Cost Reduction - Economics Discussion

The following are some important cost reduction techniques: (i) Budgetary Control;. (ii) Standard Costing;. (iii) Inventory Control;. (iv) Job Study, Works ... TopMenu Navigation Home StaticMainMenuHome ShareYourKnowledge ContentQualityGuidelines Disclaimer PrivacyPolicy ContactUs ReturntoContent ArticleSharedby ADVERTISEMENTS: Costreductionistheachievementofrealandpermanentreductioninunitcostofprod­uctsmanufactured.Itthereforecontinuouslyattemptstoachievegenuinesavingsincostofproduction,distribution,sellingandadministration.Itdoesnotacceptastandardorbudgetasimpenetrableorfixed,itratherchallengesthestandardsorbudgetscontinuouslytomakeimprovementsinthem. “Costreduction”isacontinuousprocessofcriticalcostexamination,analysisandchallengeofstandards.Inthiseachaspectofbusinessessuchasproducts,process,procedures,methods,organization,personneletc.,arecriticallyexaminedandreviewedwithaviewofimprovingefficiencyandeffectivenessandreducingthecosts. Contents IntroductiontoCostReduction MeaningofCostReduction DefinitionofCostReduction FeaturesofCostReduction CostReductionCellandCostReductionCommittee WaystoAchieveCostReduction ReductioninVarietyofProducts TechniquesofCostReduction CostReductionProgramme AreasCoveredbyaCostReductionProgramme DifferencebetweenCostControlandCostReduction DangerstobeAvoidedinCostReduction ValueAnalysisasaTool BenefitsofCostReduction AdvantagesofCostReduction MeritsandDemeritsofCostReduction DifficultiesinCostReduction  WhatisCostReduction:Meaning,Definition,CostReduction,Process,Features,Techniques,CostReductionProgramme,Difference,ValueAnalysis,Benefits,DifficultiesandMore WhatisCostReduction–Introduction Costreductionistheachievementofrealandpermanentreductioninunitcostofprod­uctsmanufactured.Itthereforecontinuouslyattemptstoachievegenuinesavingsincostofproduction,distribution,sellingandadministration.Itdoesnotacceptastandardorbudgetasimpenetrableorfixed,itratherchallengesthestandardsorbudgetscontinuouslytomakeimprovementsinthem. ADVERTISEMENTS: Itattemptstoexcavatethepotentialsavingsburiedinthestandardsbycontinuousandplannedefforts.Costcontrollacksthatdynamicapproach,itusuallydeedswiththevariancesleavingthestandardsintact.Whereascostcontrolseeksadherencetostandards,costreductionisachallengetothestandardsthemselves.Inotherwords,theaimofcostreductionistoseewhetherthereisanypossibilityinbringingaboutasavingthecostsincurred—materials,labour,overheadsetc. Costsmaycomedownifpricesofinputs,suchasmaterials,comedown.Butusually,insuchacase,soonerorlaterthepriceofthefinishedproductalsohastobereducedand,therefore,suchcostreductiondoesnotbenefittheproducermuch—areductioninthepriceofgroundnutseedswillmeanareductioninthepriceofgroundnutoil. Costreductionbeginswherecostcontrolends.Costcontrolseekstobringtheactualsinharmonywiththepredeterminedtargets.Ifthishappens,assumingnoincreaseordecreaseincosts,theprofitmarginbecomesmoreorlessfixedataparticularlevelofsales.However,thisiseasiersaidthandone.Inactualpractice,pricesmayfluctuate. ADVERTISEMENTS: Alternatively,salesmaydeclineduetovariousreasons.Inallthesecases,thebusinessmustaimatmaximisingprofitsatthesamelevelofsalesbyreducingcosts.Costreductionseekstoachieveapermanentreductionincost,withoutimpairingthequalityoftheproduct.Itisaplannedwayofimprovingtheefficiencyofbusinessoperations. CostReduction–Meaning “Costreduction”isacontinuousprocessofcriticalcostexamination,analysisandchallengeofstandards.Inthiseachaspectofbusinessessuchasproducts,process,procedures,methods,organization,personneletc.,arecriticallyexaminedandreviewedwithaviewofimprovingefficiencyandeffectivenessandreducingthecosts. Fromtheabove,followingpointsshouldbenotedaboutcostreduction: 1.Itrepresents‘realandpermanent’reductioninunitcostofgoodsmanufacturedandservicesrendered.Inotherwords,costreductionisconfinedtogenuinesavingsincostsofmanufacture,administration,distributionandselling. ADVERTISEMENTS: Thisrealandpermanentreductioninunitcostmaybebroughtaboutbytheeliminationofwastefulandnon-essentialelementsindesignofproductsandfromtechniquesandpracticescarriedoutinconnectiontherewith. ReductionincosttoconsumerasaresultofreductionintaxationorGovernmentdesignorpriceagreementswillnotbecoveredbycostreduction.Thesearenotrealandpermanentreductionsincostduetoplannedefforts.Costreductiondoesnotincludewindfallreductionorfortuitousreduction. 