Compensation here usually refers to the pay of individuals not directly associated with making the product. It represents the pay of administrative and executive personnel. As I stated in Chapter 6, a green-field approach usually helps identify excess and/or needed positions in the organization. Only by running lean and trim can an organization keep this number under control.

These are the individual benefits for employees, and they tie directly to compensation. They consist of:

The mix of benefits and the percentage of gross compensation that they represent are determined by a combination of company desires, competitive hiring situations, and federal and state mandates. However, turnaround situations require that one judiciously look at these costs, which can reach 40 percent of base pay. The greatest and most rapidly escalating of these costs is most likely health and dental insurance. Costs for this item have increased 8 to 20 percent annually over the last decade and become very problematic when the inflation in other costs has been only 3 to 5 percent annually.

I believe that employees should participate in attempting to keep this cost item under control. This can be achieved by keeping employees informed of the problem, negotiating the best “deal” through your brokers each year, and sharing increases in costs with employees through increased deductibles, copays, and other financial incentives, which encourage employees to hold down discretionary medical visits. Another effective method of holding down costs is “opting out.” It works like this: It costs approximately $1,000 to $1,600 per month to insure a family of four. If an employer picks up 80 percent of that cost, it is approximately $800 to $1,300 a month per employee. However, if an employee and her spouse both work and both have health plans at their places of employment, only one plan will pay benefits even though both plans are paid for. In this case I offer the employee an opportunity to “opt out” of my plan and will pay her an additional $400 a month to do so, thus saving $400 to $900 per month per employee. Employees must attest that other plans adequately cover them and must surrender their policies in writing. It is a “win-win” for the company and for the employee.

Another problem area for companies is the self-insured health plan in which companies pay claims on an “as incurred” basis through an administrator. This can be a cost-saving approach to medical insurance. Usually there is a blanket policy to cover a catastrophic event, and it has very high deductibles. But there is a real danger to the company when it eventually considers a sale or exit strategy, because in every self-insured plan there is a “tail” of unreported, unpaid claims that can harm the company. I do not recommend self-insurance as a general rule.

Another major area of benefit cost is the retirement plan, especially those to which there is a mandated corporate contribution. Many companies have been forced to declare bankruptcy in order to avoid the costs of such plans. In the 1990s there were many underfunded plans as a result of underperforming investments. Companies were required to “make up” the underfunding plus meet their continuing annual funding needs. These costs are called “legacy payments.” Again, many companies declared Chapter 11 to avoid this oppressive burden. Right or wrong, this cost then shifted to the Pension Benefit Guarantee Corporation, a division of the federal government.

I usually attempt to move companies from mandated contributions to a voluntary contribution plan based on achievement of certain profit goals. This book isn’t long enough to describe how this can be done, and a company needs legal experts to accomplish this. Companies can terminate old plans and put new, realistic ones into place.

Benefits, like other cost areas, are negotiable. They should reflect the nature of the business and what it can afford. But through judicious planning and negotiation, one can balance personal needs and cost.

In this discussion, insurance refers to non–health insurance, such as property and casualty and product liability.

I once ran a company that had two refineries, each insured for $250 million with a maximum payout of $500 million if both were destroyed in the same year. The cost of such insurance was enormous, especially when one considered that the investors had paid only $20 million for each of the refineries, which were now old and somewhat decrepit. They were over 100 miles apart, so the probability of both being destroyed within a single year was infinitesimal. By setting realistic insurance needs, I was able to reduce premiums by hundreds of thousands of dollars.

I had another manufacturing company where the assets were overinsured. I hired an insurance consultant to advise me about proper limits and deductibles. Since it was a multi-billion-dollar company, we saved over $1.2 million in annual premiums.

As a matter of procedure I always have an insurance consultant advise me on my current coverage plus ways to reduce premium costs without risk. Often it involves adding safety equipment or safety doors. Sometimes we find errors in classification of employee jobs, which directly affects workers compensation ratings. Thus, for the expenditure of $10,000 to $20,000 in consultant fees I save many times that amount in premiums.

