How to Reduce Your Startup’s Operating Expenses
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Editor’s Note: This article was originally published on October 11, 2021 and has been updated for accuracy and comprehensiveness.
There's never a good time for an economic downturn, and there's no telling how long one will last. Unfortunately, for many startups, this means contending with increased cash burn and a shorter runway, at least in the near future.
One of the most straightforward ways to reduce that problem is to lower operating expenses. If you're spending less each month, you'll lower your burn rate, allowing for more runway. For instance, effectively navigating a downturn may require you to defer long-term investments strategically, postpone hiring new employees, and scale back or cancel non-essential services and software tools. So even if your business has been minimally affected so far, you may be looking for ways to cut expenses so that you have more cash in case things change.
At the same time, overreacting can be a problem, too. Of course, you want to lower your monthly operating costs, but you also need to be able to get things done and position your business to thrive. So here are five ways to cut your expenses from least to most disruptive.
Put a Freeze on Big Investments
If you were planning large expenditures this year, now is an excellent time to rethink that. By now, you've probably updated your revenue projections based on the current economic situation (and if you still need to, now is the time). So, rerun your numbers with those updated projections before you make a significant purchase. Does it still make sense?
For capital investments to support growth, such as new equipment or facilities, consider what ROI you're likely to see and when. For example, if current macroeconomics means your near-term growth opportunities are likely to stall, delaying those growth plans might make more sense until your market has stabilized.
This applies to other large expenditures as well, such as marketing costs. But, again, carefully consider the value you expect to get back; like the capital investments, it may make sense to postpone extensive marketing pushes until a more favorable time.
Rework Your Operating Budget
When you put together your budget for the current year, it was almost certainly for a different world than the one we live in now. With everything that has changed since then, it's a good idea to take another look at what you plan to spend and where.
Approach this with an eye toward how your business will likely look for the following year. For example, shifting budget priority from sales and marketing to customer success might make sense if you anticipate fewer sales opportunities and higher churn. In that business environment, your growth efforts are likely to be less effective anyway, while retaining the customers you do have becomes more important than ever.
A significant caveat, however: wherever possible, base decisions on your company's specific numbers, not general guesses. For example, some companies are seeing improvements in their marketing ROI. For those companies, there might be better ideas than shifting the budget away from marketing.
Identify Opportunities to Renegotiate Ongoing Costs
Virtually every company can be affected during an economic crisis. However, your partners and vendors may be willing to work with you on adjusting payment terms to help your business stay steady. For most companies, one of the most considerable fixed costs is rent. See if your landlord is open to renegotiation or if your contract has provisions for the premises being unusable.
You probably also have several active subscriptions, from SaaS licenses to professional services. If you reach out to these partners and discuss your circumstances with them, some may be open to measures like temporary discounts or lengthening payment cycles. In extreme cases, you may be able to negotiate out of early termination penalties for services you can't afford to keep. Of course, getting new terms will only sometimes be possible, but you only know once you ask.
Cancel All Unnecessary Subscriptions
If software and services are a big part of your budget, it's time to consider what's optional to your daily operations. First, take a comprehensive inventory of all your company's tools and services, how much they cost, and what they're used for. One of the best ways to do this is to go line by line in your financial statements and see where money is going (this is one of the many reasons it pays to have accurate bookkeeping).
These exercises will often yield obvious cost-saving opportunities; it's extremely common for businesses to discover they're paying for software tools with identical functions or ones that no one is using. Eliminating unused or redundant devices is a quick win for reducing operating costs. For the rest of your tools, take a critical look at what they're used for, who's using them, and if they provide value to justify the costs.
For example, does everyone who has a license need to have a license? Are there nice-to-have software tools that the team could work without? Would dropping them be practical, or would the resulting workflow changes create a costly distraction from your team's purpose?
For this process, it's vital to work closely with your team leads to determine what's non-essential. It can be tempting to look for the highest costs and slash those, but cutting the wrong things can backfire. For example, if losing a tool creates an extra hour of manual work each day for your engineers, that's an hour they need to build your next feature. So the lost productivity will cost more than the tool did.
Reduce Payroll Costs
Actions that affect your team are usually the last resort, but sometimes, it's unavoidable. For most startups, payroll is the most significant expenditure, and if the downturn severely impacts your business, you may have to make cuts here to stay afloat. However, "cuts" doesn't have to mean layoffs. There are several other steps you can take first.
If you need to cut payroll costs, instituting a hiring freeze is an excellent first step. While this doesn't reduce your expenses, it prevents them from growing. However, it also frees up any money you had previously budgeted to spend on future hire salaries, which can give you a cushion on your runway. You can also reduce your payroll without reducing your headcount. First, if you plan to give your team bonuses, consider postponing or canceling these to preserve capital for operating costs. Next, consider lowering your employees' salaries. This is never a popular move, but it can be the difference between keeping the team intact or resorting to a layoff.
If you need to cut salaries, consider how this could affect your employees' circumstances. At first glance, it may seem the most "fair" to cut wages by a flat percentage across the board, but it's less fair than it sounds. For example, for your highest-paid employees, a 10 percent pay cut might be an inconvenience; for your lowest-paid employees, it might mean they can't pay their rent. So if you need to cut salaries, the best practice is to cut more from the higher end who can most afford it and cut the least from the low end who can't.
If more than salary cuts are needed, you can furlough some of your employees instead of permanently laying them off. Although being on furlough means people won't be paid, they'll still technically be your employees and retain their healthcare benefits. Furloughed employees can generally apply for unemployment benefits as well.
Finally, if you have no choice but to reduce headcount permanently:
- Run your numbers.
- Determine what you need to do to get back to a steady footing.
- Do it all at once.
When navigating a downturn, the best practice is to commit to layoffs as soon as possible and make a deeper-than-needed cut so you don't have to revisit this option. Layoffs negatively affect morale; that's generally unavoidable. What makes it worse, however, is ongoing uncertainty. Be transparent about what's happening and why, and then explain why you don't anticipate further reductions to your team.
The near future may be a difficult business environment for everyone, but by paying close attention to your operating expenses and knowing where to lower them, you can put your startup on stronger financial footing. Want even more insights on how to navigate turbulent markets or what to do when your business strategies aren’t working? Pilot's expert CFO services can set up the foundation and provide the strategic insights your company needs.
Check out these other helpful resources as you navigate these times:
- How to Approach Budgeting During an Economic Downturn
- (Re-) Calculating Your Cash Burn Rate in a Downturn
- Founder to Founder: Advice for Navigating the Downturn