Cost Reduction: Meaning, Definition, Cost Control, Techniques, Process, and Advantages

Cost reduction is the achievement of real and permanent reduction in unit cost of products manufactured. It therefore continuously attempts to achieve genuine savings in cost of production, distribution, selling and administration. It does not accept a standard or budget as impenetrable or fixed, it rather challenges the standards or budgets continuously to make improvements in them.

“Cost reduction” is a continuous process of critical cost examination, analysis and challenge of standards. In this each aspect of businesses such as products, process, procedures, methods, organization, personnel etc., are critically examined and reviewed with a view of improving efficiency and effectiveness and reducing the costs.

Contents

Introduction to Cost Reduction
Meaning of Cost Reduction
Definition of Cost Reduction
Features of Cost Reduction
Cost Reduction Cell and Cost Reduction Committee
Ways to Achieve Cost Reduction
Reduction in Variety of Products
Techniques of Cost Reduction
Cost Reduction Programme
Areas Covered by a Cost Reduction Programme
Difference between Cost Control and Cost Reduction
Dangers to be Avoided in Cost Reduction
Value Analysis as a Tool
Benefits of Cost Reduction
Advantages of Cost Reduction
Merits and Demerits of Cost Reduction
Difficulties in Cost Reduction

What is Cost Reduction: Meaning, Definition, Cost Reduction, Process, Features, Techniques, Cost Reduction Programme, Difference, Value Analysis, Benefits, Difficulties and More

What is Cost Reduction – Introduction

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It attempts to excavate the potential savings buried in the standards by continuous and planned efforts. Cost control lacks that dynamic approach, it usually deeds with the variances leaving the standards intact. Whereas cost control seeks adherence to standards, cost reduction is a challenge to the standards themselves. In other words, the aim of cost reduction is to see whether there is any possibility in bringing about a saving the costs incurred—materials, labour, overheads etc.

Costs may come down if prices of inputs, such as materials, come down. But usually, in such a case, sooner or later the price of the finished product also has to be reduced and, therefore, such cost reduction does not benefit the producer much—a reduction in the price of groundnut seeds will mean a reduction in the price of groundnut oil.

Cost reduction begins where cost control ends. Cost control seeks to bring the actuals in harmony with the predetermined targets. If this happens, assuming no increase or decrease in costs, the profit margin becomes more or less fixed at a particular level of sales. However, this is easier said than done. In actual practice, prices may fluctuate.

Alternatively, sales may decline due to various reasons. In all these cases, the business must aim at maximising profits at the same level of sales by reducing costs. Cost reduction seeks to achieve a permanent reduction in cost, without impairing the quality of the product. It is a planned way of improving the efficiency of business operations.

Cost Reduction – Meaning

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From the above, following points should be noted about cost reduction:

1. It represents ‘real and permanent’ reduction in unit cost of goods manufactured and services rendered. In other words, cost reduction is confined to genuine savings in costs of manufacture, administration, distribution and selling.

This real and permanent reduction in unit cost maybe brought about by the elimination of wasteful and non-essential elements in design of products and from techniques and practices carried out in connection therewith.

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Reduction in cost to consumer as a result of reduction in taxation or Government design or price agreements will not be covered by cost reduction. These are not real and permanent reductions in cost due to planned efforts. Cost reduction does not include windfall reduction or fortuitous reduction.

2. Cost reduction assumes that product or service will retain its essential characteristics and quality. If reduction in cost results in deterioration of quality, it will not be covered by the term Cost Reduction.

Cooperation and teamwork are essential features of any planned approach to cost reduction. Direct saving of cost is the most tangible objective of cost reduction, but it profoundly influences the wide sphere of business as a whole.

Cost Reduction – Definition

Cost reduction is “the achievement of real and permanent reduction in the unit cost of goods manufactured or services rendered without impairing their suitability for use intended.” CIMA (England).

