Cost-cutting is a short-term or long-term initiative to reduce costs with the aim to increase profit.
Cuts don’t have to be a drastic reduction of costs caused by a difficult economic situation. Cost-cutting has its place under normal conditions as well and should, to a certain extent, be a natural part of healing mechanisms of each company. It is totally normal that a when a company reviews all its costs, it finds out that some of them (not necessarily within the company) are unnecessary and some of them can be reduced by, for example, negotiating better financial conditions with suppliers. Therefore, companies should review their costs at least once a while.
What areas are usually first to be concerned by cost-cutting?
Companies perform cost-cutting in various circumstances (most often during crisis, when company is restructuring, when the market undergoes big changes, or when expanding) and to various degrees (it can concern the entire company or just one or several of its parts). Usually, companies are focusing on the departments with the highest costs (often, they make use of the Pareto principle - they focus mainly on areas where savings can be greatest).
Types of costs that are most often reduced:
- personnel costs - reduction is reflected either by lowering wages or salaries, by cutting off benefits, by reducing education budgets, or by dismissals. Since for most businesses, the personnel costs are the most elevated ones, many of them begin with cost-cutting process right here.
- material costs - for example, by reducing stock, increasing inventory turnover (saving can also be achieved by changing inventory management of completed products)
- production costs - by lowering the cost of production, its requirements or, for example, costs of energies by negotiating a better price
- service costs - reduction of selected services, their quality or negotiation of better price conditions
- operating costs - for example, by reducing the number of plants, buildings, preserving certain building capacities, etc.
- costs generated by inefficient technologies
- reduction of working hours (reduction of working hours, reduction of support time, etc.)
- financial cost - debt restructuring
- postponing the due date of invoices
A drastic reduction in costs in times of crisis is happening in order to maintain the necessary minimum in the company to survive a difficult economic period. If cost-cutting is of such a significant nature, it is usually part of the so-called crisis management.
What are the risks?
Rapid and superficial cost-cutting can certainly be efficient in the short run but can lead to a great damage in the long run. Drastic cost cutting should be temporary, followed by a revitalisation that has been kicked off by the cost-cutting. If large cuts are made without any vision, this can lead to a reduction in the quality of services or products, which can lead to a reduction in customer satisfaction and, as a result, a reduction in profit. Such a situation is deadly for every company.
If the cost-cutting is sensitive, systematic and well considered, then it leads to increased efficiency, economy and helps creating a healthier business in the long run, without compromising product quality and customer satisfaction.