If you increase sales and generate $1 in new revenue, you may end up with $0.50 after overheads. But if you reduce a $1 overhead, it will give you the whole $1 free and clear. We’ll get to the part on how you can generate 30 percent or more in administrative cost savings and a lot more in manufacturing overhead. But take a moment to review and understand all the overhead types, what resources you lose when you start cutting costs, and how to replace it without the costs.
What is Overhead?
Overhead refers to the ongoing cost of running your business which cannot be attributed to a specific product, service or business activity.
Examples include things such as rent and utilities, property taxes, insurance, accounting costs, depreciation, administrative salaries, etc. These things do not directly contribute to generation of profits in the way that direct materials and direct labor do, but they are still vital and necessary components of your organization. Or are they? We’ll see.
Types of Overheads
As per generally accepted accounting principles (GAAP), all such expenses can either be classifed as a manufacturing or nonmanufacturing overhead. The former refers to factory costs such rent, electricity, building and equipment depreciation, etc. Even though these costs are not directly related to production of a specific product, they must still be included in the unit cost.
As for the nonmanufacturing overhead, it includes selling, general and administrative (SG&A) and interest. Under GAAP, SG&A is not allocated to your product cost, and is reported simply as expenses in your income statement. This will include everything from rent, utilities and property tax for nonmanufacturing space to office supplies, marketing and advertising costs, interest on debt, sales amd administrative salaries, etc.
Tips for Reducing Your Overheads
This is actually about making a series of cost-cutting moves that save more money in sum than as individual measures. So you’re required to do some comprehensive cost management and needs analysis.
Migrate – Initiate a review of what it would take to move your entire IT setup to the cloud. This migration to the cloud will eliminate the need to maintain IT hardware inhouse, and also the manpower required for it. You can cut IT costs and free up some nonmanufacturing space.
Teleconference – Push for virtual meetings instead of meeting clients in person and herding your entire staff into a meeting room. Video chats on Skype or other videoconferencing tools will save money and your staff’s time spent on traveling and attending meetings.
So now you have even more space freed up, and you can add to this by reorganizing and cleaning out your factory, office and warehouse or storage rooms. You can now either move to a smaller facility or sub-lease the free space. Either way, you will see a reduction in your rent. But there’s an even better way, explained further below.
Outsource – You can outsource everything that is not a part of your core expertise. Hand over your accounting to a CPA firm, and your marketing functions to a digital marketing agency. You can reduce overheads associated with lead generation and conversion by contracting with a sales acceleration service provider.
Whether you’re the CEO of an established company or the founder of a new startup, you will have to seriously consider the advantages of outsourcing part or all of your manufacturing process. You can outsource manufacturing of the entire product, or get suppliers to manufacture the components, and just do the final assembly in your factory. You can even contract with suppliers to bring their machinery, equipment and labor to your factory to work collaboratively and produce your parts and/or product on-site.
Relocation as an Overhead Reduction Strategy
The idea is to relocate to take advantage of the lower costs, but without disrupting your business operations. For instance, many businesses in states with high taxes like California are relocating to locations in states like Florida and Texas that are more business-friendly.
By relocating to a place with an affordable cost of living and doing business, you can reduce a variety of overheads ranging from property taxes to rent and utilities.
In fact, state and local governments will be competing to offer you incentives to attract your business relocation. You can get tax breaks for a decade or more, along with free or low-cost land and buildings for your facility, affordable power, and government grants and loans too.
For example, fiber-optics company Xtellus, Inc., now a part of Oclaro, Inc. (NASDAQ:OCLR), hired the Acclaim Group to represent them in negotiations for the renewal of the existing lease of their U.S. headquarters. Acclaim’s process included identifying alternative locations to create a competitive bid process. The end result was that the existing landlord offered a reduction of $215,714 (15 percent) on the total occupancy costs of their 10,000-square-foot headquarters, but in the end Xtellus relocated to a facility in another location that offered them a $984,071 (68 percent) reduction in total costs over the 60-month lease period.
Many businesses relocate like this just to take advantage of incentives and lower costs in order to improve their bottomline. It’s a much more appealing option compared to shutting down key business activities and downsizing just to reduce your overheads. If you want to find out more about the possible advantages of relocating, hire a site selection consultant to suggest and shortlist potential sites with lower costs, and then negotiate a nice incentives package for you.