Operational efficiency and cost reduction the right way

In looking at this title, one might conclude that this is the mantra of all businesses. Unfortunately, the failures of businesses, both big and small, would indicate that this is not necessarily the case. Let's look at these two phrases separately.

What is operational efficiency? Obviously, it varies by business and industry. Does the baker bake his bread at a cost that makes the product viable in the marketplace at profit-producing price? Can the airline produce seats at a seat-mile cost that allows it to make a profit at prevailing ticket prices? Every industry has prevailing rates that one can research to determine a range of production costs. Even if that information is not readily available, just good market research should give one a good ballpark range of what one's cost should be to insure a profit. If one can't fall within that range, then maybe they shouldn't be in business!

Then we come to cost reduction. A difficult situation! Unfortunately, a lot of the problems lead to the need for cost reduction start in good times. Let's move to a fancier office, add upscale perks to senior employees, etc. In larger companies, it can lead to empire-building! This will obviously lead to higher operating costs, which can sometimes be borne by an increased boom time in revenues. But then the downturn comes. Revenues decrease, not just for your company, but across your industry. Where do you cut back? There can be agonizing decisions. Do you cut out a product line, or lay off Aunt Tillie you hired on in the boom time? I was with a major airline (no longer in existence) that had a senior human resources vice president who made it look like he was making sacrifices by laying off $75-a-week mail boys and other low-salary personnel that provided necessary services while protecting six-figure executives, some of whom were not a necessity for the success of the operation. It made life much more difficult for those vital to the success of the company to do their jobs!

So, where does one make cuts? First, let's go back to the revenue side. Where are the strengths and weaknesses of your product lines? Can you cut out a product and its related costs without damaging your other product lines? (General Motors discontinued the Oldsmobile and Pontiac brands.) If you have only one product, can you cut production (or acquisition) costs without deteriorating the quality of the product, a move that can have serious long term effects on your business. Going back to my airline example, while an excellent international service was maintained, the airline downgraded the meal service domestically so much that people from the Midwest and beyond who should be connecting at JFK to go to Europe on the same airline, were so turned off that they switched to major European carriers for the transatlantic portion! Whatever your industry, there are ways of figuring out your production costs. See where you may be exceeding them and make adjustments.

A well-run company is one that keeps constant oversight on their production costs and how they relate to the industry. This applies to their overhead costs, as well. Obviously, a good eye on competitor prices is a good idea as well!

Going back to my airline days, I had the privilege of working with a close-to-retirement Controller of the company who said "You can't save your way to prosperity!"

Adrian Woodhouse has over 30 years of experience with executive positions in finance, operation sales and asset management. He founded his consulting firm in 1989 advising accounting and leasing companies. A Princeton graduate, he has held two board positions with the International Society of Transport Aircraft Traders. He has been a SCORE counselor since 2008. Contact him through score-reno.org.