Cost Reduction Analysis

What you need to know about Cost Reduction Analysis

Cost reduction analysis is the process used by companies to reduce their costs and increase their profits. The strategies of different companies vary according to the products or services that they offer. Every decision made in the product development process affects the costs.

It is a common practice that companies launch a new product without focusing on how much will be the value. But when competition increases and prices of products or services become a major differentiator in the market, the price suddenly becomes very important.

Cost control regulates the action to keep the cost elements within the set limits. Cost reduction, on the other hand, refers to the actual permanent reduction in the unit price. It will be useful to know the difference between cost control and cost reduction.

Cost Control

Cost control is the process that is focused on rationalizing the total value by employing competitive analysis. This practice works to maintain the actual price according to the established policy. It should make sure that the operational cost must not go over the pre-determined cost.

Cost control involves a series of functions, starting from the preparation of the budget concerning the operation, evaluation of the actual performance, computation of the variances between the actual costs and the budgeted value, and finding the reasons for the same. The last function is implementing the necessary actions to correct the discrepancies.

The major techniques in cost control are standard costing and budgetary control. Cost control is a continuous process as it helps in the analysis of the causes for variances which control wastage of materials, embezzlements, and so on.

Cost Reduction

Cost reduction analysis as a process aims to reduce the unit cost of a product or service the company offers without prejudice to its quality through the use of new and improved methods and techniques. Cost reduction ascertains other ways of reducing the cost of a unit. It aims to realize savings in the per-unit cost of the product while maximizing profits for the organization.

Cost reductions aim to lower the unnecessary expenses that may occur during the production, storage, sales, and distribution of the product.

The following are the major elements of identifying  cost reduction:

  • Savings in the product’s per-unit cost
  • Savings are non-volatile 
  • No compromise with the product quality

The tools for cost reduction analysis are:

  • Research on sales and quality operation  opportunities
  • Improving the design of the product 
  • Evaluation of job performance, including the best merit rating
  • Reduction of variety

Five Steps in Cost Reduction

Many cost optimization programs failed in delivery or acceptance. There are some products that regardless of how the costs are cut, the returns are still not viable, either because customers do not see their value or there is always another company that can offer them cheaper or free opportunities. The main focus of cost reduction analysis is on value potential instead of cost or volume. There is also the point where the winning costs have been accomplished, leaving plenty of far-reaching choices on the horizon. The wins may mean withdrawing from non-viable markets, elimination of certain processes through automation, and a need for a significant shift in the business model. 

Making the correct choices and ensuring business success needs a rethinking of strategy and to see if they will align. The five steps focus on optimization instead of merely cutting value to help and ensure that the business is competitively relevant while maximizing the potential.

1. Start with strategy

The cost reduction analysis should start with a clear picture of the strategy to make sure that there is a consistent understanding of the organization. A cost reduction analysis cannot be carried out if the business strategy is not fully understood because it may not be clearly defined. The entire organization should be on the same page with regards to its business strategy, otherwise, any attempt by one unit to institute cost reduction will not be understood and will not gain any help and support from the other units.

2.  Align costs to strategy

The cost reduction analysis should look across the whole organization, differentiating the critical good costs from the non-essential bad costs. If the strategically-critical good costs are necessary to maintain the high quality of the products or the services, they should not be touched. It should be the non-essential bad costs that should be reviewed for possible reduction or, when necessary, elimination.

3.  Aim high

Aim high when working on new ways to radically optimize the cost base. The company can be bold, creative, and brave in the use of innovation and technology to help you find ways of reducing value that will make the product or service competitive while at the same time maintaining its high quality. 

4.  Set direction and show leadership

The manager who is tasked to do the cost reduction analysis must deliver cost optimization as a strategic, business transformation program. Cost reduction should not be a short-term thing that will be abandoned when working with another product. The cost reduction program should be a company-wide endeavor that is aimed to transform the way business is conducted.

5.  Create a culture of cost optimization

Ensure that cost optimization will be embedded as a culture of ownership and incentivize continuous improvement even if it means for free. The need to search for ways to reduce costs must be part of the company culture that should trickle down from the top management to the workers on the production floor.  Everyone should be looking for ways to cut costs while ensuring that the high quality is maintained all the time. It will make the company’s products popular with consumers as they are highly competitive at the same time.

The main priority in making cost reduction is the targeting of resources in areas where they earn the best return, instead of simply cutting the value in itself. The start point is the differentiation of the capabilities required to spur profitable growth from low-yielding processes and inefficient techniques. Good costs are capabilities that will differentiate your business, move it closer to the customer base, and allow it to develop high-value propositions. Identifying and focusing on things that matter to customers in the current market will ensure the success of your cost reduction strategy.

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