2.Costreductionassumesthatproductorservicewillretainitsessentialcharacteristicsandquality.Ifreductionincostresultsindeteriorationofquality,itwillnotbecoveredbythetermCostReduction. Cooperationandteamworkareessentialfeaturesofanyplannedapproachtocostreduction.Directsavingofcostisthemosttangibleobjectiveofcostreduction,butitprofoundlyinfluencesthewidesphereofbusinessasawhole. CostReduction–Definition Costreductionis“theachievementofrealandpermanentreductionintheunitcostofgoodsmanufacturedorservicesrenderedwithoutimpairingtheirsuitabilityforuseintended.”CIMA(England). Costreductionmaybeeffectedintwoways- (i)byreducingthecostperunit;and (ii)byincreasingproductivity.Costreductionhastobeeffectedwithintheorganisation. Ifitisduetoexternalfactorssuchasreductionintaxes,governmentsubsidies,etc.,itwillnotcomeunderpurviewofcostreduction.Costreductionwillimprovetheprofitability.Orelse,thesavingsincostmaybepassedontotheconsumerbywayofloweringsellingprice. ADVERTISEMENTS: Thiswillcreatemoredemandfortheproducts,economiesoflargescaleproduction,moreemploymentthroughindustrialisationandallroundimprovementinthestandardofliving.Iftheprofitisimprovedbycostreduction,itcanbeutilisedforexpansionoftheconcernwhichwillcreatemoreemployment. Valueanalysis,ValueEngineeringandKAIZEN(ContinuousImprovement)arealsotobeimplementedforcostreduction.Itshouldbeobservedfromthedefinitionthatreductionincostsshouldberealandpermanent. AnyreductionincostsduetotemporarymeasureslikewindfallreceiptsorchangeinGovernmentpoliciesetc.,isnotcomingwithinthepurviewofcostreduction.Secondly,thecostreductionmeasuresshouldnothaveanadverseimpactonquality.Ifcostreductionalsoresultsinimpairedquality,itisnotcostreductioninrealsense. Thuscostreductioncanbebroughtabout– ADVERTISEMENTS: (1)Byreducingexpenseswithoutreducingthevolume. (2)Byincreasingvolumewithoutanyincreaseinexpenses. CostReduction–TopFeatures Thefollowingfeaturesofcostreduction: (a)ReductioninUnitCosts: ADVERTISEMENTS: Theaimofcostreductionistobringdownthecostperunitofacommodityorservice.Unitcostmaycomedownifthepricesofinputfactorsalsocomedown.But,inthatcase,thereductionwillnotberealandpermanent.Soonerorlater,thepricesofinputswillriseowingtolimitedsupplyfornaturalcauses. Consequently,costperunitofthefinishedproductalsorises.Whatistherefore,neededisachangeinthemethodsofproduction,newdesign,increaseinproductivity,newstandards,etc. (b)ReductiontobePermanent: ReductionInunitcostshouldnotonlyberealbutpermanentalso.Atemporaryreductionintheunitcosthasnosignificanceif,inthenearfuture,costperunitgoesupforwhateverreason. (c)UseValuetobeUnaffected: Anyarticle,producedwiththeavailablescarceresourceshasnotonlyexchangevaluebutusevaluealso.Itsvalueinexchangeisdependentuponmarketforces.Howeveritsvalueinusedependsentirelyuponitsquality.If,therefore,anarticleistobeputtotheintendeduse,itsqualityshouldbegoodenough.Costreductionshouldnotbeattheexpenseofitsquality.Anyreductioninitscostshouldnotimpairoraffectthesuitabilityofthearticlefortheintendeduse. ADVERTISEMENTS: SpecialFeatures: 1.Unitcostisrequiredtobereducedbyreducingexpenditurewithrespecttoagivenvolumeofoutput. 2.Unitcostisattemptedtobereducedbyincreasingproduction,i.e.,productionperunitofinput(e.g.,material,labourhour,peremployee).Itimpliesenhancementintherateofyieldoroutput,expenditureremainingthesame. CostReductionCellandCostReductionCommittee Costreductioninvolvesrealandpermanentreductionincosts.Itisacontinuousprocess.Hence,itrequirescooperationofpeopleatalllevels.Theenvironmentintheorganisationshouldbemadesocongenialthathealthydiscussioncantakeplaceatalllevelsofmanagement.Thecriticismsshouldbeacceptedinrightspiritwithhonestyandgracebyall,sothatcorrectiveactionmaybetakenintime. ThisrequirestheformationofaseparateCostReductionCellwithintheorganisation.TheCellfunctionsunderthesupervisionanddirectionofahigh-poweredauthorityknownasCostReductionCommittee. Thecommitteeconsistsofresponsibleexecutivesfromvariousfunctionssuchaspurchase,planninganddesign,production,sales,distribution,finance,research,etc.Thecommitteeshouldchalkoutapropercostreductionprogrammeandfixupresponsibilityoftheexecutivestoreviewtheactualperformancefromtimetotime. ADVERTISEMENTS: Thefunctionsofcostcellcanbeenumeratedasfollows: (i)Itcollectscostdatafromdifferentdepartments. (ii)Itinvitessuggestionsfromdifferentexecutivesforimprovementandreductionofcostsrelatingtotheirareas. (iii)Itcreatescostreductionenvironmentintheorganisationbyemphasisingandexplainingtotheworkerstheimportanceofcostreductionandthebenefitswhichwillaccruetothem. (iv)Itinvitesemployeestoparticipateinframingtheschemesforcontrollingthecostsatthepointoftheirincurrence. (v)Itidentifiesareaswherecostreductionis ADVERTISEMENTS: (a)necessary; (b)desirable;and (c)possibleandfixesthepriorities. (vi)Itframespolicies,guidelinesandissuesdirectivesforbringingchangesinproductdesigns,introducingnewproductsandnewdesignsinconsultationwithtechnocratsforreducingthecostofproductionwithoutimpairingthequality. (vii)Itframespoliciesregardingreductionofcostsinadministrativeanddistributiondivisionswithoutadverselyaffectingtheirefficiency. CostReductionCommittee: ADVERTISEMENTS: Toensurethatthecostreductionschemeworksproperlyinanorganization,acostreductioncommitteemaybeformed.Thiscommitteeisentrustedwiththetaskofformulatingadetailedandwell-coordinatedplanforcostreduction. Inalargeorganization,thedepartmentalheadsandtopexecutivesformsuchacommittee,whileinasmallconcern,anyoneoftheexecutivesmaybeentrustedwiththeresponsibilityofascertainingtheareasofcostreduction. 