SHAPING STRATEGY Paradigm Shift: Is Reducing Costs Really the Answer? MARK MEHLING, MARKETING CONSULTANT
edge can yield remarkable differences in business decision making. But it can be tough to change. Te whole purpose of being in business is to make money—profits. Fixed and variable costs are an inevi- table part of any business, especially the metalcasting industry. When profits are down, the natural
U
reaction is to “reduce costs.” Of all the solutions available, this one can be “death by a thousand paper cuts”— slow, painful and inevitable. Te reason is simple: profit lies in sales, not in costs. (Of course, costs must be controlled or no amount of revenue or sales will allow profitability.)
Where Does Profit Originate? Before a single sale, there are still
expenses. If these are legitimate, con- trolled and managed (key elements), closing the business is the only way to reduce them. Tese costs have no profit. Try this simple, do-it-at-your-desk
exercise: Take your Profit and Loss (P&L) statement and remove sales rev- enue, then recompute the numbers. How much profit is there? Obviously, none. Now, with the “no sales” adjusted
P&L you just created, reduce the re- maining costs by half. Again, recompute the bottom line. Now what is the profit? My point is all profit is ultimately
born of sales. Profit only resides in revenue/sales. Consider the diagram in Fig. 1.
Every new order contributes to fixed costs, variable costs and profit. An incremental sale brings revenue that covers costs and adds profit. No cost reduction can do that. Cost reduction may magnify the profits from a sale if everything else remains equal, but it does not produce profit. Only sales produce true profits. Because of the steeper line of
revenue in Fig. 1, a single order adds much more to paying expenses than reducing cost ever can. So why do we naturally gravitate to
nderstanding profit’s true source shifts most people’s thinking. Tis new knowl-
costs will result in more accepted quotes because of lower prices. But this assumes buyers will select a par- ticular quote based solely on price, a proven fallacy. B2B buyers and buying teams make decisions based on overall value, not just price.
Unseen Consequences
Cutting costs can spawn additional expenditures in other areas. Have you ever bought olives in the
Fig. 1. A properly priced product incrementally contributes more to profit than cost adjust- ments. The misconception is that cost reduc- tion contributes, incrementally, the same as sales or revenue.
cost reduction/saving programs as an easy target? Consider these myths: Myth #1: Costs are “controllable”;
sales are not. As engineers, we are attracted to the formulaic, the observ- able. Reducing costs is a finite, defin- able, act. Increasing sales, not so much. It’s simpler to stop writing checks. Eliminate travel, training, benefits, even jobs. Each one has a visible com- ponent that, when enacted, enlarges the sales/cost gap, allowing “profit” (or smaller losses) to magically appear. It is easier (lazier?) than developing a sales system that can reliably deliver new clients, orders and profits. Myth #2: You can always reduce
costs. Sure, there’s always a little fat that can be shaved. It’s tempting to go after it, especially in lean times. Te famous PT Barnum summed up the misconception this way: “I know half the advertising for my circuses is wasted—if I only knew which half.” Metalcasters have the same challenge of knowing what to eliminate that doesn’t harm the business long term. Cut too much, or in the wrong area, and you destroy morale, customer service and long-term revenue. Myth #3: Lower costs equal lower
prices, and that means more sales. Followers of this myth hope reduced
tall, narrow jar? Tey are a perfectly ar- ranged column of 13 little green gems. Profits were down at the olive factory. After examining the jar, so perfectly packed, someone had an ingenious idea: eliminate one olive! Removing one olive would save 8%, the bean (olive?) counters noted. However, no one considered the additional juice required to fill the jar in place of the now missing olive. Buyers noticed the missing fruit and sales declined. So the company bought smaller jars. Which required machinery changes. And disposal of the old jars. By the time it was all over, the cost savings disap- peared in the mess. Had they invested in refining their sales system, profits would likely have increased. Metalcasters are exactly the same. Most decisions to shave expenses inevitably carve away at more than fat; they cut muscle and bone. It ultimately tears away at customer service, morale and long-term profit. Your image falls among buyers. Tat reduces quote requests along with client satisfaction. Bottom line: to increase profits,
work to increase revenue more than decrease costs. Additional sales/rev- enue amplifies profits over the long run more than decreasing costs ever can. Money and effort invested into sales systems will pay more back than investing in cost reductions. Increasing revenue while control-
ling costs is the key ingredient to long- term profitability and stability.
For an expanded conversation about this topic, email
Mark@TeFoundryMarketer.com for an in- depth discussion on CD available free to Modern Casting subscribers.
January 2014 MODERN CASTING | 57
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