Driving the bottom line through profitable revenue growth likely is the objective of virtually every company. This should be the number one focus, of course. If you’re not growing, you’re dying. But companies also need to focus on controlling costs. Without constant vigilance, companies can find themselves in an uncompetitive situation with bloated overhead. The episodic slashing and burning that then becomes necessary can significantly damage a company. These efforts risk producing exceptions on the financial statements, drive “one-time” charges, and hurt company culture. The better way to maintain the appropriate cost structure is to control them in a sustained fashion. Here are 5 ways to control costs.
1) Renegotiate all contracts annually. For whatever reason, American businesses presume that multiple year contracts will result in lower costs. Maybe sometimes, but not always. A smart company policy is not to have the life of a contract exceed one year. This forces annual bidding or at least renewal discussions with the current suppliers. Almost always these discussions will result in lower cost of goods. A multi-year contract will usually favor the vendor. Of course this is a lot of work. But it sure pays out.
2) Ask your customers. Annual planning sessions with customers have many benefits. Naturally these discussions primarily should focus on ways to grow the business. But too often these discussions fail to address costs. By discussing costs holistically up and down the combined supply chains, customers often can recommend ways to reduce costs. For example, how to take wasted steps out of the process, or how to plan jointly to smooth production, or maybe even how to change the product mix to get rid of costly items and replace them with some that are more profitable. Talking to the customer is never a bad thing. But talking about how to jointly improve business deepens the relationship, shows them you care, and helps reduce costs for both parties.
3) Match terms with turns. Each item in your inventory moves at a different rate. And yet suppliers normally apply a one-size-fits-all approach to payment terms. You can reduce your working capital to zero if payment terms were matched with the inventory turns of each item. By negotiating this into your contracts it incents the suppliers only to sell the best moving items and to work with you to improve inventory productivity. The results will free up cash that can be deployed elsewhere in the business and improve profits.
4) Ask vendors to own “their” inventory. Better even than matching terms with turns is to have the vendors keep title to their inventory until sold. Normally inventory acquired from a vendor is held in your warehouse for use in manufacturing conversion or resale to your customers. But why think of it as your inventory? It hasn’t been used yet so why isn’t it their inventory? Best planning results in “just-in-time” delivery so there is no inventory. But this isn’t always possible, for instance, in industries like retail where that inventory is necessary for your own customers. But again, why are you paying them and then sitting on their inventory? They need to own the inventory until time of sale. This is commonly referred to as “scan based trading” or “just-in-time trading.”
5) Hold headcount constant. For sure this is a blunt instrument and it won’t always work. But…. A long time ago I worked with a founder of a
business we acquired. I complained one day that the parking lot was too tight and we needed to expand. He smiled and told me he knew exactly how many spots were in the lot and checked the number of cars regularly. When parking became too tight he knew his headcount had become bloated and he needed to take action. While this isn’t the best or even a practical way to track headcount for most businesses, the lesson still is poignant. Efficiency is gained when revenue per employee grows. Technology, lean techniques, process engineering, etc. all are tools to free up time so employees can become more productive and you don’t have to add new headcount to grow. What if you could replace your lowest 10% of performers with new people that matched your top 10%? This would result in a huge productivity boost at virtually no incremental cost. There are a lot of techniques to improve productivity, but the point is that constantly growing headcount certainly will result in overhead growth but won’t necessarily result in profitable revenue growth.
A dollar gained in revenue is a very good thing assuming it leverages the current cost structure. But remember, only a small portion reaches earnings. A dollar saved from cost, however, goes directly to the bottom line. So while focusing on the top-line, don’t forget to engage in a systematic approach to governing costs as a way to ensure long-term value creation.
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