A Smart Approach to Cutting Costs

I am Stephen Brown. I am the COO of LedgerGurus. I'm also a co-owner and CFO of a direct-to-consumer brand, Solé Toscana. I do a lot of CFO work here at LedgerGurus. I have many years in technology as well as accounting services, with an MBA.

Also, just my explanation with my eye and my speech, I am experiencing facial paralysis, so that's why I sound a little bit off.

0:38 Stephen Brown

With me, I have Lauren Maillard. Would you like to introduce yourself?

0:41 Lauren Maillard

Hi, I'm the Director of Service Delivery at LedgerGurus. For many years, I was on the sales tax team. I helped to build and lead that team. I do some advising, consulting, fractional CFO. In another lifetime, I was a small business owner, a home health care agency. I do have my CPA and a master's from BYU.

1:02 Stephen Brown

All right, today we're going to talk about cost cutting, and really this is driven by the tariffs and the need to cut costs.

After we talk about the need, we'll talk about some benchmarks for what good costs are, optimizing discretionary and fixed expenses, and then how to improve your contribution margin.

1:26 The Tariff Impact Calculator

Stephen Brown

So as we've all experienced, tariffs are chewing into our margins and driving cost cutting.

What I want to do is revisit one of our tools, the Tariff Impact Calculator. And you can download this at the URL you see here on the screen. You can also go to our website, to resources, downloads, and you'll find that.

So we created this tool to be able to work with our customers and anybody else to take a look at what's going on with tariffs.

1:59 Stephen Brown

Now, I have here a $5 million business that is making pretty good margins. Let's see, it's almost a 10% net income.

And there's been a lot of back and forth. So I'm going to put a couple of numbers in. Let's assume you're going to China, it was, I heard different numbers, 145, 154. The reality is whatever that is, you go from a profitable business to losing a lot of money.

2:28 Stephen Brown

Another scenario would be where we're at now, 30% additional tariffs. And you can see that that takes a huge dent into my profitability. If we go down here to line 26, we go from about 400,000 in profits to about 178,000.

Now what this calculator allows us to do is play around with a couple of numbers. I have some fictitious numbers from a fictitious business. You also see how much you would need to increase revenue to offset that loss of profitability. Obviously it's bigger than the difference in the net income, because you have to account for cost of sales, or how much you'd have to reduce non-sales expenses.

3:08 Stephen Brown

We also have this advanced calculator where we can go in and plug in some additional numbers. So I put in some of the same numbers, and we can see here that this business is making about 8% net income. Decent, not amazing, but it's a decent amount.

And if we were to plug in a 30% additional tariff, you could see what happens in scenario one. In scenario two, we factor in a price increase. We have a modest price increase in here. Let's pump it up to 10%.

3:40 Stephen Brown

Unfortunately, we consider elasticity, which is the concept of higher cost, lower demand. And you can play around with that number. If you don't know your elasticity, I give you a guide on this middle guide. You could see that there's a negative impact with higher elasticity with that higher price increase.

So we could go back to a more modest price increase. And you can also see what cutting costs would look like.

4:09 Stephen Brown

So with each one of these, you can see what you would need to do to increase your revenue for each scenario. And you can also see what you would need to do to reduce non-sales expenses to be able to get to that place of equilibrium in terms of profit.

And you could play around with the numbers here. I think negative 10 wasn't enough. Go to negative 15. That's a little bit too much. So roughly about 13%, give or take a little bit, was what we need to do to get to equilibrium with profit.

4:47 Stephen Brown

So we'd recommend you download this. You could reach out to us if you would want us to walk through your numbers and do an assessment of your business, kind of do a health check.

This is somewhat self-explanatory, but there's a lot on this. What I want to talk about though is really the scenario four, which is cutting costs. So raising prices is its own calculation. Absorbing tariffs, obviously that has a negative impact.

5:23 Benchmarks for good costs

Stephen Brown

Let's talk about cutting costs. And to do that, we're going to go in and we're going to start with what are some good benchmarks. Now these are going to vary by business.

A good cost of goods sold is going to be between 20 to 60% of your sales. Now, why the big range? What I've seen is direct to consumer brands should and often can be on the lower end, around 20 to 30%. Resellers have a much harder time, because you are oftentimes competing with multiple online sellers for the same product. So oftentimes your cost of goods sold is higher because your pricing power is lower.

6:06 Stephen Brown

Marketing, and again, marketing is for direct to consumer around 20 to 33%. For a reseller, oftentimes that needs to be lower than that, because your cost of goods chews up a lot of that margin.