Most companies face the problem and cost of freight for both inbound materials and outbound finished product moving to customers. The cost of freight has continued to mount over the years as the cost of fuel has increased. It is not unusual today to find that your shipper is charging you a fuel surcharge for the recent escalation in their costs. But there are several things to remember in dealing with freight:

I have found over recent years that companies would rather buy transportation services than own transportation services. Few companies are willing to build the infrastructure necessary to maintain, schedule, insure, and route a fleet of trucks unless there is a powerful economic incentive to do so. There are excellent competing services for shipping, which can assume this function on a worldwide basis including overnight services from the U.S. Postal Service, UPS, and FedEx.

A turnaround person will examine the structure of freight costs and will ask four key questions.

A necessary part of business is travel and entertainment, including corporate meetings, customer interaction, and conventions. The great dilemma is deciding when travel becomes unproductive and wasteful as opposed to useful and additive to corporate profits.

If I am entering a troubled company, or any company for that matter, I usually install a system of travel prejustification. In other words, I create an approval form that requires anyone who travels to identify the reason for the travel, what the trip is expected to yield from an economic standpoint, who is traveling, and for how long. The mere act of justifying travel will smoke out frivolous or ill-advised trips.

The cost of travel has increased over the years, especially to major cities and international locations. Yet there is no substitute for “pressing the flesh” and in-person analysis of situations. However, substitutes for in-person travel can be more extensive use of e-mail and teleconferencing. In a number of operations around the world I substituted video teleconferencing (which has become very inexpensive) for approximately half of our trips to Singapore, England, and France.

In addition to establishing travel-justification parameters, it is possible for any size company to establish discount deals with auto rental companies, hotel chains, and airlines. By controlling the travel choices, you can reduce travel costs up to 30 percent.

In addition to establishing rules for travel (e.g., everybody flies coach) you can limit airline costs. I normally establish a travel agent through whom we book all travel and who knows our “rules” for travel.

Unfortunately, the biggest “defeaters” of any travel policy are senior executives who feel that they are above the rules and circumvent them. For travel constraints to work, it should be understood that they are for everyone, from the CEO down!

A real conundrum is the “convention.” Most industries have national or international conventions at which various competitors set up elaborate booths, ostensibly to market their products. I feel that because of the tremendous cost involved in attending these events, there need to be certain questions asked, or caveats established, prior to the decision to attend. These are:

I have spent hundreds of thousands of dollars on conventions when I felt that the effort was worthwhile. Conversely I have pulled companies out of conventions that were unjustifiable from an economic standpoint.

The worst justification for attending a convention is to show the industry that you are still around. The advent of websites and the Internet has obviated the need to “show the flag” at a convention. If you feel compelled to show at a convention, at a minimum you should do the following six things:

In general, I don’t have much use for most conventions but I recognize that they are an accepted part of life in some industries. I would rather take the money and time they take and apply these resources to one-on-one sales.

As I stated earlier, a good turnaround expert can cut travel and entertainment costs by 20–50 percent with essentially no effect on the company.

Entertainment is one of the most difficult areas to control. It has also become expensive as a result of the IRS’s position that only one half of the cost of business meals is deductible as an expense.

Thankfully the days of the two-martini lunch have disappeared into the mists of time; however, how does one control this area? The simplest answer is through limiting those who are authorized to entertain customers and then through a corporate understanding of what are acceptable levels of expense.

I have often insisted on reviewing all expense accounts in a company to determine if personnel are being prudent in their spending habits. I have often stated that I have never had an employee “pad” an expense account, because if I found out that she had attempted deceit, she would no longer be an employee.

As I stated in my first book, I have seen employees drink themselves into stupors and ruin their health over the long term all in the name of entertainment. Common sense is the key here—and it is difficult to legislate common sense.

