How to Cut Expenses
On March 17, 2020, Emily Holdman and Mark Brooks recorded a discussion on cutting expenses in light of the COVID-19 outbreak and the resulting economic halt. This recording is part of our podcast, The Messy Marketplace, available on all major podcast platforms.
You can’t cut your way to growth. When bringing a new company into our family of businesses, cutting expenses is not on our to-do list. Most expenses exist for good reasons and we’ve found that after patiently taking the time to fully understand how a business operates, we end up keeping almost all of them.
But there are times when cutting expenses is unavoidable. With travel bans, social distancing, and supply chain disruptions from COVID-19, many operators are already seeing dramatic declines in their top lines and are figuring out how best to reduce their cost structure to make it through a brutal economic slowdown that we hope is over quickly, but fear might be here longer.
How do we cut expenses responsibly without harming our long-term prospects or the team members who helped us build our companies? How do we determine if we’re cutting fat, muscle, or bone? What if cutting expenses incurs upfront costs such as severance or termination fees? Here’s what we’ve learned in the trenches.
How to Approach Cutting Expenses
Communicate Early and Often
When times are tough, your employees want to hear from you. Tell them what you’re seeing from your seat and what you believe needs to happen to keep the company healthy. The more honesty and transparency you provide, the more likely they are to help the business make it through. If you can honestly tell your team, “Layoffs are the very last thing we want to do,” they will rally to help you find ways to cut expenses and be more open to sharing some of the burden.
Be Honest With Yourself
After a 10-year economic expansion, many of us have lost the muscle memory we used to have on tight expense controls. As our businesses have grown, we’ve grown accustomed to signing off on new expenses that are “nice to have” and have gotten used to having them around, not remembering that we once operated without them. When putting pen to paper on your expense reductions, be honest with yourself about the value each expense ultimately returns to your business. You’ll be surprised how much you can live without, especially temporarily while you wait for demand to return.
An exercise called “zero-based budgeting” can help us get real about what’s necessary. Instead of starting with a full list of your expenses and crossing off what you think is excess, start with a blank sheet of paper and write down all of the things you need to run your business right now. This can be an effective tool to help identify items that aren’t as necessary as they might appear.
Put Yourself In The Approver’s Seat
If you’re not doing this already (and we hope you’re not), now might be a good time to temporarily become the check signer for your business. Nothing will give you a better sense of the money flowing out of your business than having to personally sign each outbound check. Note we are not advocating that as the owner/leader of your business that you should do this long term. It can be an effective temporary tool, but will slow the business long-term if you don’t hand this duty off once the crisis abates.
Cutting Fat
We define “fat” as expenses that can be cut without any noticeable impact to the business’s output or culture. Realistically, these are expenses we should have cut long ago, but in the spirit of “never waste a crisis” now is the perfect time to trim the fat.
Unused Employee Benefits
In the interest of treating employees well, businesses tend to accumulate employee benefits over time. Most of these benefits are well-meaning and many of them are greatly appreciated by your workforce. It is also the case that benefits rolled out long ago may no longer be used by employees (or were never really adopted). Now is a great time to examine the utilization rate of each of your employee benefits and wind down the ones that are less popular.
Contracts and recurring costs
In turbulent times, every business is looking for revenue stability. This is a great time to call your service providers and suppliers and have a conversation about your commitment to work together through this. You’ll find many of them are willing to negotiate a lower rate in exchange for a longer commitment.
This could be a great time to look at small things that didn’t used to seem that important or that employees may not have had time to implement before. This week, one of our portfolio companies took advantage of a program offered by their utility to install high-efficiency light bulbs in the warehouse at no cost -- cutting their electricity bill in half.
This is a category where you may have to pay upfront to realize the savings later. To decide if doing so is worthwhile, measure your payback period -- the time it will take to recoup your upfront expenditure in savings. If it’s less than the days of cash you have on hand assuming no additional revenue, do it with confidence.
Unprofitable Customer Relationships
Most businesses have a handful of customers where their cost to service them exceeds the revenue they bring in (sometimes by a lot). Take a hard look at your customer-level profitability. If you have unprofitable customers, it’s time to start having conversations and ultimately either raise the price they’re paying to work with you, reduce the scope of the agreement, or to “fire” them altogether.
