What is 'Cost Cutting'

Cost cutting refers to measures implemented by a company to reduce its expenses and improve profitability. Cost cutting measures may include laying off employees, reducing employee pay, closing facilities, streamlining the supply chain, downsizing to a smaller office or moving to a less expensive building or area, reducing or eliminating outside professional services such as advertising agencies and contractors, etc.

BREAKING DOWN 'Cost Cutting'

Shareholders who seek maximum monetary returns on their investments in a company expect that management will maintain growth in profits. When the business cycle is on an upswing, companies are generally able to generate profit growth. However, on a downswing, profits may fall and if they stay down for prolonged periods, management would feel the pressure from shareholders to cut costs in an effort to prop up the bottom line.

Risks of Too Much Cost Cutting

Because salaries and wages are such a large expense, many companies look to layoffs first as a cost-cutting measure when times are lean. However, there are many real or potential costs associated with firing people, including severance pay, unemployment benefits, rehiring costs, wrongful termination lawsuits, lowering of morale and the risk of overworking remaining employees. Additionally, if business turns around faster than management had expected, the company could find itself with a shortage of labor, placing the company at a competitive disadvantage in an improving business environment. Also, if a factory was closed in a recent round of cost-cutting, the company may not have sufficient production capacity to respond to a sudden increase in orders.

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