Cost reduction may be effected in two ways-

(i) by reducing the cost per unit; and

(ii) by increasing productivity. Cost reduction has to be effected within the organisation.

If it is due to external factors such as reduction in taxes, government subsidies, etc., it will not come under purview of cost reduction. Cost reduction will improve the profitability. Or else, the savings in cost may be passed on to the consumer by way of lowering selling 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. If the profit is improved by cost reduction, it can be utilised for expansion of the concern which will create more employment.

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Value analysis, Value Engineering and KAIZEN (Continuous Improvement) are also to be implemented for cost reduction. It should be observed from the definition that reduction in costs should be real and permanent.

Any reduction in costs due to temporary measures like windfall receipts or change in Government policies etc., is not coming within the purview of cost reduction. Secondly, the cost reduction measures should not have an adverse impact on quality. If cost reduction also results in impaired quality, it is not cost reduction in real sense.

Thus cost reduction can be brought about –

(1) By reducing expenses without reducing the volume.

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(2) By increasing volume without any increase in expenses.

Cost Reduction – Top Features

The following features of cost reduction:

(a) Reduction in Unit Costs:

The aim of cost reduction is to bring down the cost per unit of a commodity or service. Unit cost may come down if the prices of input factors also come down. But, in that case, the reduction will not be real and permanent. Sooner or later, the prices of inputs will rise owing to limited supply for natural causes.

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Consequently, cost per unit of the finished product also rises. What is therefore, needed is a change in the methods of production, new design, increase in productivity, new standards, etc.

(b) Reduction to be Permanent:

Reduction In unit cost should not only be real but permanent also. A temporary reduction in the unit cost has no significance if, in the near future, cost per unit goes up for whatever reason.

(c) Use Value to be Unaffected:

Any article, produced with the available scarce resources has not only exchange value but use value also. Its value in exchange is dependent upon market forces. However its value in use depends entirely upon its quality. If, therefore, an article is to be put to the intended use, its quality should be good enough. Cost reduction should not be at the expense of its quality. Any reduction in its cost should not impair or affect the suitability of the article for the intended use.

Special Features:

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1. Unit cost is required to be reduced by reducing expenditure with respect to a given volume of output.

2. Unit cost is attempted to be reduced by increasing production, i.e., production per unit of input (e.g., material, labour hour, per employee). It implies enhancement in the rate of yield or output, expenditure remaining the same.

Cost Reduction Cell and Cost Reduction Committee

Cost reduction involves real and permanent reduction in costs. It is a continuous process. Hence, it requires cooperation of people at all levels. The environment in the organisation should be made so congenial that healthy discussion can take place at all levels of management. The criticisms should be accepted in right spirit with honesty and grace by all, so that corrective action may be taken in time.

This requires the formation of a separate Cost Reduction Cell within the organisation. The Cell functions under the supervision and direction of a high-powered authority known as Cost Reduction Committee.

The committee consists of responsible executives from various functions such as purchase, planning and design, production, sales, distribution, finance, research, etc. The committee should chalk out a proper cost reduction programme and fix up responsibility of the executives to review the actual performance from time to time.

The functions of cost cell can be enumerated as follows:

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(i) It collects cost data from different departments.

(ii) It invites suggestions from different executives for improvement and reduction of costs relating to their areas.

(iii) It creates cost reduction environment in the organisation by emphasising and explaining to the workers the importance of cost reduction and the benefits which will accrue to them.

(iv) It invites employees to participate in framing the schemes for controlling the costs at the point of their incurrence.

(v) It identifies areas where cost reduction is

(a) necessary;

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(b) desirable; and

(vi) It frames policies, guidelines and issues directives for bringing changes in product designs, introducing new products and new designs in consultation with technocrats for reducing the cost of production without impairing the quality.

(vii) It frames policies regarding reduction of costs in administrative and distribution divisions without adversely affecting their efficiency.

Cost Reduction Committee:

To ensure that the cost reduction scheme works properly in an organization, a cost reduction committee may be formed. This committee is entrusted with the task of formulating a detailed and well-coordinated plan for cost reduction.

