URL: http://www.entrepreneur.com/money/moneymanagement/financialanalysis/article37902.html

Before getting a good deal on office space from an out-of-business dotcom, Earl Mollerud's office was on the third floor of a wing of a church. "It was tough during the summer because they didn't have air conditioning, and during the fall they were slow about turning on the heat," says the CEO and co-founder of Kids' Hair Inc. in Minneapolis. But, he notes, the rent was a saintly $500 per month.

Today, Mollerud, 40, cuts the cost of getting supplies to his 10 Kids' Hair salons by ordering centrally and stocking consumables at headquarters. Each Monday, managers return from sales meetings bearing a week's worth of hair-cutting supplies. "Instead of having somebody drive around delivering," he says, "they just take it back in their cars."

But Mollerud is no miser. In an industry where employee benefits of any kind are rare, he offers stylists a company-paid health insurance plan. "And it's the best one we can get," he adds. And while other stylists book appointments in cheap paper planners, Kids' Hair has invested in a central computerized appointment system that contains information on customers' personal hair problems, preferred hair styles, frequency of visits and other grooming concerns.

There's really no conflict between Mollerud's spending on some items and pinching on others. He and entrepreneurs like him use a technique resembling liposuction, a surgical procedure that removes fat from areas where it's not needed or wanted, to target only certain costs for removal. Rather than putting their entire organizations on stringent diets, they siphon off only costs that add no value. In the process, they say, their profits grow, their companies get stronger, and their understanding of their businesses increases.

Big, across-the-board cost-cutting, chiefly characterized by massive layoffs, was a fad among large corporations in the 1990s. Companies laid off more than 700,000 people during 1999 alone, according to career services and placement company Lee Hecht Harrison. But that kind of cost control failed to catch on among entrepreneurs. One reason is that small companies are leaner than large companies, so huge cost curtailment risks cutting beyond fat and into muscle. "If you take it off company-wide, you're taking off things you need," says Jeff Olson, 43-year-old co-founder of Velocity Business Publishing, a book and e-book publisher in Bristol, Vermont.

With robust sales growth, cost savings seems unimportant to many entrepreneurs. Jeff Musa, founder and president of Cutting Edge Software Inc. in Dallas, is a typical case. "Our business is in exponential growth mode," says Musa, 43, whose five-person company writes spreadsheet software for Palm Pilot hand-held computers. "Worrying about costs just drags us down."

Entrepreneurs don't appear to be suffering for their lack of cost concern. In 1998, annual business bankruptcies were down 31.6 percent from 1990, according to the American Bankruptcy Institute. But with a slowing economy, 2001 should see more bankruptcies. "Even if the economy's good," says Olson, "individual companies can certainly be mediocre—and worse."

Though survival may not be a burning issue for most firms at the moment, the seeds of the next age for cost control may already be sown, according to Wil Uecker, an associate dean at the Jones Graduate School of Management at Rice University in Houston. Shoppers of all kinds can now compare prices for many products and services using Internet search engines, online trading and shopping services such as Priceline.com and eBay. "The comparison shopping that now exists means you have to be cost-effective," says Uecker.

Finally, no matter how robust your condition, it could always be better. Liposuction cost-cutting produces savings that beautify the bottom line—even if the top line looks the same. "What it's all about is profit," reminds Mollerud. "Whatever you can bring to the bottom line strengthens the company."

Intensive scrutiny of costs is essential if you run a grocery store or other business with very low margins. But liposuction-style cost-cutting can benefit almost any entrepreneur. "With every business I've been in, costs sprout and spread like weeds," says Olson, who started typesetting and reference publishing companies before beginning his business-book enterprise four years ago. "So every now and then, it's good to spray a little weed killer."

Before starting liposuction, however, you have to determine what to cut. One way is to use activity-based costing. This technique assigns costs to business activities, such as answering help-desk calls and stocking parts bins, and can help to identify which costs contribute and which can be trimmed.

With accurate cost information in hand, you can decide on an overall cost-cutting goal. One way is to compare your costs to competitors'. Annual Statement Studies, published by Robert Morris Associates of Philadelphia, lists actual costs and other financial info for more than 140,000 mostly small and midsized companies in 525 industries. By finding the category most closely approximating your company's size and industry and comparing your costs to those companies', you get an idea of whether you're high, low or just right, Olson says.

