Survival of the leanest

Matthew Harding is one entrepreneur who’s not afraid to negotiate. When the business he owns, Ottawa-based IT-solutions provider The KTL Group Inc., came up against hard times last year, Harding didn’t waste time—he went directly to his suppliers and got them to cough up a better deal.

First stop was a frank discussion with the landlord, to whom Harding explained—without resorting to threats—that KTL Group was struggling to maintain profitability. “It was done in a very positive way,” he says. “It was basically just, ‘Look, you don’t want to lose me as a client, but I need to save some money. What can we do that works for everybody?’”

After a brief dialogue, Harding got what he was looking for: a couple hundred dollars per month in rental savings in exchange for renewing his five-year lease.

That may not sound significant but, as the Canadian economic picture darkens, it’s exactly the kind of incremental boost that for a small business can mean the difference between solvency and bankruptcy. Unfortunately, according to the American Express Small Business Monitor, not enough entrepreneurs are willing to make a case for their businesses.

The Monitor, a quarterly survey of Canadian business owners with fewer than 100 employees, approached 720 entrepreneurs in July to gauge their confidence levels and get their outlook on the economy. In addition, the survey drilled down into one area that’s foremost in the minds of many business owners—how to control costs in times of economic turbulence.

Not surprising, the leaders of fast-growing companies reported better than average performance and confidence. Among chief executives of firms appearing on the PROFIT 200, HOT 50 or W100 rankings—such as Harding, whose KTL Group ranked No. 87 on this year’s PROFIT 200—77% reported an improvement in business over the past year. This compares with 42% among SMB leaders of companies not on a PROFIT ranking.

What’s perhaps more surprising is the sense of optimism across the board. Fully 86% of respondents reported feeling confident about their firm’s prospects over the next six months. Remember, though, this question was asked in July, before the U.S. Congress engaged in a Mexican standoff over debt-ceiling limits, and before the surreal threat of defaults from multiple Western nations rocked the global economy.

“The sentiment that we saw in July was one of cautious and increasing optimism,” says Eric Nielsen, vice-president of small business services at American Express Canada. “We’ve actually seen this confidence build recently, likely in response to a stabilizing economy. Well, what a difference a few weeks makes when you look at the events on the global stage. It will be interesting to see how things play out over the next several months, and what small business owners will be telling us come the fall.”

Indeed, right up until July, Canada seemed to be managing a slow recovery. Entrepreneurs had survived the Great Recession and 12 months of intense cost-cutting, and many were actually looking forward to relaxing their cost-cutting measures in preparation for a new growth phase. More than one-third (37%) of entrepreneurs said their top priority over the next six months would be growing the business, compared with just 4% who said cost-cutting would be the top priority.

The willingness of entrepreneurs to jump back into expansion mode probably says less about the economy than it does about the character of entrepreneurs as natural risk-takers—more adept at launching and growing businesses than rationalizing them. Harding, for one, says the exercise in expense management feels like a distraction: “Creative destruction? Yeah, there’s always a possibility for creative destruction. But that’s why you get yourself a good business manager to run your company.”

In hindsight, of course, it’s obvious that small and mid-sized businesses (SMBs) had jumped the gun, and many are now in full back-pedalling mode. That includes John Kittell. A couple of months ago, the owner of Calgary-based Cheque Print Solutions Inc. was intent on expanding the square footage of his cheque-printing shop. Now, he has shelved those plans indefinitely. “I was thinking about it,” he says, “but I finally said to myself, ‘You know what? Rent doesn’t make me any more money.’”

If entrepreneurs have resigned themselves to another round of austerity measures, however, they’re being strategic about it, seeking ways to cut costs without cutting corners, losing clients—or generally undermining their growth potential.

The biggest target for those seemingly invisible savings are supplier costs, although respondents were more likely to choose the nuclear option than to attempt negotiation. Fully 29% of the entrepreneurs polled selected “switching suppliers” as their most effective way to cut external costs. Other supplier-related tactics rated most effective included “waiting for special offers or sales” (10% of respondents), “purchasing more in bulk” (9%) and “asking for better payment terms” (6%).

When it comes to controlling costs internally, the responses were not so cut and dried. Methods rated most effective include “revising work processes” (cited by 20% of respondents), “becoming more stringent with accounts receivable” (13%) and “stopping the servicing of less-profitable accounts” (11%).

For an example of internal processes turned upside down, talk to Anita Agrawal. The COO of family-owned Best Bargains Jewellery in Toronto (No. 100 on the 2010 PROFIT W100) has made the wholesale switch to a just-in-time manufacturing model in order to mitigate the risk posed by skyrocketing gold prices.