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In a large organization, the departmental heads and top executives form such a committee, while in a small concern, any one of the executives may be entrusted with the responsibility of ascertaining the areas of cost reduction.

8 Ways to Achieve Cost Reduction

Cost reduction can be achieved through the following ways:

(a) Minimization/elimination of wastes.

(b) Increasing productivity of labour.

(d) Better bargain on other elements of costs.

(e) Adopting Economic Order Quantity for purchases.

(f) Production Planning and control.

(g) Mechanisation and automation of procedures and processes.

(h) Adoption of Enterprise Resource Planning (ERP), if possible.

Reduction in Variety of Products (With Reasons)

It is a common knowledge that larger is the variety of Products more is the cost involved. A large variety of products means more investment in terms of equipment in both fixed and working capital and larger sales efforts which all push up the cost of production and sales.

The reduction in variety of products will lead to cost reduction because of the following reasons:

Reason # (i) Standardisation:

Reduction in variety of production will lead to standardisation of products. The term standardisation means that the product should be a standard one i.e. made of standard materials and components having a standard design and a standard cost.

The standardisation of products will have the following advantages:

(a) It will reduce investment in inventories since only few standard products will have to be kept in stock.

(b) The products can be manufactured in larger quantities in each process as a result of increase in the size of each batch.

Reason # (ii) Simplification:

Reduction in variety of products will lead to simplification of the production process. A simplification of production process involves less of machine setting time, longer runs, increased productivity and lower cost of inspection. As a matter of fact, standardisation will automatically lead to simplification of the production process.

Reason # (iii) Quality Control:

Standardisation involves giving a standard product to the consumer. This means that quality of the product will not be allowed to get deteriorated but rather it will continuously be retained and, if possible, improved. This will require inspection of the product at different stages of production so that defects may be remedied at the earliest stage. It will bring economy in reducing the cost in terms of reduction in the number of defective units.

Cost Reduction – Important Techniques

The following are some important cost reduction techniques:

(i) Budgetary Control;

(ii) Standard Costing;

(iii) Inventory Control;

(iv) Job Study, Works Study and Motion Study;

(v) Job Evaluation and Merit Rating;

(vi) Reduction in Variety of Products;

(vii) Value Analysis.

(viii) Standardisation of products and tools and equipment;

(ix) Improvement in design;

(x) Material Control;

(xi) Labour Control;

(xii) Overheads Control;

(xiii) Quality Control;

(xiv) Market Research;

(xv) Production Planning and Control;

(xvi) Operations Research;

(xvii) Automation; and

(xviii) Design Improvement.

Cost Reduction Programme – Requisites, Fields and Aims

Cost reduction programme aims at improvement of human efforts at all levels of the organisation which help in reducing costs. It may be a short-term or a long-term programme. A short-term programme is undertaken for sorting out immediate problems; e.g., a problem involving controlling wastages and inefficiencies in a certain department which are likely to push up the cost and reduce the profit margin.

Long-term cost reduction programme involves major reduction in costs and may also require capital expenditure. It involves setting up of the target return on capital employed and developing a scheme for its achievement through various cost reduction measures.

The following are the essential requisites for successful implementation of a cost reduction programme:

(i) There should be a separate cost reduction cell responsible for proper planning and implementation of the cost reduction programme.

(ii) There should be an efficient system of management reporting at all levels of management.

(iii) The programme should have support from the top management. It is a continuous process and, therefore, should not be allowed to degenerate into a routine affair.

(iv) There should be an operation and research procedure.

(v) There should be close co-operation amongst different executives concerned with the programme. Each departmental head should be given a list of the areas where he is expected to effect economies in cost. Moreover, he should also be encouraged to put forward his own suggestions for improvement.

(vi) There should be regular follow-up to the plan and continuous appraisal of the programme performed with the actual cost reduction performance.

