At a recent Bridgeport Regional Council event, Marie O'Brien, president of the Connecticut Development Authority, affirmed that the State's future prosperity is reliant upon three key factors: job creation, an ability to develop innovative products, and controlling the costs of doing business. This advice is "spot on" as these suggestions are clearly the key components of a sound business strategy. Let's focus on cost control. Controlling costs should not be viewed as a single event such as reducing the budget by 10% or a one time downsizing to fix short-term financial problems. Cost control must support a strategic view of the business and initiate thinking and actions with regard to improving the day to day operation of the company. Controlling business costs is not exclusive to Fortune 500 companies but rather a changed mindset that requires participation at all levels in any size business. To change our view of cost control we must understand the nature of costs and how typical business decisions increase the cost of doing business.

Cost results from "what you do" and "how well you do it."

Today, successful companies manage cost by establishing a focus on effectively managing their internal business and operations processes. These are the activities that support the delivery of goods and services, such as: Procuring material, paying a supplier, scheduling staff, or inspecting a part. These processes determine the companies' ability to respond to their

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customers. To that end, companies are now focused on understanding how their internal activities commit the company to acquire valuable resources raw material, labor, capital, and technology. Companies that understand and manage their activities in the most effective and efficient manner have better control of their costs. And according to a 2003 study by the IMA, cost management is a number one priority.

Using the vignette of a simple start up company we can illustrate how growth directly influences the activities the firm performs. The changes in types of activities and the level of activities create change in the cost and structure of the firm. When the business volume declines some of the changes in resource levels can be reversed in the short term while other commitments cannot.

The start-up phase: John Doe, a retired engineer, left his corporate position to start up his own small manufacturing company. He is the owner-operator of ABC Precision Products, a single person entity that produces specialized widgets for the aerospace industry. John currently has a one-year contract with a single customer to produce and sell 400 widgets weekly at a price of $20 per widget. The widgets are produced in John's garage with a stamping machine purchased for $20,000 using a home equity loan. John performs all business activities at ABC: procuring and scheduling delivery of the raw material from local suppliers, setting up and running the stamping machine, inspecting the finished products and packing the widgets for delivery. John accomplishes these tasks and delivers the 400 widgets in a 40-hour work week. From a cost perspective, with the exception of the stamping machine and the electricity to run it, John's costs are mostly flexible since he has no long-tem contract with suppliers and no labor costs with the exception of his own salary. This very simple structure of mainly variable costs will yield John very attractive operating margins at this volume. But let's review the effect on ABC's cost structure when John lands two new contracts. One customer requires monthly shipments of 400 widgets while the other requires quarterly shipments. To be able respond to this higher volume, more and different activities may need to be performed. John must clearly understand what new resources he must acquire to carry-out these activities.

Resources must be adjusted for changing levels of volume

The growth phase: John has decided to hire a machinist at a salary of $1,000 a week, acquire another stamping machine for $20,000 and lease new factory space at a cost of $2,000 monthly with a two-year contract. The new space John will provide room to expand and house the inventory that he must maintain to meet the fluctuating delivery schedules. The new facility creates added costs such as utilities, insurance, inventory taxes, and security. Lastly, John has also decided to hire a part time assistant at a salary of $300 weekly. The assistant will help him with scheduling of the raw material receipts from suppliers, keeping track of inventory, as well as, packaging the widgets for delivery and billing customers. Committed costs are incurred regardless of the volume produced. In this phase John has significantly increased his committed (fixed capacity) costs since the lease, utilities, and payments on the machine must be made whether they are actively producing product or idle. Further the assistant and machinist's salaries must be paid despite the number of widgets produced and sold. John's cost structure and operating margins will reflect this new level of committed resources. John will quickly understand that his profits are not dependent on the amount of resources committed not those used. However, for most companies the real problems arise when the volume decreases. It's always easy to add resources when the volume is increasing but very painful to reduce resources when the volume declines. Most companies execute that change very, very poorly.

To respond to changing business conditions and product demand, John must very carefully choose the types of activities to be performed, and each activity must be evaluated on its effectiveness, efficiency, quality, and cost. For example, John must decide whether it would be less expensive for him to pack his products for delivery or hire an outside company to perform this service for him. Summary: To establish a cost mindset and make reduction everyone's job, try the following:

+ Understand which activities add value, consume expensive resources or are strategy critical

+ Make elimination of non-value added work an ongoing process

+ Establish re-engineering projects to eliminate non-value added activities and tasks

+ Set monthly goals for cost reduction and process efficiency

+ Share the successes with employees

+ Establish resource levels and drivers of the resource levels in the annual budgeting process

Wayne Bragg is a trusted business consultant to small/mid- size manufacturing firms. He is expert in helping businesses manage the bottom line through business practice and process improvement. He specializes in Finance, Accounting and Operations Management. Wayne is an Adjunct Professor of Accounting at University of CT. He can be reached through this web site.

The opinions expressed are the author's and not necessarily those of connpost.com. Please direct comments to cdauber@ctpost.com.