- What are cost savings?
- How can cost savings increase profits?
- How can you benefit from cost savings?
- Continuing with your strategies for cost savings
Q: Why is cost savings important?
A: Saving money is always important when you’re running a business. This is true whether you’re operating a small operation or a multinational enterprise. When you continue to profit with fewer expenses, your profit margins increase. And in the end, that’s what running a business is all about.
According to a 2022 study, 57% of small businesses in the United States and Canada cut back on spending during the pandemic.
Even as lockdown measures eased, these businesses continued to streamline operations and keep expenditures at a minimum. This would suggest that entrepreneurs learned valuable cost savings lessons during the pandemic.
This study also highlighted a shift in priorities for entrepreneurs, with a move from marketing to operations management. We’re also seeing a slight increase in IT and HR spending for small businesses in 2022.
Perhaps not surprisingly, a considerable portion of respondents increased their budgets for software in 2022 – reflecting a transition towards remote work.
Small businesses are not firing employees to cut costs, however. In fact, not only are they maintaining their current employees, but they are also offering them new benefits. This suggests that talent is becoming increasingly important in the post-pandemic economy.
These statistics show that successful businesses approach cost savings in a logical, efficient manner.
Instead of simply cutting costs wherever possible, it’s important to approach this process strategically.
But how do you accomplish this?
What even is cost savings?
We’re glad you asked…
What are cost savings?
At first glance, cost savings might seem like a rather obvious concept – one that does not need an explanation.
After all, doesn’t cost savings simply refer to the amount of money you’re saving on costs?
The truth is that “cost savings” in business has a slightly more complex definition.
The result of cost savings is a “net benefit” after spending reduction. The actual process of cost savings is incredibly varied – ranging from negotiating better contracts to sourcing cheaper materials.
The goal of cost savings is to increase profits.
Because of this, cost savings is a multi-faceted process. Instead of simply reducing expenses to the greatest extent possible, businesses strategically plan for the future when they engage in cost savings.
How will cutting an expense affect your profit margins? Can you afford to stop paying for a utility? What happens when you fire too many employees? These are all questions you should ask yourself as you engage in cost savings.
The seven types of cost savings
There are seven types of cost savings, including:
Substitution
Substitution involves replacing one thing with another to cut costs. For example, you could switch to a cheaper type of payroll software. Another example would be switching from a physical office to a virtual office.
Combination
You can save money by combining many different processes under a single umbrella. The classic example is insurance. Instead of using multiple policies and providers to handle different aspects of your business, you can get an “all-inclusive” plan that covers everything you need for your operations.
Adaptation
Adaptation involves transforming your business to compete and remain relevant in the modern era. One of the best ways to adapt is to consider actions taken by other companies within your niche. What are they doing right? How are they saving money? Can you do the same thing?
Modification
A few adjustments here and there can go a long way when it comes to cost savings. You might choose to modify your employee benefits program or your shipping fees to negate some of your costs.
Putting something to another use
Is there something in your business that could be used for another purpose?
Perhaps you have an empty room in your office or home that could be dedicated towards something else. Perhaps you could even rent out the empty room on Airbnb.
If one of your workers has exceptional customer service skills but they work in IT, consider switching them to a more productive role.
Elimination
One of the most straightforward examples of cost savings is elimination. This simply involves cutting expenses entirely. For example, you could get rid of your printers – eliminating the annual costs associated with paper and ink. You might also fire employees or get rid of benefits programs entirely.
Reversing, rearranging, or revising
One example of reversing is a reverse auction. Rearranging could involve carefully going over your budget and making small adjustments, while revising might be searching for new, updated, and cheaper options. This is essentially a miscellaneous category for everything that doesn’t fall into the other six areas.
The acronym “SCAMPER” helps you remember these seven different types of cost savings.
Cost savings vs. cost avoidance
If you’ve been researching this topic, you might have heard of something called “cost avoidance.” So what’s the difference between cost avoidance and cost savings?
While they might sound similar, cost avoidance is actually pretty distinct.
When you avoid costs, you do not necessarily consider the potential effects of these cuts.
For example, neglecting to replace machine parts in your factory might help you save money, but it probably won’t lead to the best outcome.