(vii) The plan should not be confined only to reducing costs but should also examine whether an expenditure is really required or not. In other words, there should be efforts to eliminate uneconomic and unnecessary activities.

Fields Covered by Cost Reduction Programme:

The following are the specific areas which are covered by a cost reduction programme:

1. Product Design:

Designing the product is a pre-requisite to its production. It is, therefore, necessary that proper care is given to designing the product to effect economies in the cost of materials, labour, tools and equipment. The technique of value analysis is greatly helpful in designing the product. Product should be designed in a manner that it gives the maximum value at the minimum cost.

Product designing may be required either for introducing a new design or improvement of the existing design. The introduction of a new design is advantageous but risky since the new venture may or may not be successful. Hence, a careful analysis of its cost elements (i.e., materials, labour and expenses) and its marketability is necessary.

The venture concerning improvement of the existing design is advantageous since the reputation gained by the old product is likely to be enhanced and improved further through improved design of the product. The improvement should be in the direction of making the product less costly; more utility-oriented, attractive and durable.

2. Production Planning:

Production planning can also greatly help in cost reduction. The location and lay-out of the factory have significant influence on cost. Of course, the factory location cannot be changed so easily but its lay-out can be organised on more scientific lines so as to reduce the cost of production.

The Chartered Institute of Management Accountants, London, in its publication on cost reduction, has laid down the following principles for developing a sound production planning system:

(i) Production planning should be based on realistic and detailed sales forecast.

(ii) Efficient production system requires fullest possible employment of suitable production facilities, elimination of unnecessary movement and handling of materials provision of adequate working instructions, drawings tools, etc., and the most economical storage of stocks.

The design of a production system is dependent on its location because the resulting physical factors influence lay-out and also because of the fact that the location determines operating and capital costs.

In so far as physical factors of plant design are concerned, location may determine the following costs:

(a) Whether or not power is purchased.

(b) The extent of air conditioning or humidification required.

(c) Whether local sub-contracting facilities for components are available or whether provision for the manufacture of components has to be made in the factory.

(d) Storage space requirements depending on the availability of raw materials in the vicinity.

(e) The type of transportation facilities available for receiving raw materials and despatching finished goods, etc.

From the standpoint of costs, transportation costs, labour costs, costs of land, construction cost, etc., will be influenced by the location of the factory.

Even if an existing company intends to start an additional factory, the addition of a new plant is not a matter of determining location independent of the location of the existing plants. Establishment of a new plant may involve re-allocation of capacities so that the combined production and distribution costs are minimised.

Plant layout aims at developing a production system that meets the requirements of capacity and quality in the most economical way. Under ideal conditions of manufacture, plant and manufacturing facilities will be laid down after due consideration of all the factors, tending to reduce waste of time, effort, material and resources to the minimum possible level. Easily available and most suitable equipment should be obtained and utilised to the maximum possible extent.

Any dislocation of production occasioned by change of layout may lead to increased costs. Such dislocation can be averted by initially planning the layout in the best possible way. The production control department should keep abreast of the technological developments and recommend the use of the most suitable and economical type of plant and equipment.

(iii) The assessment and coordination of equipment, labour and material requirements demand the formulation of a complete operation sequence for all products the setting up of material standards and the establishment of reliable process time by the use of work measurement techniques.

(iv) Efficient production control and economic manufacture require careful determination of the lot size according to nature of methods of production employed.

(v) Machine loading and labour requirements should be related to full capacity available. Where the idle capacity is found to exist, efforts should be made to ensure its economics utilisation, say, by the introduction of a new product.

(vi) The production plan once formulated should be used as a measure of the effectiveness of actual performance with a view to correcting the unfavourable divergences as they occur. It should nevertheless be flexible enough to cope with essential changes arising from changed conditions.

(c) Direct Materials Cost Reduction:

Direct materials generally constitute 50% of the cost of a product.

