My background has been starting businesses with little money – very little money – then trying to grow them as fast as possible. As I was constantly running out of money, running my business as cheaply as possible wasn’t an option to make the business more profitable. It was essential to have just enough cash flow to keep my banker from calling in my credit line.
This required me to run businesses not with lower costs than my competitors, but costs that were so low it made it seem as if I was in another industry. For one meeting the New England chapter of The Young Presidents’ Organization, to which I belonged, I invited all members to bring along their human resources manager. The HR managers met separately and had a contest to decide which of them had the thriftiest CEO. Of course my HR manager won hands down. He explained that the carpet in our office was so tattered that there was just as much duct tape showing as there was carpet.
Practical Business Choices
In the early days, I used to think that it would be nice to have lots of capital to start my business and run it the right way. We would have luxurious offices, thick carpet, and gorgeous furniture, high-priced assistants at our beck and call, all located in a penthouse at a prime location office tower.
Then I ran across some businesses that were really well financed and did everything right. A business school friend went to work for a startup that he said had plenty of money and did everything right, including buying the best equipment, hiring the most talented people, and renting the most expensive offices.
But despite all the money and talent they started with, they managed to go bust very quickly, leaving my friend high and dry and jobless.
Another time I was bidding for furniture at a bankruptcy auction for a company with one of the most beautiful offices I had ever seen. The prestigious location had a gorgeous view of a lake, carpeting, skylights, state-of-the-art furniture, original oil paintings decorating the walls, and the newest and most elaborate built-in video equipment I had ever seen. Perhaps like other bidders at the auction – who were buying furniture at 10 cents on the dollar – I was wondering, what company was this? It turned out it was a consulting firm headed by none other than one of my Harvard Business School professors who was viewed as a legend in his field.
Frugality Goes a Long Way in Business
A legend in his field? Maybe But not a legend for being frugal. And, now, no longer a legend for being successful in business.
My takeaway lesson was that it’s nice to be smart, it’s nice to have money, it’s nice to go to Harvard Business School, and it’s very nice to be a legend in your field. But if you really want to survive in business, it’s much more important to be frugal.
The richest family in America is not a family who made their money from technology, the internet, or from finance It’s the Walton’s – owners of Walmart – who made their money from being thrifty.
Yes, that’s how founder Sam Walton ran Walmart. He insisted on getting the best price for anything he sold, and insisted on having the lowest overhead in his stores. Even after he had made billions of dollars, his corporate headquarters looked more like a truck repair garage than a corporate edifice.
The regional discount department stores that some believe Walmart drove out of business typically had general and administrative costs around 27 percent of their sales. Walmart’s was 15 percent of sales. It wasn’t that level just because of Walmart’s size. It was always low. It was low because Walton was the most frugal CEO in America. He was also arguably the most successful.
I learned that being frugal isn’t something you do because you have to; it’s something you do because you can. Being frugal is an important powerful competitive weapon. As Walton’s competitors found out, not being frugal enough was a recipe for bankruptcy and oblivion.
How Frugal Are You?
Let’s toss out some numbers here and see how being frugal might impact your bottom line. Let’s say your business has a 10 percent pretax profit margin. Not too shabby. That means costs and expenses consume 90 percent of every sales dollar.
Now let’s say that by being frugal, really watching how every penny was being spent, you were able to shave just 5 percent off of your expenses. That’s just cutting expenses by 1/20th, not that radically really at all. But that would reduce your expenses to 85.5 percent of every sales dollar. Your profit margin jumps to 14.5 percent. That’s a 45 percent increase from 10 percent. It could take you from being an average industry performer to being a stellar industry performer.
A Low Overhead Is More than Getting Rock Bottom Prices
Being really frugal and having a really have a low overhead isn’t just about getting rock bottom prices. It’s also about running your business more creatively.
The first step in trying to reduce costs isn’t actually reducing costs at all. It’s eliminating costs. At our book publishing company, during one of our cost cutting drives, I offered employees cash awards for the best cost-cutting ideas. And it was the hourly wage men and women in the warehouse who came up with a spectacular idea.
