Top-line growth is slowing down among enterprises due to an unprecedented “triple squeeze” on performance, driven by inflation, a tight labor market for skilled talent, and constrained global supply chains. To cope with the new economic reality, CEOs are turning to executives to find new ways to contain costs, increase efficiency, and reduce waste.
When done right, strategic cost reductions and cost management strategies can raise profits and improve competitive posture. When done wrong, however, cost-cutting can result in decreased innovation, deflated employee morale, reduced customer satisfaction, and long-term damage to the company.
This article provides an overview of how business leaders can harness strategic cost-cutting strategies to drive business success.
Different Types of Cost Management Strategies
1. Reducing Fixed Costs
Cutting fixed costs is often the go-to strategy for organizations when growth stalls. Fixed costs are expenses that remain the same regardless of how much or how little a business produces. These costs can include:
- Rent and lease payments
- Property taxes and insurance
- Administrative staff salaries
- Utilities such as electricity or water
IT infrastructure and technology platforms often make up a large portion of fixed costs. A recent Forrester-Hashicorp report revealed that 94% of organizations are wasting money in the cloud. Sixty-six percent of the report’s respondents listed underused or idle resources as one of the top reasons for these cloud overspends.
To reduce this waste, in this context, organizations should evaluate their IT investments with an eye for efficiency and improvement. This includes:
- Consolidating licenses for tools that have overlapping functionality
- Identifying applications or services that are no longer essential and can be retired
- Re-examining subscription services to identify unused features that can be downgraded
- Making use of open-source tools where appropriate
- Identifying opportunities to switch to lower-cost providers
Airbnb's pandemic cost-saving measures are a great example of undergoing this exercise successfully. The company slashed cloud costs in 2020 by 27% compared with the year prior. It reduced its cost of revenue by 26% to $666 million by monitoring cloud usage, moving data to lower-priced cloud services, and replacing its homegrown data backup system with Amazon's offering.
2. Optimizing Spend on Variable Costs
Variable costs are expenses that vary depending on the output of a business. Examples include:
- Raw materials and supplies
- Direct labor, such as wages and benefits
- Sales commissions and incentives
- Shipping and delivery costs
- Advertising and marketing fees
Tackling variable costs can provide an immediate impact on profit margins. Take Walmart, for example. The retail giant has found seemingly simple ways to save hundreds of millions of dollars. Some of the cost-saving measures it has implemented include:
- Changing the way it buys shopping bags, saving $60 million annually
- Using recyclable materials for workers' vests, reducing costs by 15%
- Centralizing its equipment maintenance to become more energy-efficient, saving $100 million annually
The Bentonville-based company has also previously trimmed costs by swapping out stepping stools for lighter versions, switching to a cheaper and more efficient floor wax, and replacing existing lights with LED lights in stores and parking lots.
Simple tweaks like these can add up to cost savings that make a big difference. Take a granular approach to examining variable costs, reviewing each element of the budget line-by-line to identify ways to save without sacrificing quality.
3. Achieving Cost Savings through Higher Efficiency
Top-performing companies start with a clear view of their cost structure — and then look for ways to reduce costs through efficiency gains. This can involve:
- Implementing automation to reduce human error and free up employees’ time so they can focus on more value-added activities
- Optimizing workflows to reduce redundancies
- Decommissioning marginal activities and replacing them with more efficient alternatives
- Making use of big data and analytics to uncover hidden cost savings opportunities
- Using technology such as AI-powered chatbots to reduce customer service costs
Business leaders must take a holistic, proactive approach to drive cost efficiency for their team and the organization. Rethinking processes, scrutinizing budgets, and understanding customer dynamics can help identify cost-reduction opportunities and root out inefficiencies.
Tips for Ensuring a Successful Cost Reduction Strategy
1. Take Steps to Promote a Cost-Conscious Culture
Cost-cutting initiatives need to start with a company-wide mindset change. This means having a consistent, structured process for and ensuring everyone within the organization – from executives to day-to-day staff and operations teams – understands their role in driving benchmarks for cost-effectiveness.
The best-run companies think of cost optimization as continuous improvement, not as a one-off effort to trim costs in the heat of a financial crisis.
Call on other leaders to recognize and reward cost efficiency so employees feel empowered and motivated to find ways to make the organization more efficient. Emphasize that efficiency should be a core part of everyone's job.
