By Robert Sher, Mastering Midsized
Midsized firms dedicated to growth tend to focus on revenue, earning more and more as they expand. But the meaningful measure is the bottom line, and that means managing costs, an unheralded and often neglected task. Costs get set and then forgotten. Time passes, circumstances change, especially in a volatile period, and margins slip. Driving new business doesn’t by itself improve profitability.
Most firms don’t address the problem. They are too busy trying to win new sales to undertake the painstaking effort of managing costs. Yet increasing revenues and incoming cash can mask unrealized opportunities to improve net profit. Some companies try to raise profits by cutting indirect expenses unrelated to direct manufacturing costs. But that can only go so far.
A better solution is to address the challenge of cost-of-goods-sold (COGS) directly. Identify cost management as a key component of the business, locate the primary driver of the process, engage stakeholders in operations so they contribute to and support the effort, and underscore it as a positive component of maintaining a healthy and sustainable business.
“We wanted to increase profitability at the same time as we expanded our market and agreed that driving down costs would be a key part of our strategic plan,” says Mark Murray, President and CEO of the Seattle, Washington-based craft beverage producer Jones Soda Company. “Everything was up for grabs – we didn’t care if you just reviewed a cost yesterday, we’re going to take another look at it today. It was an eye-opening exercise, and really made a difference.”
All Along the Watchtower
Active cost management requires a sentinel constantly on the lookout for cost-saving opportunities. Handled properly, it is a task not just for one person or one function, but a joint effort engaging staff across the teams, all in support of strengthening the company’s underlying finances.
Here are tips to effective cost management:
- Set cost management and savings in COGS as a key strategic priority. This means a focus on efficiency, not just growth per se. Everyone on the team must be on the same page.
- Confirm finance as the function responsible for driving cost review and management, and make sure you have the skills required: not only financial analysis but also fresh eyes on operational costs, and communications and other soft skills to consult and bring teams along.
- Agree to a schedule for regular reviews of all cost drivers – this is not a set-it-and-leave-it deal. Procurement policies can ensure best value as well as routine assessment.
- Review and, if necessary, train teams in contract negotiation. Some people just don’t take to it. Existing relationships or systems can get in the way. It’s a balance of treating suppliers with respect while also pushing hard, and you need someone on the team who relishes the challenge.
- Review all contract terms in detail and push for escalation rights so you can reassess pricing when things change. With all sorts of instability impacting both the supply chain and labor, cost volatility is back. As prices whipsaw, you need the right to adjust pricing with customers on shorter notice, which can be tough with longer-term and fixed-price contracts.
- Make a plan for savings across several functions, not just one cost area. Pennies – and fractions of pennies – add up. So do the math and figure out what moves the needle. Reaching cost-saving goals through a range of efficiencies is more achievable and less disruptive.
- Set budgets to alert you to price fluctuations. Monitor them carefully, and allow for flexibility, for example with changes in production volume. In some complex environments, monitoring appropriate pricing based on required job quality or expectations is crucial to maintaining margins.
- A competitive awareness of cost savings is also critical – that is, reducing costs enough to reduce price in order to grab market share. A savvy financial team will be just as invested in this strategy element as in hitting a budget or simply maintaining margins.
- Cost-cutting can be disruptive or threatening to other internal stakeholders when change is uncomfortable. It is essential to involve them in the process while not allowing them to stymie it with a we’ve-always-done-it-this-way mentality. Listen to reasonable objections, but also use change-management practices to reduce internal resistance.
Rising prices or opportunities to increase the margin rarely just drop into your inbox. It takes close monitoring and constant awareness to watch for price changes and regularly attempt to defend or thicken margins. Finance must bring the discipline to this.
Jones Soda is a $12 million beverage business with a difference. Along with orange & cream, cream soda and ginger beer, it has a history of unique flavor options running from candy corn to birthday cake, turkey and gravy to salmon pâté. It encourages customers to give feedback on its flavors, and invites them to submit photographs to be featured on its labels.
An experienced senior executive in the consumer-packaged goods (CPG) industry, Mark Murray originally joined as a consultant to write a three-year strategic plan. He stayed on, eventually becoming President and CEO in September 2020, because the brand is so unique. He points to their COVID-19 response, adopting a “Message of Hope” theme on the labels, and highlighting the need to pull together. “Rather than a rebellious tone, we’ve taken a softer, everybody-needs-a-hug approach,” says Murray.
As sales rose, Murray saw that cost management would be a driver for growth, and in mid-2020, he identified three main areas for margin improvement – transportation, warehousing and COGS.
“I said we need X percent out of these three buckets. Everybody was like, ‘Well, we’ve looked at that,’ and I said, ‘We’ve got to look at it again.’” Murray hired an external consultant, a graduate student with three years’ experience at McKinsey & Company, to study operations. After two months, she recommended they change their transportation system, allowing them to close one of their warehouses and realize big savings.
The key, however, was not to make one single change to gain the benefit of 10 basis points but rather to target a range of reductions across the entire supply chain to add up to the amount needed.
Murray pushed everyone to look at things with fresh eyes. “When they finally saw that we were thinking differently, developing a strategic plan as a whole, it clicked. It gave us instant credibility, in that we really were doing things in new ways,” he says.
Contracts were reviewed in detail and re-negotiated, driving down costs. Expanding business gave them fresh leverage, but they also found terms in existing contracts that could improve their position and reduce costs.
Winning the Ground Game
Dynamic cost management may be the ground game, but it can gain a lot of yards all the same. It takes focus and discipline, and you must keep at it. The process needs to be sustained, otherwise costs will start to creep up again. But it does deliver results. Jones Soda experienced increased margins of 6% in the quarter ending March 2021 as compared to the same quarter a year earlier. Not surprisingly, all that (and a bit more) fell to the bottom line. “You start by driving out a couple points. Grab a point here, grab another here, and so on. We said, this is what we need from you guys, and everyone pitched in,” says Murray. “It was a great experience, and it really helped the bottom line.”
About the Author:
Robert Sher is the founder and CEO of Mastering Midsized, a consulting firm that provides leaders of midsized businesses with advice on how to maximize growth in a way that is sustainable and predictable. Robert enjoys writing and sharing his knowledge. He publishes regularly in Forbes and has published numerous articles in Harvard Business Review. He has also written three books that crystalize what he’s learned about running, growing and profitably exiting midsized firms. Visit the company website or connect with him on Twitter or LinkedIn.