The following steps may be helpful in reducing material costs:

(i) Control should be exercised on purchasing of raw materials. They should be purchased in economic lost at economic prices from reliable dealers at appropriate times. The adoption of the Japanese Just in Time (JIT) technique may greatly reduce the material costs.

(ii) The various inventory control techniques, viz., fixation and observance of inventor,’ levels (maximum, minimum and reorder levels) of inventory, ABC Analysis, Ageing Schedule; Perpetual Inventory System followed by continuous stock taking, etc. should be adopted.

(iii) All efforts should be made to avoid/minimise losses and wastages of raw materials. Economy should also be affected in handling cost of raw materials.

(d) Direct Labour Cost Reduction:

Direct labour constitutes second important element of the cost of a product. Cost reduction in labour is possible through proper organisation and functioning of the personnel, works study and engineering departments. The personnel department is concerned with finding out the right man for the right job and the right job for the right man.

While the engineering and works study department is concerned with job studies, time studies and motion studies. All these functions go a long way in reducing costs and therefore all efforts should be made to discharge them with the intention to increase the productivity and reduce costs.

(e) Overheads Cost Reduction:

The term overheads includes factory overheads, office overheads and selling and distribution overheads. Considerable saving can be achieved in the overhead costs through cooperation of the concerned executives at different levels and creating a sense of cost consciousness amongst them as examined below.

The reduction in administrative costs whether in factory, office or selling and distribution divisions can be achieved through the following measures:

(i) Staff can be reduced by having evaluation of jobs.

(ii) Utilisation of machinery and equipment can be improved through systematic supervision.

(iii) Productivity of workers and executives can be increased through smooth flow of work.

(iv) Expenditure on printing, postage and telephone can be reduced by exercising appropriate control measures.

Similarly, selling and distribution costs can be reduced by examining the following aspects:

(i) Whether the channels of distribution are efficient and economical.

(ii) Whether distribution and selling methods ensure promptness.

(iii) Whether there is an effective system of sales promotion.

(iv) Whether the market research is adequate.

(v) Whether market methods both for home and export trade are satisfactory.

(vi) Whether there is many possibility of reducing the selling and distribution costs without impairing the efficiency of the sales division?

(f) Finance Cost Reduction:

Finance is also an important area where cost reduction is possible through the following measures:

(i) Control over utilisation of finance meant for both working capital and fixed capital needs.

(ii) Proper evaluation of investments in new projects.

(iii) Appropriate control over capital expenditure.

(iv) Profitable employment of capital with the objective of getting maximum return.

Aims of Cost Reduction Programme:

Cost reduction programmes aim at:

1. Avoiding wasteful expenditure

2. Developing cost consciousness among employees

3. Developing efficient operating procedures

4. Improving the overall efficiency of organisational work.

In order to achieve these objectives, the cost reduction programmes must be undertaken systematically. Employees must be encouraged to participate in the programmes actively. Priorities have to be outlined in advance so as to arrive at the sequence in which cost reduction efforts must be made in different areas.

Cost reduction programmes, generally, cover the following areas –

(i) Design,

(ii) Factory organisation and method,

(iii) Product Planning,

(iv) Factory layout and equipment,

(v) Utility services,

(vi) Marketing,

(vii) Finance

(viii) Office operations etc.

The cost reduction programme in respect of three important Office Operations may involve the following steps:

(I) Stationery and Supplies:

1. Use light-weight papers for office correspondence and records.

2. Letterheads should be made available in two sizes—half size for short letters and full size for normal letters.

3. Use obsolete letterheads and office forms as scratch papers.

4. For internal correspondence, make endorsement on the original letter rather than writing a separate reply.

5. Eliminate envelopes for internal mail.

6. Eliminate double colour ribbons or use them only when necessary. Turn the ribbon to ensure full use.

7. Avoid extra file copies of correspondence.

8. Standardise lesser varieties of envelopes and use window envelopes. Also put in one envelope all mails for the same destination.