2. Involve Other Organization Leaders
Competing interests can create a counterproductive tug-of-war as different groups attempt to maximize their budgets and defend against reductions. The result? Illusory savings, missed opportunities, and lost potential.
Executives should emphasize that their overarching strategy is to make choices that increase value and ensure long-term benefits for the entire organization.
Engage department heads to get cross-functional support for cost reduction efforts. Each function should contribute a plan that identifies opportunities and suggests tradeoffs. Provide detailed data (instead of high-level budget views) so that business stakeholders have enough information to weigh the impact of reduced spending in specific areas.
One way to navigate this is by adopting a cost management framework. According to Gartner, organizations that consistently use this approach ensure a shared understanding of which costs must be cut and which must be protected to drive strategy.
Similarly, using a framework makes it easier to defend one's budget and ensure strategic alignment with the broader corporate vision. Below are examples of leveraging a value framework to prioritize cost-cutting initiatives and benefits and impact matrix to arrive at those decisions.
3. Emphasize a Zero-Based Budgeting Approach
The “zero-based budgeting” approach requires teams to justify every budget item from scratch. Unlike conventional budgeting, zero-based budgeting starts with a “clean slate” every year and forces managers to assess the cost of each function.
- Helps break down silos and get teams to think more holistically about cost management
- Allows organizations to break free from their established budgeting and resource allocation patterns
- Provides executives with a clearer view of the current state of spending and helps identify areas that may be ripe for cost reduction
Companies such as General Motors Co., Guess? Inc., Signet Jewelers Ltd., and Unilever PLC have used ZBB to remove cost bloat and drive organizational agility in recent years.
For Guess, ZBB led to a whopping $60 million reduction in quarterly operating costs and a $6 million decrease in capital expenditures. Even with a pre-existing multi-year cost-cutting plan, it was ZBB that helped Guess weather the pandemic storm. By reassessing expenses with fresh eyes and identifying areas of potential savings, the clothing retailer emerged leaner, stronger, and more cost-conscious than ever before.
4. Embrace Flexible Models
Business leaders need to look for more dynamic cost-saving opportunities that enable the company to adjust quickly as the economic picture changes.
Rather than locking in long-term contracts and commitments, negotiate terms that provide flexibility on pricing, usage models, and contract lengths. For instance, buying now, pay later terms can help companies spread out the cost of technology investments and reduce the initial hit to their cash flow.
Pay-as-you-go models also provide a more measured approach to technology adoption, allowing organizations to pause, scale up, or down as needed. Likewise, implementing an on-demand workforce model can enable organizations to access specialized skills without committing to long-term contracts or full-time salaries.
And even in the face of budget cuts or hiring freezes, companies can still bring in the right talent to ensure that the goals they set out to achieve remain on track.
5. Avoid the Pitfalls of Blanket Cuts
During economic downturns, it can be tempting to make across-the-board cuts – but this approach is rarely effective. At best, indiscriminate cuts only put a band-aid on immediate budget issues. At worst, they can do irreparable damage to customer experience and growth potential.
Take Kraft Heinz, for example. At a time when consumer tastes were changing, the multinational food company implemented a ruthless cost-cutting program, including a 20% reduction in its workforce and a 40% cut in overhead. The remaining employees felt the squeeze, with slashed budgets for market research, product promotion, and marketing.
These cuts came at the expense of growth, and the company experienced declining sales for six consecutive quarters in 2019. Ultimately, the food behemoth lost $16 billion in market value, and its stock price dropped by 30%. Its fixation on reducing costs caused it to lose sight of its core objective: producing food people want to eat.
The takeaway? Identify opportunities and successes in terms of impact rather than dollars saved. Having a broad, value-based view of costs ensures that cuts are strategic and further the organization's long-term objectives rather than just providing temporary relief.
Only 11% of organizations can sustain cost savings for three consecutive years. Most companies fail to embed cost-saving measures over the long term. Whenever a financial crisis hits, they resort to the same playbook of slashing headcount, cutting discretionary spending, and delaying investments. To avoid this outcome, business leaders should consider all opportunities and base their decisions on how it impacts the organization’s broader strategic vision.
If you're looking for more insights on how to navigate uncertainty to make your business more agile and resilient, then check our blog 7 Key Business Strategies to Survive and Thrive Despite a Recession.