Reducing Waste and Cutting Costs to Improve Profit?
We all know that there a lot – and I mean a whole lot – of factors that go into the success of any given business. These range from the highly controlled to sheer dumb luck (though in actuality there are usually underlying items that just appear to manifest as luck), and each plays a part in how well any give operation will perform and sustain.
Despite widespread recognition of the need for a range of conditions, without an exclusive focus on any one of them, we as professionals just can’t seem to help ourselves when it comes to the temptation of debating which way is the ‘better way’ of doing things. If there are two paths, we have some inherent need most days to out one forth as the best. Today is one of those days.
As silly as such musings and arguments may seem, they often do spawn new ideas and insights that allow us to better understand the principles we already incorporate, and maybe even introduce a few new ones. Today’s debate is an interesting beast, courtesy of LinkedIn. Poster Richard Artes poses the question, “Which is more important: cutting costs to improve profit, or increasing customer value to increase revenue?”
Ultimately, as with every such debate, both sides will have their place and are important, but for the sake of education and learning a bit more about the implications of each, let’s dig a little deeper.
What does decreasing costs do?
First of all, let’s take a look at what exactly happens, or can happen, as a result of lowering your costs. It’s worth saying right off the bat that decreasing costs and giving attention to your margins are important, and we have huge business ideology formed and tested over decades to prove it (I’m looking at you, Lean/Six Sigma). Waste and variability reduction, the hallmarks of these ideas, are as alive and strong today, if not more so, as they were when they first entered the scene decades ago – and for good reason.
User Byron Clarke had the following to say on the importance of profit margins:
“…if you attack waste it results in reduced cost, if you reduce cost then you become more competitive, if you become competitive you should win more business and you revenue grows, however, this revenue will have profit!!”
It’s a nice train of thought, but there seems to be disconnect between reducing costs and becoming more competitive. The problem is in the implication that reducing costs makes a business more competitive naturally, without some other intermediate step. A better way to phrase this concern is that there are various ways in which a business comes to be “more competitive,” and only addressing one of them isn’t always what you’re looking for.
For example, if a business lowers costs it may be able to produce more product with a given budget and within a certain amount of time (if budget was previously a constraining factor). The business can become more competitive in this way in terms of its ability to produce, but it really only matters if there are enough interested customers demanding those products already – otherwise you just have waste that’s been transferred into a new form.
Keeping this in mind, we get the first glimpse of the “chicken and the egg” situational nature of this debate: If you already have the demand, then waste reduction/cutting costs so you can produce more and/or increase your profit margin per unit is the way to go. If however, you need to first increase customer value as perceived about your brand in order to create an increased market, then that’s where you’ll want to focus instead.
Another way to view this debate is as a revenue vs profit discussion. As Artes points out, a company can survive indefinitely without profit (breaking even, paying all employees, etc.), but it can’t survive without revenue.
What does improving perceived customer value do?
If you are in a position to do so, boosting your perceived product seems to be the way to go. Improved perception of your brand and product is a sure fire way to drive sales and position you as a player in your market (duh!).
Key to keep in mind here is that the costs and processes behind a product have no direct effect of how appealing or valuable a product is to your customer, this why it’s intentional that I denote “perceived” value. Actual value, determined by your own costs, is then important only to the supply (your) side of the equation and not the demand one (theirs). Nobody cares how much it cost you to make something, though they may care that it looks like it was expensive.
While the behind the scenes work might not affect perceived value, Artes reminds us that the four P’s certainly can. You’re probably already familiar with them (and if not, shame on your marketing professors), but here’s a quick run through:
- Position: what are you positioning your product as, a luxury item? An everyday brand? This is about carving out your niche.
- Perception: what people think of you; does this align with the message you’re trying to portray?
- Product: what you’re actually selling.
- Price: What are you charging? What are people willing to pay?
Marketing 101 aside, the point of all of these is to increase competitiveness in a given market. These are the true tools of increasing competitiveness, rather than “cutting costs” as Clarke seemed to suggest.
Ultimately, both factors are essential for you to be able to thrive, though if you’re forced into choosing where to spend your time and effort, I would opt to create your market and then make the manufacturing adjustments (supply) in order to meet the demand.
Either way you go about it, you’re going to find yourself in a balancing act that requires you to keep both aspects relatively even with each other; as one changes, the other has to follow to make the best use of your resources and/or position. What’re your thoughts on the supply/profit vs demand/revenue debate? Weigh in below!