Reduce Your Expenses

IT Strategy: Reducing Expenses

Okay, so a couple of days ago, I wrote about the effects automation should have on a business. More investment in technology yielded greater automation, reduced or diminished the impact of labor, increased productivity, systemized the business to transform it from a job and into an asset, and increased profitability.

And in that discussion, I promised you that I'd discuss three strategies that business can use to apply their technology investments. One of the three strategies, Reducing Expenses, is the easiest to understand and the most obvious.

Greater investments in technology automates the business, improves productivity and efficiency, and reduces operating expenses. Tech investments allow you to do more with less. That, in turn, improves profitability.

It's a Great, Basic Strategy ...

Reducing Expenses is the easiest, most basic strategy for applying IT expenditures. It's the first place we look to when trying to measure a Return on Investment (ROI) associated with technology investments.

In calculating an ROI for this kind of strategy, you'd approach it in four steps:

1. Measure the cost of doing nothing - add up how much it terms of labor and materials to do the existing business process.
    
2. Measure the time involved for doing the existing business process.
    
3. Apply the technology investment.
    
4. Now compare the new cost of labor and materials, and, the time it takes to get the business process done.
    
5. Divide the dollar amount saved against the amount spent on the technology investment.

Example:

Let's say that a business process took $6,500 and 16 hours in labor and materials and time. In investigating the business process, it's determined that $2,000 in technology spend can help the employees work smarter. After deployment, new measurements are taken. The new process is $3,900 and takes just 11 hours to perform.  That's a $2,600 savings from $2,000 worth of investment, or a 130-percent ROI. Plus - and a big bonus here - we're saving five hours. Gosh, more time! What's that worth?

... But You Can't Reduce to Zero

Pretty cool, huh? Well, it's cool for the first couple of go-arounds anyway. Eventually, we'll run up against the limits of what current technology can offer us. We can only reduce expenses so far. We can't make the business process operate at $0.00 dollars and at zero expenses taking zero time. That's impossible!

It's the Law of Diminishing Returns at play - over time, we can only reduce expenses just a little bit more, just a little closer to zero (but not actually reaching zero), until there's a huge shift or change in technology - which means every incremental investment returns less and less time and money.

That makes Reducing Expenses a common, basic strategy but an insufficient play in the long-term. It has to be paired with other techniques to obtain even higher returns from technology spending. Next time, we'll talk about another approach: Containing Expenses.

R

On Being an Owner

In a previous post that I wrote this week, I talked about the difference between an owner and an employee. There's a big difference and you definitely want to be an owner. 

Remember: an owner is a person who owns the process of production. They have the capability to make changes to way work is performed, and to reinvent work where necessary. 

So, okay: why do you want to be an owner and not an employee? 

Let’s say you’re an employee and you earned $1.00.

The federal IRS gets paid before any of your other debtors. That’s roughly $.20 taken from your $1.00 check before you receive anything.

Your state, too, may incur an income tax and let’s say that was $.10.

Then it’s your turn to contribute to Medicare/Medicaid which is another $.10, if you make less than $63k/year.

So far, instead of earning $1.00, you’re netting $.60. Right off the top.

The employee pays their taxes first. Remember this. It's important.

Now, from here, an employee's condition may vary but their plight is predictable.

The next largest expense is housing which could be as high as 30% of net income, or, $.18. After housing, the common everyday employee is now left with $.42.

Okay, now the employee must subtract utilities, food, and transportation. What’s interesting about these expenses is that they’re variable depending upon the price of energy. These expenses can rise faster than your than an employee's base pay. Let’s say, combined, they’re ~9% of their net pay, or 5.5 cents.

Following thus far? Subtracting necessities, the employee is now looking at  $0.36 for disposable income.

Then there is life, medical, and auto insurance. Yes, certainly, these things are disposable and not required ... still, you might feel differently about that assessment. Premiums on medical, in particular, rise about 25-percent per year, out-pacing the growth of income, just as utilities and transportation, insurance premiums rise faster than your earning potential and erodes your disposable income. Let’s pretend those are another 10-percent of net, or, 6 cents.

As an employee, your net disposable income is now about a third of your gross, or, $0.305. And from that 30-odd-cents, you must save for retirement, and experts suggest that should be at least 10-percent of gross wages, or, $.10, leaving the employee with $0.205.

You see, employees really don’t make $1.00. They actually make a fifth of their gross, or, $.20.

It is from that 20-cents that employees pay for daycare, apparel, entertainment, charitable contributions, education, student loans, and the like.

And employees feel the pinch in times where those variable expenses like utilities and insurance erode what little play they’ve left.

That’s an employee's view of the universe. It is a cycle of debt and poverty. It also explains why real wages for the middle class have flatlined since the the 1970's. Meanwhile, the employee owns nothing, really – not the guarantee of a job (thanks to the demise of unions), not a real pension, not even his house because the bank can foreclose on it on default – and the employee has little money or assets by which to create wealth. 

Employees just have obligations. 

Employee poverty is a form of socially-accepted slavery, heck, we even tell our kids, “Go out there and get a good job”, or, “Go to school to find work”, or, “Man, I can’t wait until I find a job.” 

The owner’s view of the universe is quite different.