Fulfillment, ideally, is about 10 to 15%. Payroll is ideally 10 to 15%. And a really healthy net operating income is 10 to 15%, but I would say minimum 5% is what you should be targeting.

6:36 Stephen Brown

So let's talk through this. Why 10 to 20%?

Well, first off, it provides a financial reward to owners. Can you get away with less than 10%? Sure, you definitely can. But that is the incentive of ownership.

The higher margin also is going to give you a buffer for economic turbulence. So like what we're experiencing now, those who have the 10 to 20% profit margins have a lot more wiggle room. They could absorb some of the costs if they chose to do so to maintain customers.

7:13 Stephen Brown

The other reason is just business value. Higher profit businesses are worth more. And so you're going to be ready for investors and sales of your business if you choose to do those, because investors and people who are buying businesses want to see strong margins.

7:36 Lauren Maillard

Stephen, here's a question for you. I'm just wondering how many ecommerce businesses are able to stay in that range with everything that's happened over the last six months now with tariffs?

7:52 Stephen Brown

Well, I think we're definitely seeing a compression on profitability. Can we get back to that 10 to 20%, or is five to 15 going to be the new normal? To be determined, I think. In the short term, being able to achieve 10 to 20% net income is going to be much harder.

8:15 Stephen Brown

I would say 5% minimum is what you should be targeting. That's kind of your break the glass minimum. And retail has been a low margin industry. And I feel like what we're seeing over the last couple of years is ecommerce is really starting to follow traditional retail, where those larger margins are becoming harder to achieve. And some of that comes down to increased marketing spend, and now we have pressure on cost of goods sold.

8:48 Stephen Brown

So again, these are ideals. I don't see 20% very often, very rarely. I do see 10% from time to time. I see a lot more single digits. But 10 to 20% is going to give you investor exit readiness. It's going to give you financial resilience, and it's going to be much more rewarding to owners of the business.

9:15 Discretionary spending

Stephen Brown

So what can a business control? Well, one of the most important things they can control is their costs. And I'm going to start by going from easy to hard.

Let's start with discretionary spending. Discretionary spending is the easiest thing to cut. It is your food, your travel, your software and subscriptions, and your unproductive marketing.

9:38 Stephen Brown

This could also include stuff that an owner is pushing through the business, the car, those other things. That can be a good tax strategy, but when tax strategy creates losses, it's not a good strategy. Tax strategy is good when you have profits.

So what I encourage people to do is to look at that discretionary spending. And I see a lot of waste in a lot of businesses. A lot of people living a lifestyle in their business instead of trying to create business value and business wealth.

10:13 Stephen Brown

Now, how do you take control of discretionary spending? One of the best ways to do that is through three functions.

First is budgeting, right? If you want an outcome, set a target. Go into your financials, whether it's QuickBooks or Xero or whatever else you're using. Understand what you're spending. Model what you want to spend, target a spend level, and share that budget with those who spend.

10:45 Stephen Brown

So set targets. So few businesses do this. It's unfortunate. I can guarantee you that every publicly traded company, that every private equity owned company, is operating against a budget. And there's nothing to prevent you from doing that. It does take some work. It does take some energy. That's something we do. That's something I do with my customers. It's doable.

11:12 Stephen Brown

The second thing I would say is control. So once you have that, how do you ensure that you stay within those limits? One of the dangers is just using corporate cards with no limits. So there are different ways you can create controls.

There are some of the tools I want to bring forward: virtual cards, putting card limits on your corporate cards if you have to use those, using some of the more modern tools like BILL Spend & Expense, used to be called Divvy, Ramp, Brex. These are all modern corporate card tools that allow you to really have granular controls.

11:47 Stephen Brown

So that's step number one, putting some controls and limits to prevent overspending.

And then finally, reporting out. I would say at minimum you have reports monthly, you report out the budget versus actual so people can see what they spent against what they were budgeted, and share that, make sure that information is shared with those who spend. If you want to change behavior, you have to inform them.

I guarantee you, when you put this three-pronged approach to controlling discretionary spending, you will have positive outcomes.

12:20 Lauren Maillard

Stephen, just a little fact that I've seen is that food expenses for ecommerce businesses are usually between five and 15% of net income.

12:34 Stephen Brown

Food or?

12:36 Lauren Maillard

Food expenses. Travel expenses can be between 10 and 30% of net income. So it seems like they're small things, but they can really add up.

12:45 Stephen Brown

Yeah, I mean, this stuff can blow it, and a lot of it is a lifestyle, right?

