Cost reduction, Cost Control & Challenges

Cost reduction is an extension of cost control. Cost reduction is a much wider concept than cost control. Cost control is essentially a short-term programme in as much as it relates to objective and standards. But cost reduction could have both short-term and long-term programmes.

Cost reduction should not be confused with cost control. Cost Control is the regulation of the costs of operating a business and is concerned with the keeping expenditure within acceptable limits. The major assumption in cost control is that unless costs exceed budget or standard by an excessive amount, the control of costs is satisfactory.

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According to the Terminology of Cost Accountancy of the Institute of Cost and Management Accountants London, Cost reduction is to be understood as the success of real and unchanging reduction in the unit costs of goods manufactured without impairing their suitable for the use intended.

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Features of Cost Reduction

These are Features of Cost Reduction given below:

1.??????Cost reduction is not concerned with setting targets and standards. Cost reduction is the final result in the cost control process.

2.??????Cost reduction aims at improving the standards.

3.??????It is continuous, dynamic, and innovative in nature, looking always for measures and alternatives to reduce costs.

4.??????It is a corrective function.

5.??????This is applicable to every activity of the business.

6.??????It adds thinking and analysis to action at all levels of management.

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Cost?control is a process of regulating or control the cost of operation within an organization. Basically, it is the practice of identifying and reducing business expenses to increase profits. Cost control starts with the product planning?process.

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The owner of the company compares the company’s actual financial results with the budgeted expectations, and if actual costs are higher than pre-planned costs, management?needs to take action. Thus, cost control makes actual costs conform to planned costs.

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Cost control can be defined as a tool of management executives to regulate the working of the manufacturing concern. Cost control helps business firms to producing the product at a minimum cost in order to achieve maximum profit.?

Difference between cost control and cost reduction

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1.?Objective?of Cost control is to maintain the cost accordance with the?pre-determinant standard. On the other hand,?objective?of the cost reduction is makes continuous effort to?reduce the cost.?It’s challenge all existing standard to establish?new and improved standard.

2.?Cost control?approaches?to lock the momentum to reach the lower possible costs under existing circumstances. Where,?approach?of the Cost reduction as no condition is permanent, it continuously tries to find new method to reduction cost.

3.?In?nature?Cost Control is a?preventive function. All costs are optimized before they are obtained.

Unlike the Cost Reduction, this is a?corrective function?in?nature. It presumes that there is always a chance for reduction in the achieved costs.

4.?Cost Control does not ensure?quality maintenance?of products. However, cost reduction ensures 100% quality maintenance.

5.?Cost control assumes the existence of?certain standards?which cannot be challenged. On the other hand, Cost reduction assumes the existence of?hidden potential savings?in the standards which are therefore capable of constant challenge or improvement.

6.?The important tools of the cost control are?standard costing?and?budgetary control. And important tools of cost reduction are?Value Analysis, work study, operations research, simplification and standardization, etc.

What’s the Right Level of Overhead?

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Indirect cost or ‘Overhead’ or ‘on cost’ or ‘Burden’ cannot be identified with specific products or jobs. So it is appropriated to the output on some reasonable basis.

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On the basis of functions overhead is classified as 1. Factory Overhead 2. Administration or Office Overhead and 3. Selling and Distribution overhead.

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Companies undertake administrative cost reductions for a number of reasons—to protect earnings, to gain.

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Getting to 30% or More

Cross-Department and Program-Elimination Ideas 1. Coordinate parallel activities. 2. Shift the burden to the most...

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1.??????Coordinate parallel activities.

Many departments conduct similar activities or purchase the same items independently, on a small scale. In such cases, coordination can reap valuable savings. For example, departments often buy supplies without regard to what others are ordering. This prevents the organization from using its combined purchasing power to reduce prices. At one company, a department ordered the very supplies and equipment that others had in excess. Fruitful areas to examine include paper, photocopying, personal computers (particularly if only some departments require the newest machines), and furniture.

2.??????Shift the burden to the most efficient location.