Cutting Muscle
We define “muscle” as expenses that can be cut temporarily without permanent impacts on the success or culture of the business, but, like muscle, hurt you from moving when you need to. The impact of these cuts will be felt short-term and may delay growth, but are ultimately survivable and acceptable should you need to make them to keep the business afloat.
Long-Term Projects
If your company has been successful, you or your employees may be working on projects whose benefits won’t be realized for several months or even years. If these resources -- we’re talking about both money and people here -- are at all interchangeable, consider shifting them to near-term projects that can either generate immediate revenue or help you reduce expenses. Can these team members take work off the desks of the sales team so they can spend more time selling? Can they take on work that you’re currently paying an outside firm to do? Get creative about redeploying employees to initiatives with immediate impact.
Advertising
Brand advertising spend that is used primarily to get your name out there generally has a positive impact on sales, but the incremental sales it generates tends to be in future periods. If you spend a substantial amount in this category, consider cutting back by prioritizing where you’re spending on brand, or pausing these initiatives altogether.
If your advertising spend has a long breakeven window, meaning you spend today and it takes several months or even years for you to make that money back from the customer relationships it generates, you may decide to pull back on short-term spend to make sure your business stays solvent today.
Neither of these ad spend pullbacks should be done lightly. You are trading off short-term security at the expense of longer-term growth. But if these cuts are needed for survival, ad spend reductions are a viable place to look.
It’s also worth remembering at times like this that the least expensive customers to acquire are the ones you already have. You may be able to generate incremental revenue at low cost (though cost yourself long-term margin) through retargeting, early renewals, extensions, cross-sells, or upsells.
Travel
Yes, we should all be limiting travel during a global pandemic. But much of the sales travel we do is related to “business development” -- building relationships and keeping leads warm rather than actually closing sales. If this describes the way your business uses travel, consider cutting back temporarily until the economy rights itself.
Executive Incentive Payments
If your business does periodic incentive payments, bonuses, or profit sharing, consider asking your leadership team if they’re willing to defer their disbursement until the economy rights itself. This should always be done in tandem with a similar commitment from you on your own incentive pay to show both your seriousness and your solidarity in doing what it takes to get the business back on track.
Cutting Bone
We define “bone” as expenses that, when removed, are likely to cause long-lasting if not permanent impacts to your company’s ability to perform. Cutting bone should be a last resort, but can be necessary if the situation is dire.
Layoffs
From a strictly financial perspective, some layoffs could be filed under “fat.” Most companies will overhire at some point in their history, and may have employees on the payroll who are adding little, if any, value. No matter how little value an employee generates, a layoff fundamentally changes the relationship between “management” and “employees.” There is an aspect of “being in this together” that is altered that, speaking frankly, may never be fully recovered.
If you decide to do layoffs, we’d recommend a one-time event that cuts deeper than you immediately need and ensures future layoffs are off the table. The drama of multiple rounds of cuts will be extremely demoralizing even to those who remain.
Layoffs can also be expensive if employees require severance. Make sure you know what you’re getting into and measure your payback period.
Pay Cuts or Furloughs
We think about broad pay cuts or unpaid time off in the same category as layoffs. Even if they are done with the company’s best interests at heart, they will alter the way front-line employees think about management and can have a lasting impact even if you restore pay after the emergency subsides. Again, do everything you can to ensure this is a one-time event.
Selling Real Estate, Receivables, or Equipment
If your business finds itself desperately low on cash, asset sales are a viable option. In a sense, asset sales are a “layoff” of sorts -- you are bringing in short-term cash in exchange for long-term value creation. A potential option might be a sale-leaseback, where you sell the equipment or real estate to a third party, pocket the cash, then lease back the equipment over time. Before you do this, exhaust all traditional financing mechanisms. It’s usually better to borrow against these assets than sell them outright, particularly given today’s interest rates.
Reducing Health Care Benefits
While hunting for large expense items, your employee health care benefits likely caught your eye. For many companies, this line item is the largest in the overhead category after salaries. While it may be tempting to make cuts here, do so with extreme caution. Cutting health care does more to damage culture than either layoffs or pay cuts because they can be interpreted as management saying, “We don’t care about your well-being,” which is especially problematic under the current circumstances. If you must tread into the “bone” category, consider other options first.
Conclusion
Cutting expenses is a lot like surgery -- it’s delicate work under stressful circumstances. With good communication and a knowledge of your company’s vital systems you can conserve cash today, emerge stronger and leaner on the other side, and ensure your business lives a long, healthy life.
