Cost And Effect
In the movie "Dr. No," James Bond is admiring a huge aquarium in the archenemy's laboratory when a voice from out of nowhere surprises him. "One million dollars, Mr. Bond," Dr. No says, walking into the room. "You were wondering what it cost." Bond coolly responds, "As a matter of fact, I was."
Small-business experts say entrepreneurs should be more like Bond--not necessarily employing a license to kill but being more concerned about costs. "Usually small-business owners think growth in sales is all they need to worry about," says William F. Doescher, senior vice president at Dun & Bradstreet, an international research-based business information provider in Murray Hill, New Jersey. "But they might grow right out of business if they don't watch their costs."
To help small-business owners control costs, Dun & Bradstreet and Entrepreneur surveyed 501 small businesses to find out what they're spending on, how it's changing and why. The results reveal some surprises, a lot of strengths and more than a few weaknesses in the ways entrepreneurs measure, understand and control their costs.
What takes the biggest bite out of small-business budgets? According to the survey, compensation, taxes, sales and marketing, and employee benefits represented the highest costs for small-business owners. An average of 28 percent of total sales went to compensate employees, while taxes consumed another 15 percent. Sales and marketing expenses accounted for 9 percent, and more than 4 percent of revenues was devoted to employee benefits.
While these results were fairly predictable, other findings were more surprising. For instance, entrepreneurs expected to lose only 2.7 percent of their 1997 revenues to bad debt. Slow payers were likewise not a problem, with more than three-quarters of customers paying on time.
The survey broke down results by size of business and type of ownership, allowing for other surprises. For instance, women-owned businesses lagged behind others in providing employee benefits, including health insurance. And while firms with 21 to 100 employees led smaller firms in the use of technology, minority-owned firms were the most active of all in technology use.
Costs By Category
It's no surprise that employee costs are a major burden on small businesses. Al White, owner of a Form You 3 Weight Loss Centers in Tallahassee, Florida, found it so burdensome that last December, she laid off the last of her nine employees. While White is now working harder as a nonemployer, she's getting more out of her business.
Other small-business owners appear to be getting more as well. Of the 28 percent of revenues devoted to employee compensation, 60 percent went to pay executives. This seemingly high proportion is explained by the responding firms' small sizes rather than by excessive pay rates for the executives, experts say. And, along those lines, the percentage of revenues consumed by executive pay was smaller among larger firms, amounting to less than 38 percent of total pay for firms with more than 20 employees.
Employee compensation doesn't have to suck up all your capital. Employers can control costs by using incentives to encourage savings, says Tom Gillis, a management consultant and author of Guts & Borrowed Money (Bard Press). Pay your employees, especially managers, a percentage of savings resulting from any cost-cutting ideas they come up with, Gillis suggests. To be most effective, the amount should equal 5 percent to 20 percent of the employee's base pay, he says.
You can also control employment costs by using temporary workers, who can be brought on to respond to growth and dismissed when not needed. Similar flexible spending approaches can be applied to many other areas such as by outsourcing for professional services and using leased facilities and equipment. These strategies are especially important for controlling costs in a business's early years, says Murray Low, director of the entrepreneurship program at Columbia University in New York City.
Few entrepreneurs are taking this advice to heart, however: Less than 1 percent of sales is spent on outsourced labor, according to the survey. And while most firms outsourced legal and accounting work to professionals, only a minority used outside help for marketing, consulting, credit and collections, and payroll.
Entrepreneurs should also try to use nonfinancial compensation, says Low. That may include anything from simple praise to opportunities for advancement. Knowing your employees well is key. "You have to figure out what is most cost-effective to provide and in what combination," Low says.
Just as larger firms devote smaller percentages of revenues to executive pay, they devote more money to employee benefits. In fact, three out of 10 small companies offered no benefits to employees. The fact that women-owned firms trailed in offering health benefits can probably be explained by the fact that women-owned firms tend to be service companies, which, as a group, offer fewer benefits, according to Karl Egge, an economics professor at Macalester College in St. Paul, Minnesota.
Small-business owners who don't offer benefits may be losing out, however, because of their inability to attract high-quality employees, warns Doescher. "If prospective employees have to choose between a job they like and one with benefits, they'll go with the one that provides benefits," he says.
However, Doescher adds that it's not necessary for small-business owners to attempt to match the benefits provided by large employers. Instead, he says, they should aim to match what other small businesses provide.
Michael Kurela suffered a loss his first two years in business, largely because he invested in computers and other technology that were needed to open Penn Consulting, his one-person Pittsburgh financial management and consulting firm.
"My costs were extremely high," Kurela recalls. "I didn't want to take [on] debt to fund the business, and my first few years were complete losses."
Like Kurela, almost 90 percent of small businesses surveyed had computer equipment in their offices, and a majority also reported having fax machines and copiers. But, surprisingly, expenditures for technology, not including telecommunications, accounted for only a fraction of 1 percent of the median annual sales of the surveyed companies.
Why? Experts say costs for new PCs and other equipment occur infrequently. Every two to three years, a small business adds or replaces its PCs and other gear, spreading the purchase out over many months.
One area where entrepreneurs should spend more now to save in the long run is on information technology for gathering cost information. Only 71 percent reported using accounting software, and even fewer use spreadsheet software.
Low says failure to gather and analyze financial data is a common error of small businesses when it comes to understanding and controlling costs. "You need to have internal accounting [in place]," he says, "so you can observe and manage your own trends."
