How to improve the cost-efficiency of your business
This blog post discusses various strategies and how to conduct a cost-benefit analysis to improve organizational cost-efficiency.
Perhaps one of the most popular buzzwords in the world of senior management is cost-efficiency. One can often find CEOs and Sales VPs talking about how, to improve the business bottom line, they should be making the processes more cost-efficient. Unfortunately, even in the upper echelons of business management, there are times when cost-efficiency is often confused with another close counterpart: cost-effectiveness.
To understand the fundamental difference between cost-effectiveness and cost-efficiency, here’s a story of two friends – Lloyd and Harry.
Lloyd and Harry both bought new cars together. Just as Harry parked his shiny new sedan in Lloyd’s driveway, Lloyd wagered a bet. “I betcha, Harry,” Lloyd said, “that my SUV can beat your sedan to the top of that hill over there.” Harry laughed and said, “Alright, Lloyd, you got yourself a bet. The winner gets 500 bucks, how about that?” They both shook hands on it, and off they went racing! While both of them started off on the same road, after some distance, Lloyd decided to take a detour. ” Hey Harry, guess what? I don’t need to go up this long winding highway to the top, I’ll just take the old town road!” And with that, he swerves off onto the steeper, shorter, but poorly maintained ‘shortcut.’ Harry, meanwhile, decided to stick to the highway, because he knew that even though it was more distance to cover and he would have to pay a toll, the road was well-maintained, and he could speed up along the way without having to worry about any damage to his car.
After an hour or so, both Lloyd and Harry arrived on the hilltop, at precisely the same time! As Lloyd walked out of his car, with one hand on his sore bum, he extended the other towards Harry and said,” Well, it looks like we both won the bet!” Harry instead replied with a smile,” I guess so, Lloyd. But it seems like you lost more in the process!” pointing to Lloyd’s car and the visible damages to the body, paint, tires, not to mention the fuming engine!
Just like Lloyd and Harry, business owners also face decisions and choices from time to time. Sometimes, all the alternatives under consideration can lead them to achieve the desired results by expending resources (cost-effectiveness). Still, only one of them will help the business achieve the outcome while minimizing resource expenditure (cost-efficiency). A succinct way to remember this difference is to remember that
“being effective is about doing the right things while being efficient is doing things right.”
What is cost-efficiency?
As explained in the example above, cost-efficiency is a type of business efficiency strategy. Simply put, it is the act of saving money by making a product or performing an activity in a better way. Businesses measure cost-efficiency by monitoring the ratio of the output produced to the costs incurred. Another way to measure cost-efficiency is to measure the revenue generated against the expenses incurred. An interesting point to note is that there is no upper limit to cost-efficiency. By either improving the output for a given input or reducing the input required to produce a given output, businesses can continue to improve their efficiency. This is why you hear CEOs of companies of all sizes and maturity levels continually focusing on making their businesses more efficient.
Why is cost-efficiency critical?
The fundamental focus of most, if not all, businesses is to improve their customer value (revenue) generation capabilities, which in turn helps those businesses increase their profit margins. Cost-efficiency is one of the most commonly used strategies to increase the profit maximization capabilities of a company and becomes more and more critical for the business as it grows and expands. The more cost-efficient decisions that business owners make, the more profitable the company becomes.
How to be profitably cost-efficient?
There are many ways to be cost-efficient, and businesses usually deploy one or more of these strategies based on where they find themselves in terms of scale and maturity. Let’s understand a few of these strategies with the example of a small local business – Lindy’s Lemonade.
Lindy has a small lemonade stand where she offers homemade lemonade. She can’t compete with other food trucks and local restaurants that provide a variety of food items in addition to lemonade. And she certainly can’t compete with big cola brands selling bottled lemonades either. But to make the most profit out of her current business, Lindy focuses on a tactic called cost-cutting. To do so, she does all the work by herself – buys lemons, makes the lemonade, sells the lemonade, manages the stall and cash, and so on. This also helps Lindy sell her lemonade much cheaper.
Slowly, Lindy’s profits accumulate, and she buys a food truck. Lindy now brings her sister Sherry, who makes fantastic smoothies, into the business with her. Together, they split all the work between themselves, but now customers coming to Lindy’s food truck have a shade to stand in, have to wait for lesser time, and have multiple options to choose for what they would like to drink. With this increased value that Lindy provided to the customers, she was able to charge more for her lemonade and smoothies. So, even though Lindy’s overall business costs went up, she was able to maintain more or less the same cost efficiency, which meant that her revenues (and hence the profit) increased much more. This tactic is called value creation.