Rather than pay a trash company to haul away our damaged books, they found a salvage company that would pay us for the damaged merchandise. So they came up with a suggestion that not only helped eliminate an expense, but turned an expense item into a profit item.
In really trying to cut costs it may not always be possible to find an expense that you can turn into a profit. But the first thing that must be done in cutting costs is to find expense items you can totally eliminate.
Eliminate Unnecessary Expenses
Next, I look for opportunities to totally change the process and, subsequently, materially change the cost. Sometimes this might mean lowering your internal costs, or it might involve working with a supplier to get them to lower their costs.
One way, for example, might be to work much more closely with one particular supplier, perhaps by consolidating all of your purchasing there. This might lower their costs and, in turn, produce significant cost savings for them that they can pass on to you.
Finally, it’s imperative that you get the best price on everything you can. I believe everything can be negotiated. Once, I was at a McDonald’s restaurant and they ran out of the small salads. So I persuaded the manager to sell me a large salad for the price of a small salad. As I said, just about everything is negotiable.
I believe the best way to negotiate with your vendors is be nice – very nice – and get them on your side. When your sales reps and account managers visit your venders, get them rooting for you. Have them explain to your suppliers that you are a small business competing against much larger firms and you need to do everything you can to get your cost basis lower; that you want to work with them, you want to be a long time customer, but you really need them to help you bring your cost structure down. Furthermore, if they can help you, they can expect more business from you
When it comes to cost cutting, I love to go through the budget and the actual expenses and look for ways we can either eliminate or cut to shreds every single expense item possible.
Related: Planning For Profits
When it comes to cutting expenses, some take precedence over others. Specifically these are the recurring expenses, and of course, larger expenses. So to be rational about cutting costs, you want to spend more time and energy cutting the recurring costs, especially the more expensive items. Yes, you want to install cost consciousness throughout the organization, but you also want to use your time strategically when it comes to cost cutting.
So, from a cost-cutting perspective, I divide costs into three categories: one-time expenses, overhead items and cost of goods sold.
When one-time expenses are of modest amounts and are nonrepeating items, I am not going to get too excited about them.
When my operations manager spends $10 for a new wastebasket or my sales manager spends $15 ordering business cards for his new assistant, I’m not going to ask that they go out and get three quotes. Maybe we’ll have a specific designated vendor for business cards or a designated vendor for day-to-day office items and with whom we have negotiated annual discounts. But in general these are the types of purchases I am not going to spend much time considering.
Then there are the so-called overhead items. These are things that are sometimes the inevitable costs of running a business: office rent, electricity, Internet supplier charges, phone services, and more. I hate overhead expenses. They don’t directly drive your business ahead, but if your business is to grow, you need to spend some money on overhead.
Home Offices Can Eliminate Tons of Overhead
In starting a small start-up business, the first thing I would try to do is avoid paying rent at all. I’d try very much to run my business out of my house. If you can do this, you’ll not only save on rent money, but you can cut down on a lot of the other overhead costs that come along with a regular commercial office.
When I was starting my book and magazine publishing business, for years I ran them out of the tiny, one-bedroom basement apartment where I lived. I’d stack boxes filled with my book inventory into every cranny imaginable and, at times, would have as many as 10 employees working there. Now and then, large semi-trailer trucks would come by to drop off and pick up book shipments. These apartments weren’t zoned for commercial use, of course, but I kept a friendly rapport with the neighbors, and thanked them profusely when they had to move their cars so the trucks could get by. I saved a ton of money that I was able to reinvest to build the business.
Sooner or later your business will likely grow to the point at which you need a regular commercial office, and you will see your other costs grow along with it. Other people, such as your operations manager and your CFO, may tell you that you simply have to be prepared for the overhead costs that go along with the commercial office. Don’t you believe them.
For instance, you can rigorously make sure that the heat and AC get turned down during off hours. You can consider insulating any leakage areas in the building. Maybe you can even buy electricity through an alternate supplier. As one of my friends in business school said, “There is no such thing as a fixed costs.”
Cost of Goods
The third major silo of costs of in terms of cost cutting is the cost of goods sold. This is the direct cost of the making of products or delivering services. It’s a very obvious area of negotiation with your vendors as well, in order to get the best price possible. Most businesses do the negotiation fairly well.
