Have you ever really thought about how your financial decisions affect others? Every decision involving dollars, no matter how big or small, creates a chain reaction. Allow me to elaborate.
We decided about a year ago to “cut the financial fat.” This, to our family, meant to cut out some of the extra monthly overhead. Our reasons were plentiful – a down economy that creates income volatility, a desire to give more to needy people, and additional costs like schooling for our kids.
One of the things we cut is our yard service. For $100/month, our yard service took care of everything – mowing, edging, weed eating, aerating, fertilizing, hedge trimming, etc. For those that live in urban areas, $25/week seems very cheap, but then again, this is the Rock Hill/Fort Mill area of the country….not downtown Manhattan.
After we made the decision to fire this company, I started to think about the economics behind the decision. Because we decided to stop paying $100/month, the yard business now has less revenue. For purposes of this example, I will assume that many other people also stopped using this same yard service, as I doubt that losing one customer is material to a mature company.
Revenues are down substantially. If the owner of the business would like to maintain his profit, he needs to cut expenses by an amount equal to the reduction of revenue. Typically, PEOPLE are the most expensive part of a company’s overhead, so the owner could cut people. However, if he does that, his service will suffer – the yards will take longer to mow, and they will not be mowed as often. If the quality of the service drops, the customers he still has might decide to bolt, which will only reduce revenue further. This actually makes the problem WORSE.
So, he decides not to cut people. What else can he do?
He will immediately “cut the fat” out of his business. Every single expense will be examined, and here is a hypothetical list of what could be eliminated.
Water cooler in office: $50/month
After hours answering service: $150/month
Office rent: cut from $750/month to $500/month by moving locations
Coffee: stop offering free coffee to employees ($100/month)
Fertilizer: stop using Scott’s, switch to generic and fertilize once/year instead of twice
Gasoline: switch from 88 octane gas to 82 octane, saving $300/month
Obviously, I could name a thousand more of these, but these should do. The owner has successfully cut his overhead, which means his profit will remain in spite of his own reduction in revenue.
Problem solved…..for him. Problems created for others….
What ripple effects do his moves have?
The water company loses a customer, so they make less money. They turn around and fire 3 of their salespeople because the other 5 can service the lower workload. Also, his secretary Sally is upset that she no longer has access to the water cooler.
The answering service decides to switch every employee to part-time, which eliminates their benefits, cutting a huge expense. They lose 10 people who leave to seek full time employment, while the employees that remain have lower morale. Also, the healthcare providers see a decrease in business and mulls a large layoff.
The former landlord for the yard company now has empty space to fill. In this economy, he fails to find another tenant so he decides to raise the other rents to offset the empty space. Now, each tenant is thinking of jumping ship too, just like the yard company did.
Royal Cup coffee is opposed to firing people, so they instead reduce the quality of their coffee. Cheaper beans, etc….this waters down the coffee, which will cost them the true coffee connoisseur. Of course, those are their best customers.
Switching from Scott’s to generic fertilizer cuts the earnings of the Rock Hill Wal Mart, since that is the vendor of choice for the yard company. Wal Mart’s margins are lower on the cheap stuff, so they decide to get rid of one of the forklifts they use to haul skids around. After seeing the Rock Hill location save money by eliminating a forklift, the Fort Mill location copies. Then, all Wal Mart locations across the country decide that one forklift will do. Their oil and gas consumption is halved, which reduces the price of oil. If the price of oil plummets, the cost of gasoline will drop. Coincidentally, that will irritate the owner of the Circle K, Bart.
Bart was already upset that the yard company stopped buying the 88 octane gas, but now he has to drop his prices to reflect the lower cost of oil.
If the price of oil falls enough, the United States may decide to cease exploration and continue to buy most of the needed oil from the Middle East.
It is all a vicious circle. This chain reaction never stops. Every money decision affects a thousand other things.
This is the beauty of our economy. Capitalism. Each business owner has to do what is right for their individual company just as each family has to act in the best interests of their family.
This interdependence is not a bad thing, but it is something that needs to be understood. Once you grasp this concept, the world of finance makes a whole lot more sense.
The opinions expressed in this material do not necessarily reflect the views of LPL Financial.