Cost cuts equal Productivity

I keep hearing how companies can't keep cutting costs to improve profitability. Well, from a purely mathematical point of view, I agree that cost cutting has a limit after which we would have liquidation. However, mathematics also tells us that profits can be made at any sales level as long as costs are less.

The cost cuts that business has undertaken, as well as other productivity improvements were designed to allow them to make profit with lower revenue. Once these reductions were obtained, they merely need revenue to stay flat, or increase. However, if revenue is seen to be decreasing further, there can and will be additional cost cuts.

Now one of the outcomes of this is that companies that have heavy leveraged positions are faced with fixed debt payments that can't be easily reduced. Basic accounting talks about fixed vs variable costs and the various permutations thereof and the more costs are variable the easier they are to reduce. Many companies have outsourced a lot of what once were considered core capabilities and in a downturn can simply reduce orders to reduce costs. Personnel are of course generally a variable cost and the high unemployment we are seeing is evidence of that.

So, companies that have kept fixed costs at a reasonable level can cut costs to a very low level to maintain profitability. The companies that had high fixed costs (debt) have either gone bankrupt or may end up there. This is the way weak companies get shaken out of the market and the more adaptable companies get bigger eventually. So, if a company made profits last quarter because of cost cuts, it will most likely make more profits this quarter. The three scenarios we face are revenues got worse, not the most likely scenario, revenues were flat or revenues increased. In the latter two of the scenarios profits will be the same or higher than they were last quarter. In the first scenario, the profitability will depend on additional cost cutting. However, this is the least likely outcome, since clearly economic activity was higher last quarter than it was in the preceding one.