Once cost-cutting is underway, you can see how well you're doing by comparing your effectiveness against competitors in the real world. And even if you're winning your share of the market and earning profits, explains Uecker, your cost-cutting has to continue.

Once your goals and monitoring mechanisms are in place, it's time to find and surgically remove the most wasteful activities and expenses. Olson likes to cite a maxim from business author Jim Schell: "Avoid waterfalls in the lobby." The idea is that you can safely eliminate any cost that adds little or nothing to the value of your service or product.

Employees are the first place to look. "Not only are you paying them salary and benefits," says Olson, "but you have to provide them with equipment, space and supervision in the form of managers." When you add all that up, a full-time employee may cost $100,000 a year. "Getting rid of 10 managerial or professional employees can save you a million dollars," Olson says.

		One way to keep costs down is to make sure all your product lines are strong sellers. Not sure how to do that? We can help you evaluate whether you've got a loser in Better Off Dead.

But don't just start slashing workers. Instead, ask yourself and your managers whether you can justify the workers you have. Says Olson, "Everybody on the payroll must be doing something that must be done and that can't be done cheaper."

If you have a job that must be done but isn't being done as cheaply as possible, look first to outsourcing. Uecker, who handles executive MBA and executive nondegree programs at the Jones Graduate School, says the outsourcing of routine tasks, such as making copies or supplying the office coffee machine, frees up his staff for more important duties.

Even Musa, admittedly not an avid cost-cutter, says, "We sometimes use consultants instead of high-priced [employees] to do the same job." The difference in outsourced help, he says, is flexibility. "It's not a recurring cost. It's terminable."

Musa also exercises discretion in hiring outside experts. Attorneys and other expensive professionals shouldn't be overused, he says. "You can probably cross out one point on a contract and sign it without running it by legal again, although they want you to," he says.

Also, selling any idle equipment or outdated inventory on which you may be paying taxes and expending maintenance can generate cash while reducing outlays. "I'm constantly surprised at what companies keep on their books," says Olson, who recalls one company whose bankruptcy filing revealed it owned a condo in Hawaii for the convenience of vacationing executives.

Next stop: your products and services. Selling products that don't produce profits and services that don't entice customers can be hugely expensive. "In every company I've worked for, people tried to push products the market wasn't responding to," Olson says. "It means you're just spraying out costs."

Don't just focus on products and services, Uecker advises. Look also for customers who aren't carrying their weight. Small companies desperate to boost sales are especially vulnerable to taking on customers who promise large revenue boosts but who—for reasons like excessive service requirements, slow payments or demands for discounts—produce low profits or even losses, he says.

For growing companies, it's often more important to avoid new costs than to trim existing outlays. Before adding any cost, ask whether it will benefit customers, or only you. That's why Mollerud operated out of a church sublet. With annual sales exceeding $2.5 million, he could have easily afforded more luxurious space. But, he says, "that doesn't matter to our customers."

New expenses that commit you to long-term outlays should be scrutinized with an especially vigilant eye. Musa declined a shot at a low-priced high-speed Internet connection because he didn't need that much bandwidth. "We do a double take at recurring costs or anything that requires us to make a long-term commitment," he says.

Some expenses probably shouldn't be cut. Never scrimp on anything that affects your value proposition or your core competency, Uecker says. "What is it you really bring to the market?" he asks. "You never want to cut there."

For Mollerud's business, that means not reducing compensation for stylists staffing his salons. "You can't keep staff if you don't pay," he reasons. "So we try to find ways for them to make even more money." Liposuction means doing the right thing in the right place. Like a plastic surgeon who does a tummy tuck here and injects some collagen there, financial surgery builds up a company in critical areas while trimming nonessentials.

For most small companies, the issue is not so much reducing costs as finding the best possible allocation of resources. Says Mollerud: "Our philosophy is to optimize costs, not minimize costs. If we can add costs in a way that benefits the business, we do."

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Mark Henricks is Entrepreneur's "Cutting Edge" columnist.

Contact Sources

• American Bankruptcy Institute, www.abiworld.com
• Cutting Edge Software Inc., (800) 991-7360, www.cesinc.com
• Kids' Hair Inc., emollerud@yahoo.com
• Robert Morris Associates, www.rmahq.com
• Velocity Business Publishing, (802) 453-6669, www.agilemanager.com