When trying to boost their bottom line, many businesses implement cost-cutting measures. But cutting costs can mean sacrificing quality - and that risks customer satisfaction and retention.
A better way to optimize revenue and resources is to adopt a cost efficiency mindset instead. Cost efficiency is about reducing the cost of delivering your services, without undermining the services themselves.
A cost-efficient approach improves the overall profitability of a business. That’s true of any enterprise. But it is especially important for businesses that deliver client projects.
When you’re managing interconnected and unpredictable client projects, it’s easy to go over scope, over time, and over budget. And that undermines profitability.
In fact, in their Pulse of the Profession 2021 report, the Project Management Institute found 73% of projects met their goals. But only 62% were within budget and 55% were on time. 34% of projects suffered scope creep and 12% failed altogether.
By adding cost efficiency practices into your project management, you’ll be better placed to predict, monitor and manage project costs - so you can reduce wasted investment and maximize your margins.
Cost efficiency means being able to deliver projects and services at the lowest possible price without compromising quality. It’s about driving down costs while maintaining a high level of service, quality, and innovation.
Cost efficiency isn’t the same as cost cutting. That focuses on saving money without necessarily considering the longer-term impact of that on the business. Cost efficiency can help you achieve cost savings - but by spending less money and time to achieve the same results. Never in a way that's detrimental to your customer, reputation, or business sustainability.
It’s a strategy that prioritizes spending and investing wisely to achieve a goal in the smartest way possible - whether that’s achieving specific project outcomes for a client, or achieving overall revenue goals for your business.
Cost efficiency is important because it ensures your business is profitable, successful, and sustainable. If you're not cost-efficient, you'll end up spending more money than you generate - and that's the fast track to business failure.
Running a cost-efficient business lowers costs, increases your profit margin, and unlocks revenue for growth. The more cost-effective the business, the more profitable it becomes.
But cost efficiency isn't just a financial metric, remember. It exists at the intersection of cost and quality. Cost efficiency is also important because it ensures your business continues to meet and satisfy client needs. Without the quality factor, your business will quickly lose customers and revenue will drop.
This diagram shows how cost and quality interact to create cost efficiency.
Cost efficiency and cost-effectiveness are often confused. They're similar but different measures of business success.
This means that a business can be effective without being efficient, but it cannot be efficient without being effective.
For example, if you spend £10,000 on a marketing campaign and generate £250,000 worth of sales, your marketing cost per sale is £40. However, if your profit margin on each sale is only £2 and it takes two months to make a sale (on average), then you might not have been very cost-effective overall.
So when thinking about your business's costs, don't just focus on how much things cost: think about whether there are cheaper ways of achieving the same result without cutting corners.
A cost-benefit analysis helps organizations evaluate the economic worth of pursuing a particular project or opportunity. It is a useful tool for businesses looking to achieve cost efficiency because it:
To conduct a cost-benefit analysis for a project, you need to list the benefits and costs of a project and quantify these in financial terms.
As you'll see, some are easier to quantify than others. But expressing each cost and benefit as a monetary value is essential. It enables you to determine whether a project is financially viable and to compare projects like-for-like before deciding which to pursue.
If a project is financially sub-optimal, you have the opportunity to redesign the project with cost savings before committing to it.
There's an old saying that 'you can't manage what you don't measure.' So whilst it might sound obvious, you need to set a project budget if you want to manage costs.
In a project- or professional service-based business, your people are your biggest asset and your biggest expense. So determining your project's critical path - and then calculating resource allocation and cost - is one of the most important factors in project accounting. Here's an example of a project budget you can build with Runn to monitor project costs:
Looking at data from past projects can help you estimate the budget and resource allocation needed for future projects. Known as analogous estimating, this can support more informed resource and capacity planning than a well-intentioned guesstimate.
But remember that the world of work is always changing - and what worked last year might not be the answer today. Some industry influencers - like Accenture - recommend a 'zero-based budgeting' approach. This involves starting from scratch with budgets each year and justifying all resources against strategic objectives cascaded from senior management.
