Cost Reduction: Meaning, Essentials and Techniques

In this article we will discuss about Cost Reduction:- 1. Meaning of Cost Reduction 2. Cost Reduction Programme 3. Steps 4. Tools and Techniques 5. Advantages 6. Disadvantages.

Contents:

  1. Meaning of Cost Reduction
  2. Cost Reduction Programme
  3. Steps taken for Success of Cost Reduction Programme
  4. Tools and Techniques of Cost Reduction
  5. Advantages of Cost Reduction
  6. Disadvantages of Cost Reduction



1. Meaning of Cost Reduction:

Cost reduction is a planned positive approach to reduce expenditure. It is a corrective function by continuous process of analysis of costs, functions, etc. for further economy in application of factors of production.

The Chartered Institute of Management Accountants, London defines cost reduction as follows:

“Cost reduction is to be understood as the achievement of real and permanent reduction in the unit cost of goods manufactured or services rendered without impair­ing their suitability for the use intended or diminution in the quality of the product.”

The definition given above brings to light the following characteristics of cost reduction:

a. The reduction must be a real one in the course of manufacture or services rendered. Real cost reduction comes through greater productivity.

Greater productivity may be through:

(i) obtaining a large quantity of production from the same facilities;

(ii) using materials of lower price and of different quality without, however, sacrificing the quality of the finished product, i.e., reducing cost through the process of substitution;

(iii) simplifying the process of manufacture without sacrificing the quality of the finished product;

(iv) changing features of the product suitably without sacrificing the quality of the product etc.

b. The reduction must be a permanent one. It is short-lived if it comes through reduction in the prices of inputs, such as materials, labour etc.

The reduction should be through improvements in methods of production from research work.

c. The reduction should not be at the cost of essential characteristics, such as quality of the products or services rendered. Thus, cost reduction must be a genuine one and should aim at the elimination of wasteful elements in methods of doing things. It should not be at the cost of quality.

Cost reduction is a continuous process of critically examining various elements of cost and each aspect of the business (i.e. procedures, methods, products, management including market and finance etc.) is critically examined with a view to improving the efficiency for reducing costs.

Every plan of cost reduction proceeds with this assumption that there is always scope for cost reduction. A continuous research is made into various areas for finding out the best possible methods of performance for ensuring minimum possible costs.

The reduction in costs should be real and permanent. Reduction due to wind falls, changes in government policy like a reduction in taxes (or duties or due to temporary) and measures taken for tiding over financial difficulties do not strictly come under the purview of cost reduction.

Broadly speaking reduction in cost per unit of production may be effected in two ways:

i. By reducing expenditure but the volume of output remains constant.

ii. By increasing production viz. increasing the out turn, but the level of expenditure remains unchanged.



2. Cost Reduction Programme
:

Cost reduction aims at improvement of human efforts. In a business organisation several persons are engaged in diverse activities. It may be a short-term or long-term under special problems such as reduction in profit, specific inefficiencies in certain spots (or fall in production).

A special cost reduction programme is geared into action to meet the situation and improve the position. Long-term cost reduction plans improve major reductions in costs and may involve capital expenditure.

Briefly, a programme of cost reduction consists of the following:

a. Numerous centres or points where costs are incurred are located and grouped according to departmental responsibility.

b. Each such point or group or points is then submitted a value analysis scheme to determine whether optimum efficiency has been achieved in its performance or whether there is a norm for cost reductions.

c. Suitable techniques are, therefore, applied to reduce costs. No cost reduction programme can be effective unless a joint effort is made by all the departments concerned and the plan is linked with responsible management. Allocation of responsibility of the various cost reduction levels of management is an important requirement for control of cost reduction of the operation and spheres under his control.

The programme for cost reduction should be clearly defined and responsibilities delegated. Thus, each executive should be aware of his role in the over-all scheme of cost reduction and of the function he has to perform.