In bankruptcy one is allowed to “reject” executory contracts. Leases are considered executory contracts, and the shedding of unwanted lease and rental arrangements is a great advantage of Chapter 11 proceedings. In the absence of taking this extreme action, one is forced to negotiate with landlords. Turnaround experts regularly renegotiate leases.

In Chapter 8 I discussed how to build a back door into leases during negotiation. Unfortunately most companies haven’t provided such an escape hatch, so renegotiation is called for.

The first step in lowering rentals and leases is to understand your position. A study to determine if the rents you are paying are competitive is mandatory prior to beginning your efforts. For example, one company I worked with had leased but never occupied office space in Manhattan. The space was costing $100,000 per month but the company had experienced hard times prior to moving to the facilities and had even purchased and installed expensive new furniture in the office space.

The landlord was adamant that we continue to honor a lease that had four years left to run. No amount of negotiation seemed to work until we found a technical problem with the lease. We finally settled for three months’ rent and leaving the furniture behind in order to get out of the obligation.

On other occasions I have been able to renegotiate leases based on over-market rates or certain nonperformance by the landlord. For example, in one retail chain we identified properties where the company was losing money and restructured the rent from a fixed payment to a percentage of our cash flow.

Some other negotiating tools one can use include:

Most companies shy away from renegotiating because of the mere existence of the lease document. I feel that most landlords are reasonable businesspeople who wish to keep a tenant and wish to see them succeed. In almost every renegotiation effort I have been able to achieve some savings. One must merely have the chutzpah (nerve) to start the renegotiation process.

Depending on the type of business you are in, legal costs can be quite significant. These costs break down into three areas:

Unless they are extremely large or have need for internal legal function due to the number of matters handled as part of the regular business, most companies outsource their legal help.

One of the most helpful resources can be your attorney. Conversely, a poor attorney can be an impediment to growth and a deal breaker, not a deal maker. The key is to identify counsel, both internal and external, who has good business sense but also has a balanced approach to business risk. These people are identified through their reputations and recommendations of others.

A good patent attorney can help you build a portfolio of intellectual property, including trademarks and brands that can carry extremely large values in the event of a sale. For example, I know of companies that have utilized licensing of brand names and patents as major sources of income. Many companies are reticent to spend the money on this endeavor, but in most instances it is well worthwhile to protect what you have developed.

In the area of contracts and acquisitions, a good attorney can help you avoid problems in the future through intelligent crafting of documents.

Needless to say, the ultimate and least satisfying use of attorneys is lawsuits. Unfortunately we live in a litigious world and you will be forced to defend yourself or sue many times during your business career. The key to winning any lawsuit is to hire the best attorney you can find who can advise you on the merits of your case as well as the economics of the lawsuit. Remember that litigation is a process into which one goes in as a pig and emerges as a sausage.

One of the worst days in my business career was realizing that I might have to sue my own attorney for overbilling. A company that I had as a client was suing another company for fraudulent conveyance in an acquisition. The company we were suing had grossly overstated its backlogs of orders and projections of future sales. Our attorney, who was already deep into the case when I was hired, had indicated that an early resolution would occur.

Despite my pleadings for detailed billings and economic estimates of cost to pursue the legal action, the attorney wasn’t responding. The case dragged on and a bill from the attorney finally showed up. The bill was for several million dollars. Obviously, I was aghast at the amount and called for a legal audit by an independent firm that specializes in such things.

It turned out that our case had become a “dumping ground” for hourly charges by everyone in the firm. We were paying $200 per hour for secretaries to copy documents and many other overcharges. After threatening to sue, we settled the case and our attorney’s fees, and we avoided a potential disaster.

In evaluating legal costs, one should get estimates of the costs of any action well in advance of the activity. A real signal as to the merits of the case is to ask the attorney if she will take it on contingency, or as percentage of the award. If it is a strong case, most attorneys will consider a contingency arrangement.