In the end, avoiding costs can affect your profits negatively in the long run – even if it seems to boost profit margins in the short term.
That being said, cost avoidance is neither inherently good nor bad. It can be beneficial or detrimental to your business depending on whether your strategy is effective.
Cost savings vs. cost reduction
Cost savings and cost reduction are also similar concepts, but they’re not exactly the same.
While cost reduction focuses entirely on dollar amounts, cost savings takes a more holistic approach and examines the “bigger picture.”
Cutting costs might save you money, but it might also affect other areas of your business – and this can result in new expenses created elsewhere.
Or it might impact non-financial aspects of your company, such as your reputation among your consumers, or your sustainability score.
While cost reduction dismisses these secondary knock-on effects, cost savings takes everything into account.
Cost reduction itself is divided into three categories:
Cost savings
Yes – cost savings is technically a type of cost reduction. As previously noted, it represents a more specific, holistic strategy. However, it is still under the general “umbrella term” of cost reduction.
Avoided costs
Cost avoidance is another type of cost reduction. As previously noted, this involves deferring or eliminating costs in the hope of boosting profits. Again, whether or not this is beneficial depends on the efficacy of your strategy.
Opportunity costs
Most of us have heard of opportunity cost, as this has become something of a buzz phrase today. An opportunity cost is the “road not taken” – the loss of potential gain from choosing one option instead of another.
A classic example is letting your money sit in a bank account rather than investing it, and the fact that you could have purchased stocks or bonds represents an opportunity cost. The same logic applies to your business.
Cost savings examples
So what do cost savings actually look like?
Here are a few examples:
- Reduce spending
- Avoid IT upgrades
- Eliminate waste
- Use less physical resources
- Review insurance
- Review benefits programs
- Pursue sustainability
- Combine functions and events
- Check banking fees
- Outsource
- Invest in new equipment
- Reduce travel
- Reduce inventory
- Discontinue products
- Negotiate better deals
- Downsize
- Relocate
- Alternative marketing
- Business model adjustments
Most of these examples are pretty self-explanatory, but others require a little more discussion.
Sustainability deserves a special mention because it allows you to kill two birds with one stone. Not only does sustainability lower your operating costs, but it also helps you achieve a better reputation among your customers – potentially increasing demand for your products.
With this in mind, it’s clear that moves like recycling or eliminating waste can boost your profits in more ways than one.
Combining functions and events is actually another simple way to save cost. Combining a charity event and a conference can be an excellent way to cut costs, since you won’t have to book a space twice.
We also need to mention quality. Ironically, you can engage in cost savings by increasing or decreasing the quality of your products/services.
When you increase quality, you may be able to cut back on marketing costs because your product speaks for itself. High quality naturally cultivates word-of-mouth marketing, making it easier to sell these products.
On the other hand, you can also cut costs in a more obvious fashion by lowering the quality of your products or services. However, this is a slightly risky move, and it may lead to a variety of issues in the future.
Sometimes, the best way to engage in cost savings is simply to cut your losses.
If you’re exploring a new market and struggling to find success, it often makes sense to get out early and focus instead on a more dependable strategy. Expanding your American business into Asia, for example, can be incredibly difficult and costly.
On that same note, switching up your entire business plan may be the most effective way to save costs, especially if it’s the only viable way to survive.
How do you show cost savings?
If you want to take a more analytical approach to cost savings, consider the equation for cost savings percentage.
First, calculate how much it costs to produce each product. Next, implement your cost savings strategies and recalculate the cost to produce each product.
Subtract the new number from the old number and divide the difference by the original cost.
Finally, multiply the result by 100. You will be left with the cost savings percentage – or the amount of money you just saved your company.
How can cost savings increase profits?
Cost savings boost profits in a number of important ways.
The most obvious reason for this is simple. Assuming that your sales remain consistent, reducing costs will always increase profits.
However, cost savings can increase profits in several more subtle ways, including:
Productivity
Cost savings can boost productivity.
For example, automation or recycling may cut expenses, but they also make your business more productive in the long run by allowing workers to focus on projects that require a higher skill level.
Improving Your Product
Other types of cost savings can improve your final product.
