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Cost Reduction

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

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Cost Reduction Meaning

Cost reduction is an important strategy that ensures savings in cost per unit, ultimately maximizing profits for the enterprise. It aims to eliminate unnecessary expenses in the production process, such as stock, range, selling, and product distribution. 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, eliminating unnecessary production and operational expenses. Cost-saving programs target specific areas to minimize costs by improving work methods, arrangements, and products. These cost-saving measures can be applied at various production, storage, and distribution stages through advanced and scientific operational techniques. Including research and development activities is important to implement cost-saving initiatives effectively.

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 the organization’s goods and services, directly impacting 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 saving on 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 improving efficiency. It can be viewed in many ways, such as eliminating waste, increasing productivity, improving product design, incentive 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 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 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 maximized.

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 desirable attributes.

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

Product design improvement can lead to reduced costs, as described below.

i) Material Cost: A change in the product’s design may result in material cost savings. 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 decreased operating time, thereby reducing overall labour costs.

iii) Factory Overhead: Reduced operating time can have a cascading effect; it saves labour costs and various factory overhead expenses.

iv) Packing and Transportation: A product’s compact design results in reduced packaging and transportation costs.

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

2) Administration

Items under this heading include savings affected by modifying the range of cash discounts for 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 by 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 an economical cost, effectively utilizing capital to maximize returns, eliminating over- and under-capitalization, and eliminating wasteful use of capital, among others.

6) Marketing

Implementing strategic measures is the key to cost minimization in this function. These include revising the remuneration methods of salespeople, re-arranging the representatives’ territorial responsibilities, modifying current advertisement methods, 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 production quality; it remains the same.

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

v) Achieving this goal is also possible by producing more 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 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 try to resist them. Many consider these challenging to put into practice.

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