What is cost reduction?

Cost reduction is the practice of minimizing your company’s expenses. To calculate your profit, subtract your expenses from your revenue. The lower your expenses are, the less money you have to subtract. As a result, implementing innovative cost-saving ideas can help you increase your company’s profit margin.

Why should you cut business costs?

The main purpose of cutting business costs is to increase your profit margin. That said, there are several other reasons to reduce your company’s expenses as much as possible:

• Prepare for a merger/acquisition: Reducing your expenses could help you strengthen your financial position before you enter into merger talks or look for another company to acquire your business.
• Seek an investment: Whether you want to borrow money from a bank or sell shares of stock, you’ll likely have to give potential investors information about your company’s finances. Reducing costs could help you demonstrate that your company uses investors’ funds wisely.
• Achieve a competitive advantage: Once you have a cost-cutting program in place, you can use the savings to launch new products and services, making your company more competitive.
• Shift your priorities: When you have your costs in check, you can spend your money where it really matters—on items needed to introduce new products and services, hire employees or promote your brand.

6 strategies for cost reduction

Before you cut business costs, it’s important to review your budget and determine where you can trim expenses. When you’re ready to make changes, consider trying some of these strategies for cost reduction.

1. Reduce your overhead

Overhead is any expense that isn’t directly related to one of your products or services. Rent, insurance premiums, utilities, office equipment and legal expenses are all examples of overhead. Note that these expenses are typically ongoing. For example, you have to pay rent every month or replace office equipment from time to time, which means overhead can get expensive.

If your overhead costs are a bit higher than you’d like, here are a few ways to reduce them:

• Negotiate lower premiums with your insurance company.
• Lower the coverage limits on some of your insurance policies.
• Move your operations to a facility with lower rent and/or better lease terms.
• Hire an attorney as needed instead of maintaining in-house counsel.
• Use digital documents to reduce your shipping and mailing expenses.
• Set the thermostat a little higher in the summer and a little lower in the winter to reduce your utility bill.

2. Take advantage of bulk discounts

Many vendors may offer discounts for bulk orders. For example, a printer may charge $1.50 each for up to 50 custom postcards. If you order 500 postcards at a time, however, they may be willing to reduce the price to 75 cents each. That’s $375 worth of potential savings. 

The key to using this strategy effectively is to avoid making bulk purchases you don’t really need. 

3. Revamp your hiring process

It costs money to advertise a job, interview candidates, conduct background checks and complete the onboarding process. If a new employee quits within just a few months, you have to start all over, incurring the same expenses a second time.

To reduce turnover, make your hiring process as efficient and informative as possible. For example, combine interviews with preemployment assessments instead of making each applicant come to your office on two different days. It can also be helpful to answer frequently asked questions on your company careers website.

4. Cut travel expenses

Travel expenses can add up quickly, especially if you have employees taking international flights or spending several nights per month at hotels. If you need to cut business costs, take a look at your travel budget and see if there’s any wiggle room.

One way to reduce your travel expenses is to use video conferencing software. Instead of traveling to off-site meetings, employees can use this software to meet with clients, vendors and other stakeholders. Sometimes, it makes sense to pay for travel, such as when you send a salesperson to a trade show, but using video conferencing software may help you eliminate unnecessary travel expenses.

5. Seek input from employees

If you haven’t done a task in a while, you may not realize the process is outdated. It’s also possible that employees don’t have the resources they need to complete the task successfully. That’s why it’s so important to seek input from employees when you want to cut costs.

For example, employees may be using an old-fashioned process that requires them to make multiple copies of a document. If someone tells you that the process is outdated and wasteful, you’ll have an opportunity to make positive changes. You may be able to switch to a digital method or reduce the number of copies needed, limiting the cost of office supplies for the year.

6. Update your purchasing policies

Finally, consider updating your purchasing policies to ensure employees can’t spend more than expected on office supplies, equipment and other items. You may want to set a spending limit, such as $50 or $100 per purchase without prior approval.

It’s also helpful to have a set of approved vendors, as you may be able to negotiate discounts with each one, increasing your company’s purchasing power without a corresponding increase in costs.

Frequently asked questions about company cost reduction

What are the seven types of costs?

There are seven types of business costs:

• Direct costs: Direct costs are the costs associated with a specific good or service.
• Indirect costs: Indirect costs, also known as overhead, are general expenses that aren’t related to a specific good or service.
• Variable costs: Variable costs are expenses that change based on production. For example, the cost of fabric goes up and down based on how many items a clothing company produces each month.
• Fixed costs: Fixed costs are expenses that remain the same regardless of production levels.
• Sunk costs: Sunk costs are costs your company has already incurred. They don’t have any effect on future decisions because you’ve already spent or committed to spending the money.
• Controllable costs: A controllable cost is an expense that you can control. For example, you can control the cost of printing by limiting the number of pages produced each month.
• Opportunity costs: An opportunity cost is the benefit that you give up when you choose one course of action over another.

What are the six types of cost savings?

The six types of cost savings you can use in your strategies for cost reduction are combination, substitution, adaptation, reallocation, modification and elimination.

How can you reduce costs and increase profit?

To reduce costs and increase profit, start with a review of your expenses from the past year. Think about how you used each item. Did it help you achieve your business goals? If not, consider reducing the amount of money you allocate to that category in the coming year.