Cost Reduction

X-MBA - Batch 24
Guide : Prof Sarojini Managerial Economics

Mayank Mathur Kumar Kashyap Jha Madukar Thorat Laxmi Khandayat

The Flow
o o o o o o o o o

Introduction Cost Reduction .Definition Cost Reduction .Why ? Cost Reduction Techniques Non Conventional Approach Stages of Cost Reduction Emerging Business Models : Characteristics & K S F Conclusion Acknowledgement & References

Who wants what...

Cash !!

Value !!
Customer
Low Cost High Quality Availability

Company

Profit Repeat Business Growth

Cost Reduction
Cost cutting is no longer the solution to sustainable profitability, The key to success is finding creative ways to prevent cost. COST REDUCTION

Cost Reduction
Cost reduction is to be understood as the achievement of real and permanent reductions in the unit cost of the goods manufactured or services rendered without impassing their suitability for the use that is intended- ICWA London.

Cost Reduction & Control

The revival and subsequent boom in the corporate sector in the last couple of years was primarily driven by the conscious efforts towards controlling costs.

Goals of Cost Reduction

Reducing the cost per unit Elimination of waste Improving operations Increase in Productivity Cheaper Material Improved Standards of Quality

Cost ReductionWhy
1st
To Stay Profitable , As the demand cycle goes through a dip and sales begins to shrink, companies typically look inward to keep afloat. And the time-tested way of doing this is by slashing at the cost structure and save money.

2nd

In a highly competitive market place increasingly populated by multinationals, the best way for companies to survive and grow is by offering better quality products at cheaper price. The only way to do this is by constantly chipping away at the cost structure to eliminate unproductive expenditure so that the company will have pricing freedom in the marketplace.

Cost ReductionWhy
Old Equation COST + MARGIN = SELLING PRICE New Equation MARGIN = SELLING PRICE COST. Of this, only one variable, cost , is under the control of the company while the market dictates selling price. Margin therefore is a function of how efficient the company is in controlling costs.

Changing Perspective Of Profit

Cost + Profit = Sales
In a sellers market cost and profits are reimbursed by the customer.

Sales - Cost = Profit

With more players in the market place, Selling price is determined by the market forces ; having locked to a level of cost , focus is on cost control and reduction . Cost information is for tactical decision making.

Sales -Profit= Cost

Selling price is determined by market forces: Profit is determined by the risk/return profile of business with a focus on cost management to achieve the targeted results.

Cost Reduction is
Cost reduction refers to the real and permanent reduction in the unit cost of the goods manufactured or services rendered. (i)By reduction in unit cost of production : This is usually brought by elimination of wasteful and nonessential elements in the design of products and from techniques and practices carried out. (Any reduction in costs due to changes in Government policy like reduction in taxes or duties or due to price agreements do not come into the area of cost reduction as these are not real and permanent reductions in costs).

Cost Reduction
(ii) By increasing productivity: This refers to increase in the volume of output with the expenditure remaining the same. But this should not be achieved at the cost of the characteristics and quality of the product. Areas Of Cost Reduction : o Design o Factory organisation and method o Product planning o Factory layout and equipment o Utility services o Marketing o Finance

Techniques Of Cost Reduction

1. Value Analysis :
Value analysis is the identification of unnecessary cost i.e. cost that neither provides quality, nor use, nor life, nor appearance, nor customer satisfaction. Thus value analysis attacks costs at production stage.

2. Economic Batch Quantity: (EBQ)

EBQ is that point where carrying costs equals set up cost approximately. At this point the total cost will also be minimum.

3. Economic Order Quantity: (EOQ)

EOQ is the quantity fixed at a point where total cost of ordering and the cost of carrying the inventory will be minimum.

Value ...
The Manufacturing or business process is a Value Stream

Any process that delivers value to the customer is a value stream

Techniques Of Cost Reduction

4. Activity Based Cost Reduction : Any resource-consuming activities cause costs. Its aim is to directly control the activities that cause costs, rather than cost. By managing activities that cause costs, costs will be managed in the long run. Cost causing activities :
o o o o

Designing, Engineering Manufacturing Marketing etc.

Techniques Of Cost Reduction

5. Just-In-Time Approach: (JIT) The aims of JIT are to produce the required items, at the required quality and in the required quantities, at the precise time they are required. JIT helps in cost reduction by a. Elimination of non-value-added activities, b. Zero inventory, c. Zero defects, d. Zero breakdowns, e. Single batch ordering.

J.I.T. represent targets and create a climate for continuous improvement & excellence.

Techniques Of Cost Reduction

6. Total Quality Management (TQM)
All business functions are involved in a process of continuous quality improvement. TQM reduces cost by producing the products correctly the first time rather than wasting resources making substandard items and incurring additional expenditure on inspection, rework and scrapping. It helps organisations to achieve their quality goals by providing reports and measures that will improve quality.

TQM aims at a customer-oriented process of continuous improvement that focuses on delivering products or services of consistent high quality in a timely fashion.

Techniques Of Cost Reduction

7. Supply Chain Management : (S.C.M.) SCM attempts to build a cost effective chain beginning with the ultimate customer and links all the previous suppliers under one platform. An effective SCM eliminates most of the activities in between customers and raw material suppliers along with associated costs. Most of the non-core activities are outsourced and hence fixed costs are kept minimal.

In S.C.M. close interaction between the corporate R&D and the suppliers facilitates continuous improvements in product design, process methodologies, etc. resulting in customer value enhancement and cost reduction.