9. Establish centralised control of designing and printing of all office forms.

10. Systematise the collection, use or sale of waste paper. Waste paper can be shredded and used for packing purposes.

11. Reduce the number of grades and varieties of pencils used; replace wooden pencils with mechanical ones.

12. Economise on the usage of pins, clips, staples, tags etc. by issuing them in packets.

13. Provide a thorough inventory of all office stationery and office supplies. Introduce a periodic check-up of all costly items. Prepare cost statements for each stationery item used by each clerk.

14. Issue supplies in sufficient but not in excessive quantities.

(II) Machinery and Equipment:

1. Ensure regular maintenance of machinery and equipment. Arrange annual servicing by recognised agencies.

2. Provide staggered working hours for the use of the same machine in different departments.

3. Provide for multiple shifts to secure fuller utilisation of machines and equipment.

4. Instruct all employees in the careful and proper use of machines.

5. Standardise machines and equipment.

6. Locate office equipment at such a place where it is.

7. Mechanise the processes of routine nature.

8. Cover all machines at the end of work-day.

(III) Layout and Services:

1. Ensure maximum use of office space.

2. Provide all equipment needed by employees nearer to them to minimise their movements.

3. Rearrange office to secure maximum daylight. Paint ceilings and walls in light shades.

4. Designate persons responsible for putting off lights and fans after working time.

5. Persons responsible for disconnecting water works, air-conditioners and waters.

6. Put restrictions on the use of telephone for personal calls.

Areas Covered by a Cost Reduction Programme – Product Design, Factory Organisation and Production Methods, Administration, Personnel, Marketing and Finance

The specific areas covered by a cost reduction programme are:

Area # 1. Product Design:

Designing the product is a pre-requisite to its production. As such, it influences all other functions, and costs of materials, labour, tools equipment, etc. Hence, any cost reduction programme should start with the design of the product to take advantage of the benefits accruing at every stage influenced by the design.

The objectives of a design function may be many. At times, they may be conflicting also. It is, therefore, necessary to investigate the effect of a new design or improvement of the existing design upon cost of production. Research should be made on the available alternative designs, and their comparative costs, without lowering quality of the finished product.

A study of the cost reduction potential of design involves consideration of the following factors:

i. Materials – Availability of cheaper substitutes, physical and chemical properties of materials, and the yield factor, storage problem, investment in inventory, etc.

ii. Labour – The effect of design on reduced time of operation, and increased productivity.

iii. Tools and Equipment – Reduction in the cost of tools, jigs, fixtures and other equipment necessary to make the product on the basis of the design.

iv. Standardisation and Simplification – Standardisation and simplification lead to increased productivity. It is, therefore, necessary to pay constant attention to find ways to introduce standardisation and simplification.

v. Shape and Appearance – The design should, as far as possible, be compact in order that cost of packing and transport may be reduced.

Area # 2. Factory Organisation and Production Methods:

The benefits of cost reduction cannot be secured without a good plant layout and factory organisation. An organisation structure, with a scalar chain, satisfying the principle of ‘unity of command’, is necessary. It is equally important to lay down very clearly, authority relationship for the successful implementation of a cost reduction programme.

A well-defined channel of communication avoids misunderstanding and difference of opinion. There should be delegation of authority. Persons responsible for spending should be identified. There should not be any organisational conflict.

Clearly defined authority relationship avoids jealousy and friction. Besides, it facilitates implementation of a cost reduction programme. Modernisation of plant and equipment offers considerable scope for cost reduction. Attempts should be made to study the effect of introducing new production methods, techniques and processes on cost.

Area # 3. Administration:

Administration is a strategic area which has cost saving potential. Attempts should, therefore, be made to enlist the co-operation of management consultants for exploring the possibility of cutting down expenditure incidental to recruitment of staff, economising stationery cost, reducing travelling expenses, overtime, telephone and such other items of administration overhead.

