Spend to Cut Costs

Although spend to cut costs may sound counter-intuitive, there is sound logic to it. Let’s dig a little deeper.

First, this is in no way referring to some of the loony ideas you may sometimes hear to justify spending on pet projects. Typically, those are masked with a comment like, “You have to spend money to make money.” Well, yes that’s true to a point. For example, you do have to spend on products to sell, payroll and related expenses for people to perform various tasks, and things such as utilities. But, those are not the kind of expenditures that people often try to get approved with that kind of comment. No, they are frequently trying to justify buying something like a fancy piece of furniture that probably adds no value to the bottom line but rather reduces profits and cash flow.

An Example

Years ago I worked for a company where a particular division wanted to upgrade their computer system and the cost was not small. I was tasked with getting them to justify the expenditure. At first all I got were reasons similar to “You have to spend money to make money” but worded more along the lines of “Our current system is outdated.” Now that may well have been true but this reason was given without any regard to whether there might be a more cost-effective solution. In this particular case the division was pressed long enough that they finally provided ample justification along the lines of how it would improve the operations of the division. The old system was cumbersome and significantly slowing things down and struggling to handle the current demands. We eventually believed that over time this would represent a situation where they could spend to cut costs.

A Little Analysis

Now consider another example. Imagine you work for a small manufacturer that is trying to automate much of its production. The plant manager wants to buy a piece of production equipment that will allow production time to be decreased 10 percent. On the surface that sounds great, right? But in order to know if this is a good expenditure some detailed financial analysis is needed. Consider the following:

  • If the piece of equipment cost $100,000 and has a life expectancy of 10 years then it will add $10,000 a year to expenses
  • An upfront cash requirement and/or a loan will be needed to finance it. Either way there is a drain on cash
  • How much ongoing maintenance will be required for the equipment?
  • What will be the cost of any training on the equipment?
  • Will someone with particular experience need to be hired to operate it?
  • Other than maintenance, what additional operating cost will be incurred to use it?

I think you can see that when we say spend to cut costs that is a rather simplistic statement that requires some detailed analysis to make an informed decision. It is very similar to what happens on the personal level when someone is driving an older car. At what point do the expenses and inconvenience of repairs for the older car become high enough to justify buying something newer. In this case the cost of the status quo must be compared to the cost of something newer.

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As always, your comments are welcomed.

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