The Dangers of Cutting Costs

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Last time I shared with you how to calculate your company’s break-even point. We learned that either raising prices or lowering costs will help you break even and start making a profit. Today I want to share with you the dangers of lowering your expenses.

When trying to operate a successful and profitable business, keeping your eyes on your expenses is key. As you start making money, it’s easy to loose track of your expenses and not worry as much as you did when you were first starting out. It’s a good rule of thumb to review your income statement each month (or quarterly, at a minimum) to ensure you know where your money is going. The expenses your business incurs should be geared towards making money.

Lowering expenses can be a good thing, if you’re cutting out non-value added extras. Can you save money on office supplies, what about shopping around for phone service & long distance pricing, etc. There are always ways to save costs.

On the flip side, cutting costs can be detrimental to your business. I know, you think I’m crazy. Right? Think about it for a minute… Your business is successful because you offer a product or service that others value and want to purchase. Your customers have come to expect a certain standard from you and expect your product and/or service to meet or exceed this standard. Sadly, cutting costs can have a negative affect on your customers.

Let’s look at two examples.

  • Let’s say you operate a vacation rental business, where you rent furnished vacation homes on a weekly basis. You would like to boost profits, so you decide to cut costs. The first cost you look at is your cleaning and maid service. This is a major expense to your business. On paper it looks like a better idea to hire a less expensive cleaning service. This results in your rental homes no longer being in pristine move-in condition, creating negative goodwill with your customers. The scary part is that it takes a year or more for your business to see the negative affect poor cleaning has on your business. A year or two down the road, you realize you have fewer repeat customers and are not able to keep your vacation homes rented. The main reason is that the quality of product you offer suffered because lowering your expenses looked good on paper.

  • Let’s say you own a web design business and are looking for ways to save money. After looking at your income statement, you realize that wages and salaries is your biggest expense. So you decide to let go of a few employees to lower your costs. At first, your employees understand and are happy to work a little harder to cover the extra work load. However, after several months your employees start to get burnt out. They want to spend time with their friends & family and are getting frustrated putting in overtime hours and working on the weekends. The scary part about cutting labor costs is that the effect does not happen immediately. Your over worked employees have resulted in a higher employee turnover rate (which actually is costing you more in recruiting & new-hire training). The longer hours has also resulted in the loss of creative employees and a loss of productivity. Although lowering labor costs looked good on paper, it had an ill effect on your business’ ability to generate more income.

In closing, keeping a good eye on your expenses is a good thing. As businesses become established, it’s easy to overlook some expenses that are not geared towards bringing in sales and revenues. Keep in mind, when looking at your expenses and brainstorming ways to save money, remember to consider the long-term affect of your cost cutting actions. How will lowering these expenses affect my product and/or service? It’s a good idea to track and measure your cost saving strategies to ensure they are not negatively impacting your business over time. Remember, what looks good on paper can sometimes have a negative impact on your sales and income.

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