Entrepreneurs and corporate executives regularly make short and long term decisions based on cost considerations. But too often, they turn out to be “penny-wise pound-foolish” decisions that are counterproductive and do more harm than good. Below are the most common of these false economies that can guide management in decision making.
1. Cheap Labor
Cheap labor is not cheap if offset by the cost of high absenteeism, tardiness, poor workmanship and high overtime due to inefficiency. More workers may be hired beyond what is necessary because of their low productivity and output. You may also need more supervisors to manage these employees. In getting cheap labor, you get what you pay for, and you get what you deserve. Your total labor cost may be lower by hiring few efficient workers with higher wages than by hiring many inefficient ones with low pay.
Penny-pinching in hiring managers can have a worse impact than getting cheap labor. If they turn out to be incompetent, the decisions they make or made can adversely affect company performance and profitability even after they have been fired or retired. Do due diligence in getting and paying managers and executives as if making a major capital investment. Don’t hire or promote managers based solely on qualification, tenure, or experience. Get only those who will protect your profits, guard your assets, prevent loss, and assure your growth and future.
2. Downsizing
Company-wide downsizing to reduce costs to increase profits is risky. If understaffed or “bottleneck” departments or business units are also downsized, the over-all capacity of the company to produce and process orders may be diminished, thus resulting in lost sales instead of savings. Cutting frontline staff may slow down service that can lead to lower sales and repeat sales. Reducing back office staff may increase workload, errors, overtime and can delay vital support service to the frontline. The optimal manpower strategy is rightsizing – the downsizing of overstaffed departments and the upsizing of understaffed ones. Downsize company-wide only to cut capacity to match lower market demand, but never to cut costs to increase profits.
3. Promotion From Within
While hiring and promoting from within may improve employee morale, the savings in recruitment costs, salaries, job advertising, and onboarding time may be more than offset by the opportunity losses from not getting more qualified, experienced and competent people from outside. This common policy may lead to force fitting available internal personnel to the job or position. Getting the best from current employees who are qualified and interested will not guarantee outstanding performance and may actually slow down progress in achieving company goals. Hiring should be market driven. You don’t have to give priority to internal hires especially for jobs that are critical or strategic.
4. Lowest Bidder
Getting the lowest bidder from pre-qualified bidders is a faulty, false economy procurement policy. Qualified bidders are not equally qualified. The policy ignores the best bidder “the first among equals” who can do the job much better than the rest and whose performance can more than offset its higher bid. But the bigger issue is that the winning lowest bidder may have high costs due to inefficiencies and mostly likely will try to recover or increase its profits by underpaying their employees and understaffing. By cutting corners, they may deliver substandard quality and have delayed and unreliable deliveries. Suppliers are business partners who affect your capacity, quality, lead times, and customer satisfaction. They decide your final costs and profits if you largely outsource. Choose only cost-efficient “low cost” suppliers, instead of those with “low price”. Instead of the lowest bidder, choose the most reliable bidder, the most agile bidder, the most innovative bidder, the most capable bidder, the most experienced bidder, the most responsive bidder, the most flexible bidder or the most professional bidder.
5. Breakdown Maintenance
Many companies have a breakdown maintenance policy of “if it ain’t broke, don’t fix it” to save on the upfront and regular cost of preventive maintenance which “replaces before failure”. Breakdown maintenance also results in more costly downtime and disruption compared to the planned downtime of preventive maintenance. Unscheduled disruptions due to breakdown maintenance can cause loss of production capacity and unserved orders. Unscheduled downtimes can be longer since replacement parts and repair personnel may not be immediately available.
6. Cheap Equipment
It may be false economy to buy an equipment or system at half the price but with half the life, durability, reliability and warranty of a standard product. What you save in capex may be much less than the additional opex you would incur in maintaining these cheap products. Moreover, they may be less durable, reliable, user-friendly and hard to maintain. They may cause costly disruption in business and order processing that can also lead to lost sales. You can incur more downtimes due to more frequent replacements. Moreover, cheap equipment may have higher defects rates, lower yields and poor after-sales service. You lose precious time managing, fixing, and replacing them towards the end of their lives. They may lack important features and can be expensive to customize. Consider these opportunity losses and hidden costs when doing a cost-benefit analysis in procuring and investing in equipment and systems. It would likely turn out you don’t have to buy the cheapest. Follow this same process and principle in buying materials or supplies. You don’t save on cheap packaging if it causes product damage, losses and cheap image.