One of the most common laments heard during budget season is “We could reduce costs here if Department X would change what it’s doing—but it has budget constraints, and so it can’t.” The irony is, budget season is the time to bring up such cross-department trade-offs, because that’s when spending can be shifted.

Eliminate duplicated analysis.

When one department buys items from another department using transfer prices, the same “sale” may be recorded, analyzed, and reviewed by as many as five separate departments (the buyer, the seller, the transporter, quality assurance, and finance/accounting). In most cases, a single neutral department can be assigned the entire analytical task.

Eliminate low-value meetings and forums.

We know of one company where the top three to four layers of management are virtually paralyzed 20% of the time—that is, one full day each week, on what the employees ruefully refer to as “Meeting Monday.”

If you feel similarly paralyzed, consider organizing a cross-department audit of all regularly scheduled meetings to figure out which ones can be repurposed, consolidated, or eliminated. At one professional-services firm, such an audit significantly reduced the time that its busiest and most valuable employees (the account executives) spent in meetings, thus increasing their productive hours (time devoted to directing account teams and pursuing new clients) by 20%.

Curbing Costs in Unstructured Departments

Every company has unstructured departments—marketing, strategic planning, financial analysis, operations...

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Get Staff Buy-In

Changing your organization’s mindset?on cost reduction is key to success. Share the benefits of reducing waste in your organization. And meet with leaders to underscore the importance of their role in helping the business reduce costs.

Replace Unproductive Staff

Most likely, there is at least one member of your team that’s underperforming. While you may be holding off on releasing them due to a number of personal reasons, there comes a time when letting them go is more cost-beneficial than keeping them around.

Reduce Maverick Spend

Unapproved spending (or Maverick Spend) is particularly rampant in organizations without clear insights into purchase order approvals. By increasing transparency in your procurement process, you’ll reduce unapproved spending, consolidate orders, and get discounts on goods and services that keep your company within budget.

Reduce Wages

This should only be used as a last resort. Reducing wages can damage employee morale. However, if it’s wage reduction or dismissal, employees will often prefer wage reduction. Still, be very careful before reducing wages. There are plenty of other?(better)?cost-cutting measures.

Review Previous Cost-Cutting Strategies

Organizations often have to put tasks on hold. Unexpected things happen and that causes the focus to shift. Rather than waste time and resources reinventing solutions, review previous cost-cutting strategies and see if they’re still applicable.

Reduce Meetings

Most meetings are an expensive waste of time. On average,?organizations spend 15% of their time?in meetings, 37% of which are meaningless. Meetings should be short, only involve key players, and have a strategic goal. Remove any meetings that don’t meet these criteria. And use other channels like presentations, email, and memos to share information.

Transform Business Processes

In 60% of jobs,?at least 33% of the activities?can be automated. Automation and integration reduce the need for time-intensive, manual tasks. Integrations connect your disparate systems. And automation moves the data between chose systems efficiently.

For example, if you're still manually processing invoices, you're wasting a lot of time and money.?

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Key Sourcing Strategy or Tool – Five Levers of Expense Management

I have introduced the Five Levers approach before, but it is particularly appropriate for a team that is beginning to execute a cost reduction plan. The Five Levers strategy is a combination of proven purchasing practices and operational strategies, sound supplier audit practices and a proven strategy to reduce your costs on a sustainable basis.

The Five Levers approach depicted below is a process or tool that your management responsible for procurement, should use for all sourcing projects going forward. This tool is designed to provide the right solution to meet the actual needs, at the right cost.

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Strategic Approach?– Applying the Five Levers Approach:

Lever I – Requirements:?Rather than just renewing your waste agreement at a new price, dig a bit deeper. What size container do you really need??What is the best container size and frequency of pick-up required? Once that is known, then it is time to move to the next lever.

Lever II – Solution:?Do you need one supplier or multiple suppliers? Should you open up category selection (office supplies) to employees to order anything they want, or should you limit those choices (to a limited core list)? Should you standardize on low cost alternatives or allow the purchase of more expensive branded items?