8WaystoAchieveCostReduction Costreductioncanbeachievedthroughthefollowingways: (a)Minimization/eliminationofwastes. (b)Increasingproductivityoflabour. (c)Moreefficientpurchasesofrawmaterials. (d)Betterbargainonotherelementsofcosts. (e)AdoptingEconomicOrderQuantityforpurchases. (f)ProductionPlanningandcontrol. (g)Mechanisationandautomationofproceduresandpro­cesses. (h)AdoptionofEnterpriseResourcePlanning(ERP),ifpos­sible. ReductioninVarietyofProducts(WithReasons) ItisacommonknowledgethatlargeristhevarietyofProductsmoreisthecostinvolved.Alargevarietyofproductsmeansmoreinvestmentintermsofequipmentinbothfixedandworkingcapitalandlargersaleseffortswhichallpushupthecostofproductionandsales. Thereductioninvarietyofproductswillleadtocostreductionbecauseofthefollowingreasons: Reason#(i)Standardisation: Reductioninvarietyofproductionwillleadtostandardisationofproducts.Thetermstandardisationmeansthattheproductshouldbeastandardonei.e.madeofstandardmaterialsandcomponentshavingastandarddesignandastandardcost. Thestandardisationofproductswillhavethefollowingadvantages: (a)Itwillreduceinvestmentininventoriessinceonlyfewstandardproductswillhavetobekeptinstock. (b)Theproductscanbemanufacturedinlargerquantitiesineachprocessasaresultofincreaseinthesizeofeachbatch. (c)Theproductswillbeofimprovedquality,greaterreliabilityandoflesscost. Reason#(ii)Simplification: Reductioninvarietyofproductswillleadtosimplificationoftheproductionprocess.Asimplificationofproductionprocessinvolveslessofmachinesettingtime,longerruns,increasedproductivityandlowercostofinspection.Asamatteroffact,standardisationwillautomaticallyleadtosimplificationoftheproductionprocess. Reason#(iii)QualityControl: Standardisationinvolvesgivingastandardproducttotheconsumer.Thismeansthatqualityoftheproductwillnotbeallowedtogetdeterioratedbutratheritwillcontinuouslyberetainedand,ifpossible,improved.Thiswillrequireinspectionoftheproductatdifferentstagesofproductionsothatdefectsmayberemediedattheearlieststage.Itwillbringeconomyinreducingthecostintermsofreductioninthenumberofdefectiveunits. CostReduction–ImportantTechniques Thefollowingaresomeimportantcostreductiontechniques: (i)BudgetaryControl; (ii)StandardCosting; (iii)InventoryControl; (iv)JobStudy,WorksStudyandMotionStudy; (v)JobEvaluationandMeritRating; (vi)ReductioninVarietyofProducts; (vii)ValueAnalysis. (viii)Standardisationofproductsandtoolsandequipment; (ix)Improvementindesign; (x)MaterialControl; (xi)LabourControl; (xii)OverheadsControl; (xiii)QualityControl; (xiv)MarketResearch; (xv)ProductionPlanningandControl; (xvi)OperationsResearch; (xvii)Automation;and (xviii)DesignImprovement. CostReductionProgramme–Requisites,FieldsandAims Costreductionprogrammeaimsatimprovementofhumaneffortsatalllevelsoftheorganisationwhichhelpinreducingcosts.Itmaybeashort-termoralong-termprogramme.Ashort-termprogrammeisundertakenforsortingoutimmediateproblems;e.g.,aprobleminvolvingcontrollingwastagesandinefficienciesinacertaindepartmentwhicharelikelytopushupthecostandreducetheprofitmargin. Long-termcostreductionprogrammeinvolvesmajorreductionincostsandmayalsorequirecapitalexpenditure.Itinvolvessettingupofthetargetreturnoncapitalemployedanddevelopingaschemeforitsachievementthroughvariouscostreductionmeasures. Thefollowingaretheessentialrequisitesforsuccessfulimplementationofacostreductionprogramme: (i)Thereshouldbeaseparatecostreductioncellresponsibleforproperplanningandimplementationofthecostreductionprogramme. (ii)Thereshouldbeanefficientsystemofmanagementreportingatalllevelsofmanagement. (iii)Theprogrammeshouldhavesupportfromthetopmanagement.Itisacontinuousprocessand,therefore,shouldnotbeallowedtodegenerateintoaroutineaffair. (iv)Thereshouldbeanoperationandresearchprocedure. (v)Thereshouldbecloseco-operationamongstdifferentexecutivesconcernedwiththeprogramme.Eachdepartmentalheadshouldbegivenalistoftheareaswhereheisexpectedtoeffecteconomiesincost.Moreover,heshouldalsobeencouragedtoputforwardhisownsuggestionsforimprovement. (vi)Thereshouldberegularfollow-uptotheplanandcontinuousappraisaloftheprogrammeperformedwiththeactualcostreductionperformance. (vii)Theplanshouldnotbeconfinedonlytoreducingcostsbutshouldalsoexaminewhetheranexpenditureisreallyrequiredornot.Inotherwords,thereshouldbeeffortstoeliminateuneconomicandunnecessaryactivities. FieldsCoveredbyCostReductionProgramme: Thefollowingarethespecificareaswhicharecoveredbyacostreductionprogramme: 1.ProductDesign: Designingtheproductisapre-requisitetoitsproduction.Itis,therefore,necessarythatpropercareisgiventodesigningtheproducttoeffecteconomiesinthecostofmaterials,labour,toolsandequipment.Thetechniqueofvalueanalysisisgreatlyhelpfulindesigningtheproduct.Productshouldbedesignedinamannerthatitgivesthemaximumvalueattheminimumcost. Productdesigningmayberequiredeitherforintroducinganewdesignorimprovementoftheexistingdesign.Theintroductionofanewdesignisadvantageousbutriskysincethenewventuremayormaynotbesuccessful.Hence,acarefulanalysisofitscostelements(i.e.,materials,labourandexpenses)anditsmarketabilityisnecessary. Theventureconcerningimprovementoftheexistingdesignisadvantageoussincethereputationgainedbytheoldproductislikelytobeenhancedandimprovedfurtherthroughimproveddesignoftheproduct.Theimprovementshouldbeinthedirectionofmakingtheproductlesscostly;moreutility-oriented,attractiveanddurable. 2.ProductionPlanning: Productionplanningcanalsogreatlyhelpincostreduction.Thelocationandlay-outofthefactoryhavesignificantinfluenceoncost.Ofcourse,thefactorylocationcannotbechangedsoeasilybutitslay-outcanbeorganisedonmorescientificlinessoastoreducethecostofproduction. TheCharteredInstituteofManagementAccountants,London,initspublicationoncostreduction,haslaiddownthefollowingprinciplesfordevelopingasoundproductionplanningsystem: (i)Productionplanningshouldbebasedonrealisticanddetailedsalesforecast. (ii)Efficientproductionsystemrequiresfullestpossibleemploymentofsuitableproductionfacilities,eliminationofunnecessarymovementandhandlingofmaterialsprovisionofadequateworkinginstructions,drawingstools,etc.,andthemosteconomicalstorageofstocks. Thedesignofaproductionsystemisdependentonitslocationbecausetheresultingphysicalfactorsinfluencelay-outandalsobecauseofthefactthatthelocationdeterminesoperatingandcapitalcosts. Insofarasphysicalfactorsofplantdesignareconcerned,locationmaydeterminethefollowingcosts: (a)Whetherornotpowerispurchased. (b)Theextentofairconditioningorhumidificationrequired. (c)Whetherlocalsub-contractingfacilitiesforcomponentsareavailableorwhetherprovisionforthemanufactureofcomponentshastobemadeinthefactory. (d)Storagespacerequirementsdependingontheavailabilityofrawmaterialsinthevicinity. (e)Thetypeoftransportationfacilitiesavailableforreceivingrawmaterialsanddespatchingfinishedgoods,etc. Fromthestandpointofcosts,transportationcosts,labourcosts,costsofland,constructioncost,etc.,willbeinfluencedbythelocationofthefactory. Evenifanexistingcompanyintendstostartanadditionalfactory,theadditionofanewplantisnotamatterofdetermininglocationindependentofthelocationoftheexistingplants.Establishmentofanewplantmayinvolvere-allocationofcapacitiessothatthecombinedproductionanddistributioncostsareminimised. Plantlayoutaimsatdevelopingaproductionsystemthatmeetstherequirementsofcapacityandqualityinthemosteconomicalway.Underidealconditionsofmanufacture,plantandmanufacturingfacilitieswillbelaiddownafterdueconsiderationofallthefactors,tendingtoreducewasteoftime,effort,materialandresourcestotheminimumpossiblelevel.Easilyavailableandmostsuitableequipmentshouldbeobtainedandutilisedtothemaximumpossibleextent. Anydislocationofproductionoccasionedbychangeoflayoutmayleadtoincreasedcosts.Suchdislocationcanbeavertedbyinitiallyplanningthelayoutinthebestpossibleway.Theproductioncontroldepartmentshouldkeepabreastofthetechnologicaldevelopmentsandrecommendtheuseofthemostsuitableandeconomicaltypeofplantandequipment. (iii)Theassessmentandcoordinationofequipment,labourandmaterialrequirementsdemandtheformulationofacompleteoperationsequenceforallproductsthesettingupofmaterialstandardsandtheestablishmentofreliableprocesstimebytheuseofworkmeasurementtechniques. (iv)Efficientproductioncontrolandeconomicmanufacturerequirecarefuldeterminationofthelotsizeaccordingtonatureofmethodsofproductionemployed. (v)Machineloadingandlabourrequirementsshouldberelatedtofullcapacityavailable.Wheretheidlecapacityisfoundtoexist,effortsshouldbemadetoensureitseconomicsutilisation,say,bytheintroductionofanewproduct. (vi)Theproductionplanonceformulatedshouldbeusedasameasureoftheeffectivenessofactualperformancewithaviewtocorrectingtheunfavourabledivergencesastheyoccur.Itshouldneverthelessbeflexibleenoughtocopewithessentialchangesarisingfromchangedconditions. (c)DirectMaterialsCostReduction: Directmaterialsgenerallyconstitute50%ofthecostofaproduct. Thefollowingstepsmaybehelpfulinreducingmaterialcosts: (i)Controlshouldbeexercisedonpurchasingofrawmaterials.Theyshouldbepurchasedineconomiclostateconomicpricesfromreliabledealersatappropriatetimes.TheadoptionoftheJapaneseJustinTime(JIT)techniquemaygreatlyreducethematerialcosts. (ii)Thevariousinventorycontroltechniques,viz.,fixationandobservanceofinventor,’levels(maximum,minimumandreorderlevels)ofinventory,ABCAnalysis,AgeingSchedule;PerpetualInventorySystemfollowedbycontinuousstocktaking,etc.shouldbeadopted. (iii)Alleffortsshouldbemadetoavoid/minimiselossesandwastagesofrawmaterials.Economyshouldalsobeaffectedinhandlingcostofrawmaterials. (d)DirectLabourCostReduction: Directlabourconstitutessecondimportantelementofthecostofaproduct.Costreductioninlabourispossiblethroughproperorganisationandfunctioningofthepersonnel,worksstudyandengineeringdepartments.Thepersonneldepartmentisconcernedwithfindingouttherightmanfortherightjobandtherightjobfortherightman. Whiletheengineeringandworksstudydepartmentisconcernedwithjobstudies,timestudiesandmotionstudies.Allthesefunctionsgoalongwayinreducingcostsandthereforealleffortsshouldbemadetodischargethemwiththeintentiontoincreasetheproductivityandreducecosts. (e)OverheadsCostReduction: Thetermoverheadsincludesfactoryoverheads,officeoverheadsandsellinganddistributionoverheads.Considerablesavingcanbeachievedintheoverheadcoststhroughcooperationoftheconcernedexecutivesatdifferentlevelsandcreatingasenseofcostconsciousnessamongstthemasexaminedbelow. Thereductioninadministrativecostswhetherinfactory,officeorsellinganddistributiondivisionscanbeachievedthroughthefollowingmeasures: (i)Staffcanbereducedbyhavingevaluationofjobs. (ii)Utilisationofmachineryandequipmentcanbeimprovedthroughsystematicsupervision. (iii)Productivityofworkersandexecutivescanbeincreasedthroughsmoothflowofwork. (iv)Expenditureonprinting,postageandtelephonecanbereducedbyexercisingappropriatecontrolmeasures. Similarly,sellinganddistributioncostscanbereducedbyexaminingthefollowingaspects: (i)Whetherthechannelsofdistributionareefficientandeconomical. (ii)Whetherdistributionandsellingmethodsensurepromptness. (iii)Whetherthereisaneffectivesystemofsalespromotion. (iv)Whetherthemarketresearchisadequate. (v)Whethermarketmethodsbothforhomeandexporttradearesatisfactory. (vi)Whetherthereismanypossibilityofreducingthesellinganddistributioncostswithoutimpairingtheefficiencyofthesalesdivision? (f)FinanceCostReduction: Financeisalsoanimportantareawherecostreductionispossiblethroughthefollowingmeasures: (i)Controloverutilisationoffinancemeantforbothworkingcapitalandfixedcapitalneeds. (ii)Properevaluationofinvestmentsinnewprojects. (iii)Appropriatecontrolovercapitalexpenditure. (iv)Profitableemploymentofcapitalwiththeobjectiveofgettingmaximumreturn. AimsofCostReductionProgramme: Costreductionprogrammesaimat: 1.Avoidingwastefulexpenditure 2.Developingcostconsciousnessamongemployees 3.Developingefficientoperatingprocedures 4.Improvingtheoverallefficiencyoforganisationalwork. Inordertoachievetheseobjectives,thecostreductionprogrammesmustbeundertakensystematically.Employeesmustbeencouragedtoparticipateintheprogrammesactively.Prioritieshavetobeoutlinedinadvancesoastoarriveatthesequenceinwhichcostreductioneffortsmustbemadeindifferentareas. Costreductionprogrammes,generally,coverthefollowingareas– (i)Design, (ii)Factoryorganisationandmethod, (iii)ProductPlanning, (iv)Factorylayoutandequipment, (v)Utilityservices, (vi)Marketing, (vii)Finance (viii)Officeoperationsetc. ThecostreductionprogrammeinrespectofthreeimportantOfficeOperationsmayinvolvethefollowingsteps: (I)StationeryandSupplies: 1.Uselight-weightpapersforofficecorrespondenceandrecords. 2.Letterheadsshouldbemadeavailableintwosizes—halfsizeforshortlettersandfullsizefornormalletters. 3.Useobsoleteletterheadsandofficeformsasscratchpapers. 4.Forinternalcorrespondence,makeendorsementontheoriginalletterratherthanwritingaseparatereply. 5.Eliminateenvelopesforinternalmail. 6.Eliminatedoublecolourribbonsorusethemonlywhennecessary.Turntheribbontoensurefulluse. 7.Avoidextrafilecopiesofcorrespondence. 8.Standardiselesservarietiesofenvelopesandusewindowenvelopes.Alsoputinoneenvelopeallmailsforthesamedestination. 9.Establishcentralisedcontrolofdesigningandprintingofallofficeforms. 10.Systematisethecollection,useorsaleofwastepaper.Wastepapercanbeshreddedandusedforpackingpurposes. 11.Reducethenumberofgradesandvarietiesofpencilsused;replacewoodenpencilswithmechanicalones. 12.Economiseontheusageofpins,clips,staples,tagsetc.byissuingtheminpackets. 13.Provideathoroughinventoryofallofficestationeryandofficesupplies.Introduceaperiodiccheck-upofallcostlyitems.Preparecoststatementsforeachstationeryitemusedbyeachclerk. 14.Issuesuppliesinsufficientbutnotinexcessivequantities. (II)MachineryandEquipment: 1.Ensureregularmaintenanceofmachineryandequipment.Arrangeannualservicingbyrecognisedagencies. 