I think one of the things I would say, as you're trying to tighten up your discretionary spend, is, do we need food in the office every day? I mean, those numbers you threw out there kind of shocked me, Lauren. That feels a little bit high.

13:06 Stephen Brown

Travel, is that conference really, travel is expensive, right? I'm a former road warrior. I regularly spent thousands a month traveling, and then went to a private equity company where we had tight budgets, and I had to really work hard to stay within my travel budget with my team. We had conferences we needed to go to, we had customer events we needed to go to.

13:26 Stephen Brown

There are simple things you can do with travel, simply by putting in rules like no booking tickets less than three weeks out. Travel has its own set of controls you can put into place. I don't see this as big of an issue.

And a lot of times with discretionary spending, the biggest offenders are the owners. And so you have to decide, do I want profits or do I want lifestyle? And the answer might be lifestyle. And my response would be, as long as you're not breaking your business, more power to you. But when you have to decide between lifestyle and business viability, I would always say get lean.

14:14 Stephen Brown

A great example, I recently read the biography of Sam Walton. And let me tell you, that guy was lean and mean, and Walmart has a very lean culture to this day. They're the biggest retailer in the world, and they do not operate extravagantly.

And you could argue that's fueled their success. Their ability to put their money back into the business and grow the business has allowed them to create value.

14:48 Stephen Brown

At the end of it, they told stories of sharing bedrooms with his fellow travel mates. I mean, that's pretty extreme. Granted that was a different era, but it worked out well for him. He and his kids are billionaires. So good on the Waltons.

15:01 Fixed expenses and the three O's

Stephen Brown

More difficult expenses are more of your fixed expenses. And I would say the biggest categories are payroll, rent, and some other overhead.

Let me take the other two first with fixed expenses. A lot of people, you have to ask yourself, since COVID, do I really need an office? You may have a warehouse, you may be doing fulfillment, and so for sure you need a physical space. But if you are outsourcing everything, do you need an office?

15:36 Stephen Brown

We at LedgerGurus are virtual in nature. I don't pay rent, I don't pay utilities. The team is happy to work in their own spaces because they don't have to drive to an office. So there's a lot of power in leveraging a virtual approach. That's one way you can cut a lot of overhead.

15:54 Stephen Brown

But one of the biggest ones is payroll. And I want to talk about getting efficient with payroll with the three O's.

O number one, optimize. So we've done some of this here at LedgerGurus the last couple of years, as a labor intensive business. So we've had to really do a lot around defining expectations.

16:20 Stephen Brown

We use EOS, the Entrepreneurial Operating System, here at LedgerGurus, and they have some concepts of making sure you have the right person in the right seat, and part of that is making them understand what that seat entails. And then there's also a sense of, is that person, do they get it? Do they want it? Do they have the capacity to do it?

16:35 Stephen Brown

A lot of times in small businesses, you've got a lot of people running around. You may or may not know who's getting it done and not. Oftentimes you do when you're really small, but as you start growing, you may not realize if your labor is truly efficient.

So I'd start with, is your team doing what they're expected to do? How do you measure success? This is a journey we're on. It takes time and energy, but I can tell you the more you put into it, the more you get out of it. And it's been really insightful for us.

17:10 Lauren Maillard

I'd add to that, prioritize what you want to get done.

17:16 Stephen Brown

Yeah, I mean, you can't do everything, and part of cutting costs is cutting effort. Are the things that you're doing moving the needle, or can you just stop doing something?

17:31 Stephen Brown

The next thing I would do is outsource. And I speak from this as somebody who gets outsourced to. Ecommerce businesses have been good at this for years, with marketing, with accounting, with legal, et cetera.

You can also use short-term consultants. Like I said, ecommerce businesses are really good at this, but you can do the same exercise and make sure, hey, are they doing what I need them to do? Can I get more from them?

18:03 Stephen Brown

One of the biggest things I see is, you can get specialized skill, instead of getting one low grade employee, you can oftentimes get a fraction of capabilities through this approach.

18:19 Stephen Brown

And the last, that we're seeing a lot in our industry and all industries, is just offshoring. I hear a lot of conversation. Philippines seems to be a hotbed for a lot of ecommerce businesses, India, Mexico. A lot of it's countries that have good language skills, because of the nature of your business. It's just the reality. US labor has gotten more expensive.

18:42 Stephen Brown

Can you move some of your efforts offshore? This is something that we've looked at, and you can. I've run into some ecommerce businesses that are heavily offshore. I've seen some that do hybrid, and I see some that get away with no offshoring.