Techniques Of Cost Reduction

8. PERT Analysis: Programme Evaluation Review Technique (PERT) reduces cost by giving an optimum schedule for the activities necessary to complete a project. Some other cost reducing techniques are : 9. Simplification and Standardisation 10. Design analysis 11. Substitute material utilisation 12. Production planning and control 13. Technological forecasting 14. Market research etc.

Non-Conventional Approach
Relook : o Material Cost o Manpower Cost o Cost Management Initiatives o Selling and Distribution o Funding Cost

Non-Conventional Approach
o Material cost Cost reductions thru o E-sourcing

Discovery of new sources Competitive pressures Rationalisation of suppliers Re-Visiting Designs

o Thrust on Value Engineering

Application oriented engineering

o Product Life Cycle Management

Non-Conventional Approach
o

Manpower Cost Right-sizing of Employees - VRS Schemes Optimum utilisation of Manpower o Transition from Machine engagement time to Man-engagement time. o Productivity-linked wage settlements o Adopting new concepts CELL Layout

Stages in Cost Reduction

Cost Positioning Cost Design Cost Management Cost Cutting

Stage 1. Cost Cutting

Cost Cutting involves cuts in spending based on arbitrary criteria.
o Costs are divided into committed and discretionary categories. o Cuts target discretionary before committed; large before small expedient before sensitive. o Performance measured against historical standards.

Limitations of Cost Cutting

o o o o o o o o Impairs critical constraint resources Sacrifices long-term strategic objectives Induces padding of budgets Demoralizes employees & suppliers Reduces customer service Expansion/contraction cycles create waste Influenced by politics not mission Lack of organizational learning

Stage 2. Cost Management

Cost Management involves a systematic approach to cost reduction that involves an understanding of relevant cost drivers.
o Costs are organized by resources, activities, and cost objects. o Reductions achieved by eliminating unused capacity, nonvalueadded activities, and reducing activity cycle times. o Performance measured against long-term target standards.

Standard Vs. Kaizen Costing

Standard Costing
o Goal to meet cost performance standard o Standards set annually o Compare actual with standard costs o Investigate when standards not met o Managers & engineers set standards o Assumes process stability

Kaizen Costing
o Goal to achieve cost reduction standard o Standards set monthly o Compare actual cost reduction with target o Investigate when target cost reduction not achieved o Workers set kaizen standards o Assumes continuous improvement

Stage 3. Cost Design

Cost Design involves an evaluation and redesign of the internal value chain. It seeks to improve the relationship among resources required and work performed to satisfy customer requirements.
o Costs are organized by process and subprocess. o Reductions achieved by eliminating redundancy and conforming to operational strategy. o Performance measured against best-in-class standards of performance.

Stage 4. Cost Positioning

Cost Positioning involves an evaluation and redesign of the external value chain. It seeks to improve the relationship among supply chain members to enhance competitiveness.
o Costs are organized by links in the value chain. o Reductions achieved by consolidation of links, sharing information, better coordination, and exploiting synergies among supply chain members. o Performance measured against strategic objectives such as market share and price targets.

Comparison of Stages
Stages
Basis Objective Time Horizon Perspective Cost Measurement Cost Cutting arbitrary spending cuts Achieve cost reduction targets Short Term Internal classified into committed & discretionary Cost Management understanding cost drivers Satisfy customer requirements Cost Design redesign internal value chain Enhance company competitiveness Long Term Internal organized by links in the internal value chain Eliminate redundancy & conform to operational strategy Best-in-class standards Activity-Based Planning Cost Positioning redesign external value chain Enhance s. chain competitiveness Long Term External organized by links in the external value chain Consolidate links, share information, coordination, & synergies Strategic objectives Strategic Cost Management

Medium Term Internal organized by resources, activities, & cost objects Reduction Methodology Reduce Eliminate unused discretionary, large capacity, NVA & expedient costs activities & reduce cycle times Performance Standards Common Tool Historical standards Standard Costing Long-term standards Kaizen Costing

EMERGING BUSINESS MODELS

o

In the Present Scenario, the very nature of competition will change. Increasingly customers will demand Ever-greater choice, so that products and services are customised for market segments of one customer. Procurement will find new ways of working with suppliers and new ways of working internally. New business models will emerge that organisations must learn to recognise and understand. The key issues o The driving forces o The characteristics of new business models o The keys to success & o The challenges companies face

Five Forces Of New Economy

o o o o o

Globalization of both markets and sources. Open for business 24 x 7. The rapid expansion of internet. Continued evolution of transport services. Service economy.

CHARACTERISTICS OF NEW MODELS

o o o o o

Focus on core activities. Automation/integration. Complexity of relationship. Ubiquitous and real-time information. Organisational structure.

KEYS TO SUCCESS

o o o o

The Supply Chain The Balance of Power The Competitive Landscape Services not Product

Conclusion : Cost Reduction is

Elimination

Reduction

Modification

Bench mark operating parameters to world class companies to achieve it

Questions ?

Acknowledgement & References

o All resources taken from the www are gratefully acknowledged . o http://wiki.answers.com/Q/What_is_the_theory_of_Cost_Control_and_Reduction _in_Managerial_economics o http://en.wikipedia.org/wiki/Cost_reduction o http://www.mbaknol.com/managerial-economics/cost-reduction-in-managerialeconomics/ o http://factory-costreduction.com/

Thank You