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Cost reduction and cost avoidance

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Cost reduction
Generally defined as the act of cutting costs to improve profitability. Cost reduction, should therefore, not be confused with cost saving and cost control. Cost saving could be a temporary affair and may be at the cost of quality. Cost reduction implies the retention of essential characteristics and quality of the product and thus it must be confined to permanent and genuine savings in the costs of manufacture, administration, distribution and selling, brought about by elimination of wasteful and inessential elements form the design of the product and from the techniques and practices carried out in connection therewith.

In other words, the essential characteristics and techniques and quality of the products are retained through improved methods and techniques used and thereby a permanent reduction in the unit cost is achieved. The definition of cost reduction does not however include reduction in expenditure arising from reduction or similar govt. action or the effect of price agreements. The three fold assumption involved in the definition of cost reduction may be summarized as under:- 1.

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There is saving in a cost unit

2. Such saving is of a permanent nature
3. The utility and quality of goods remain unaffected, if not improved A cost reduction, which is a “hard” cost saving, usually takes the form of a tangible year-over-year bottom-line cost reduction such as: the direct reduction of a capital or operating expense, such as a decrease in the annual lease payments, a reduction in the telecommunications cost, or a reduced annual IT maintenance fee a process improvement that results in real and measurable cost reductions, such as a process improvement that allows more units to be produced on the line in the same time-frame (productivity improvement) and/or with the same amount of raw material inputs (waste reduction) a net reduction in prices paid for the raw materials procured when compared to prices paid in the previous year

Cost avoidance
The act of eliminating costs or preventing their occurrence in the first place. Cost Avoidance: Cost saving resulting from a situation where, without some action on the part of the buying organization, some form of increased cost would be incurred. Examples would include an announced price increase that is negotiated down, substitution of a lower-cost item for the one that was requisitioned, change to lower weight packaging material to offset a transportation cost increase (if the packaging material costs less than what is currently used then there would also be a cost decrease).Whether a cost saving is a reduction or an avoidance, it also can be categorized as “hard” or “soft.”Hard cost saving: Less money goes out of the organization, now and/or in the future depending on whether the saving is a reduction or an avoidance. Must be actually or potentially measurable in budget or operations reports. Hard cost savings drive acceptance by management of total cost of ownership cost saving approaches. A cost avoidance, which is a “soft” cost saving, usually takes the form of a more intangible cost avoidance, which does not show up on, but materially impacts, the bottom-line cost such as: a delayed price increase, despite rising costs on the commodity markets a negotiated purchase price that is lower than the initial quote additional value-add services in a contract that are free-of-charge long term contracts with price-protection provisions

the identification of a new production process that supports utilization of a lower cost material

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, which are two sides of the cost containment coin, are important and necessary for a company that wants to achieve and maintain profitability, especially in a weak economy.

Contingent workforce management
Organizations are relying more heavily on contingent workers to meet critical staffing needs. As this need continues to grow, the coordination of staffing suppliers and the ability to strategically administer the process and control spend becomes paramount. Establishing clear, enterprise-wide management programs can ensure consistency, flexibility and responsiveness that drive results. Successfully implementing a Contingent Workforce Management program requires a technology solution with a foundation based on standardized efficient and effective processes. However, true strategic optimization is difficult to achieve without a clear win-win strategy and partnership within your supply chain. Key to realizing a true partnership model is derived from a clear understanding of the primary value proposition organizations may recognize within a structured program and how an organization can leverage those vendor benefits in their quest to achieve true supply chain and flexible workforce optimization.

Design for supply
Focuses on the design and selection of common components for product families or platforms. This concept is to minimize component variations used to produce each brand or family of products. While it is important for marketing to differentiate each offering so that it can adequately satisfy the needs of unique consumer segments, differentiations that are not discernable by consumers should be minimized Supplier management

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 aims to analyse and design the infrastructure of the supply chain network (production and distribution) which best fits the supply chain strategy. The aim is to optimise both the level of service towards your customers as well as cost of the supply chain.