However, to really save money on the cost of goods, you need to get more creative. One possibility is that instead of becoming confrontational with your suppliers and endlessly demanding lower prices, you work with them like a partner and jointly explore ways to reduce costs.
At Adams Media, for example, we would sit down with our book printers and carefully explore different paper options as a way to reduce costs, paper being the single most expensive part of the process.
Then we would consider changing the sizes of some books so they could printed on particular presses thereby saving press time, the second highest cost.
As you go through the cost-cutting process, some costs just seem sacred and untouchable. But I suggest to you as an experienced entrepreneur that you never view any cost as sacred or untouchable.
In the book publishing industry, the most important venue for launching and announcing books to bookstores for the critical holiday selling season was the annual trade show, then called the American Booksellers Association Convention (now BookExpo America).
Every large book publisher had a huge impressive display that took up hundreds of square feet, cost tens of thousands of dollars to build and required expensive union labor to assemble and disassemble. Every big book publisher would pay for travel and lodging for hundreds of personnel. They would sponsor elaborate parties and events to entertain their bookseller customers, as well as the media, book agents, and other industry people. Even small book publishers had elaborate displays at this event. This convention was a huge part of every publisher’s marketing budget. The event was considered sacred – everyone attended and everyone spent a ton of money.
Then one year, the unthinkable happened: two of biggest publishers decided not to attend. They decided they had been spending too much money and not getting enough payback to justify it. Many in the industry said they were foolish, that they were taking a huge risk, that their stature in the industry would plunge, and their advance sales would suffer. They called it a huge mistake.
Well, their sales did not collapse. They saved a pile of money and they didn’t rush back to try exhibiting in future years either. In fact, other publishers followed suit, either skipping the convention altogether or, more commonly, slashing their expenditures at the event.
So what did we do? Well, we attended the American Booksellers Association Convention and eventually I got caught up in the game like everyone else, opting for bigger and bigger booths and more elaborate displays.
For many years our displays were never as polished as the bigger players because I just couldn’t bring myself to spend that much money. But one year, I found a used display that was incredibly impressive. It had huge motorized spinning light boxes where I could display giant blow-ups of my new book covers. But it required that I buy a larger display space on the convention floor than usual, and that I spend more money on graphics for the display. Then there were the additional costs of the union labor to set up the display and to take it down.
I arrived at the trade show proud as peacock with my new beautiful display. I knew my firm would be finally showing the world that we had truly arrived in the world of big publishers. Then one of my independent sales reps, always a guy to share his candid thoughts with me, said, “Bob, now your booth display looks just like all the other big publishers.”
I was thinking, yes, isn’t that great. Aren’t I proud? Then he went on to say, “You no longer look different or creative at all.” Suddenly, I didn’t feel so good after all. What was the business justification of spending so much money just to look the same as everyone else? Sure, it was good for my ego, but it was a lousy business strategy.
In my endless search to boost my profit margins in the book business I also had to consider the cost of author royalties. For the trade paperback books we published, the industry standard was paying the author a negotiated guaranteed advance payment that ran against a royalty rate of roughly 7.5 percent of the retail price. Well, 7.5 percent of the retail price was roughly 15 percent of the wholesale price, a huge cost.
The model in the book industry was that literary agents would take an author’s proposal to many publishers and then make a deal with the publisher who guaranteed the highest advance. I had several issues with this model. For one, it meant that the actual royalty rate was often much higher than 7.5 percent if the guaranteed advance did not earn out. It also meant that the book publishers didn’t decide what topics to publish, instead they waited for authors to come to them with proposals.
After many years in the business and a lot of thought about strategy and costs, I decided to turn this model on its head. I began emphasizing publishing books without paying authors any royalty at all. Instead, we would decide what topics we wanted to publish. We would seek out experts. We would pay them a flat fee but no royalty.
It wasn’t an easy change to make but we did it. What was the net result? Our profits margins reached three times the industry average, despite the fact that we were much smaller than the largest publishers who benefited from economies of scale.
So does it pay to be frugal in running a business? You bet it does.