Generally defined as the act of cutting costs to improve profitability, cost reduction should not be mistaken for cost saving and cost control. Cost saving might only be a temporary solution and could come at the expense of quality. In contrast, cost reduction ensures that the essential characteristics and quality of the product are maintained, and it should focus on achieving permanent and genuine savings in manufacturing, administration, distribution, and selling by eliminating wasteful and unnecessary elements from the product’s design and associated techniques and practices.
In summary, cost reduction is achieved by using improved methods and techniques that maintain the essential characteristics and quality of products. However, this definition does not include cost reduction resulting from government actions or price agreements. The definition of cost reduction is based on three assumptions.
- There is saving in a cost unit
- Such saving is of a permanent nature
- The utility and quality of goods remain unaffected, if not improved
A cost reduction, which is a “hard” cost saving, typically takes the form of a tangible year-over-year reduction in bottom-line costs. This can include direct reductions in capital or operating expenses, such as decreased annual lease payments, lower telecommunications costs, or reduced IT maintenance fees. It can also involve process improvements that result in real and measurable cost reductions, such as increased productivity on the production line or reduced waste through more efficient use of raw materials. Additionally, cost reduction may involve paying lower prices for raw materials procured compared to the previous year.
The concept of cost avoidance involves preventing or evading expenses, thereby leading to savings. This occurs when the purchasing organization takes actions to prevent cost escalation. These actions may include negotiating a lower price increase, substituting a higher-priced item with a cheaper alternative as initially requested, or switching to lighter packaging material to offset an increase in transportation costs (as long as the new material is less costly and leads to reduced overall costs).
Whether a cost saving is classified as a reduction or an avoidance, it can also be categorized into “hard” or “soft” savings. A hard cost saving refers to a decrease in the amount of money leaving the organization, either immediately or in the future, depending on whether the saving is achieved through a reduction or an avoidance. Hard cost savings must be quantifiable in budget or operations reports, and they are crucial in gaining management acceptance for cost-saving strategies that consider the total cost of ownership.
A cost avoidance refers to a type of cost saving that is considered “soft” and typically involves intangible factors that may not be immediately evident but still have a significant impact on the overall cost. Examples of cost avoidance include a delayed price increase despite increasing costs in the commodity markets, negotiations resulting in a purchase price lower than the initial quote, inclusion of additional value-added services in a contract without additional charges, long-term contracts with provisions to protect against price changes, and the discovery of a new production process that allows for the use of less expensive materials.
SIX FUNDAMENTAL SOURCES OF COST
- Raw material collection, processing, and handling costs
- Design, component, and production costs
- Inventory, distribution, and overhead administration costs
- Loading, shipping, and insurance costs
- Negotiation, requisition, approval, receipt, reconciliation, and payment costs Reconciliation, and collection costs
COST REDUCTION AND AVOIDANCE MEASURES
Both types of cost control, cost containment and profitability, are crucial for a company aiming to achieve and sustain profitability, particularly in a fragile economy.
Contingent workforce management
Organizations are increasingly relying on contingent workers to fulfill important staffing requirements. With the continuous growth of this need, it becomes crucial to effectively manage staffing suppliers and strategically oversee the process while controlling expenses. By establishing comprehensive management programs throughout the organization, consistency, flexibility, and responsiveness can be achieved to drive positive outcomes. The successful implementation of a Contingent program is imperative.
The Workforce Management program needs a technology solution that is built on standardized, efficient, and effective processes. However, achieving true strategic optimization is challenging without a win-win strategy and partnership within the supply chain. A clear understanding of the primary value proposition within a structured program and how organizations can leverage vendor benefits is crucial to achieving supply chain and flexible workforce optimization.
Design for supply
The primary focus is on designing and selecting common components for product families or platforms. This aims to reduce the number of variations in components used to create each brand or product family. It is crucial for marketing to distinguish each product offering to meet the specific needs of different consumer segments. However, differences that are not noticeable to consumers should be kept to a minimum. Supplier management is also an important aspect.
