Improving Performance, Lowering Fixed Costs - Part 5

Improving a target metric like ROAI (Return on Assets Invested) can be achieved through various strategies. Previous discussions have examined the effects of increasing prices, boosting sales volume, or reducing variable costs. In each scenario, significant changes were required, even under constrained assumptions, to elevate ROAI from 12.5% to 20%.

Fixed costs are expenses that remain constant regardless of the level of goods or services produced or sold. These costs are incurred at regular intervals and do not fluctuate with production volume. Examples of fixed costs include rent or lease payments, salaries, insurance premiums, property taxes, and depreciation of assets. Fixed costs are considered indirect costs because they are not directly tied to the production process but are essential for the overall operation of the business.

Original Example:

Revenues $500,000 (Price per Invoice $250/Invoice x 2000 Invoices)

Cost of Goods Sold $240,000 (Variable)

Other Variable Expenses $60,000 (Variable)

Operating Expenses $150,000 (Fixed)

Assets Invested $400,000 (Loans, Note Payable, Common Stock, Preferred Stock, etc.)

EBIT = $50,000

ROAI = $50,000/$400,000 = 12.5%, Target is 20%.

In getting to a 20% ROAI, EBIT must be $80,000 or increase by $30,000 (again, assuming all other variables remain the same) suggesting that Fixed Costs need to be reduced by an equivalent amount. Historically, organization use layoffs of employees as the quickest method of reducing fixed costs. However, there's are downsides to simply reducing employment including:

• Loss of Talent and Institutional Knowledge - including top talent and those with critical skills and institutional knowledge, which can be difficult and costly to replace
  

• Negative Impact on Remaining Employees who see an increased workload which can lead to burnout, decreased productivity, and higher turnover rates.
  

• Damage to Company Reputation making it less attractive to potential employees and customers.

• Lowered Innovation and Productivity where the loss of skilled employees and the resulting low morale can stifle innovation and reduce overall productivity.

Take the Long View

Small businesses must take the time when examining fixed cost reductions. Firms can identify essential expenses and reduce fixed costs by following some of these strategies:

1. Conduct a Thorough Expense Audit - identify and categorize them as essential or non-essential. This involves:

• Reviewing bank statements, credit card statements, invoices, and expense reports to itemize every expense.

• Review categorization of expenses ensuring that fixed costs (rent, salaries, insurance, etc.) from variable costs (supplies, utilities, etc.)] are separated.

• Categorizing expenses as essential (critical for operations), positive (contributing to growth), negative (wasteful), or distinguishing (unique competitive advantage).

2. Prioritize Essential Expenses - Once expenses are categorized, prioritize the essential expenses that are critical for the startup's core operations like:

• Rent or mortgage payments

• Salaries and wages for essential staff

• Insurance premiums

• Legal, auditing and regulatory fees

• Essential utilities (internet, phone, etc.)

• Critical software and technology subscriptions

3. Analyze Non-Essential Expenses - Scrutinize non-essential expenses and identify areas where costs can be reduced or eliminated such as:

• Subscriptions or services that are underutilized or redundant

• Non-essential travel and entertainment expenses

• Excessive office supplies or inventory

• Underperforming product lines or services

4. Benchmark Against Industry Standards - Compare your startup's expenses with industry benchmarks to identify areas where you may be overspending which can assist by:

• Prioritizing cost reduction opportunities based on potential savings

• Negotiate better rates with suppliers and service providers

• Identify opportunities for outsourcing non-core functions

5. Involve Cross-Functional Teams - Gather input from representatives across different departments and teams. They can provide valuable insights into:

• Purchasing habits and operating expenses specific to their areas

• Potential areas for cost savings or process improvements

• Essential expenses required for their operations

6. Implement Continuous Monitoring and Optimization - Establish a regular process for monitoring expenses, identifying cost-saving opportunities, and optimizing spending. This may involve:

• Setting up budgets and forecasts to track expenses

• Implementing spend management software for real-time visibility

• Regularly reviewing and renegotiating contracts and agreements

8. Embrace Technology

• Use cloud computing and software-as-a-service (SaaS) tools to reduce the need for expensive hardware and maintenance costs.

• Automation: Implement automation tools to streamline operations and reduce labor costs.

9. Energy Efficiency - Implement energy-efficient practices such as using LED lighting, programmable thermostats, and proper insulation to reduce utility costs[6][19].

10. Cost Effective Marketing Efforts - Startups often operate with limited budgets, making it essential to adopt cost-effective marketing strategies that can help reduce fixed costs. Here are some strategies based on the provided sources:

• Search Engine Optimization (SEO) - Improve your website’s SEO to rank higher in search engine results, driving more organic traffic. Use free tools like Google Analytics and Yoast SEO to optimize your content.

• Referral Programs - Encourage your existing customers to refer new customers by offering incentives such as discounts or free products.

• Partnerships and Collaborations - Partner with other small businesses that have a similar target audience but are not direct competitors.

Summary

Lowering fixed costs is a quick way to improve your target profitability number like ROAI. Yet, there are lots of trade-offs including that the cutting fixed costs without a lot of thought can lead to loss of 'institutional memory and muscle' when key employees or customers leave. In the example provided, Fixed costs would need to be reduced 20% ($150,000 to $120,000) to obtain an ROAI of 20%. This strategy on a quick basis is not recommended unless the firm is fighting for its survival and time is of the essence. Yet, careful examination of essential vs. non-essential expenses on an ongoing basis, careful planning and creative spending can increase the productivity from your fixed expenses over the long-haul.