Process Cost Reduction - An Example

“We have to cut budgets by 10%”. This dreaded statement is all too familiar these days, but is no less
intimidating for the department manager faced with its implementation. How do you approach it?

We recommend approaching this problem the same way you would approach any process problem. Do
a through study of the current situation, develop alternatives, evaluate your options, select the best
approach and implement it, gathering feedback as you go.

So how do you start? Well, cost is generally calculated using the traditional accounting approach. This
approach lists all budget items by type of expense, such as the following example:

Salaries $267,000
Benefits cost $ 59,000
Postage $ 17,000
Supplies $ 18,500
Telephone $ 12,000
Equipment $ 6,500
Travel $ 3,000
Miscellaneous $ 4,000
_______________________________________
Total Budget $387,000

A 10% budget reduction means $38,700. Where do you get that kind of reduction from the items on
this list? Unfortunately, it usually means someone must lose their job. But how? Who? Who does the
work (which hasn’t changed)?

A better way to approach the problem is to take a look at the work done by the department and see
what opportunities exist to do the work better. To start, take a close look at the work being done and
how long it takes. The goal here is to assign actual costs for each of the processes involved.

Assumptions for our example (substitute your own numbers here):

• Salary and benefits divided by (2,080 hrs. x 5 people) = $26.12/ hour fully loaded wage rate.

• Receive orders @10 minutes per order = 5,833 hours at $26.12/hour, plus supplies, telephone
etc. (be sure to use only those costs used in this process, which is a portion of the budgeted total).

• Resolve errors @ 30 min each – be sure to add in any other resources consumed in this process
(telephone, mail, etc.)

• Generate confirmations @ 5 minutes each - be sure to add in any other resources consumed in
this process (telephone, mail, etc.)

• Answer inquiries @ 20 min each - be sure to add in any other resources consumed in this
process (telephone, mail, etc.)

• Generate reports @ 1 hour management time each. - be sure to add in any other resources
consumed in this process (telephone, mail, etc.
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After a review, we discover process costs that look like the following:

• Receive orders (35,000/yr) $172,400

Open mail
Review order
Input into order system

• Resolve errors (6,300/yr) $ 97,300

Missing information
Incorrect data
Input corrected data

• Generate Order confirmations (35,000/yr) $102,000

Print
Fold
Insert
Affix label
Mail

• Answer inquiries (500/yr) $ 14,060

• Generate reports (3/mo) $ 1,240
_______________________________________________
• Total $387,000 ...

From this information, you have something to work with. Where would you start? For me, the answer
is obvious. What is causing the errors that cost $97,300 per year to fix? If we can find out and fix that
problem, we will have our budget savings identified. However, we also have an opportunity to look at
other areas. Is there a better way to receive orders and generate confirmations? Can the inquires be
categorized and FAQs issued? Do the inquiries result from the high error rates? Nevertheless, we can
now focus on cost reduction opportunities.

Of course, we know that we eventually must translate process savings back to budget items. That
probably means not filling the next vacant position, taking on more work for the same people (after
unneeded work has been eliminated, of course), or re-assigning one or more people to other areas
where they are needed.

The point here is that we need to actually reduce work, not just people. Simply eliminating people is
the lazy manager’s way of cutting budgets. Of course, the survivors have to work harder because work
was not eliminated!!

Using process studies, it is not particularly difficult to assign actual costs to performing the work. Look
at the time it takes to do each of the tasks, add other resources consumed in the process (don’t forget
management overhead cost) and multiply by the number of instances and the total process cost is
revealed.

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Key Points:

1. The Accounting view is where costs must ultimately be realized. The accounting view is
primarily focused on cash costs, not so much on non-cash costs.

2. Process view is primarily focused on the cost of a business process. This is where the costs are
actually incurred.

3. Resources are allocated to a process.

4. Begin by examining the 10 functions, then break out business systems. Break it down to the
smallest measurable process.

5. Look at inputs (resources) consumed during the process.

6. Measure outputs from the process.

(I think we need to add . . .)

Methodology for translating process cost savings to actual dollars-spent savings:

1. .

2. .

3. .

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