But with the three O's, you can get a more efficient payroll.

19:08 The contribution margin triad

Stephen Brown

All right, let's talk about one of the biggest areas of spending, which is your cost of sales, which results in your contribution margin.

So contribution margin is the dollars left over after your cost of sales. And that is your cost of goods sold, your fulfillment costs, I would argue your advertising spend, and your merchant fees. So these are dollars you wouldn't spend if you weren't selling anything.

19:39 Stephen Brown

The one here that sometimes gets questioned is advertising. Should that be considered a cost of sale? I would argue for an ecommerce business, what would happen if you didn't spend on advertising?

Now, usually cost of sales are things you have to spend as part of the sale. So when I sell, I send them my product, I have to fulfill it, I have to do the merchant fees. Advertising is a cost before the sale. But again, I like to consider it a part of that contribution margin triad. Or I guess it's a quartet, but I hold merchant fees out. Merchant fees tend to be small and fixed in nature.

20:20 Stephen Brown

And your profitability, your underlying profitability, is driven by this triad.

A couple of things with this triad. You can get away with one being a little bit higher than target. And again, let me go back to target levels. So target levels, 20 to 60% on cost of goods. Again, if you're more towards the 60%, you need to be at 20% or oftentimes much lower on your marketing, because fulfillment tends to be a similar cost regardless of your business model.

20:53 Stephen Brown

So higher cost of goods sold, lower marketing. Lower cost of goods sold, you're usually going to have to spend more on marketing for customer acquisition.

Do I see a lot of businesses over 33%? Yes. Since the iOS 14.5 change from a couple years ago, marketing has become a lot less efficient, and so there's been a lot more pressure there. But what I tell people is, you can have one of these that are outside of a target range, but you usually can't have two. When you get two of these categories that are way outside of an ideal target, it really becomes difficult to run a profitable business.

21:30 Improving the triad, and bonded warehouses

Stephen Brown

So let me talk briefly about some things that you can do to optimize your contribution margin triad.

So first is improving cost of goods sold. This is very difficult. It usually takes months to quarters, sometimes even longer.

21:49 Stephen Brown

So I think right now, with the tariff pressure, there is pressure to consider changing or adding manufacturers. Having more than one manufacturer gives you supply chain resilience. Having manufacturers in different countries can give you a tariff strategy. I think that's the big focus right now.

But this takes time. You've got to find somebody who can make your products. Sometimes you can't find a manufacturer outside of China. So I think Chinese importers are particularly feeling this pressure, but that is one area.

22:25 Stephen Brown

The other thing is, sometimes changing your product design can have a material cost. Maybe different materials can be less expensive. You might have a design that also has impact on fulfillment costs.

I'll give you an example. We have a customer who did dog crates. They decided to come up with a collapsible crate. It was both very popular, which drove sales, but it also reduced costs, because that cost of shipping inbound and to the customer went down, because you could compress that volume of the product. So that's a clever product innovation that both drove sales and improved their costs.

23:12 Stephen Brown

But again, these take time. Another one that can take time, but usually not as much, this is definitely, I would say, changing, improving fulfillment can take months to quarters. Really you're looking at a couple of key things.

So a lot of people, whether you're using your own warehouse or 3PL, is your warehouse location ideal? I've done an analysis with some customers over the years, and one of the things I look at is, where are your customers at?

23:44 Stephen Brown

Do you have a West Coast, California based warehouse, where labor's expensive, where real estate's expensive, and where you are about as far as you can get from the rest of the population? Simply moving your warehouse to a more central location, and I would say the population center is more like Ohio, kind of that Midwest region, you can see significant improvements oftentimes in terms of your labor costs, your real estate costs, and oftentimes your cost of shipping, because you're shipping shorter distances to the majority of your customers.

24:24 Stephen Brown

On that note, shipping contracts. Do you have shipping contracts? Does your 3PL have shipping contracts? Are you getting the best deals?

And finally, I'd look at packaging. Again, this can come back to product design as well. You can make some changes in product design that can improve the volume of your package. You can do things to reduce packaging costs, right?

24:43 Stephen Brown

So looking at the design of packaging, is it necessary? Obviously with consumer products, customer experience is really important. But how important is it? And can you streamline that in a way that would cut some costs?

24:58 Stephen Brown

The last of the triad is advertising efficiency. Now you can have immediate improvements, but one of the things I see with a lot of small businesses is they outsource their advertising spend and they don't really have a sense of whether it's efficient or not.

