Even well-run businesses sometimes face the need for cost cutting at times. It might be because of macro problems like recessions, or because of business-specific problems that come up on occasion. You know better than anybody what risks your business faces, and why cost cutting might be necessary.
I’ve been through it with my own business several times, and in the process I’ve learned these three lessons. They’ve helped me keep cost cutting strategic, helping me do the least possible damage to my business’s long-term prospects.
1. Realize that sales and spending are connected.
I recommend never separating sales from spending in forecasts and projections. Neither exists in a vacuum. Spending can drive a sales forecast. Sales typically depends on drivers such as leads, marketing activities, etc.
A common mistake in cost cutting is cutting spending programs that drive sales without dealing with the cut in sales that results. I’ve found that projections work better when they have conceptual links between the sales forecast and the spending budget.
I once consulted with a manager who gathered his team together to push up their collective sales forecast. Then, after locking the sales forecast, he decided to push down the spending budget. That was frustrating for team members who knew they needed marketing or sales expenses to meet their sales goals—and it didn’t work.
As you make projections and forecasts, consider this: As sales drop, you may see some automatic cost cutting tied to sales. Whether your direct costs are costs of goods sold or costs of services delivered, they can drop when sales drop.
“Having a good planning process can help track the progress of actual results, which can help when you regularly compare them to projections and budgets.”
You may also discover, as I did when my software business fell in 2008, that there can be automatic cuts in non-discretionary spending triggered by sales. In my case our co-promotion and administration fees—charged by channel partners as a percent of sales—fell in direct proportion to the declines in our sales.
2. Understand the full cost of cutting payroll.
During the Great Recession in 2009, I watched my CEO cut costs without having to let people go. As she looked at where to save money, she considered the potential savings from cutting headcount and payroll, but also added back the future costs of finding replacements and retraining people later on, when the business recovered. That tipped the scale towards keeping people and cutting costs somewhere else.
She managed her revised business plan very carefully. Her projections showed exactly what levels of key indicators would trigger layoffs. We watched and waited, hoping for a turnaround before the numbers went down too far. As it turned out, our business did recover in time to avoid the layoffs. And since we hadn’t lost anybody, we didn’t have to recruit and train new people. We were better positioned for the growth that followed.
This is a lesson I could have used during the previous recession in 2001. Back then I had waited too long to cut expenses. Instead of cutting costs strategically, I had to let five of our 33 employees go on the same day. (Thankfully they understood it was a business decision and not a personal one.) Six months later, after sales recovered, we had to find new people and train them.
3. Cost cutting requires planning to be effective.
Strategic cost cutting is a good reason for having a strong planning process. It’s my belief that well-managed companies keep up-to-date forecasts and spending budgets.
The forecasts and projections can help connect the dots by identifying the interconnections in the business, such as the link between sales and spending. Having a good planning process can help track the progress of actual results, which can help when you compare them to projections and budgets regularly.
Contrary to the common myth that rapid change voids planning and budgeting, it turns out that planning and budgeting, when done right, can create a dashboard effect. As things change, your planning process can give you a quick assessment on what’s changed, by how much and how that may affect the other parts of the business. This knowledge can help you react quickly. It’s like having full dashboard in front of you: dials showing you the status between projections and results; knobs to adjust; and switches to turn on and off based on your adjustments to spending and ongoing forecasts.
You probably don’t want to wait for the event that necessitates cost cutting. Consider these tips to help you set up an ongoing effective planning and budgeting process.
Author: Tim Berry
Founder and Chairman, Palo Alto Software, Inc.