For example, automation may result in fewer mistakes on the assembly line. Improving quality is another example of cost savings that obviously puts a better product in the hands of your customers. This can boost your profits in a less obvious manner.
Satisfied Customers
Cost savings can result in better customer satisfaction, which in turn can lead to higher profits. While cutting costs can certainly cause displeasure among your customers, it can also have the opposite effect.
When you cut costs, you can pass on those savings to your customers in the form of lower prices. This in turn creates higher demand for your products, boosting profits in the process.
Elimination of Competitors
Some cost savings strategies can be so effective that they actually cause your competitors to go out of business.
When you cut costs and offer your goods for lower prices, your rivals might not be able to compete. At the very least, it will keep them on their toes and provide you with a larger share of the market. Once again, this can result in increased profits.
In addition, the actual process of cost savings essentially forces you to take a closer look at your business’ finances.
You might be completely unaware of where your business is leaking cash, and this holistic approach allows you to address concerns effectively.
When you engage in this exercise, you gain a better understanding of your business’ finances and begin to feel more confident about the future.
Finally, it’s worth pointing out that cost savings is a more effective option compared to cost reduction or cost avoidance because it examines the bigger picture instead of simply the dollar amounts involved.
How can you benefit from cost savings?
The best way to benefit from this process is to approach cost savings with an extremely analytical mindset. Keep the bigger picture in mind and analyze your KPIs (key performance indicators) for further insights.
Once you’ve identified your weak areas, develop effective strategies to reduce costs – without causing negative consequences in the future.
With that being said, there are a few cost savings strategies that almost always produce results, regardless of the unique characteristics of your business.
First, you could simply relocate and enjoy the tax benefits offered by other states.
The interesting thing about this strategy is that you don’t need to physically relocate your business in order to take advantage of these tax benefits.
With a virtual address, you can simply re-register your business in a different state while maintaining operations in your home state.
Check out virtual address providers like Alliance Virtual Offices, and you’ll see how easy it is to implement this strategy. You can pick any address you like – from New York and Los Angeles to Hawaii and Alaska.
Another excellent option is to switch from a physical office to a virtual office. This ties in with the strategy above, and it allows you to cut costs associated with utilities, office rent, and many others.
Working remotely is more viable today than ever before, and you can coordinate your entire team while working from home without any real impact on your profit margins.
Again, you can find all the information you need about virtual offices via Alliance Virtual Offices.
Virtual offices also come with a host of other benefits, including mail forwarding and flexible workspaces whenever you need them.
This allows you to keep your home environment separate from your work environment and promote a degree of privacy and security. Your business mail will go straight to your virtual office address, and you can have it forwarded or pick it up at your convenience.
If you ever need to hold a team meeting or confer with investors, Alliance Virtual Offices gives you access to conference rooms and office spaces that exude a professional, polished atmosphere.
Another effective strategy is to use Alliance Virtual Offices’ Live Receptionist service.
Cutting unnecessary employees is one of the most obvious ways to engage in cost savings. Employee wages represent some of the biggest expenses for most businesses, and you can replace many of these employees with automation, freelancers, and other solutions.
For example, Alliance Virtual Offices’ Live Receptionist service allows you to hire a dedicated customer service professional for just a few dollars a month.
Your new Live Receptionist will pick up your business calls and provide customers with an excellent first impression. They can take messages, answer basic questions, and forward calls when necessary.
Continuing with your strategies for cost savings
At the end of the day, the only person who knows the best cost savings strategies for your business is you.
The process of cost savings should be tailored to meet the needs of each specific business, and it requires research and planning for best results.
Perhaps your business will benefit most from trying new software. Maybe the best solution is to switch to a virtual office and work remotely.
Whatever the case may be, cost savings can be highly beneficial – not only boosting profit margins but also improving the general stability of your business.
And remember:
This process never truly ends.
The best entrepreneurs are constantly searching for ways to engage in effective cost savings. If you do the same, you’ll outcompete your rivals and strive for continuously higher degrees of success.
The fact that you’re reading this article means you’re already off to a great start.
The only thing left to do is take action and start engaging in effective cost savings today.
Further Reading
