Every responsible business owner wants to reduce costs.

But there are obvious costs—the kind that stares back at you from a ledger, and there are hidden costs.

Hidden costs are usually **much** bigger but tend to go unnoticed because of their low emotional impact.

For example, once I helped a business with about 80 employees evaluate their employee churn. They were paying a low wage and “couldn’t afford” to be competitive.

In the previous year, they had conservatively experienced $300K of employee churn costs. (We assigned $4K of costs to employees who were recruited, hired, and trained, but left within a month without contributing any value.)

So we converted that $300K into higher starting wages and employee longevity tripled. The new annual churn cost was about $30K, a 90% reduction. We stopped paying a hidden cost and things got way better.

It was a profound lesson in the difference between obvious and hidden costs.

 

So today we’ll do a thought experiment.

I constructed a hypothetical scenario. Let’s walk through it and see how many levels we can think about costs and savings.

 

LEVEL 1 – Raw Cost

You have two employees: Sara and Bill.

Sara and Bill both make widgets.

Sara makes $25/hour and Bill makes $20/hour.

If you replace Sara with another Bill, you save $5/hour.

That’s $10K per year in savings. High five?

 

LEVEL 2 – Unit Cost Of Production

It turns out that Sara produces 700 widgets per month. Bill produces 500. That’s 1200 widgets.

Their combined wage is $45/hour. That’s $7800/month.

(That puts your labor cost per widget at $6.50.)

If you replace Sara with another Bill you’d get 1000 widgets per month for $6933.

(That would put labor cost per widget at $6.93.)

But if you replace Bill with another Sara, you’d get 1400 widgets per month for $8666.

(That would put labor cost per widget at $6.19.)

Two Saras reduce the labor cost of a widget by 74 cents, or 10.7% compared to two Bills.

 

LEVEL 3 – Cost Of Under-Leveraged Talent

Sara tells you she spends a lot of time fixing Bill’s mistakes.

She says she can do her job and Bill’s job if you buy her a new $5000 machine. But after 3 months, if she’s successful, she wants a retroactive pay increase to $35/hour.

3 months later, Sara is consistently producing 1200 widgets per month for $35/hour.

That puts her labor cost of a widget at $5.06.

Your savings before the cost of the new machine are $1.44, or 22%.

That’s $1728/month in savings, so your payback period for the machine is just under 3 months.

 

LEVEL 4 – Opportunity Cost

Sara finds out about a company that can manufacture the widgets for $3.50 each with a 2000 widget commitment. (You’re still paying $6.50 in labor costs from LEVEL 1.)

Sara wants to manage the outsourcing partner and focus on increasing quality and customer satisfaction. She wants $35/hour (or $6067/month).

You let go of Bill and promote Sara.

Now your cost for 2000 widgets/month is $7000 of outsourcing plus $6067, or $13,067. The cost of a widget is now $6.53. Your cost per widget went up 3 cents.

But now you have someone focusing on quality and on customer satisfaction.

As a result, demand increases. You’re able to raise your price and differentiate yourself from your competitors in the market.

And you teach Sara how to upsell.

 

Conclusion

There are so many levels from which to evaluate costs. So many business owners only see what’s in their ledger. They don’t see what drives it.

By taking a more holistic view of the business, you start to separate costs from investments. That’s when you can really start to scale your business.