Cost reduction

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Cost reduction programs and Lean in cost reduction strategies

Cost Reduction programs are a frequent feature in many businesses during challenging economic times or during significant change in an industry. Lean tools and culture form an important backbone to most well-structured and strategic cost reduction programs.

Most businesses embark on such programs to conserve profit margins or offset significant drops in sales and profitability. These businesses operate in a reactive mode and are always playing catch up to the most efficient players which engrain a lean and efficiency discipline to every facet of their operation and business. This enables them to be profitable at every stage of the business cycle.

Nevertheless cost reduction programs have become more common as the business cycles shorten and competition becomes more intense in many industries.

Cost reduction strategies - How to do it?

Cost reduction programs can take many forms and the strategy should be set right from the start depending on the type of business its complexity and the economic forces the business is facing.

Choosing the right strategy is also important in the early stages as some decisions cannot or are too costly to be undone.

A common strategy starting point is to refer to the most basic rules of efficient business and Lean manufacturing culture, which tells us that we must maximize our output from each unit of inputs into a productive process. This leads to a review of the cost structure of the business. A common solution to cut costs is to reduce employees, but this too early and without the correct strategic review can set up the business for failure or prove expensive in years ahead. This has been evident in the finance industry when many large banks reduced head count during the financial crisis only to add workers quickly two years after chasing a rebound in business.

Where to start?

A sound strategy is to take an overall in depth view of the major cost components of the business

In most developed countries Raw materials for production, energy and man power are the most significant items in cost structures for manufacturing industries.

Cost of raw materials bought for production can also provide substantial benefits if alternate suppliers are researched and better supply contracts negotiated. Some raw material suppliers maybe cheaper overseas or in another part of the country, a delivered cost analysis or import parity pricing analysis should be done on major raw material requirements to evaluate alternatives.

Can substitutes be found for some raw materials? Some fillers or raw materials can be substituted for more cost effective solutions and still deliver the required characteristics in finished products. In some industries raw materials have been substituted for waste products from other industries. An example of this is in the Gypsum industry where mined natural gypsum has been substituted by synthetic gypsum which is a byproduct of flue gas scrubbers in coal fired power plants. In some countries the cost of this raw material is very low due to the abundant supply.

Can packaging be improved or economized? Packaging can deliver substantial cost benefits such as reduced raw material and manufacturing costs. Several home ware and appliance companies have improved their packaging to yield substantial financial and environmental benefits.

The drive to invest in energy efficient plant and equipment is driven by the cost of energy. Kilns, dryers and calcining processes can be fitted with heat recovery or heat exchanger systems which depending on the application can provide substantial savings. Choice of energy in some countries maybe influenced too by availability of infrastructure such as gas pipelines or availability of cheap energy sources.

Specialist firms can be contracted to look at energy efficiencies in burners and overall energy use in a production process or business. Business leaders must look at the viability of renewable and alternate energy sources as well which can provide other benefits to the business and wider community.

Is raw material being wasted … where? And how is it being wasted?

The elimination of waste is at the core of Lean manufacturing and many tools exist to identify and eliminate wasted resources. Our Lean manufacturing waste focus page can further explain these.

Human Resources

Create an organizational structure from scratch; do not refer to the current structure of employees or focus on current conditions. The key is to focus on current and near term future needs to be able to effectively compete in the marketplace. In many industries knowledge and highly skilled manpower is essential to attain a competitive advantage. Each role in the organization chart should have two to three key skills beside it. These skills should be possessed by the person filling in that role.

Review the current organization structure and people in each role versus the ideal structure and take note of skills gaps and needs for the ideal structure. Could people in current roles possess skills that could be used in another area? Could junior team members fill in other higher level positions? Or are people in roles which are no longer relevant to the business’ operations?

This review should lead to a list of changes that could be implemented to achieve a more efficient personal cost structure. Any dismissal should be strategically thought about and well planned. Rushed decisions can prove costly long term.

Other areas to look at ...

A review of other costs should also be performed, even things such as office location and office space can yield cost savings and boost productivity, refer to the Lean office page for more on this topic.

Finance department responsibilities can also hold hidden savings such as credit terms to customers and payment terms to suppliers. These can help boost cash flow, reduce company interest expenses and enable the company to become more liquid.

Many executives and business leaders will have a preferred cost reduction framework; these can vary in strategy and approach due to different experiences in the corporate world.

Although every industry and business is different, managers and operations executive embarking on their first cost reduction program or restructure should initially focus on the areas of raw materials and inputs (price, quality and waste), supply and logistics expenses, energy and personnel expenses. The major pitfall in any restructure or cost reduction program is making cost cutting decisions or just reducing human resources that may hamper the business in years to come.

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