In a couple of years, with all the profits, Lindy sets up her own bottled-lemonade and smoothie manufacturing business. Lindy’s experience in the field and the word-of-mouth promotion from her existing customers helps her business take off. She is now able to leverage economies of scale to source raw materials directly from wholesalers, invest in machinery that reduces the time it took to prepare lemonades and smoothies and set up a distribution network with local stores to save on sales costs. This is innovation, and innovation helps Lindy’s business both improve its cost-efficiency and customer benefits.
Implementing cost-efficiency: How to do a cost-benefit analysis
As the name suggests, a cost-benefit analysis is a systematic approach to evaluate the pros and cons of different business decision alternatives to find out which option provides the best method to achieve the desired benefits while minimizing the costs. A cost-benefit analysis is typically useful to either determine:
- an investment or business decision is sensible by understanding if, and by how much, the benefits outweigh the costs, or
- to compare between several alternatives (investments or decisions) to compare the overall benefits provided by each with the total costs involved in implementing each
Here’s how you can do a simple cost-benefit analysis:
Step 1: Start by creating two separate lists – one for all the costs associated with the project or decision and one for all the associated benefits. Be sure to make this list as comprehensive as possible.
Step 2: When thinking of associated costs, think in terms of:
- Direct costs – Labor, raw materials, manufacturing, inventory, etc.
- Indirect costs – Overheads, rent, utilities, etc.
- Intangible costs – Impact on employees, impact on customer perception, etc.
- Opportunity costs – ‘Buy vs. build,’ time cost, alternative investments, etc.
- Cost of potential risks – Regulatory risk, competitive threats, environmental impact, etc.
Step 3: Benefits may include one or more of the following:
- Tangible benefits such as an increase in revenue or sales
- Intangible benefits such as improved customer satisfaction and an increase in employee productivity or morale, etc.
- Competitive advantage or market share gained
Step 4: Once you’ve created a comprehensive list of costs and benefits, apply a monetary value to all of the items in the two lists. Be very careful to not underestimate the costs or overestimate the benefits.
Step 5: Make a quantitative comparison to see if the aggregate value of the benefits outweighs the aggregate value of the costs. If yes, then it is rational to go ahead with the decision. If not, then the business should either reevaluate the project/decision to see if there’s a way to reduce the costs or increase the benefits or drop it altogether.
Why it’s more cost-efficient to move to the cloud
There are plenty of good reasons to move your business processes to the cloud, but one of the most significant benefits of cloud migration is that it saves you money. Here are some reasons why moving to the cloud makes economic sense:
- Zero upfront costs as financing the capital for setting up the infrastructure becomes your service provider’s problem, not yours.
- Scalability which means that you only pay for what you use, instead of ownership and maintenance costs of hardware that you may or may not use to its entire capacity due to peaks and troughs in workload
- Reduced costs associated with risks involving data security or business disruption
- Reduced energy costs since you won’t be dealing with too much or idle on-site hardware
- Reduced environmental costs both in terms of lowered energy costs as mentioned above and also because you can benefit from the efforts that your service provider has taken to reduce its carbon footprint, instead of spending that money yourself on carbon offsetting
Cloud telephony is an example of how moving to the cloud can make your business more cost-efficient versus a traditional business phone system. There are zero upfront investments in hardware, no delays as you can set up a modern phone system almost instantly, lowered business risks with an assurance of cutting edge security and business continuity, and pricing models that make sure you pay only for what you use.
Also, cloud telephony empowers your business with advanced call routing capabilities like team-based routing, time-based routing, intent-based routing, and much more. An excellent call routing solution can bring down your operational costs by:
- helping customer queries get resolved faster and thus, reducing incoming call charges
- distributing the call load evenly to prevent agent burnout or attrition
Besides switching to the cloud, there are many more tactical ways to save costs without compromising your business’ value or customer benefits.
Find your winning strategy
No one guaranteed trick will make your business cost-efficient. In fact, it would be wrong to think of cost-efficiency as the goal in itself. Much like operational efficiency, consider cost-efficiency as a process that must be deeply ingrained in the fundamental fabric of your business. Businesses that continuously evaluate the cost-efficiency of their strategies and decisions stand to generate more customer benefits with lesser resources, increase their revenue, and improve their profitability.
Illustrations by Mahalakshmi.
Freshcaller is a modern-day reimagining of our everyday phone system for customer support, sales, IT, and HR teams. With its cloud-based architecture, Freshcaller brings together the best of legacy features like IVR and advanced call routing capabilities like Smart Escalations, Customizable Performance Reporting to help you set up state-of-the-art phone operations. Freshcaller offers phone numbers in 90+ countries, requires zero phone hardware, and is extremely easy to use.
Visit the Freshcaller web page for more information.
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