A broad term describing the various acts of identifying, acquiring, and managing the products and/or resources needed to run a business or other organization. These include physical goods as well as information, services, and any other resources needed. Supply management divisions within large corporations can be very large, with budgets in the billions and employing hundreds of workers. The main goals within supply management are to control costs, efficiently allocate resources, and gather information to be used in strategic business decisions. Distribution network re-design.
Supply chain network design involves analyzing and designing the infrastructure of the supply chain network, including production and distribution, to best align with the supply chain strategy. The objective is to optimize both customer service levels and supply chain costs.
Containerization is a cargo shipping method that involves a freight forwarder consolidating multiple consignments to form a complete container load. This arrangement provides enhanced security at reduced shipping rates. Upon reaching the destination port, the consolidated shipment is then broken down into its original individual consignments for delivery to their respective consignees. This shipping method is also known as grouped shipment.
Combine Cargo adheres to all customer requirements stated in the shipping instructions and handles the warehousing, securing, and loading of the cargo into containers. Through consolidation, the cost of transporting smaller volumes of goods is substantially reduced by moving them together. This enables clients to benefit from lower shipment costs and allows for the utilization of multiple modes of transportation.
Companies that use multiple modes of transportation to meet their shipping needs are engaged in multimode transportation. The goal is to minimize costs by utilizing different transport methods and fulfilling requests as efficiently as possible, as delays in cargo delivery can result in significant contractual penalties.
Strategic Sourcing is a procurement strategy that utilizes the collective purchasing power to reduce costs for commonly used goods and services. This approach offers improved pricing, quality, and overall service. The goal of strategic sourcing is to leverage buying power in order to obtain goods and services at lower costs while maintaining high quality and service standards. Brand building involves directly enhancing a brand’s equity through advertising campaigns, as well as indirectly through promotions such as endorsing causes or sponsoring events.
SOFT FUNNY MONEY
Cost avoidance, also known as “soft savings,” is the act of slowing the rate of cost increases or obtaining “value-added” services. It is considered intangible, hence referred to as soft funny money that can be easily manipulated. An example of cost avoidance is resisting or delaying a supplier’s price increase.
Purchasing the product at a price that is lower than the initial quote is considered a saving. In addition, receiving free training or having a long-term contract with price protection provisions are also classified as savings. Another way to save is by introducing a new product or part number which requires a new material purchase. Although the spend is lower in these cases, the savings are classified as avoidance because there is no historical comparison.
Purchasing Services utilizes supply chain business strategies to identify and monitor genuine cost savings. They strive to achieve the most economical pricing that considers price, quality, service, delivery, and other important factors for evaluating the overall value of the required products and services that support the organization’s mission. However, Purchasing Services ensures that pursuing cost savings alone does not dictate the choice of a product, supplier, or work method when meeting a need.
Purchasing Services understands the importance of consistently satisfying customer needs and delivering top-notch products and services. When reporting cost savings, our department adheres to established criteria used in the private industry. This ensures that we can clearly identify, measure, and directly attribute the savings to the active participation of one of our purchasing representatives during a transaction, project, or contract negotiations.
The organization’s goal is to generate a substantial return on investment through different methods, including securing new contracts, saving costs on projects, avoiding expenses, recurring savings, and generating revenue. These cost savings are achieved by the deliberate actions of Purchasing Services staff members. A purchase cost saving or avoidance occurs when a product or service is acquired at a lower price compared to what was previously paid for the same item or a similar one.
The primary objective of any business is to generate economic value for its customers, as without this, there would be no sales or trades. It is essential to consider this factor when assessing supply chains for potential cost savings. When the same level of customer satisfaction can be attained at a reduced expense, it contributes to the creation of extra economic value. This value can manifest in lower prices for customers, higher profits for sellers, or a blend of advantages for both parties involved. To enhance economic value, supply chain management concentrates on minimizing costs within the supply chain. A productive approach to accomplish this objective is:
- Identify cost drivers
- Identify total cost categories
- Develop cost reduction activities/programs, e.g. continuous improvement
- Measure costs over time.