In any case, keeping current on legal costs and their potential result is very important. In staff meetings, I always ask for a review of legal items, including costs, and this review should be part of board of directors meetings.

I was involved with a retail chain that had used full-page newspaper ads very effectively; however, the company’s advertising costs as a percentage of sales were twice as great as its nearest competition’s. We began to decrease the ad frequency slowly to determine at which point sales volume would begin to suffer. We found that at frequency levels above 110 percent of that of the competition there was no appreciable change in sales. Thus, we had reached consumer saturation at the 110 percent level, and any spending above that level was wasted.

Advertising and promotion are obviously your ways of reaching the consumer. I find it interesting that in troubled times, when sales are not doing well, companies will cut back on their advertising budgets to save money but will spend more on advertising during the good times. This is counterintuitive. Under adverse conditions, companies should spend more in order to capture a greater share of a diminishing market.

The secret of advertising is effectiveness. This combines ad design, the type of media, the frequency, and the follow-through system. A good advertising agency can advise you about the proper combination of these elements, and a good public relations firm can get media attention at lower costs than a full-blown ad campaign.

In industrial environments where you are selling products to other businesses, a combination of direct mail and ads in industry-related magazines is the proper approach, whereas consumer products may require a combination of print, radio, and TV advertising.

Ways to save on advertising yet continue to get your message out there include:

Almost every company today needs a good website. Consumers have learned to preshop on the Internet and are better informed prior to making a purchasing decision than ever before. It is important that you obtain the proper links to your site on search engines so that your product or service appears among early choices when people put certain key words into a search engine. This service is performed by Internet marketing specialists, and I encourage the use of such individuals. Also, the website should capture information from a potential buyer if the buyer so desires; that is, the website should make it easy for a potential buyer to contact the company or order product.

Your website should tell your story and be a selling tool; thus, if it is to remain fresh, it should be modified at least every six months, or more often if possible. A website is a living interactive reflection of the company and can do harm if it becomes stale.

The sum of all this is that advertising should be appropriate to your business model and doesn’t necessarily have to cost an arm and a leg. The information you received from benchmarking can give you clues as to what competitors spend and how they spend it. Again, the key to advertising is utilizing a really good ad agency that can guide you in the selection of both media and the type of ads that are proper for your business and fit your budget needs.

Unfortunately, with the advent of new and broader methods of communication, the opportunities for abuse have also expanded. I don’t mean to sound overly controlling, but you need to control the use of telephone, fax, and e-mail in order to ensure that these resources are not being wasted.

Let’s review the various forms of communication. They are:

Just like any other vendor, you need to evaluate telephone services on a regular basis. Due to the highly competitive nature of the telephone and all phone business, the costs of this form of communication have dropped over the years. However, some companies have locked themselves into contracts for service and equipment that are well above market. It is important to examine these systems and negotiate new deals that can save significant amounts of money over the long term. There are also new options such as voice over internet protocol (VOIP), which are emerging as low-cost alternatives to standard long-distance service.

Moreover, most new computer-based phone systems can control access and control who can make long-distance or international calls. Most phone systems have the ability to print out phone records on a continuous basis. The mere mention of this record keeping and the desire that employees eliminate or limit personal calls can reduce long-distance calling by 50 percent.

It’s not only the cost of the calls but rather the inefficiency that such abuse causes that is the most disturbing. I have detected people calling phone sex numbers and relatives abroad until I took the precautionary steps.

E-mail abuses are also a major problem. I find that people will e-mail associates sitting in the office space next to them rather than getting up and speaking to them. Companies need to make personnel aware that e-mails are not for casual conversation and can, and often are, used as evidence in court. I have acted as an expert witness in a number of court cases, and part of the incriminating evidence has been e-mails among the parties. The parties never expected the e-mails to be published in a court of law. Also there is the problem of explicit or pornographic websites, for which an employer may find itself liable in a sexual harassment lawsuit.