Lever III – Financial:?Everyone focuses on price, yet it is but one component of the entire transaction. Secure a good price….and lock it. Secure favorable business payment terms with early payment discounts. Negotiate favorable delivery terms and protect the pricing and terms for sustained periods of time.

Lever IV – Process:?Price is important, but so is the process related to the acquisition and payment of the product or service. Should you order via internet? Should you pay the invoice with a credit card? Should your team be pulling three credit bureaus at one time because it is easier? Process considerations must not be overlooked when you select and implement a new supplier and program.

Lever V – Compliance:?A lot of good, thoughtful work goes in to creating an effective solution for an organization. If the levers listed above are followed, the solution should be auditable. Supplier compliance audits focus on ensuring that price and business terms are adhered to by the supplier. Another form of compliance is to ensure that your employees are using the designated suppliers and running off and using some new solution.

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Pitfalls to avoid

Reducing costs can have a negative effect, so you’ll need to be sure that changes will not compromise your operational performance.

Some common pitfalls include:

? Over-dependence on one supplier could put you at risk if your supplier fails.

? Reducing your marketing budget could affect your marketing strategy.

? Tighter control of business finances could leave you without a safety margin if cash flow becomes tight.

? Cutting short-term costs such as training, research and development, or advertising can lead to long-term weaknesses.

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The possible dangers of any cost reduction plan may be as follows:

1. Quality may be sacrificed at the cost of reduction in cost: To reduce cost, quality may be reduced gradually and it may not be detected till it has assumed alarming proportion. Quality may be reduced to such an extent that it may not be accepted in the market and the business may be lost to the competitors.

2. In the beginning cost reduction programme may not be liked by the employees and danger may be posed to the programme because success of any cost reduction plan depends upon the willing cooperation and active participation of the employees.

3. It is possible that reduction in cost may not be real and permanent. It may not be based on sound reasons and may be short lived and cost may come back to the original cost level when temporary conditions (i.e. fall in prices of materials) due to which cost has reduced disappear.

4. There may be a conflict between individual objective and organizational objective. It is possible that a head of a particular department may follow activities which may reduce the cost of his department but may lead to increase in cost for the organization as a whole.

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Why Cost Reduction Fails

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Most cost initiatives fail because they’re too ambitious, lack a clear strategy, and don’t have buy-in from leadership. Sadly,?nearly half (43%) of cost-cutting initiatives fail. If you want to move your organization past dreaming about becoming more efficient, then you need a roadmap.

As a result, you’ll not only succeed at cost-cutting, you’ll transform your organization into a highly efficient competitor in your space.

Current Challenges

Most business organizations find themselves involved in cost reduction initiatives from time to time. To sustain an organization over the long term, cost reduction efforts need to become deeply ingrained in the business structure itself and that is usually accomplished through a Spend Management or Purchasing Department. Purchasing is typically charged with sourcing, quoting, negotiation, implementation and supply base management responsibilities including compliance audits.

If ownership and management is really serious about impacting and controlling expenses, the current tactical approach to cost reduction needs to change. Tactical, short term cost reduction efforts often resemble fire-fighting. Put out the fire and move on to something else. Then when sales dip, re-organize the team and repeat the effort to feel good about impacting expenses.

Cost cutting refers to?measures implemented by a company to reduce its expenses and improve profitability. Cost cutting measures are typically implemented during times of financial distress for a company or during economic downturns. Cost-saving initiatives can?help offset rising expenses or falling profits

Work With Business Transformation Specialists

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There are a lot of ways to cut costs in your organization. Some are quick wins. Others will take time. And still, there are approaches that may end doing more harm than good. That's why if you won't want to waste money trying to save money, you need to team up with experts.

Rather than get tangled up in business expense reduction, you need to work with a team that can leverage experience gained in multiple channels to help you avoid expensive mistakes and reduce waste quickly.

Working with consultants that specialize in business transformation will save you time and money while ensuring any investment you make in better systems yields a high return.