Area # 4. Personnel:

Possibilities of cost saving should be explored even in this area. Adoption of suitable work study techniques may be considered along with simplification of work to reduce the labour content of products and labour time. Labour relations may be improved by suitable incentive schemes. Employee suggestion schemes may be introduced to reward the employees who suggest cost reduction methods, as well as to boost their morale.

Area # 5. Marketing:

Cost saving on the marketing side is equally desirable and necessary also. Selling and distribution channels and the methods employed should be reviewed. It should be seen whether there is optimum utilisation of salesmen’s time. It is also necessary to see whether the anticipated sales are in consonance with the advertising cost. Alternative advertising media should be explored. Prospective markets should be developed. Causes of product failure should be investigated into.

Area # 6. Finance:

Capital employed in the business should yield optimum benefit. For this purpose, it is necessary to see that capital is not locked up on assets which cannot be employed any more. Special attention is to be paid to detect obsolete and slow moving items of stock. Sources of capital should be reviewed and cost of capital should be studied in relation to the available sources.

Difference between Cost Control and Cost Reduction

Cost reduction is closely related to cost control. In fact, cost control and cost reduction are considered to be the two aspects of the same problem, viz., cost improvement. Even according to Dobson, “reduction of expenditure contributes to cost improvement.”

But yet, cost control differs from cost reduction in the following respects:

(a) Cost control is one of the aspects of the managerial function of ‘control’. As such, it is only a routine exercise. It is carried out with the main purpose of increasing operational efficiency. Cost reduction, on the other hand, is a special exercise carried out by management with the object of cost improvement, i.e., securing a real and permanent savings in costs.

(b) Cost control aims at achieving target costs. This is accomplished by setting targets of performance and striving hard to achieve them by avoiding wastages and inefficiencies. Cost reduction, on the other hand, aims at bringing about savings in the standard set by presuming the existence of concealed potential savings in the standards. It thus challenges the standards and aims at improving them through research.

(c) Cost control has its applicability to those items of cost for which standards have been set. These standards relate mostly to productive operations. However, cost reduction has universal applicability. It applies to every area of the business. It does not concern itself with the standards of performance, and does not also depend upon the standards.

(d) Cost control is essentially static in nature. It attempts at achieving the best possible results at the lowest cost under given conditions. Cost reduction, however, is a dynamic function. It has no visible and ultimate goal. It does not assume the existence of a given condition, which is permanent. Continuous study, analysis and research which offer scope for cost reduction are relied upon by management.

(e) Cost control techniques aim at preventing costs from rising. Cost control is thus, a preventive function. When costs are controlled, the ultimate goal is said to have been reached, and costs are optimised. Cost reduction is a corrective function. It may operate even when there is an efficient cost accounting system. Since there is nothing like stagnant efficiency, cost reduction programme offer ample scope for reduction in the achieved costs under controlled conditions.

(f) Cost control results in cost improvement. The technique is thus, a means to an end. Cost reduction is, however, the end itself. Cost reduction begins where cost control ends.

(g) Cost control lays emphasis on the present and past behaviour of costs whereas, cost reduction emphasises partly on the present costs and mostly on future costs.

Some of the other differences are:

Difference # Cost Control:

1. It is the achievement of predetermined costs or goals.

2. It assumes that everything is well with the standards or norms set-up which are therefore not challenged.

3. It is concerned with setting up standards, comparing actuals with it, analysing the variances and taking remedial measures to correct them.

4. It is a preventive function as it prevents the costs from exceeding the standards.

5. It often lacks dynamic approach.

Difference # Cost Reduction:

1. It is the achievement of real and permanent reduction of cost.

2. It assumes the existence of concealed potential savings in the standards or norms which are therefore subjected to continuous challenge for improvement.

3. It is not contended only with maintenance of performance as per pre-determined standards.

4. It is a corrective function as it seeks to improve performance and reduce costs by challenging the standards even when efficient cost control system exists.

5. It is a continuous process of analysis by different methods of all the factors affecting costs, efforts and functions in a concern. The main objective is to have continuous economy in costs.