With gold prices at precarious heights, Agrawal says, its jewellery inventory could no longer be safely stockpiled—an issue that at first glance may seem related to cash flow rather than cost. But as any banker will tell you, there is indeed an opportunity cost in holding cash reserves to mitigate the risk of a sudden market crash. “If it didn’t sell, we’d just be stuck with it,” Agrawal explains. As a result, Best Bargains now carries only enough of the raw precious metal to satisfy orders. This approach gives up the efficiency of bulk manufacturing, but it also brings significant cost-cutting and pricing benefits, such as decreased inventory requirements and increased potential for custom orders.

Another key Monitor finding was the clear distaste entrepreneurs had toward cost-cutting tactics requiring confrontation. For instance, tactics such as “refusing to pay the increase” or “requesting bonus goods or services” fall to the bottom of the list, with only 2% of respondents rating each of these as most effective. In most cases (86% and 82%, respectively), entrepreneurs didn’t even try these tactics.

Similarly, reducing perks for customers and employees and reducing staff wages or benefits—measures all requiring difficult conversations—were rated most effective by the fewest respondents. In fact, more SMB leaders were more willing to switch to new suppliers or lay off staff than to negotiate for better terms or lower wages.

Scratch deeper, however, and it’s clear that entrepreneurs do have leverage, especially when they apply pressure to points of vulnerability and depressed markets. For instance, 37% of respondents reported that the cost of renting commercial real estate hadn’t increased or had even decreased—a fact that KTL Group’s Harding has already exploited to full advantage.

Kittell’s printing business, meanwhile, was able to take advantage of the depressed U.S. dollar and even more depressed U.S. forestry industry by switching to a U.S.-based paper supplier: “We were able to cut the costs in half versus a supplier we were using in Canada, so that has made a substantial difference for the business.”

Another depressed market identified by the Monitor is labour, where only 26% of respondents reported an above-average cost increase in the prior year. One respondent, who spoke on condition of anonymity, has taken advantage of the loose market with an innovative staffing solution.

Rather than continuing to hire full-time employees, her company has begun to rent out office space to self-employed contractors. “They can entertain their own clients on their own jobs and use the facilities for that purpose,” she says. Contractors pay a monthly rental fee and can set their own fees—and even reject assignments. The company, in exchange, gets the flexibility to requisition work only as needed. So, when business dries up, labour costs fall automatically, and vice versa.

The flip side of cutting costs, and arguably just as important in bolstering the bottom line, is raising prices. As with cost-cutting, every cent in increased pricing drops directly to the bottom line. Despite this potential, however, entrepreneurs reported a deep-seated reluctance to raise prices: 51% of respondents said they could maintain profit margins simply by cutting costs without raising prices, while 47% said, remarkably, that they would rather lose profit than lose customers.

It’s a sentiment that Harding agrees with unflinchingly: “Just because there’s some turbulence in the markets and in the economy, that’s not an excuse for me suddenly to gouge my customers or change the way I do business.”

But while 24% of SMBs reported losing customers last year, the numbers also show that there is almost always some room for negotiation. Respondents reported little to no resistance to price increases 54% of the time (38% reported “not much” and 16%, “none”). Conversely, SMBs reported “a lot of resistance” only 8% of the time, suggesting that, in most cases, clients are at least willing to consider a price increase.

“That’s an area in which SMB owners have a lot of opportunity,” says Amex’s Nielsen. “The relatively modest blowback from customers among small business owners surveyed would indicate that customers do expect prices to increase from time to time. And, in most cases, the feedback from customers was not sharp or severe.”

Ross Rodgers, co-founder and creative director of Toronto-based print advertising agency RadonicRodgers Design+Marketing, has taken a pre-emptive approach to raising prices. His company has launched an internal project aimed at identifying key differentiators and working out a plan for communicating those differentiators.

“Sometimes, you get so caught up in running the business, you overlook the incredible successes you’ve achieved for clients,” says Rodgers. “And when you look at it, it can be pretty impressive.” His company is now building case studies that highlight its successes—and serve as testimonials for clients. “Already, it’s making an impact. It’s giving us a bit more pricing power.”

In the end, the overwhelming majority of respondents (61%) listed “explaining the price increase” as the most common way to prevent customer attrition in the face of increases. The next most common tactics included “extending payment terms” (18%), “offering discounts for advance payment” (16%), “offering long-term contract options” (12%) and “offering bulk or bundling discounts” (11%).

Harding, however, feels the debate between cutting costs or raising prices ignores the key advantage that SMBs possess. “I think larger companies don’t innovate,” he says. “But to be competitive as a small to medium business, it’s essential that we innovate, keep the customers happy, find new ways to do things.”

Absent any breakthroughs, though, Harding will admit that keeping an eye on the bottom line is not a bad thing. In the event the economy relapses into recession, in fact, it might be the only thing.