I am often asked “what is the most common problem you have found in failing businesses?”  The number one issue is always Leadership.  However, a close second is that many leaders do not understand their costs.  They have defined structures to accumulate and report costs within cost centers; they have developed consolidations to summarize costs across businesses; and, of course, they abide by the regulations in developing systems to report those costs for public consumption.  However, that does not mean that they KNOW their costs.

I think that in many cases businesses are not willing to ADMIT their costs.

I was once hired to turnaround a business that had grown nicely but had never turned a profit.  The first week I was there I asked the CFO “How do you we price our services.”  I was told, “We take our variable costs and add 30%…and that should be enough to cover our overheads and profits.”  As my cost accounting teacher is fond of saying, “You would think so, but I would suggest to you…” that six straight years of losses would suggest otherwise.

As a leader you MUST understand the importance of costs and require that the appropriate costing system be developed and managed correctly in your business.  It is fundamental to generating information that you need for decision-making.  It is as important as understanding the market you are in, determining the differentiators that set your business apart from others, or defining the features and benefits of your products or services.  Without that level of understanding of your costs:

  • setting prices and managing profitability becomes a gamble.
  • you cannot understand the key drivers of your business processes or the opportunities for improving those processes and reducing costs.
  • you cannot effectively plan for growth and investment.

Interestingly, I think that in many cases businesses are not willing to ADMIT their costs.  They are aware, either intuitively or consciously, that they are not operating efficiently.  They do not want to include costs from an inefficient operation into their overall cost structure, so they calculate costs based on the way IT SHOULD BE if everything were working well.  That’s like saying I can drive from Princeton to the theatre district in Manhattan in one hour.  Conceptually true, but it rarely happens.  There will almost always be traffic to throw me off plan.

Do you really know what it costs to deliver your products or services?