Knowing Your True Costs

It's not about what you think it is.

By Anthony Noel

For years now, I've written and taught managers about the absolute necessity of knowing their costs. If you don't understand how much it costs you to do what you do, how can you reasonably expect to become profitable?

You can't, of course.

We businesspeople make spending decisions every day, some obvious, some less so. That plywood truck pulling up to your loading dock, for example - pretty obvious, right?

But there are other choices we make that bring with them murkier cost obligations, and smart managers know how to bring these responsibilities into the light before making a final buying decision.

One example of a less-defined cost liability is the purchase of used equipment. The more we can independently confirm about a particular machine's service record, maintenance issues and general reliability, the more informed our decision will be about whether it is the right machine at the right time.

But right now, I am thinking about even cloudier decisions. Commitments, really, is a better word for them.

The subject came to mind recently when I was dealing with a distributor that had seemingly constant inventory problems. Over the past 30 years, many distributors, like many large manufacturers, have adopted a "just-in-time" inventory philosophy. These companies rely on great supply chain relationships, rather than great amounts of warehouse or stockroom space, to enable them to meet their customers' needs.

It makes sense, because less investment in inventory means less money sitting around in a cavernous facility, for which the company is paying to light, heat and maintain. Without question, the move to leaner organizations has extended beyond the payroll to include the facilities and products that are key to a company's bottom line.

Lean thinking, however, comes with costs of its own, costs that are not always evident to managers choosing to make their companies' practices more streamlined. Such was the case with the distributor to which I refer.

This multi-branch dealer did a great job of taking customer orders. But, like Jerry Seinfeld told the car rental representative at the airport rental counter, "You know how to take the reservation, you just don't know how to hold the reservation. And that's really the most important part of the reservation, the holding."

This distributor had all the necessary computer hardware and software in place to run a lean inventory-keeping and material-ordering operation. But it didn't invest in training its people to make the operation as effective as possible.

The reason? Well, you know those cartoons of folks with dollar signs in their oversized eyeballs? That's it.

Today, too many managers go lean because of the money it can save them right now, rather than seeing the indirect costs - and yes, eventual savings - that doing so can produce. The critical term being "eventual."

Rather than looking at all the ramifications of such a process-shifting decision and allocating funds for the intensive (and constant) training and re-training such a shift will entail, many managers only see the (always inflated) initial savings. And in their dollar-sign-eyeball haze, they buy into something with little clue as to its intricacies.

My example distributor was in that very boat. It had made the switch, but not the investment. Years later, the powers-that-be were still running around with dollar signs in their eyes, scarcely realizing they were no longer in the distribution business, but in the scrimping-and-saving-money business.

An oft-quoted truism is that one should keep his or her costs as low as possible and sell the product for as much as the market will bear, and what is in between is the profit. While there is a lot of truth in that, one point omitted by this adage, and therefore overlooked by its adherents (the dollar-sign-eyeball crowd), is that "product" includes "service."

Generally speaking, people will gladly pay a higher price for an item that is available when they need it, in the condition they expect. Both have a lot to do with service. And service costs money. Money for training, money for moving goods, money for additional equipment to keep growing. Also, money for developing procedures that work.

Those procedures will gradually lessen the cost of moving goods and training people, because they will become engrained. And once you hit your stride, watch out: People will beat a path to your door; it doesn't matter what you are selling.

There is no easy way to develop the habit of questioning the long-term costs of a decision. But if I had to choose one word that might help, it would be "skepticism." Ask yourself, "What does this do for me in the next year? The next five?" And even more basic than that, "Do I really believe that this thing (or system, or whatever) can do what the salesperson (or whomever) is telling me it will do?"

Once you are sold, and I mean absolutely convinced, take ownership of your decision. Make the investment necessary to make it work for your company, and make sure the budget to do so is protected, year in and year out. If you choose not to do so, rest assured you will wind up paying anyway: in lost sales, disgruntled customers and embittered employees.

I am of the belief - and experience has borne it out again and again - that there is a cost for every decision we make. The success of our choices is dependent upon whether we recognize their true cost going in and commit to paying that cost willingly, or ignore the reality and have the cost extracted from us as we kick and scream.

Anthony Noel is a management consultant. Send him e-mail at


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