2.Providestaggeredworkinghoursfortheuseofthesamemachineindifferentdepartments. 3.Provideformultipleshiftstosecurefullerutilisationofmachinesandequipment. 4.Instructallemployeesinthecarefulandproperuseofmachines. 5.Standardisemachinesandequipment. 6.Locateofficeequipmentatsuchaplacewhereitis. 7.Mechanisetheprocessesofroutinenature. 8.Coverallmachinesattheendofwork-day. (III)LayoutandServices: 1.Ensuremaximumuseofofficespace. 2.Provideallequipmentneededbyemployeesnearertothemtominimisetheirmovements. 3.Rearrangeofficetosecuremaximumdaylight.Paintceilingsandwallsinlightshades. 4.Designatepersonsresponsibleforputtingofflightsandfansafterworkingtime. 5.Personsresponsiblefordisconnectingwaterworks,air-conditionersandwaters. 6.Putrestrictionsontheuseoftelephoneforpersonalcalls. AreasCoveredbyaCostReductionProgramme–ProductDesign,FactoryOrganisationandProductionMethods,Administration,Personnel,MarketingandFinance Thespecificareascoveredbyacostreductionprogrammeare: Area#1.ProductDesign: Designingtheproductisapre-requisitetoitsproduction.Assuch,itinfluencesallotherfunctions,andcostsofmaterials,labour,toolsequipment,etc.Hence,anycostreductionprogrammeshouldstartwiththedesignoftheproducttotakeadvantageofthebenefitsaccruingateverystageinfluencedbythedesign. Theobjectivesofadesignfunctionmaybemany.Attimes,theymaybeconflictingalso.Itis,therefore,necessarytoinvestigatetheeffectofanewdesignorimprovementoftheexistingdesignuponcostofproduction.Researchshouldbemadeontheavailablealternativedesigns,andtheircomparativecosts,withoutloweringqualityofthefinishedproduct. Astudyofthecostreductionpotentialofdesigninvolvesconsiderationofthefollowingfactors: i.Materials–Availabilityofcheapersubstitutes,physicalandchemicalpropertiesofmaterials,andtheyieldfactor,storageproblem,investmentininventory,etc. ii.Labour–Theeffectofdesignonreducedtimeofoperation,andincreasedproductivity. iii.ToolsandEquipment–Reductioninthecostoftools,jigs,fixturesandotherequipmentnecessarytomaketheproductonthebasisofthedesign. iv.StandardisationandSimplification–Standardisationandsimplificationleadtoincreasedproductivity.Itis,therefore,necessarytopayconstantattentiontofindwaystointroducestandardisationandsimplification. v.ShapeandAppearance–Thedesignshould,asfaraspossible,becompactinorderthatcostofpackingandtransportmaybereduced. Area#2.FactoryOrganisationandProductionMethods: Thebenefitsofcostreductioncannotbesecuredwithoutagoodplantlayoutandfactoryorganisation.Anorganisationstructure,withascalarchain,satisfyingtheprincipleof‘unityofcommand’,isnecessary.Itisequallyimportanttolaydownveryclearly,authorityrelationshipforthesuccessfulimplementationofacostreductionprogramme. Awell-definedchannelofcommunicationavoidsmisunderstandinganddifferenceofopinion.Thereshouldbedelegationofauthority.Personsresponsibleforspendingshouldbeidentified.Thereshouldnotbeanyorganisationalconflict. Clearlydefinedauthorityrelationshipavoidsjealousyandfriction.Besides,itfacilitatesimplementationofacostreductionprogramme.Modernisationofplantandequipmentoffersconsiderablescopeforcostreduction.Attemptsshouldbemadetostudytheeffectofintroducingnewproductionmethods,techniquesandprocessesoncost. Area#3.Administration: Administrationisastrategicareawhichhascostsavingpotential.Attemptsshould,therefore,bemadetoenlisttheco-operationofmanagementconsultantsforexploringthepossibilityofcuttingdownexpenditureincidentaltorecruitmentofstaff,economisingstationerycost,reducingtravellingexpenses,overtime,telephoneandsuchotheritemsofadministrationoverhead. Area#4.Personnel: Possibilitiesofcostsavingshouldbeexploredeveninthisarea.Adoptionofsuitableworkstudytechniquesmaybeconsideredalongwithsimplificationofworktoreducethelabourcontentofproductsandlabourtime.Labourrelationsmaybeimprovedbysuitableincentiveschemes.Employeesuggestionschemesmaybeintroducedtorewardtheemployeeswhosuggestcostreductionmethods,aswellastoboosttheirmorale. Area#5.Marketing: Costsavingonthemarketingsideisequallydesirableandnecessaryalso.Sellinganddistributionchannelsandthemethodsemployedshouldbereviewed.Itshouldbeseenwhetherthereisoptimumutilisationofsalesmen’stime.Itisalsonecessarytoseewhethertheanticipatedsalesareinconsonancewiththeadvertisingcost.Alternativeadvertisingmediashouldbeexplored.Prospectivemarketsshouldbedeveloped.Causesofproductfailureshouldbeinvestigatedinto. Area#6.Finance: Capitalemployedinthebusinessshouldyieldoptimumbenefit.Forthispurpose,itisnecessarytoseethatcapitalisnotlockeduponassetswhichcannotbeemployedanymore.Specialattentionistobepaidtodetectobsoleteandslowmovingitemsofstock.Sourcesofcapitalshouldbereviewedandcostofcapitalshouldbestudiedinrelationtotheavailablesources. DifferencebetweenCostControlandCostReduction