If you are a manufacturer, there are only 3 areas where you can cut costs. And if you’re an operations manager for a manufacturer, you have probably been asked to cut all three at some time. The areas in question are materials/inventory, operating expenses, and labor. Cost cutting is almost always a short-sighted attempt to “make the numbers” or perhaps mask a performance issue, if you work in a publicly traded company. The problem is that there is rarely any risk assessment of potential negative effects from the cost cutting. Put another way, focusing on cost is going to really cost you!
Materials/inventory: What could be bad about getting a lower price on raw materials? I’m going to speak at length about that in my next blog, so I’m going to leave that alone for now. What about reducing costs by carrying less inventory? As long as “less” doesn’t mean I occasionally run short, I’m for it. Unfortunately, this is usually what happens. I’ve seen a $500K shipment held up by a $2 part because of a “purchasing freeze” to cut costs. And then it cost $30 to have it expedited!
Operating Expenses: It can cost a lot of money to keep the factory up and running so there is always the temptation of cutting some of these costs. I visited a beverage company where the main piece of equipment, the filler, had a catastrophic failure. The gear box underneath basically exploded. The OEM was contacted for a replacement. They didn’t carry them in stock because they said, and I quote, “those never fail”. Well, in fact they do if you don’t follow the suggested preventive maintenance (PM) process. Yes, the company had cancelled their PM contract with the OEM to cut costs! In just two days, they lost more revenue than the annual cost of the PM service contract. They were down for 5 days total.
Labor Expenses: Reducing workforce is probably the quickest way to cut costs and unfortunately is often the first cut companies make when they feel the need to tighten the belt. For many cyclical industries (I’m looking at you auto makers), this is a de facto way of doing business; hire during booms and fire during busts. From an ethical standpoint, it is disgusting to treat human beings as expendable commodities and I’ll leave it at that. But it is also bad business. When the boom comes, the business is unprepared for the volume. It takes a significant amount of time to rebuild capacity. I visited one company shortly after the COVID recession was subsiding and the Ops Manager complained about the fact that he was having trouble hiring people to deal with sudden influx of orders. He considered the workers that he had fired “ungrateful” for not returning to the jobs they were fired from! In the past, they had always come back so he just treated them as equipment he could turn on/off as needed. He didn’t calculate the lost revenue as he tried to increase production, but it was substantial.
The other general problem with focusing on costs in a for-profit business is that this is a short lever. You can’t even reduce it to zero. If you reduced operating expenses or labor costs to zero, you no longer have a business!
So what should you focus on? Instead of focusing on reducing spending, focus on getting the most out of what you do spend. (You might also want to take a peek at my previous blog “Don’t do more with less”.) Focus on ROI and speed. If you can hire twice as many contractors and truly get the project done in half the time, it is usually worth it. Those in the construction business can surely relate. Generally speaking, a 10% increase in revenue would have about 4X the effect of a 10% decrease in expenses. Bigger lever!
In my next post I will provide a deep dive into a real-world example and describe some negative effects that go unrecognized when focusing on material cost.
Don’t focus on cost,