The Rest Of The Story
The 15 percent of sales consumed by taxes may seem high, but Egge says the survey results are in line with what larger businesses pay. And while you may not be able to escape taxes, there is probably plenty you can do to limit expenditures for other costs that, while smaller, are still important.
Facilities costs amounted to a little more than 2 percent of total sales, but they could be even lower if entrepreneurs took advantage of just-in-time inventory practices to minimize space required for inventory, says Gillis. Leasing space, practiced by just half the small businesses surveyed, is generally preferable to owning a building or other space, stresses Low.
Sometimes low costs may indicate a problem. The very low bad-debt ratio cited in the survey may be explained by the fact that small businesses tend to do mostly cash business, without extending credit to customers, says Egge. Many are retailers who offload all risk of nonpaying customers onto bank charge cards, he adds. However, low bad-debt ratios also suggest small businesses are stunting their own growth by turning away credit-worthy customers.
According to the survey, nine out of 10 small businesses carried some type of insurance, but insurance costs as a whole were small--less than 2 percent of revenues. However, White says the insurance savings she has realized by getting rid of all her employees has saved her considerable money. "I've cut down on the types of insurance I carry," she says.
Experts warn that entrepreneurs should be cautious when deciding where to cut costs. The figures reported for one major expense--sales and marketing--may actually represent underspending by small businesses. "Small businesses should advertise more," says Doescher. "Some don't advertise at all." In fact, the survey results showed that one in five small businesses does no advertising or promotion.
So where are they spending the 9 percent of annual sales devoted to sales and marketing? Print ads were used by most, while smaller numbers used direct mail, radio, television, telemarketing and billboards.
This is the first survey Dun & Bradstreet has done on small-business costs, so it's difficult to spot any trends. However, experts identify several long-term changes in costs that small businesses should be aware of.
First, Gillis says to be on the lookout for changes in the way costs are accounted for. He points to the growing popularity of activity-based accounting, a way of allocating costs to specific activities in a business, as an example of the way the accounting field is changing its approach.
Technology is also changing the way costs are measured, says Gillis. Faster, cheaper computers and improvements in data-gathering tools such as bar codes continue to make cost-accounting faster and more accurate. "Those advances help you know what your costs are and how to handle them," he says.
Another important consideration is finding new ways to whittle down the biggest overall cost category--compensation and benefits. Low predicts that outsourcing will become much more common for small businesses in the years ahead.
Entrepreneurs may also want to watch for new costs that are growing in importance. Egge feels one of the major ones, which is barely recognized now, will become far more significant for small businesses in the near future.
"It's called opportunity cost," Egges says. "It occurs when CEOs and presidents have to wear too many hats at one time. They have to [evaluate] whether to go with computers, hire more people, buy more insurance or do more outsourcing. [By failing to plan ahead], they're jumping around like chickens with their heads cut off--that's a major cost of doing business."
When all is said and done, how important are costs? Too much emphasis on cost control can hamstring a company's growth just when it needs it most. Too little, as Doescher warns, can cause you to grow right out of business.
About Dun & Bradstreet
Dun & Bradstreet (D&B), with the world's largest business information database, tracks 47 million companies worldwide--11 million in the United States alone. Businesses use D&B's services to find new customers and evaluate their creditworthiness, identify potential suppliers, and collect overdue receivables.
Through face-to-face and telephone interviews and public records searches, more than 200 million financial transactions are added to D&B's files annually, and that's just in the United States. D&B updates its information base continually--more than 960,000 times each business day.
When businesses are entered into the D&B database, they are issued D&B D-U-N-S Numbers (comparable to Social Security numbers for companies). Required by the U.S. government for all businesses in its Central Contractor Registration database and used by the United Nations and the European Union, the D&B D-U-N-S Number is quickly becoming the universal standard for identifying businesses on the World Wide Web as well.
To have a D&B D-U-N-S Number assigned to your business free of charge, call (800) 234-3867.
Dollars And Sense
How should you use the results of a small-business cost survey? "Benchmark your company against the survey results, and see how you score in the various categories," suggests William Doescher, senior vice president at Dun & Bradstreet. Cost data could help you become the most efficient producer of your product or service.
That's a fine suggestion, but it's not that easy in practice. What's typical for one company isn't for another. For best results, you need competitive intelligence. That means finding out the spending patterns of your direct competitors. Then you can try to beat them at their own game. The problem? "Competitive information is hard to get," says Tom Gillis, a management consultant and author of Guts & Borrowed Money (Bard Press).
Comparative shopping, pumping vendors for information and simple observation will help some. You may also obtain good information from an industry association. For instance, many automotive trade groups have model financial statements describing what percentage of revenues average member firms actually spend on various costs, according to Gillis.
Another caveat: Even if the survey results are from the right industry, cost surveys will show different results depending on the age of the company. For instance, says Murray Low, director of entrepreneurship at Columbia University in New York City, a start-up company will spend less on fixed costs such as machinery and more on variable costs such as labor than an established firm.
One thing even the most general costs survey can do is alert you to the need for good record-keeping and cost accounting so you can identify your own costs. "If you got that one idea from this survey," says Doescher, "you would have spent your time wisely."
Form You 3 Weight Loss Centers, 1233 N. Adams St., Tallahassee, FL 32303, (850) 222-2311
Tom Gillis, (713) 622-2818, tsgillis@ att.net
Penn Consulting, (412) 766-3311; http://www.penncon.com