The cost of doing business in Australia is climbing, and as the story often goes, it’s our SMEs that are feeling the squeeze most.
Over the past two years, rises in electricity, insurance, and more recently, fuel, along with climbing inflation and cost of living, have sloshed together into one almighty current. And even with brief moments of reprieve, small and medium-sized businesses have found themselves needing to swim against the tide to stay afloat and on course.
For business owners, the challenge isn’t purely in adapting to the higher hard costs of essentials like electricity, insurance, and fuel. Rather, it’s adapting to the compounding effects these increases have on the entire business environment.
To use one of our recently onboarded clients as an example:
Operating a business in the manufacturing industry, in the last two years, this client has seen increases in hard costs of electricity, insurance, and fuel.
As a chain reaction to the aforementioned inflation drivers, they’ve also been dealing with rising costs of raw materials, wages, warehousing and logistics, and supplier pricing more broadly.
The challenge for this client, as it is for many SMEs, is that there isn’t one obvious culprit. It’s not a single line item the business owner can point to and say, “That’s the problem.” It’s the cumulative pressure of several costs moving upwards at once.
For anyone who has visited a store, gone to work, or paid a bill in the last two years, the observation that things are getting more expensive across the board is hardly a revelation.
In fact, customers’ acceptance of an environment where everything is going up is what has enabled businesses to increase their prices in line with costs without copping much blowback.
However, there’s a shift in motion.
As the economy slows, customers are becoming more sensitive about what they spend and less willing to accept price hikes, however justified they may be.
This turning of public sentiment is forcing business owners to rethink how they respond to their own swelling costs. While passing costs on to their customer may have been a perfectly palatable solution in the recent past, the appetite for acceptance is starting to ebb.
So, if you can’t raise your prices to counteract rising costs, what can you do instead?
1. Review your cost base
When you have limited control over what’s coming in, exercising control over what’s going out becomes even more critical.
When we step in, we help our clients take a step back and build an objective view of their cost base. In practice, this means reviewing the business’s expenses through its profit and loss statements, management reports, and forecasts, so owners can see exactly where their money is going and pinpoint the opportune areas for potential savings. From there, they’re able to make decisions that will help keep their net profit margin as close as possible to where it needs to be.
2. Separate the ‘must-have’ from ‘nice-to’
As we build out the business’s expense profile, we’re flagging two key categories of items in particular: First, the discretionary expenses, the items that bear no material impact on the business’s ability to operate well; and second, the major expense categories.
Discretionary items are a testament to the proverb that little by little, a little becomes a lot. A staff weekend here, a forgotten subscription there, before you know it, these small and often spontaneous expenses add up to something far bigger.
We’ve worked with business owners who have made a habit out of shouting their team lunch every week, a small cost in the moment, that can total $15,000 per year, when all is said and done.
Depending on the business’s unique circumstances and needs, in this scenario, we investigate the impact of turning the dial back. We ask: What would change for the business if we cut that spend back to $8,000? Or if we removed it altogether?
This is where prioritisation matters. We start by first looking at the expenses that have virtually no bearing on the business’s ability to operate well, before turning attention to the larger, more sensitive cost categories.
3. Adjust (not remove) the essentials
The goal of cost base optimisation isn’t to cut out the things your business needs. On the contrary, it’s to take a closer look at those essential costs and ask whether they could be working harder for your business.
We often find that insurance is an area ripe for review, and often, realignment. While insurance is essential for any business to function, the way a policy is structured can have you paying more than you need to, without necessarily giving your business better protection.
For instance, a business might be paying $20,000 a year across its insurance policies, with a $2,000 excess on certain claims. By reviewing the structure of that cover, business owners may find they can afford to carry a higher excess, say, $5,000 and potentially cut their annual premium in half as a result.
4. Talk to your suppliers
Don’t discount the value of negotiating with your suppliers. This doesn’t necessarily mean requesting the same goods at a lower price point. Rather, it’s coming to the table open to discuss an arrangement that benefits both parties.
Acting as an external CFO to our clients, we’ve stepped in to help guide many, many of these negotiations over the years. We’ve seen many agreements reached, such as discounts for early payment, and volume or bundle-based pricing arrangements.
Recently, we worked with a client who was buying a particular size product from their supplier. After reviewing their purchasing and production process, we identified that they could switch to a different size of the same product, at a lower cost, while still producing the exact same end product.
It was a simple change, but a valuable one. It enabled that client to improve their margin with zero change to their customers’ end product.
5. Assess the value brought in by your people
Earlier, I mentioned that when we go through this analysis, we flag the major expense categories. For most businesses, the single biggest expense category will be wages, which begs the question: Are we getting an acceptable level of productivity out of our people? And if we’re not, how can we restore the balance—either through reducing headcount or solving the problems that are hindering productivity?
How we help our clients assess the productivity of their people varies depending on the industry. For professional outfits that use timesheet or task-tracking systems, getting a gauge on productivity is reasonably straightforward. From timesheet data, we can see whether time is being recovered when it makes its way to an invoice.
Let’s say our review finds that only 50% of time has been recovered in a given month. The natural next question is: what happened to the other 50%? In some cases, the split may be entirely justifiable. The unrecovered time may have gone towards business-critical work, such as team management, R&D, or administration. But even then, the data can help highlight opportunities for process improvement. If the business is falling behind industry productivity benchmarks, it may prompt a closer look at the systems, tools, or processes behind the work.
For example, outdated systems may be creating unnecessary admin, slowing the team down and making it harder for people to spend their time where it adds the most value.
For industries that don’t use timesheets, the assessment can be more challenging, but it’s still possible. In those cases, we may look at industry benchmarks, such as wage spend as a percentage of revenue. If a business is spending more on wages for every dollar of revenue than others in its industry, it can be a sign that the team structure, overheads or processes need a closer look. It may suggest the business has more people than it needs to generate its current level of sales, or that its people aren’t being used as productively as they could be.
When it comes to withstanding rising costs and a potentially slowing economy, your pricing strategy isn’t the only lever you have to pull. As a business owner, there are so many more you have at your disposal. The key is knowing where to look, what to prioritise, and how to protect your margin without weakening your business.
If rising costs are putting pressure on your business, get in touch with me or the Ulton team. We can help you understand where the squeeze is stemming from and make informed decisions about your next steps.