Cost Reduction Meaning, Scope, Techniques and Process

Table of Contents:-

  • Cost Reduction Meaning
  • what is Cost Reduction?
  • Scope of Cost Reduction
  • Cost Reduction Techniques
  • Cost Reduction Process

Cost Reduction Meaning

Cost reduction is an important strategy that ensures savings in cost per unit ultimately leading to the maximization of profits for the enterprise. It aims to eliminate unnecessary expenses which occur during the production process such as storage, selling, and distribution of the product. To identify cost reduction, we should mainly focus on the following major elements: savings in per unit production cost, ensuring that the quality of the product remains unaffected, and ensuring that the savings are consistent and stable.

Cost reduction involves introducing creative approaches to work more efficiently, which aims to eliminate unnecessary production and operational expenses. Cost-saving programs are designed to target specific areas to minimize costs by improving work methods, arrangements, and products. These cost-saving measures can be applied at various stages of production, storage, and distribution through the use of advanced and scientific operational techniques. For effective implementation of cost-saving initiatives, it’s important to include research and development activities.

It is a planned and proactive strategy aimed at minimizing expenses. Reducing expenditures is the primary aim of our cost-reduction campaigns. It is a continuous process to achieve long-lasting benefits.

What is Cost Reduction?

Cost reduction refers to a tangible and enduring decrease in the unit cost of goods and services provided by the organization which directly impacts their quality and efficiency. Various techniques are used to achieve cost deduction, such as budgetary control, standard costing, material control, labour control and overhead control. Cost reduction is a strategic approach that focuses on decreasing the per-unit cost of a product. It is a continuous and perpetual process that lacks a discernible conclusion.

Achieving competitive advantages over the long run often necessitates a substantial research and development budget within cost reduction programs. Economizing aims to see whether there is any possibility of bringing about a saving in the costs incurred on materials, labour, overheads etc.

Cost control is possible by implementing the following improvements:

  • Simplifying the methods of distribution.
  • Using a lower quantity of inputs to obtain the same output.
  • Obtaining more outputs from the same inputs and facilities.
  • Improving the location and layout of the plant, warehouse and other resources.

Cost reduction is defined by CIMA, London as “the achievement of real and permanent reduction in the unit cost of goods manufactured or services rendered without impairing their suitability for use intended”

Thus, cost reduction is, the term used for a planned and positive approach to the improvement of efficiency. It can be viewed in many ways, such as the elimination of waste, increasing productivity, improvement in product design, incentives schemes, better technology and techniques, new layouts and better methods, etc.

If the cost reductions are not based on sound reasons, such as enhanced methodologies, the costs will swiftly revert to their original size.

Scope of Cost Reduction

The extensive scope of cost reduction opportunities makes it impossible to thoroughly examine all potential areas for applying savings measures. Wherever costs occur, there exists an opportunity to reduce them. Management must recognize that there is ample room for expense minimization in every aspect. Reducing costs should involve everyone, from top-level executives to those on the shop floor. However, in the following areas, the scope of cost reduction is the largest:

1) Product Design

The design of the product offers the most meaningful opportunity for cost reduction. Product design is the first step in production, if expense minimization can be made at the design stage, then it is likely that the benefits can be availed to the maximum.

To reduce costs in product design, you should always consider these two fundamental aspects.

i) A successful product must satisfy all its intended functions and have an appealing shape or other desirable attributes.

ii) The product should retain its ‘esteem’ or ‘aesthetic’ value. This is the case for many products which have the shape or other characteristics which please the eye.

Improvement in product design can lead to a reduction in costs as described below.

i) Material Cost: A change in the design of the product may result in savings in material cost. Economical substitution for existing material should also be taken into account. For example, Substituting brass with more affordable alloys is an option for manufacturing kitchen utensils. Substituting metal with plastic is an option for curtain ring production.

ii) Labour Cost: Improvements in design can lead to a decrease in operating time, thereby reducing overall labour costs.

iii) Factory Overhead: Reduced operating time not only helps in saving on labour costs but also in factory overhead,

iv) Packing and Transportation: The compact design of a product results in reduced cost of packaging and transportation.

v) The cost of tools, jigs, and fixtures may decrease with design enhancements.

2) Administration

Items under this head include savings affected by modifying the range of cash discounts to customers, introducing mechanical and electronic aids to office routine, modifying internal and external communication systems, etc.

3) Organising

Cost reduction can also result from enhancing factory organization, such as establishing clear lines of authority and responsibility, defining communication channels, and promoting coordination and cooperation among different executives.

4) Production

A savings measures programme should make a study of the sequence of operations to find out the best one, use the most suitable machines for the work, use jigs and fixtures to reduce operating time, reduce idle time, reduce scrap by the use of better quality tools, to provide better working conditions conducive to efficiency, etc.

5) Finance

A cost reduction programme should aim at securing capital at economical cost, effectively utilising capital to maximize returns and eliminating over and under-capitalization and wasteful use of capital, etc.

6) Marketing

Implementing strategic measures is the key to cost minimization in this function. These include revising the methods of remuneration of salesmen, re-arranging territorial responsibilities of sales representatives, modifying current methods of advertisement, improving product design and production quality to reduce after-sales service, economizing channel of distribution, improving packing, etc.

Features of Cost Reduction

Features of cost control are as follows:

i) Cost reduction genuinely aims to minimize expenses throughout the production process.

ii) It includes a permanent expense reduction. It is more due to internal factors. For example, reducing government taxes is not classified as budget trimming because it lacks permanence.

iii) It does not compromise the quality of production; rather, it remains the same.

iv) Decreasing expenditure at a given level of output can lower the unit cost.

v) Achieving this goal is also possible by producing a larger quantity of goods. This strategy maintains the same level of expenditure while simultaneously increasing output. 

Advantages of Cost Reduction

i) Cost reduction improves the cash flow of an organization.

ii) A cost reduction program helps to achieve the goals of the company.

iii) It is permanent which affects the organizational performance in the long run.

iv) Cost reduction is a pivotal factor in enhancing the profitability of an organization.

v) Cost reduction does not compromise the quality of production while reducing the cost.

Disadvantages of Cost Reduction

The challenges of cost reduction often come in pairs. Some of the disadvantages are as follows:

i) This technique has its limitations and may not work in all cases.

ii) The proper implementation of this technique necessitates a planned strategy.

iii) The cost-reduction technique requires a lot of research which adds to the cost of the company

iv) Cost reduction programs are continuous. It involves continuously striving to minimize expenses. However, most organizations, implement these measures on an ad-hoc basis.

v) Workers and employees of an organization generally do not like to implement cost-saving programs and they try to resist it. Many consider these challenging to put into practice.

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