Shipment consolidation,
Cargo shipping method in which a freight forwarder at the port of origin combines several individual consignments to make up a full container load. This arrangement allows the goods to be shipped as containerized-cargo that offers greater security at lower shipping rates. At the port of destination, the consolidated shipment is separated back into the original individual consignments for delivery to their respective consignees. Also called grouped shipment. Combine Cargo follow all the customer requirements in the shipping instructions given to us and take care of the cargo warehousing, securing and loading in to the container. Consolidation can significantly reduce the cost of moving smaller volumes of goods by moving the goods together. The client enjoy the low shipment saving cost. Multi-mode utilization

Multimode transportation refers to companies using several means of transport to fulfill their freighting needs. Apart from minimizing the total cost spent on the different transport modes, requests should be fulfilled as far as possible, since there are often huge contractual penalties in delaying cargo.

Strategic sourcing
Strategic Sourcing is a system wide procurement strategy. It takes advantage of the combined buying power to cut costs for common goods and services. This approach provides better pricing, quality, and overall service. Strategic sourcing aim to leverage buying power to achieve lower costs of purchasing goods and services without compromising quality or service Brand building

Enhancing a brand’s equity directly through advertising campaigns and indirectly through promotions such as cause championing or event sponsorship.

SOFT FUNNY MONEY
Cost avoidance refers to “soft savings.” Often cost avoidance involves slowing the rate of cost increases or obtaining “value-added” services. Cost avoidance is intangible so it described as soft funny money and easy to manipulate. Example resisting or delaying a supplier’s price increase,

purchase price that is lower than the original quoted price, value of additional services at no cost, e.g. free training, long-term contracts with price-protection provisions, and Introduction of a new product or part number requiring a new material purchase; spend is lower, but savings classified as avoidance due to a lack of historical comparison.

LEGITIMATE COST
Purchasing Services identifies and tracks legitimate cost savings through supply chain business strategies aimed at achieving least total cost pricing that takes into account not only price, but factors such as quality, service, delivery and all other aspects relevant for assessing the total value of the products and services required in support of the mission of the organization. Purchasing Services will not allow the pursuit of cost savings be the sole determining factor in the selection of a product, supplier, or work method to meet the need. Therefore, it is essential that Purchasing Services meet those needs consistently with the best quality of products and services. When reporting a new cost savings, Purchasing Services utilizes private industry acknowledged cost savings criteria to ensure that all reported savings are identifiable, measurable, and a direct result of the involvement of a purchasing representative in a transaction, project, or contract negotiations. New contract and project cost savings; cost avoidance, recurring savings, and revenue generation contribute to the organization’s mission to produce significant Return-on-Investment Reported cost savings are the result of a planned or deliberate action taken by a Purchasing Services staff member. A purchase cost savings or avoidance occurs when a lower than previously paid cost results in the purchase of the same, or comparable product or service. This may be accomplished by a number of means including but not limited to: Reduce the purchase or ownership cost of the desired product or service Avoid a higher cost that would have otherwise occurred

Improve the total value of a purchased product or service
Strategic preferred contract supplier relationships
Competitive bidding of annual requirements and spot purchases Spot buy transaction negotiation or addition bid solicitation Equivalent product substitution or standardization while meeting customer requirements Favorable contract terms and conditions

Reduction or elimination of a new cost that would have otherwise occurred

CONCLUSION
Therefore the ultimate goal of every business organization is to create economic value for customers. If this is not done, nothing will be sold or traded. This fact must be kept firmly in mind when analyzing supply chains for potential sources of savings. To the extent that the same customer satisfaction can be achieved at lower total cost, additional economic value is created. The additional value may go to the customer in the form of lower price, it may go to the seller in the form of higher profits, or it may be shared by both entities. In the process of increasing economic value, supply chain management is most often looking to lower costs in the supply chain. To accomplish this, a proven approach consists of: • Identify cost drivers

• Identify total cost categories
• Develop cost reduction activities/programs, e.g. continuous improvement • Measure costs over time

Cite this Cost reduction and cost avoidance

Cost reduction and cost avoidance. (2016, Jul 02). Retrieved from https://graduateway.com/cost-reduction-and-cost-avoidance/

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