What Is Cost Cutting?
Cost cutting refers to measures implemented by a company to reduce its expenses and improve profitability. Cost cutting measures are typically implemented during times of financial distress for a company or during economic downturns. They can also be enacted if a company's management expects profitability issues in the future, where cost cutting can then become part of the business strategy.
Key Takeaways
- Cost cutting is a measure taken by a company to reduce its expenses and improve profitability.
- When a company is in financial distress or there is an economic downturn is when companies are most likely to enact cost cutting measures.
- Cost cutting measures can include laying off employees, closing facilities, downsizing offices, and streamlining the supply chain.
- When embarking on cost cutting it's important to have a cost cutting strategy that classifies costs as bad costs, good costs, and best costs.
- As part of a cost cutting strategy, it's important for a company not to over cut costs, leaving it unprepared for increased demand or in a position where it may incur more costs.
Understanding Cost Cutting
Shareholders who seek maximum monetary returns on their investments in a company expect that management will maintain growth in profits. When the business cycle is on an upswing, companies are generally able to generate profit growth. However, on a downswing, profits may fall and if they stay down for prolonged periods, management would feel the pressure from shareholders to cut costs in an effort to prop up the bottom line.
Cost cutting measures may include laying off employees, reducing employee pay, closing facilities, streamlining the supply chain,downsizing to a smaller office, or moving to a less expensive building or area, reducing or eliminating outside professional services, such as advertising agencies and contractors, etc.
Implementing new technology can also be seen as a cost cutting method. For example, a new machine may replace a certain number of employees, cutting labor costs, where the cost of the machine is made up after a certain period of time of not incurring labor costs.
Cost Cutting Strategy
When embarking on cost cutting, it's important to implement a strategy before arbitrarily cutting costs. Some costs are necessary, so it's important to classify costs into good costs, bad costs, and best costs.
Good costs focus on the company's growth and are aligned with the company's customers and how to meet the needs of those customers. Bad costs are those that do not match up with the company's growth strategy, and waste resources. When bad costs are cut, they can free up resources that can be used in a more productive capacity. Best costs are the costs associated with what makes a company unique, how it differentiates itself from the competition, and how it provides true value to its customers.
Once a company is able to allocate its cost into one of the above classifications, it will make it easier to focus on cutting bad costs and maximizing on best costs.
It's also important to note that cost cutting doesn't necessarily mean completely cutting a cost. It can also refer to optimization and efficiency. Optimizing productivity actually reduces costs, so it's important to measure productivity. Today there are apps that allow companies to monitor the productivity of employees as well as time spent on different work and projects.
Risks of Too Much Cost Cutting
Because salaries and wages are such a large expense, many companies look to layoffsfirst as a cost cutting measure when times are lean. However, there are many real or potential costs associated with firing people, including severance pay, unemployment benefits, rehiring costs, wrongful termination lawsuits, lowering of morale,and the risk ofoverworking remaining employees.
Additionally, if the business turns around faster than management had expected, the company could find itself with a shortage of labor, placing the company at a competitive disadvantage in an improving business environment. Also, if a factory was closed in a recent round of cost cutting, the company may not have sufficient production capacity to respond to a sudden increase in orders. This all factors into ensuring a company has a sound and adaptable cost cutting strategy.
FAQs
Cost cutting measures may include laying off employees, reducing employee pay, closing facilities, streamlining the supply chain, downsizing to a smaller office, or moving to a less expensive building or area, reducing or eliminating outside professional services, such as advertising agencies and contractors, etc.
What is the importance of cost cutting? ›
Cost reduction has many potential benefits, including improved profitability, cash flow, and competitiveness. When done correctly, cost reduction can also help improve quality and service levels while still maintaining or improving bottom-line results.
What are some key factors you look at when developing your cost reduction strategies? ›
The best cost reduction strategies track all operating expenses. They calculate every penny related to storage, supply, and office space. The key is comparing those operations costs to the established budget. If a business is way over budget in any area, it should consider this a red flag.
What are the negative effects of cost cutting? ›
Cutting costs will cause a company to have less profit and it may also affect the market making it difficult for the company to increase sales. If the company is not able to increase its sales, it will eventually have to cut costs and the death spiral will start.
What is an example of a cost reduction strategy? ›
Cost reduction: Examples
Bringing down office expenses, such as electricity bills, by opting for energy-saving technologies or scaling down on office space by offering remote working options. Negotiating better terms with suppliers to source material at lower costs or be offered higher trade discounts.
What is the purpose of the cost strategy? ›
Cost strategy is built on no-frills. Cost leadership strives towards cutting costs to a minimum possible levels in order to provide customers with lower prices and thus boost their savings.
What are the pros and cons of cost-cutting? ›
There are many pros and cons to cost reduction. The pros include saving money, improving efficiency, and reducing waste. The cons include potential job losses, lower quality products, and less customer satisfaction. The decision of whether or not to pursue cost reduction depends on the specific situation.
What is cost-cutting in operations management? ›
It is worthwhile to dig into your various business processes to find areas where you can make improvements and thus cut costs. “Reviewing work methods, eliminating non-value-added activities and redesigning plant space to reduce movements are examples of effective strategies for cutting costs,” Trudeau says.
What are the critical success factors of strategic cost reduction? ›
The results show that cost culture, top management commitment, and participation are of particular importance for the success of cost reductions. Their influence drives significantly planning and controlling measures which in turn determine the effectiveness of cost reduction measures.
What is the best mix of cost reduction strategies? ›
The most effective cost-reduction strategies usually involve a combination of cost-savings measures, such as reviewing current contracts, outsourcing certain services to cost-effective providers, and using cost-efficient technology.
Low-cost providers are in the best position among sellers in bargaining with high-volume buyers because they are able to beat rivals' pricing to land a high-volume sale while maintaining an acceptable profit margin.
What are the pitfalls of low cost strategy? ›
Perhaps the biggest pitfall of a low-cost provider strategy is getting carried away with overly aggressive price cutting and ending up with lower, rather than higher, profitability.
What are the 5 disadvantages of cost principle? ›
5 disadvantages of cost principle
The costing records only indicate previous performance, but management makes long-term decisions. Cost accounting incorporates costs at a specified pace. The prior year's cost is not the same as current year's cost. As a result, cost figures aren't particularly useful.
What is another word for cost-cutting? ›
lessening, cutback, cutting short, retrenchment. in the sense of economy.
What is an example of cost strategy? ›
Cost Leadership Strategy Examples
Some examples of this approach include: Walmart is a United States retail firm that has different discount stores in a total of 217 countries. It applies cost leadership strategies by selling its products at low costs to attract as many customers as possible for a bigger profit margin.
What is the cost strategy approach? ›
The cost leadership strategy involves a business method focusing on gaining a competitive edge by reducing costs across the organization. It is not just a single tactic but a framework that applies to every aspect of operations.
What is cost cutting turnaround strategy? ›
Cost-oriented turnaround strategies include reducing research and development (R&D), stretching accounts payable, eliminating pay increases, reducing accounts receivable, cutting inventory, investment diversification, and reducing marketing activities.
What is cost cutting in operations management? ›
It is worthwhile to dig into your various business processes to find areas where you can make improvements and thus cut costs. “Reviewing work methods, eliminating non-value-added activities and redesigning plant space to reduce movements are examples of effective strategies for cutting costs,” Trudeau says.