There are programs that monitor computer activity. Employees should be advised that such programs are being used and the consequences of improper action. By taking these few simple steps, you can reduce the cost of communication dramatically.

As far as mail and courier services are concerned, by establishing adequate approvals for their use and tracking these costs separately, one can gain control of these expenses.

Earlier in this chapter I discussed the use of teleconferencing in place of travel. I believe it is a great cost-saving tool. There are now a number of low-cost, dial-in teleconferencing services that can be utilized. The company should identify the service to be used and who within the organization is authorized to set up teleconferences so that this area of communication is not abused. Fax facilities should be treated in the same manner as telephone communication and may even be centralized.

A great many of the cost-saving solutions I have provided to this point sound like micromanagement and for that I apologize, but I have seen and lived through so many inefficiencies and abuses that I would be remiss if I didn’t learn from these painful lessons.

Energy costs represent an ever-growing problem for most companies. As I write this, the cost of oil has risen to over $70 per barrel, and the cost of energy has affected companies with regard to the power and gas that they consume, the fuel that they use for shipping, and the energy used in their supplies and in the petrochemicals and petrochemical-based supplies that they utilize. All companies use energy to a greater or lesser extent. The question is how to reduce the cost of this very valuable consumable.

Warranties can be considered a major opportunity, a sales expense, or a cost center. Let me explain. I once ran a company that made thermally insulated glass windows and had developed a new process for fabricating and sealing the windows. In view of its new process, it decided to offer a three-year warranty on the new windows as opposed to a normal six-month warranty. In addition, it agreed in its advertising to take windows back “for any failure.” The program worked as an advertising ploy and sales increased 10 percent; however, warranty replacement began to soar. The company had made a nearly fatal error: It had failed to understand the nature of its customers—building contractors who tend to handle building supplies somewhat roughly and consider normal breakage of windows as a cost of construction.

This cost was now passable back to my client, the manufacturer, which began facing enormous warranty costs. The warranty had been poorly written and my client had failed to realize the consequences of its actions.

In another instance, I was able to improve the warranty on a new high-tech thermal printer we were about to market, but only after extensive testing and determination that there would be no appreciable increase in warranty costs. We also obtained backup warranties from various high-wear component manufacturers. In other words, we really gave away nothing in order to get a very positive marketing tool.

Another approach is to use warranties as a profit center. Most major appliance manufacturers and auto dealers offer extended warranties on their products. These extended warranties are very, very profitable and the revenue stream from such programs can exceed the profit from the original product sale. The reason for this is that most manufacturers have lowered the “infant mortality rate” on their products and know almost exactly when units will begin to fail. By knowing this fact, they can adjust the stream of charges for extended warranties to generate strong cash flow. They can exclude or charge more for high-wear parts that they know will fail early. They can also exclude “abuse” of the product as a condition of the warranty claim.

Retailers typically pass warranty claims back to the manufacturers with impunity and usually have agreements that allow them to do so. But a major weakness in many companies is the methodology they utilize for handling warranty and repair claims. There are unscrupulous people out there who take advantage of companies with regard to claims. The answer to this is a method of tracking and classifying repairs and replacements and keeping the customer informed via e-mail each step of the way. By doing this you can inform the customer of any charges for items not within warranty parameters and obtain approval for any noncovered expenses.

In the same way extended warranties can be used as a profit center, factory repairs can also be used as a method of generating positive income and profit streams. There are also companies that will perform this service for you on a nationwide or worldwide basis and will provide on-site repairs for the customer. This is a good solution for companies that do not wish to devote internal resources to this effort. The arrangement with these outside repair companies will often involve selling parts to them at a discount, plus some sharing of repair revenue.