Whichever approach works best for your business, strategically setting budgets and allocating resources is always going to be better than a more ad hoc approach. Armed with a realistic budget, project managers are equipped to manage costs for maximum efficiency - and to look for ways to save money without undermining outcomes for clients.
When it comes to cost efficiency, resources must be matched to projects in the most intelligent way possible.
Over resource a project - with more staff or more qualified staff than the project requires - and you'll increase costs without necessarily improving customer satisfaction or gaining any commercial advantage.
Under resource a project - with too few staff or less qualified staff than the project requires - and you may make initial savings on wages. But at what cost to the project? You may incur higher costs, long-term, as a result of the project overrunning and disappointing the client.
You need to be mindful of your MVPs - most valued players. These resources are in high demand and their availability can make-or-break a project, so they need to be allocated to the highest priority projects.
You can use your cost-benefit analysis to avoid spending resources on projects that aren't worth the investment.
You can't reduce cost without knowing where it comes from. To find out, you need to know how your team spends its time.
To do this, you need to know what your lead time is for specific tasks, and at what effort level you are working on them. Here is a way to figure that out:
Track your time and analyze it later. Just recording how long everything takes will help you see where the most time is being spent, and help you improve future estimates.
When you're creating a cost model, it's important to use a consistent way of measuring costs for all resources. To introduce consistency, CFOs must be crystal clear about the formulas they use to calculate key business metrics. Having the same unit of measurement for all services across various teams and departments will help you standardize and simplify your analysis. Here are some tips on how to ensure your cost measurements are consistent:
The concept of cost efficiency is one that nearly every business owner understands. Minimize costs, and you maximize profit. However, many companies fail to understand that the most important factor in this equation is not necessarily price, but return on investment (ROI).
In other words, it's not enough to simply cut costs. You also need to make sure that those cuts are worth what they save you because there are many situations when you may be saving money in the short term but losing out on value - and money - in the long run.
This is often a problem when business owners are dealing with IT services. They may look at the price tag for a specific service or product and conclude that it's too expensive for their budget. As a result, they decide to go with something cheaper - only to find out later on that their decision ended up costing them more than they saved.
One common problem project businesses commit way too often is operating with razor-thin margins. Selling services below market value may seem like a good marketing strategy at first. You'll win custom and get projects under your belt, which you can use to win more customers.
But this strategy can seriously backfire.
A good strategy is to sell your products at a competitive price - one that allows you to deliver quality outcomes and not lose money.
A better strategy is to build a premium brand that allows you to attract higher-paying clients and charge a higher fee for your services.
Plus, your pricing model will affect project profitability as well.
The pricing model you've agreed on at the initial stage of the project can in fact influence its future profitability.
When deciding what pricing model to adopt for your next project, you should consider the relationship between revenue streams and operating margins. Each type of revenue stream - time & materials (T&M), fixed-price (FP), or retainer - comes with its own twist, which affects the operating margin.
While there are no hard-and-fast rules about which model works best for every business or project, here are some facts and tips that may help you make an informed decision.
Time and materials-based projects often yield the best margins, according to the findings of the 2020 SPI research, as long as bill rates are established appropriately.
According to the survey, IT Consultancies produced the highest time and materials margins of 38.7%, compared to 36.9% for fixed price models.
The time & material model is less hazardous than a set price commitment since it assumes that the project's cost is based on real time spent and an hourly rate. Another advantage is that your teams will be more adaptable to changing requirements because they won't have to nail down and plan all of the work ahead of time. When it comes to your financial strategy, paying for completed labor might imply two things: less uncertainty and more money saved.
A change control process is essential in project-based businesses. When your organization manages multiple projects - and team members work across several at a time - a change to one project can have implications for the others.
For example, if a certain staff member is critical to both Project A and Project B - and project A overruns - Project B will need to reschedule or reconsider their staffing.
