costs?
It’s tempting to cut costs in the most expensive area – labor. But it’s important to be smart about doing so. Cuts to employee benefits can spur higher rates of turnover, and training new employees is often more expensive than maintaining the ones you currently have. It’s worthwhile to explore other cost cutting options before looking at anything that will impact employment or compensation.
If you do, however, understand that employees appreciate comprehensive benefits and paid time off more than extra perks, so cut those before looking deeper. Things like free lunches or holiday parties can be eliminated in order to keep your staff employed while cutting down on the amount you spend.
Outsourcing may also offer a significant reduction in cost. Hiring outside consultants means lower rates and money saved on benefits a full-time worker would otherwise need to be provided. Outsourcing tasks also brings the dual benefits of letting you draw from more varied experience and talent – often people who don’t need the training an employee would – and letting you prioritize the most essential tasks while your outsourced team takes care of the rest.
Another place to start is reducing supply and production expenses. Instead of sticking with your usual supply chain, reach out and search for new vendors and wholesalers. Market growth often spurs new interest in a supply chain, and you may find new, cheaper options you weren’t aware of before. Selling leftover materials instead of recycling them can provide a small boost to your bottom line.
Properly understanding the space you need is a great way of cutting down on overhead as well. For many companies, the pandemic forced major changes in how – and where -- their employees worked. Fifty-two percent of middle market and 67% of commercial businesses responding to our survey instituted work from home in 2020. According to the SBA, 40% of the US workforce telecommuted or worked from home by mid-2020. For many companies, this model has stayed in place and offers an opportunity to reimagine the workspace and its related costs. One local professional services firm has opted to maintain a flexible, telecommuting model post-Covid and has subsequently moved to a much smaller office and reduced its rent by over 50%. Workers still come to the office, but less frequently, and individual offices have been replaced by small, more flexible meeting spaces. As an interesting rule of thumb, the American Society of Interior Designers estimates that office workers can function very well in a workspace of between 75 and 150 square feet, yet the average space per employee pre-Covid was 325.
Because location has a big influence on cost, renegotiating leases, relocating to somewhere cheaper or with tax incentives for business, can provide you with savings and keep you in a good space.
When it comes to operating expenses, three other areas can afford significant opportunities to save: Insurance, Marketing, and Banking/Finance. Breaking down your expenses and getting help to fully understand the implications can provide some of your biggest savings.
Comparing insurance providers often leads to savings as providers not only shop policies but also take more account of your business needs. Ask your current provider for a policy review. And carefully evaluate your policies to avoid accidental overlap. In the health insurance arena, changing to high deductible plans will lower premiums and you can offset the increase in deductibles with a tax-advantaged Health Savings Account for employees. It’s a smart move, likewise, to understand the taxes you must pay and any tax deductions for which you qualify.
Marketing is a major arena that incurs high costs, and in the internet age there’s plenty of alternatives waiting for you instead of the usual avenues of advertising. Any marketing areas that aren’t producing results worth the money invested should be evaluated, and you can focus on cheaper options. Social media is a great place to garner interest from potential customers and focusing on public relations by leveraging your expertise to be featured by media outlets can also provide a boost. Digital advertising can be targeted geographically and by customer type and gives the option of setting a budget upfront. However, social media is not a panacea and more traditional programs might serve you best. Regardless of what you choose, never neglect the power of current customers. Promoting to a customer email list through email campaigns and special discounts can attract customers and keep them coming back to your business without the cost of traditional advertising. The American Marketing Association estimates that for most small businesses, over two-thirds of sales come from current customers – either directly or indirectly through word-of-mouth referrals.
In a related effort to save, many businesses have looked to the revenue side of the equation. During and post shutdown, many businesses adapted to changes in their customers’ behaviors by providing digital and virtual ways to shop. As consumers’ use of eCommerce grew, so did businesses’ use of digital tools to help manage finances. Between 2019 and 2020, businesses using mobile banking tools grew by 23%; businesses using remote deposit grew 21%. The result has been increased efficiency in cash management in terms of optimizing payables and receivables and protecting against fraud.
Fraud has always been a concern for businesses and its frequency exploded during Covid, increasing by over 60% in 2020 – 2021. Last year, an estimated 47% of businesses were victims of fraud (payments.com, 6/22), with a median cost to the business of $205,000. In 42% of cases involving small businesses, fraud was the result of insufficient internal controls. That number falls to 25% of middle market and larger companies. New cash management tools and services such as Positive Pay and business debit and credit card controls can go a long way to prevent such losses and are worth checking out from your bank.
In other areas of finance, businesses were able to save money by refinancing credit, finding cheaper providers of merchant services and credit cards, and negotiating discounts for the early payment of invoices (2%/10 net 30.)
Lastly, don’t be afraid to hire experts. People who know how to create efficient cost cutting strategies can teach you how to cut costs in business and provide a baseline for you to move forward. Your CPA or your banker are good places to start, and the knowledge they impart can help you improve your actions going forward, keeping costs low in the future.
If you would like more information on resources to help with your cost cutting strategy, reach out to a member of our Business Banking team.
The First Citizens National Bank is the 4th oldest national bank in the United States still operating under local leadership. It prides itself for its unique style of community banking, blending leading-edge technology and convenience with outstanding personal service, and access to experts who provide advice and tailored solutions to more complex financial questions. Founded in Wyandot County in 1860, the Bank operates thirteen banking and ATM locations in Wyandot, Hardin, Marion, and Delaware Counties, including branches in Powell, Marion, Delaware, and Upper Sandusky. The Bank is a trusted partner to local businesses in north and central Ohio. They understand the critical importance of business success to community and community health and are invested in providing content on topics that are of importance to success of local businesses.