So one of the things that we always encourage is learning marketing. Whether you are outsourcing your advertising spend or doing it in-house, this is learnable. Is it complex? Yes. Is it challenging? Yes.

25:37 Stephen Brown

I'll give you an example. The business that I co-own with two partners, that's a direct to consumer business, Solé Toscana, we bought that in 2022. And we took an approach of, let's spend our way to growth. So we deployed a lot of experts, agencies, creative types, and we spent a lot of money and we lost a lot of money.

26:05 Stephen Brown

After a couple of months of that, my partner here at LedgerGurus told our operating partner at that business, hey, you have a marketing background, why don't you dig in and figure it out? And he did. We cut most of our agencies. We had plenty of creative, and he dug in and just started learning digital marketing, and we really improved our efficiency significantly.

Did it take time? Yes. But as we made those steps, were we able to have quick results? Yes, we were.

26:45 Lauren Maillard

Would you recommend using a software like Triple Whale?

26:51 Stephen Brown

Triple Whale is an analytics tool that can help you understand attribution. I think over time, the attribution that we're seeing in Facebook and Google, there are some that are like, hey, these analytics tools are not the way to do it.

The other thing you have to be aware of is, if you're optimizing using the data from those tools, you really need to be doing, I forget the name of them, I think they're called CAPI connectors. You need to be feeding the data from those tools back into Meta so that they can know.

27:32 Stephen Brown

But one of the things I would want to do, if you have an agency, is how would I hold them accountable? A campaign review, an ad review.

If you're using somebody to generate creative, AI is really improving efficiency. So you should either be able to get similar creative for less cost, or more creative for the same price. So I'd definitely be holding them accountable to their usage of AI and how they're getting more out of that.

28:06 Stephen Brown

Too many brands, and this is the challenge, when you're really small, you might have the product idea and you want to throw the rest over the wall. But I would discourage you from doing that. Hold them accountable, learn enough to understand what they're spending on, what they're not, what's efficient, what's not efficient, and move accordingly.

28:28 Stephen Brown

Now, one bonus tip. This has to do with cost of goods sold, but it's really a timely strategy. This is the concept of a bonded warehouse. Bonded warehouses are something that can be really helpful during tariff turmoil.

Goods can stay in the warehouse for a set period without triggering import fees. So basically they go off the boat, they go in the warehouse, you don't have to pay the tariffs. You only have to pay when the goods leave the warehouse for domestic consumption. And if for some reason you're passing them on to a different country, you don't have to pay duties at all.

29:05 Stephen Brown

So this is a good way to allow you to be agile. Now granted, you're going to have cost of storage. So you do have to consider the cost of storage to offset that strategy. But I guarantee you, those that are using bonded warehouses for China when they were importing during the 145% plus tariff period are probably really happy, because they could pull them out now that they're down to 30% at a much lower cost.

29:37 Stephen Brown

So to summarize, here are the four categories. I didn't really get into merchant fees. There are some things you can do around merchant fees, this last point, and that can be done relatively quickly, but your impact's going to be really small. You might save less than a percentage point of your income. Oftentimes it's less than a half of a percentage point, which is why I don't have a separate slide. But here you see the summary.

30:06 Stephen Brown

If it was me, I would always be considering all three, looking at those ideal benchmarks and saying, what can I do to improve things?

Sometimes your hands are cuffed. If you're reselling somebody else's product, changing the manufacturer may not be an option. Or maybe it is. Maybe it's time to resell somebody different who's got better margins. If you're manufacturing in China and you can't find alternative manufacturing, you may not be able to do much there.

30:40 Stephen Brown

But those are some things you can consider. Fulfillment costs, right? There are ways to cut costs. A lot of times you set up your business, you get a 3PL, it's working, it's not broke, don't fix it. But I'd say if you're spending more than 15% on fulfillment, you should really consider optimizing that category.

31:02 Stephen Brown

And then advertising. Ever since the changes in Apple and the corresponding degradation of digital advertising efficiency, this is just a constant battle. And you need to be fighting it, and you need to be doing it with your agencies and not expecting them to do it themselves.

31:25 Stephen Brown

So these are some things to look at. Some quick, some take longer.

What I would say in terms of next steps is, one, get an understanding of what the impact of tariffs are, if you haven't figured that out already. That calculator can be a really good guide. And then connect with us. We can give you some thoughts if you want us to walk through the calculator on a consulting call. If you want us to help you with some or all of your finance and accounting needs, we can do that. Our goal is to help ecommerce sellers be as successful and as profitable as possible.

With that, we'll wrap this up. Thank you for joining us today.