In summary, the keys to keeping warranty costs low are to:

Did you ever notice that right around Christmas or at the beginning of school in the fall, supplies and paper goods are being consumed more rapidly? Or if you look in desk drawers, you and others have a “stash” of pens, paper, and other supplies? For fear of sounding petty, I’m not going to spend long on this expense item, but it is a cost and most companies don’t focus on this cost of doing business. By merely having a supply closet or room and having one individual dispense and order supplies on an “as needed” basis, this expense can be reduced significantly. It’s up to you if you wish to have a department charge-back system for this item, but it’s a method of controlling one of those expenses that often gets lost in the overall scheme of things. In service businesses or advertising agencies the cost of offices supplies can be quite large.

Another area of supplies that can be very sizable is factory consumables. Items in this category are things like lubricants, grinding wheels, tools, and safety gear such as helmets and safety glasses. These often get lumped into the cost of goods sold category.

The larger the company, the bigger the amount spent on factory consumables. In one company, I found that the white cotton gloves we provided to personnel for polishing chromed parts were disappearing at an alarming rate. A brief investigation provided us with the alarming knowledge that we were unknowingly providing communion gloves to most of the town of Rockford, Illinois. By making the gloves yellow and imprinting them with the company name, the shrinkage slowed to normal levels. In another company, I found massive kickbacks by merely tracking the inflation on our usage of consumable products. In one company, our sales had not grown for several years but our consumables costs were growing at 10–15 percent per year. One of our more seasoned purchasing agents was perpetrating the fraud. The kickbacks were over $1 million a year. Needless to say, we had an early termination and pressed for a criminal conviction. I will discuss fraud in more detail in Chapter 18.

One of the biggest expenses in business, taxes, is considered last in the list of controllable expenses. Considering that the tax man can take 50 percent or more of your profits in federal, state, and local taxes, one needs to be very aggressive in approaching this cost item. There is an absolute need for a very good tax consultant. A tax consultant can alert you to legal opportunities to reduce tax costs on a continuing basis. This gold-plated individual may or may not be part of your auditing firm and is usually found by word of mouth. The various tax laws always confuse me because they are continually changing, and despite protestations to the contrary they seem to become more and more confusing and arcane.

If you plan well in advance, you can legally minimize your exposure to the bite of the tax man (or woman). Some instances of this approach that I have used are:

Now, one must remember that many of the tax-reduction methods I may utilize also reduce taxable profits. This may cause duress in public companies or companies that are being prepared for sale.

An example of this was a privately held outdoor-sign company, referred to in Chapter 1. The company would spend approximately $30,000 to $60,000 (at that time) on the construction of new signs. The tax code allowed us to depreciate these signs over five years. The average life of a sign was 30 years. We were growing rapidly and were keeping our profits at a minimum through this perfectly legal device. Our cash flow was very large, but our P&L did not reflect this due to the high depreciation expense. Our local banker called to discuss the company’s mediocre financial statements and the fact that standard performance ratios were showing us to be a less-than-desirable client. Despite my explanation of what we were doing to reduce taxes, the banker was unsympathetic and wanted to terminate the relationship. My ire was raised to the boiling point and I called the president of the bank to explain our situation to a rational person.

Fortunately he “got it” and I never saw the hapless soul who delivered the bad news again. We eventually sold the company and the price was based on a multiple of the company’s earnings before interest, taxes, depreciation, and amortization. Since this calculation reflected our cash flow, we were in great shape.

As you can see, it is desirable to reduce taxable income without reducing cash flow. The law also allows the use of legitimate reserves for things such as litigation, bad debt, and inventory shrinkage as proper reductions in profits. You should take guidance from your tax consultant on these items as well.

There are many businesses that have special tax considerations such as depletion, which refers to the use of mineral or oil assets, for example. Your tax consultant should have knowledge of the special tax provisions that are applicable to your specific business.

Another time that a really good tax person can help immensely is when you are preparing for sale. There are tax-minimization approaches that can help a seller or purchaser, and you should have full knowledge of them prior to the transaction. The caveat I place upon this consideration is not to let the tax considerations drive the deal, but use them as one factor in your consideration.