A tricky scenario for any business: Sales are booming, but profits are shrinking. A little digging reveals expenses have increased faster than revenue. The business needs to get costs under control.
The process of cost control involves a series of actions to optimize a business’s spending. Learn more about cost control strategies and how to implement them successfully.
What is cost control?
Cost control, also known as cost optimization, is the limiting or reducing of a business’s expenses to avoid net losses and increase profitability and financial stability. Cost control can make a business more competitive, improve its operational efficiency, and lead to long-term growth and success—without compromising the quality of its products or services.
If you run an ecommerce company, you likely aren’t spending as much on real estate as a company with physical storefronts, so that’s a built in mode of cost control. However, you’re still likely paying for manufacturing or sourcing, inventory management, order fulfillment, shipping, and marketing. Cost control helps you keep track of these and other expenses and remove inefficiencies.
4 types of business costs
Before you implement cost control measures, it's important to understand what kinds of costs your business incurs. These generally fit into one of the following four categories. Some costs may fall under more than one category, depending on the type of business and its accounting methods:
1. Fixed costs
Fixed costs remain the same, regardless of changes in a business’s output. Fixed costs include rent or mortgage payments on warehouses, insurance premiums, and staff salaries. Fixed costs are typically based on long-term commitments or agreements, such as leases, insurance policies, or employment contracts. As a result, businesses only have infrequent opportunities to reduce them, like when a contract or lease is up for renewal.
2. Variable costs
Variable costs vary in proportion to the amount of goods produced or services delivered. When the number of goods produced increases, variable costs increase, and vice versa for decreased production. Raw materials, labor, sales commissions, and distribution costs are typically variable costs.
3. Direct costs
Direct costs are directly associated with making a product or providing a service. Direct costs are also called cost of goods sold (COGS). Direct costs include raw materials and hourly labor for a manufacturing business, or inventory purchases and wages for order-fulfillment staff. Direct costs typically rise or fall as output increases or decreases, meaning they’re variable.
4. Indirect costs
Indirect costs are expenses that don’t vary much when the output of goods or services changes, so they tend to be fixed. Indirect costs also are called overhead costs or selling, general, and administrative (SG&A) costs. Examples include office rent, business insurance, payroll management, and administrative staff salaries. Cost-control efforts often target indirect costs first because they tend to have less effect on a business’s production of goods or services.
Free Value Chain Template
Explore your business activities and discover new ways to lower costs and improve quality. This template helps you analyze each step for better performance.
8 cost control measures to optimize your business
- Create a budget
- Monitor employee spending
- Review suppliers
- Consolidate expense reports
- Tighten inventory
- Improve quality
- Automate
- Outsource
Here are eight effective cost control strategies to consider to streamline your expenses:
1. Create a budget
Start by developing a detailed budget of your expected business income, and project expenses for a specific period such as a month, quarter, or year. Once you’ve created a budget, categorize and prioritize your expenses. Compare your baseline budgeted costs and actual expenses, and then target those costs that don’t seem justifiable compared to the returns they generate. Ensure all employees and managers understand the importance of controlling costs, and involve them in budget planning.
2. Monitor employee spending
You don’t need to micromanage every purchase, but it’s important to have a clear understanding of spending across departments. Look at software subscriptions, travel, and other large or recurring purchases to see if there’s room for cost savings. Set rules around using company credit cards, create daily per diems for travel, and establish clear procedures for approving other expenses.
3. Review suppliers
Supplies and contractor services often account for a significant portion of a business’s costs. Ensure your procurement and purchasing teams keep close tabs on all suppliers.
Consider renegotiating for better terms for bulk purchases, or ask for discounts for prompt payment. Look at software providers to learn if consolidating subscriptions with one company can lower costs. If you’re a manufacturing business, have at least a few suppliers for flexibility, in case one vendor has delivery or scheduling problems.
4. Consolidate expense reports
Put various expense reports such as supplier bills, employee expense reimbursements, payroll, and shipping onto a single platform. This will give a clear view of your total business costs, so you can assess which to target. This can also help you prepare financial reports such as income statements and cash-flow statements.
5. Tighten inventory
Inventory control involves having enough inventory to satisfy customer demand while keeping warehousing costs down. Lean inventory management can help you avoid overstocking (as well as understocking) and the cost overruns associated with carrying excess stock. Techniques for controlling inventory costs include accurate demand forecasting, first in, first out (FIFO) stock rotation, identifying and clearing out slow-selling products or dead stock, and regular inventory audits.
6. Improve quality
Quality control practices can significantly reduce costs by minimizing product returns. Do quality checks on your products to ensure they’re up to your standards, write accurate and detailed product descriptions so customers know exactly what they’re buying, and streamline the checkout process to reduce cart abandonment. Offer customer loyalty incentives and analyze purchase data to personalize communication and customer service, so customers receive not just a high-quality product but an all around satisfactory experience.
7. Automate
Build a suite of software to automate repetitive tasks such as order processing and payment processing, inventory management, and customer support. This can free up your team to focus on finding customers and building sales, product development, and long-term strategy—ultimately leading to cost reduction. Artificial intelligence (AI) tools can even help you take notes, send automated emails, write copy, and edit videos and images.
8. Outsource
Outsourcing is a common method to control costs. Many businesses find it cheaper to pay a specialized third party to perform a task than to take on the work in-house. Payroll, accounts payable, and cloud-based data storage are among the most widely outsourced tasks.
Challenges of cost control
As you implement cost savings across your business, it’s important to be aware of the challenges and find ways to mitigate them:
Incomplete data
Without accurate data about your business expenses, you can make budgeting decisions that fail to contain costs. Knowing your sales data, the success of your marketing campaigns, and your inventory, shipping, and personnel costs is imperative to cost management. Using customer relationship management (CRM) software, tools like Shopify’s analytics and reporting dashboards, and integrations with other tools can help ensure your crucial data is complete and centralized.
Inflexible budgeting
Setting a rigid budget leaves little room for unforeseen changes in your business or market volatility. Allow some flexibility in the budget, so you can periodically review and adjust. Do some scenario planning, including potential costs for unexpected events and contingencies.
Alignment
To streamline cost-control processes effectively, you need to sync with your business goals. In other words, don’t cut costs just for cost-cutting’s sake—cut where it won’t hurt profit, and spend where it yields the most growth. Alignment also means squaring up your work calendar with the actual calendar, helping you anticipate periods of higher costs—like bustling holiday shopping months for an online gifts retailer.
Internal resistance
Employees or teams may balk at new cost-control strategies. They may see the effort as adding to their workload or making their jobs less flexible. Consider training sessions that explain the benefits of the new cost controls or implementing a reward program for employees who identify ways to save money.
Cost control FAQ
What is the cost control process?
Cost control is the process of identifying and optimizing a business’s expenses. You can implement cost savings by creating a budget, tracking project costs, improving inventory management, and consolidating expenses.
What is key to effective control?
To make your cost control measures effective, you need to begin by identifying and categorizing your costs, and developing a proper bookkeeping and accounting system. Create a detailed budget and regularly review actual costs against the budgeted figure to understand how they match up.
What is an example of cost control?
An example of cost control is renegotiating contracts with suppliers. For example, you can buy multiple items or larger quantities from the same manufacturing supplier to take advantage of bulk pricing. Or you can consolidate the software you use by sticking with a single company that can provide you with a cost-effective suite of services rather than paying for individual tools from separate companies.
