5 Steps to Cutting Overhead Safely
If a company is making an adequate margin on its product or service, but not a good profit, overhead costs may be a source of the problem. That sounds simple enough, but it isn’t an indiscriminate exercise. Cutting in the wrong places can do your company irreparable harm.
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Over the years, we have helped numerous small businesses reduce their overhead costs safely through a process called overhead value analysis (OVA). Our intent is to identify savings in the company’s overhead costs. And, here, you can follow the steps outlined below and do the work yourself -- though we have found there is significant value when business owners call in an unbiased third party.
To illustrate OVA, we describe below a specific engagement where we identified significant savings for a property-management client. The client had hired us to help her increase profitability and improve her financials for creditors -- plus, of course, make money. And there was some urgency to these tasks: At the time of our engagement, the firm was losing approximately $10,000 each month.
1. Get an overview of the operation.
We met with the owner and her operations manager to get a clear picture of how the organization runs and the key responsibilities of each department. This always involves getting an organization chart (which we often have to create ourselves).
In this case, the operations manager had a current chart. The goal of this step is to gain a very clear understanding of how the senior people think the organization operates. (Caution! The understanding of senior people, even in a small company, does not always match reality.)
2. Identify the tasks and the time people are spending on each one.
We met individually with each employee of the property-management firm. There were fewer than 15 employees, so it was possible to meet with everyone. Had the firm been much larger, and/or had there been individuals filling the same role (e.g., leasing agents), we could have met with a reasonable sample of those employees instead.
During these hour-long meetings, we typically ask the employees how they spend their time. We have them lay out exactly what tasks they do. Then we ask how long it takes to do each task and how often these employees perform the task. When their estimates don’t pass the sniff test, we dig deeper, asking penetrating questions and requesting to see work products.
We want the estimates to be as accurate as possible, and we want them to be difficult to sandbag. Amazingly, after we do the math, we often find that the sum of the time people spend doing their tasks is significantly less than the number of hours for which they are paid.
In the case of the property-management firm, we found one senior employee who could account for only approximately 18 hours of work each week. When we showed her the results, she was embarrassed, but could not account for any other tasks or responsibilities. There were similar, if not as dramatic, findings with other employees of the firm.
3. Determine the number of hours it should take to do each task.
As described, we first identify the time people say they spend doing each task. Next, we determine how much time that work should take. We do this by cross-checking estimates from other employees who perform the same task. It may be necessary to get two individuals together to resolve any significant differences.
We then meet with supervisors and senior managers to get their assessments. Ultimately, we settle on an estimate of how long each task should take.
With the property-management company, we first discussed our findings with the owner and operations manager. And both were shocked at the length of time some employees reported spending on tasks. For instance, the operations manager insisted that a credit and background check should take less than 15 minutes to complete, not the hour claimed the employee claimed.
4. Identify opportunities for reduction.
Usually, we find opportunities to reduce overhead in three areas:
- Tasks that do not need to be done -- We sometimes identify tasks that are redundant or for some other reason do not need to be done. Obviously, we can eliminate such tasks and save the time required to complete them. Again, with the property-management firm example, we were able to show how employees could centralize a task, saving time and eliminating the chance of redundant work.
- People who are underutilized -- As described, we make the best estimate we can of how long each task should take. We do the math and determine the number of hours needed to complete the tasks of each department versus the number of hours available; and we identify areas of underutilization. For the property-management firm, we told the owners they could reduce head-count by 25 percent.
- Work that could be done by a less costly resource -- We often find that highly compensated people are spending a significant amount of time doing things that could be delegated to less expensive resources. For the property-management company, we suggested combining two senior jobs by first delegating a few tasks to a lower-compensated resource. This would save the firm more than $70,000 annually while making the company's staff more efficient.
5. Finalize the action steps and calculate the benefit.
Finally comes the hard reality. Many possible savings opportunities have been identified. However, to capture actual savings requires a reduction in:
- Number of employees
- Average compensation per employee
- Money paid to third parties
Sometimes, companies can achieve savings by not filling vacancies or by delaying hiring as the business grows. More often, the owner faces difficult, gut-wrenching decisions. But, if the company is going to save money and become profitable, difficult choices must often be made.
The property-management firm decided to implement several of our recommendations, while passing on some of the job eliminations. The owner could not bring herself to terminate the long-term employees. While she did not reap all of the benefits she might have (we calculated a possible savings of approximately $250,000 annually), she was able to make a few tough decisions and cut overhead by more than $100,000. This brought the firm to break-even.
The owner also cut her own compensation to bring the organization fully into the black. This, of course, made the financials more acceptable to the company's bankers.
Overhead value analysis is a powerful tool for reducing waste and increasing profitability. Capturing the benefit most often requires tough decisions. If you have the stomach for it, you can usually find ways to cut overhead without cutting efficiency. Sometimes, OVA will be the best option.