Costreductioniscloselyrelatedtocostcontrol.Infact,costcontrolandcostreductionareconsideredtobethetwoaspectsofthesameproblem,viz.,costimprovement.EvenaccordingtoDobson,“reductionofexpenditurecontributestocostimprovement.” Butyet,costcontroldiffersfromcostreductioninthefollowingrespects: (a)Costcontrolisoneoftheaspectsofthemanagerialfunctionof‘control’.Assuch,itisonlyaroutineexercise.Itiscarriedoutwiththemainpurposeofincreasingoperationalefficiency.Costreduction,ontheotherhand,isaspecialexercisecarriedoutbymanagementwiththeobjectofcostimprovement,i.e.,securingarealandpermanentsavingsincosts. (b)Costcontrolaimsatachievingtargetcosts.Thisisaccomplishedbysettingtargetsofperformanceandstrivinghardtoachievethembyavoidingwastagesandinefficiencies.Costreduction,ontheotherhand,aimsatbringingaboutsavingsinthestandardsetbypresumingtheexistenceofconcealedpotentialsavingsinthestandards.Itthuschallengesthestandardsandaimsatimprovingthemthroughresearch. (c)Costcontrolhasitsapplicabilitytothoseitemsofcostforwhichstandardshavebeenset.Thesestandardsrelatemostlytoproductiveoperations.However,costreductionhasuniversalapplicability.Itappliestoeveryareaofthebusiness.Itdoesnotconcernitselfwiththestandardsofperformance,anddoesnotalsodependuponthestandards. (d)Costcontrolisessentiallystaticinnature.Itattemptsatachievingthebestpossibleresultsatthelowestcostundergivenconditions.Costreduction,however,isadynamicfunction.Ithasnovisibleandultimategoal.Itdoesnotassumetheexistenceofagivencondition,whichispermanent.Continuousstudy,analysisandresearchwhichofferscopeforcostreductionarerelieduponbymanagement. (e)Costcontroltechniquesaimatpreventingcostsfromrising.Costcontrolisthus,apreventivefunction.Whencostsarecontrolled,theultimategoalissaidtohavebeenreached,andcostsareoptimised.Costreductionisacorrectivefunction.Itmayoperateevenwhenthereisanefficientcostaccountingsystem.Sincethereisnothinglikestagnantefficiency,costreductionprogrammeofferamplescopeforreductionintheachievedcostsundercontrolledconditions. (f)Costcontrolresultsincostimprovement.Thetechniqueisthus,ameanstoanend.Costreductionis,however,theenditself.Costreductionbeginswherecostcontrolends. (g)Costcontrollaysemphasisonthepresentandpastbehaviourofcostswhereas,costreductionemphasisespartlyonthepresentcostsandmostlyonfuturecosts. Someoftheotherdifferencesare: Difference#CostControl: 1.Itistheachievementofpredeterminedcostsorgoals. 2.Itassumesthateverythingiswellwiththestandardsornormsset-upwhicharethereforenotchallenged. 3.Itisconcernedwithsettingupstandards,comparingactualswithit,analysingthevariancesandtakingremedialmeasurestocorrectthem. 4.Itisapreventivefunctionasitpreventsthecostsfromexceedingthestandards. 5.Itoftenlacksdynamicapproach. Difference#CostReduction: 1.Itistheachievementofrealandpermanentreductionofcost. 2.Itassumestheexistenceofconcealedpotentialsavingsinthestandardsornormswhicharethereforesubjectedtocontinuouschallengeforimprovement. 3.Itisnotcontendedonlywithmaintenanceofperformanceasperpre-determinedstandards. 4.Itisacorrectivefunctionasitseekstoimproveperformanceandreducecostsbychallengingthestandardsevenwhenefficientcostcontrolsystemexists. 5.Itisacontinuousprocessofanalysisbydifferentmethodsofallthefactorsaffectingcosts,effortsandfunctionsinaconcern.Themainobjectiveistohavecontinuouseconomyincosts. DangerstobeAvoidedinCostReduction Costreductionisausefuldevicetobringdowncostsinarealway.Thepayoffsseemtobequiteattractive,intheformofreducedexpenditure,bettercostconsciousnessamongemployees,andhigherprofitsforfurthergrowth.Onthenegativeside,however,somedangersneedtobelookedintocarefully. 1.Sacrificingquality–Inanattempttoreducecosts,productqualitymightbesacrificed. 2.Sacrificingoverallgoals–Adepartmentmayresorttocertainmeasureswhichmightbebeneficialfromitsownangle,butnotfromtheorganisationalpointofview. 3.Sacrificingemployeemorale–Employeesmay,inthebeginning,begintolookatcostreductionprogrammeswithscepticism.Itmaybelabelledasanotherattempttosqueezetheirbloodtoincreasetheprofitsfortheorganisationwithoutanypersonalpayoffs. 4.Panic,Crashprogramme–Theprogrammemaybetakenupbymanagementinahurry.Itmightbegearedintomotionasalastresort,viz.,whenthereisaseriouscashshortageorwhenlossesbeingtomountupseriously.Suchpanicmeasuresdonotyieldconcreteresults. Thesedangerscanbeeasilyavoidedifthecostreductionprogrammeisundertakensystematically.Itshouldnotbepressedintoserviceasanemergencymeasure,whenthingsgooutofhand.Theremustbeactiveparticipationofallemployeesandtheymustbelievethatthepayoffsaregoingtobesubstantial(bothfortheorganisationandtheemployees). CostReduction–ValueAnalysisasaTool Valueanalysisisaplannedwayofreducingcosts.Itisanattempttocriticallyexaminethevariousprocessesofaproductwithaviewtosubstitutealternativeswhichcostless.Thevariousfunctionswhichareinvolvedinthemanufacturingofaproductareexaminedwithaviewtoimprovethe‘value.’ Thus,valuemaybeequivalenttofunction/costorworth/price.Valuecanbeimprovedby (i)improvingfunctionwhilethecostremainsame, (ii)reducingcostswhilethefunctionsremainsameor (iii)improvingfunctionsandreducingcostssimultaneously.ValueEngineering,whichisusedasamodernmethodtoeffectcostreduction,attackscostsinthedesignstage. Theeffortistobringdowncostsbyimprovingproductfunctions.(ValueAnalysis,itshouldbenoted,attackscostintheproductionstage).Howeverthesevalueanalysisandvalueengineeringareused,moreorlessinthesamesense,becausetheyapplythesamemethodologyandtechniquesandhavethesamebasicobjectives. CostReduction–Top8Benefits Awell-thought-outandproperlyimplementedcostreductionprogrammeisaboontotheundertaking. Thebenefitaccruingfromcostreductionmaybesummarisedasunder: (i)Theconcernadoptingacostreductionplansuccessfullybecomesmoreprofitable.Itthusoccupiesanenviablepositionintheindustry. (ii)HighertaxablecapacityoftheundertakingresultsinincreasedrevenuetotheGovernment. (iii)TheUndertakingwillhavecapacitytobuildupreservesandtherebyenjoysfinancialstabilityduringaperiodofbusinessadversity. (iv)Theconcernwillhavethecapacityoffinanceexpansionormodernisationprogramme. (v)Goodwillcaneasilybebuiltup. (vi)Increasedcompetitivestrengthoftheindustrymaystimulateexports. (vii)Incentivetootherundertakingstoadoptsimilarcostreductionprogramme. (viii)Higherdividendstoshareholdersandreasonablepricesandgoodqualityproductstoconsumers. CostReduction–MainAdvantages Themainadvantagesofcostreductionmaybesummarisedasfollows: 1.Costreductionincreasestheprofitsofanundertakingwhichultimatelyprovidesabasisformoredividendstoshareholders,higherrateofbonustostaffandretentionofmoreprofitsforploughingbackinbusiness. 2.Duetoincreaseinprofits,managementmayspendmoreinprovidingamenitiestoworkers.Itwillensuremorecordialrelationshipbetweenmanagementandworkersandreducethelabourturnover. 3.Increasedprofitabilityoftheundertakingduetocostreductionaddstoitsgoodwill. 4.Reductionintheunitcostindicatesbetterproductivityandefficiency.Theefficiencyofafirmmaybenefitthemembersoftheindustryasawhole. 5.Higherprofitabilitywillensureincreasedrevenuetothegovernmentbywayoftaxation. 6.Costreductionmayleadtolowerexportpricesresultinginhighertotalexports. Somemoreadvantagesgiveninpointwiseformat: 1.Costreductionincreasesprofit. 2.Consumersgetgoodsatcheaperrates. 3.Itfacilitatesmoredividendstoshare-holders. 4.Italsoprovidesmorebonustoworkers. 5.Itresultsincreaseinsales. 6.Itgivesroomforexpansionofbusiness. 7.Continuousemploymentfortheworkers 8.Expectedreturnoncapital 9.Economicuseofresources. 10.Increaseinproductivity CostReduction–MeritsandDemerits MeritsofCostReduction: (a)Sincecostreductionresultsinprofitincrement,theshareholdersofthecompanygetfairdividendsfromthecompany. (b)Costreductioninstitutesabalancedwagestructureandsuitableworkingconditions,whichresultsinimprovingthelabourer-man­agementrelationships. (c)Sincequalitygoodsandservicesareofferedtothecustomers,itenhancesthereputationandgoodwilloftheconcern. (d)Reducedcostperunitresultsinproductivityinanindustryandisanindicatorofefficiency. (e)Sincecostreductionleadstoincreaseinprofits,thegovernmentearnsrevenue,spendstherevenueinpublicutilityworksandservices,andfinallythegovernmentmayearnhugeforeignexchange,since,onaccountofcostreduction,exportpricesarereduced,thusresultinginhigherexports. DemeritsofCostReduction: (a)Asmallconcernmayfinditcostlytofollowandimplementthecostreductionplan. (b)Someconcernsmayshowunwillingnessinchangingtheirage-oldproductdesignsthroughwhichtheyareearningrevenueovertheyears,thusignoringtheconceptofcostreduction. (c)Costreductionschememayimpairthequalityoftheproductofaconcern. CostReduction–Difficulties 1.Employeesresistcostreductioncampaignastheyarenotawareofitspurpose.Theythinkthattheymaylosetheirjobs. 2.Costreductioncampaignsareoftenconductedhurriedlyinsteadofcarefullyintroducingthem. 3.Effortstoreducecostofmaterialandlabourmayerodeconfidenceinestablishedsystemsusedforestimatingmaterialusageandlabourproductivity. 4.Theymaybeconfinedtoaparticulardepartmentwiththeresultthatcostsarereducedinonecostcentreonlytoreappearasanadditionalcostinanothercostcentre. RelatedArticles CostAccounting,Costing,CostReduction TimeValueofMoney FeaturesofProcessCosting WelcometoEconomicsDiscussion.net!OurmissionistoprovideanonlineplatformtohelpstudentstodiscussanythingandeverythingaboutEconomics.Thiswebsiteincludesstudynotes,researchpapers,essays,articlesandotheralliedinformationsubmittedbyvisitorslikeYOU. 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