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Cutting Expenses Makes No Sense Unless You Use This Filter

In the last 3 Blogs I wrote about the first 3 ways to grow a business, any business.

Way number 1 is to increase the number of customers/clients (of the type you want)

Way number 2 is to increase the transaction frequency (or in business terms, the number of times they buy)

Way number 3 is to increase the average value of each sale.

And, way number 4 is to increase the efficiency of how you do the first 3.

The measurements of the first 3 ways to grow your business are a breakdown of what is in your total sales figure:

Number of active customers

X

Number of times they shop/buy

X

The average sale per transaction

=

Total revenue

All 3 of the above can be measured and when you increase each one as an independent strategy you can achieve some explosive growth!

So, you may be wondering….

How Do You Measure Increasing the Efficiency of Your Systems?

The measurement for the efficiency of your systems is the cost per transaction.

For your variable costs it is your gross profit margin.

For your fixed expenses it is the total fixed costs divided by the number of transactions.

And, this is where it can get very slippery!

Because we all know that Profit is equal to Revenue less Expenses, then it would seem that the way to increase profit is to reduce expenses!

And this is a huge mistake, if applied without further thinking …

Even Huge Companies Really Get This Wrong

I read the other day that stock repurchases (something that was illegal under SEC rules in the past) are all the fashion in the public company world.

In other words, large companies increase stock value by using internally generated cash to buy their own stock back.

This increases the share value, and then the Executive stock options are worth more, which they cash in on.

Do you see a motivation here?

All this is done at the expense of the people who are generating the bulk of the share value – the people who work there.

So, am I saying that a business should not reduce its costs?

No, I am not. What I am saying is that a company must use a different way of thinking when they examine each cost of the business…

Before Axing a Cost, You Must Ask These 3 Questions

As I mentioned above, because revenue – expenses = net profit, it would seem logical to think that reducing expenses will increase net profit.

And, this would (in most cases) be totally wrong.

Why?

Because costs drive value.

I will repeat that – costs drive value.

And if you reduce them willy nilly, you will end up cutting the heart out of the business, and revenues will eventually, sometimes quickly, decline with the cost-cutting.

There are 3 Vital Questions to Ask Before Eliminating or Reducing any Expense

They are:

  1. Does this expense help to increase sales?
  2. Does this expense help to increase Return on Investment?
  3. Does this expense help to increase cash flow?

 

If the answer is “no” to any of those questions, then either cut it, or replace it with a lower cost alternative.

 

Let’s look at some simple examples. Take rent – perhaps you are in a high-traffic location for a retail store and you are paying $500 a square foot. You find another location for $250/ square foot.

 

If the high-traffic location can generate more than twice the sales per square foot, then it is a better investment than the lower cost alternative.

 

Coming back to my example of the share re-purchase schemes by public companies. Imagine that they – instead of buying back their own shares – invested in better infra-structure, team training, and higher wages. Perhaps those drivers of value can result in higher sales and thus higher net profit.

 

From the higher profit, dividends could be paid to the shareholders, and everyone wins.

 

The Best Way to Create Effectiveness and Efficiency is Systems

 

As Michael Gerber said in his underground bestseller, The E-Myth, the systems are your business.

 

Put another way, without good systems, there is just you, “doing it, doing it, doing it”. You may be good at the technical work of the business, but that is not what is required to create a sustainable business. For that you need systems!

 

Your systems must revolve around what your customers truly value so that you can deliver a consistently awesome product or service in a manner that has people feel cared for and appreciated.

 

Start by flow-charting every vital customer-centric function of your business, and eliminate steps that add no value, and add steps that do.

 

One way to find out what your customers value is to run a Client Advisory Board, where you meet (or rather someone else meets with them rather than you as owner, so they will be more honest) with a select group of your best customers and ask them what is working and what is not working in your business.

 

It takes guts to do that, yet most good(A) customers will not trash your service offerings – they will offer constructive feedback that will help you run a better(and hence more profitable) business in service to them.

 

Thanks for reading….