7. Training as Optional Expense
Training should not be treated as optional nor a reward for a select few just to save on training expense. The cost of ignorance and incompetence due to lack of training far outweighs training costs. Moreover, you waste money with cheap education and training that impart no useful skills and knowledge to employees. You can lose customers and incur losses with the slipshod workmanship of untrained or inadequately trained staff. They may also need more supervision and are less productive since they cannot multi-task. Company-wide training must be continuous and consistent. As technologies, competitive landscape and customer expectation change, training and skills upgrading must be a continuous process. Treat company-wide training as a strategic investment that cannot be postponed or compromised.
8. Firefighting
Firefighting is fixing and solving problems as they come without doing root cause analysis (RCA) to prevent their recurrence. While you seem to have saved on costly downtime to reflect and do RCA, you actually incur more lost time and costly disruptions since the same problem will recur indefinitely. You also spend precious management time blaming, punishing and replacing people. It could even get worse every time until you have to stop the process or whatever you are doing permanently or indefinitely as the problem paralyzes your operations and take down your business. Firefighting is also throwing money at the problem. Because of unreliable equipment and frequent breakdowns, you buy more equipment. Because of inefficiencies and high absenteeism, you hire more employees. Because of an incompetent manager, you give him an assistant manager. Because you cannot trust the checker, you hire a counter-checker.
9. Micromanagement
Micromanagement is false economy since expensive management time is spent on trivial issues that a lower paid officer can competently handle and decide on. Instead of hiring capable and trustworthy people, some executives micromanage since they cannot delegate tasks and empower the people currently under them. Managers and executives should spend much more time in strategic planning and execution instead of controlling and monitoring. Micromanaging is a total waste of their time and pay.
10. Selling Defects
Selling defects to willing customers at a discount may seem like a smart decision compared to discarding, scrapping, or reworking them. In the short run, some cost of production may be recovered or loss minimized with this policy, but in the long run it is false economy. Instead of building a culture of quality, of “right the first time” , workers will not aim for perfection since they can see that management can sell their mistakes. The vicious cycle begins as more costly defects are produced with no motivation to do root cause analysis or continuous improvement. Some workers may even make defects intentionally so they can buy them later at a hefty discount. But the bigger loss or casualty in selling defects is brand reputation. If a slightly defective class A product is sold at a discount as class B, the brand is diminished and sales of good class A products may actually be cannibalized.
Conclusion
The mother of all false economies is “cost cutting”. It is better and safer to say “cut waste” instead of “cut costs”. All value-adding activities and assets of any business have costs. If these are inadvertently cut together with the non-value adding ones in an all-out company wide cost-cutting program, the impact to business performance can be adverse – poor quality, delayed services, loss of brand reputation and value proposition, and overall increase in costs. It is better to cut the wasteful drivers of specific costs instead of the cost themselves. To cut inventory costs, cut overproduction. To cut financing costs, cut overbuying and overinvestment. To cut manpower and manpower costs, cut idle and unproductive manhours. To cut management overhead costs, rightsize and empower people. To cut logistics costs, cut the unnecessary transport and storage of goods. To cut product costs, cut the complexity of design and improve manufacturability. To cut processing costs, cut the complexity and inefficiencies in the process. To cut servicing and service personnel costs, cut service time and steps. To cut advertising and selling costs, improve product quality and desirability. Finally, increasing the right costs, costs that enhance value may reduce the final total costs and increase profits in the long run.
Prof. Rene T. Domingo or RTD is an adjunct faculty at the Asian Institute of Management. He is also an international management consultant, author, trainor, and executive coach in the areas of strategy, entrepreneurship, lean operations, quality management, process and productivity improvement, and service operations. He has guided his large and SME clients in manufacturing, service, banking, hospitals, construction, real estate, and airline maintenance in improving their sales and profitability.
If you need strategic coaching and training in improving your business performance and growing your enterprise, you may contact RTD at rtd@rtdonline.com