Without a change control process, project changes can happen ad hoc and under the radar. There is no centralized way to assess the impact of project changes. And the implications and costs of a change can go un-managed.
A change control process requires that any project changes are submitted for assessment and approval before going ahead.
Putting a change control process in place will reduce the financial impact of unexpected project changes - allowing senior stakeholders to maintain control of costs and overall portfolio profitability.
When you work in a project-based business - the likelihood is - you live to please clients and you love to deliver great work. This attitude is why you attract and retain so many customers. But the flipside of this approach is that you might be doing TOO much to keep clients happy - overservicing their contract.
When you overservice, you undermine your cost efficiency. Remember that cost efficiency is about delivering projects at the lowest possible price without compromising quality. You're aiming to strike the balance between customer satisfaction and cost.
If you put too much into the project, you can elevate customer satisfaction at the expense of your budget. And if your customer would have been happy anyway - without the extra effort - then this reduces cost efficiency.
Choosing quality over quantity is a cost control strategy that creates a virtuous circle of business benefits.
In a project-based business, it's tempting to accept every opportunity that comes along. We're all conditioned by the 'make hay while the sun shines' mentality to take work when we can get it. But that isn't always the best strategy.
Imagine two businesses:
The latter approach can lead to employee burnout, increased project management complexity and cost, and trap Business B in a cycle of reactivity.
In comparison - as part of the cost management approach - Business A takes on a smaller number of bigger projects. A strategy that - according to the PMI - reduces project management costs compared to the total installed cost of a project. This is one way they increase their cost efficiency.
Their strategy also allows for optimal resource utilization - staff aren't chronically overworked and abandoning the business due to burnout. And it gives them more time to be strategic and proactive - marketing their services and pursuing even more great-fit opportunities.
Among all the metrics you can use to assess your business, revenue growth is perhaps the most valuable. Some businesses focus on achieving sales targets. Others look for earnings growth. But revenue growth is the most holistic and strategic path to long-term profitability.
Revenue growth uses a formula to work out revenue generated by your business in a certain amount of time, compared to a previous - identical - amount of time. For example, this year compared to last year.
There's a simple formula to work out your revenue growth:
(Current period revenue - previous period revenue) / previous period revenue
(This month's revenue - last month's revenue) / last month's revenue
(£50,000 - £46,000) / £46,000 = 0.087 (rounded up)
This translates into revenue growth of 8.7% for the period. Nice work!
Unlike earnings growth, revenue growth doesn't account for expenses incurred. So you might wonder why revenue growth is a better metric to check.
Obviously, both are very important. But focusing on earnings growth alone could lead your business to focus TOO much on cost-cutting measures. These could negatively impact customer satisfaction and retention.
A revenue growth strategy is more holistic. It looks beyond sales and cost-savings as a shortcut to profit.
It creates a holistic, organization-wide responsibility for growing revenue - including marketing and pricing strategy, project management, customer success, and HR. This delivers tangible benefits including well-managed costs, improved customer satisfaction, and sustainable growth and profitability.
Savvy business leaders know that digitization and automation deliver efficiencies - both in terms of productivity and costs.
There are lots of opportunities for automation for project-based organizations looking to control business costs.
Because automation allows you to use fewer resources to achieve greater output, you can increase capacity and scale more easily.
The biggest asset - and expense - for professional service firms is its people. By managing your human resources effectively, you can significantly improve your cost-effectiveness.
One way to achieve cost efficiencies in relation to staff is to leverage resource planning technology, like Runn.
Runn allows you to:
And all from an intuitive dashboard that doesn't just make resource management easier, it makes it a pleasure.
See just how easy resource planning can be - start your seven-day free trial today.
Start mastering project financial management today to avoid any budget overruns tomorrow.
Is your business one of the many dealing with staffing constraints? Proper project prioritization may be able to help - we'll explain how in this guide.