If an owner makes $1.00, something made it for them - like a business, royalties, an automated system, or, as interest off of their investments.

For the owner, money works for them, not the other way around, and because they’re not making a straight swap of time/labor for money like employees, owners can earn a lot more money … even when they’re not working.

Unlike employees, owners aren’t taxed right away. Instead, the owner gets to make pre-tax deductions to lower their taxable income. Think about that. They’re allowed to generate expenses that employees must also pay for (transportation, meals/travel, lodging, housing, vehicles, even employee-sponsored daycare), and then used that to lower their tax burden so they’re taxed at a lower rate, unlike employees, that must make such expenses after-tax. Owners pay taxes last.

So owners make more, by working less, and are taxed at a lower rate than employees, because they're allowed to deduct their expenses prior to being taxed, and are therefore taxed at a much lower rate. 

Income an owner earns can also be hidden. Unlike employees, instead of having to pay income taxes or capital gains, they can roll those earnings into real estate or other assets which, in turn, makes them more money without incurring more tax liability.

And sometimes, owners may not even have to pay taxes.

In paying considerably less taxes yet making more money, the owner has real assets: things that make them money without trading their time/labor for cash flow.

Thus excess money can be poured into tax shelters, charities, other businesses, land improvements, or other financial instruments that lower their taxes and yet further increase their cash flow.

Owners have more cash flow. More cash flow = more financial freedom.

Meanwhile, owners own the obligations owed by employees. The employee must pay out mortgages, insurances, living expenses, health care, retirement … all of these commitments … to other owners, yet meanwhile, the employee owns nothing.

Employees cannot be an owner and have others indebted to them. Employees don’t have the excess capital to build businesses, make investments, or buy assets that’ll make them money without trading their time/labor for it.

Owners know all of the tax loopholes and incentives, yet employees can never exercise them. They don’t have the means.

To be an employee is a form of servitude. Employees owe to owners and can never pay themselves.

To be an owner is a form of empowered self-mastery in a capitalist system. Owners own the capital and means of production by which to reduce their obligations, and pay themselves first. 

This is why you want to be an owner. Are you an owner? Or are you an employee? If you're a small business owner, how are you responding to the problem of managing your business: from the perspective of an owner or of an employee?

R

Effects of Automation on a Small Business

In a previous post, I was talking about how you might be trading your time for money. That's how an employee thinks, and not how an owner thinks.

An owner is a person who is in charge of their own labor, production, and output cycle. They are the boss.

Maybe they are the owner of their own work (they're a freelancer). Maybe they own the work of others (they're a boss). Maybe they own their own small business. Regardless, an owner is a person who can make rational decisions that change a business process.

So an owner - recognizing that they've created a business model that trades their time for money, and that they want something more than just a job - attempts to invest in technology. Technology, they presume, will make them more productive and reduce their hands-on time with the business. That's a fairly reasonable assumption:

Investment in technology will increase automation, improving the owner's efficiency and productivity. An example: instead of writing out invoices and timecards and expenses, they subscribe to an online cloud service that automates capturing their time and expenses, prepares their invoices, sends them, and facilitates payment. That, indeed, improves productivity for the owner and increases how effectively they use their time.

But there's several ancillary benefits here. Primary, they've started a process of systemizing their business.  Systems are repeatable business processes and can be sold, and through this investment, they're actually building an asset out of their business rather than relying upon it for a job.  Greater systems reduces the friction of a business - that is to say the number of touch-points the owner has to run through to keep the business operating. Think about it: if the owner is able to automate a majority of their billing processes, then it takes less touch (less effort, less friction) to keep the business going and the money coming in. 

That allows them to scale: take on more clients and to become more profitable over time. And more profits leads to spending money with the highest potential of return - probably re-investing in more technology. So it becomes a virtuous circle: investments in technology produce a visible, meaningful return that increases the value of the business as an asset, and, pushes profitability up.

That's probably going to be a lot different in terms of a strategic outcome than somebody else who didn't invest in technology - rather, let's pretend they spent their money on marketing. They got the word out about their businesses and attracted more clients, and find themselves more busy than they've ever been. They're working like a great employee of the job they've created for themselves.

They didn't invest in technology which means they don't have an ability to automate, and that pushes up the cost of their labor. They've got to pay attention to the little things like time capture, invoicing, and receivables, and they aren't spending time on their work product. That pushes their productivity and efficiency down. Further, they haven't systemized the business. They haven't built an asset ... it's just their job that they continue to toil away at, touching more and more things (creating more friction), reducing their profitability and their ability to reinvest their profits in the business.

Do you see their mistake here? They spent money on marketing and attracted a bunch of new business, working harder instead of smarter, which made them less of a return and didn't bolster their business as an asset. They did, however, perform well under the stress of a job. 

More investment in technology creates more automation and more systems. In turn, that transforms the business into an asset - something that can be resold and repeated by anyone over time. 

So, okay. Next time around, let's talk about how businesses can confront the problems of investing in technology or labor. We'll talk about the options small business. In the meantime, take a look at your small business. Where are you automating? Where's the low-hanging fruit that would systemize your business and transform it from a job and into an asset? How is the lack of technology reducing your capability to grow, expand, and scale?

R