3. Steps taken for Success of Cost Reduction Programme
:

a. A cost reduction programme must be appropriate to the organisation.

b. A cost reduction programme should not be taken as a onetime activity. It is a continuous activity aimed at reducing cost continuously by innovating new ideas from time to time. Cost reduction is a corrective function based on the philosophy that every human action can be improved by continuous effort.

c. Cost reduction should not be done by arbitrary cost slashing. It should be real and permanent reduction in cost.

d. To make cost reduction programme acceptable to the employees of the organisation, the example of cost reduction should be first set by top executives. The success of cost reduction programme depends upon the co-operation of all persons involved in the programme.

e. Persons giving innovative ideas for cost reductions should be suitably rewarded by giving raise in wages and salaries, promotion and special awards.

f. A cost reduction programme should not merely take into consideration reduction in cost but it should also consider all other factors (i.e. social and legal aspects) which will be affected by the programme of cost reduction.

g. A cost reduction programme should be evolved with the idea that even the most efficient firms incur unnecessary costs, that is, there is always scope for cost reduction in every firm.

h. There should not be any overlap between the cost reduction measures, that is, there should not be double counting of cost reductions.



4. Tools and Techniques of Cost Reduction:

The various techniques and tools used for achieving cost reduction are practically the same which have been suggested for cost control.

Some of these are:

(i) Budgetary control,

(ii) Standard costing,

(iii) Standardisation of products and tools and equipment’s,

(iv) Simplification and variety reduction,

(u) Improvement in design,

(vi) Material control,

(vii) Labour control,

(viii) Overhead control,

(ix) Production planning and control,

(x) Automation,

(xi) Operation research,

(xii) Market research,

(xiii) Planning and control of finance,

(xiv) Value analysis,

(xv) Quality measurement and research,

(xvi) Cost benefits analysis.

(xvii) Contribution Analysis

(xviii) PERT

(xix) Job Evaluation and Merit Rating.



5. Advantages of Cost Reduction:

Cost reduction causes a definite increase in margins. The saving in cost may also be passed to consumers in the form of lower prices or more quantity in the same price. This will create more demand for the products, economies of large scale production, more employment through industrialisation and all-round improvement in the standard of living.

Government may also stand to gain by way of higher tax revenues. Increased competitive strength to the industry stimulates more exports. Thus, profit is increased by reducing the costs, it can be utilized for expansion of the organisation which will create more employment and overall industrial prosperity.

Cost reduction is essential of a product has to withstand its global market. Brand loyalty is fading away fast. Now-a-days consumers have become price and quality conscious. Hence cost reduction is the key for global competitiveness.

There are many advantages of cost reduction. Some of these are:

a. Cost reduction increases profit. It provides a basis for more dividends to the shareholders, more bonuses to the staff and more retention of profit for expansion of the business which will create more employment and overall industrial prospects.

b. Cost reduction will provide more money for labour welfare schemes and thus improve men- management relationship.

c. Cost reduction will help in making goods available to the consumers at cheaper rates. This will create more demand for the products, economies of large scale production, more employment through industrialisation and all-round improvement in the standard of living.

d. Cost reductions will be helpful in meeting competition effectively.

e. Higher profit will provide more revenue to the government by way of taxation.

f. As a result of reduction in cost, export price may be lowered which may increase total exports.

g. Cost reduction is obtained by increasing productivity. Therefore, a developing country, like India, which suffers from shortage of resources, can develop faster if it makes the best use of resources by increasing productivity.

h. Cost reduction lays emphasis on a continuous search for improvement which will improve the image of the firm for long-term benefits.

According to G. Kantharaj,

“In the particular context of a developing economy, it becomes predominantly important to emphasize on Cost Reduction in agriculture, industry, public administration, etc. Cost Reduction cannot be ushered in by a magic wand. Cost reduction is everybody’s concern. ……. The motto of every industry and every organisation should be to produce more goods and to render efficient services. Spiraling up of prices and inflationary trends seem to have reached a Point of No Return in the country. The situation cannot be salvaged, unless every responsible individual wages a war vehemently to curtail the wastages and delays in his own jurisdiction.”



6. Disadvantages of Cost Reduction:

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

a. 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.

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

c. 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.

d. There may be a conflict between individual objective and organisational 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 organisation as a whole.


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