Dangers to be Avoided in Cost Reduction

Cost reduction is a useful device to bring down costs in a real way. The pay offs seem to be quite attractive, in the form of reduced expenditure, better cost consciousness among employees, and higher profits for further growth. On the negative side, however, some dangers need to be looked into carefully.

1. Sacrificing quality – In an attempt to reduce costs, product quality might be sacrificed.

2. Sacrificing overall goals – A department may resort to certain measures which might be beneficial from its own angle, but not from the organisational point of view.

3. Sacrificing employee morale – Employees may, in the beginning, begin to look at cost reduction programmes with scepticism. It may be labelled as another attempt to squeeze their blood to increase the profits for the organisation without any personal payoffs.

4. Panic, Crash programme – The programme may be taken up by management in a hurry. It might be geared into motion as a last resort, viz., when there is a serious cash shortage or when losses being to mount up seriously. Such panic measures do not yield concrete results.

These dangers can be easily avoided if the cost reduction programme is undertaken systematically. It should not be pressed into service as an emergency measure, when things go out of hand. There must be active participation of all employees and they must believe that the payoffs are going to be substantial (both for the organisation and the employees).

Cost Reduction – Value Analysis as a Tool

Value analysis is a planned way of reducing costs. It is an attempt to critically examine the various processes of a product with a view to substitute alternatives which cost less. The various functions which are involved in the manufacturing of a product are examined with a view to improve the ‘value.’

Thus, value may be equivalent to function/cost or worth/price. Value can be improved by

(i) improving function while the cost remain same,

(ii) reducing costs while the functions remain same or

(iii) improving functions and reducing costs simultaneously. Value Engineering, which is used as a modern method to effect cost reduction, attacks costs in the design stage.

The effort is to bring down costs by improving product functions. (Value Analysis, it should be noted, attacks cost in the production stage). However these value analysis and value engineering are used, more or less in the same sense, because they apply the same methodology and techniques and have the same basic objectives.

Cost Reduction – Top 8 Benefits

A well-thought-out and properly implemented cost reduction programme is a boon to the undertaking.

The benefit accruing from cost reduction may be summarised as under:

(i) The concern adopting a cost reduction plan successfully becomes more profitable. It thus occupies an enviable position in the industry.

(ii) Higher taxable capacity of the undertaking results in increased revenue to the Government.

(iii) The Undertaking will have capacity to build up reserves and thereby enjoys financial stability during a period of business adversity.

(iv) The concern will have the capacity of finance expansion or modernisation programme.

(v) Goodwill can easily be built up.

(vi) Increased competitive strength of the industry may stimulate exports.

(vii) Incentive to other undertakings to adopt similar cost reduction programme.

(viii) Higher dividends to shareholders and reasonable prices and good quality products to consumers.

Cost Reduction – Main Advantages

The main advantages of cost reduction may be summarised as follows:

1. Cost reduction increases the profits of an undertaking which ultimately provides a basis for more dividends to shareholders, higher rate of bonus to staff and retention of more profits for ploughing back in business.

2. Due to increase in profits, management may spend more in providing amenities to workers. It will ensure more cordial relationship between management and workers and reduce the labour turnover.

3. Increased profitability of the undertaking due to cost reduction adds to its goodwill.

4. Reduction in the unit cost indicates better productivity and efficiency. The efficiency of a firm may benefit the members of the industry as a whole.

5. Higher profitability will ensure increased revenue to the government by way of taxation.

6. Cost reduction may lead to lower export prices resulting in higher total exports.

Some more advantages given in point wise format:

1. Cost reduction increases profit.

2. Consumers get goods at cheaper rates.

3. It facilitates more dividends to share-holders.

4. It also provides more bonus to workers.

5. It results increase in sales.

6. It gives room for expansion of business.

7. Continuous employment for the workers

8. Expected return on capital

9. Economic use of resources.

10. Increase in productivity

Cost Reduction – Merits and Demerits

Merits of Cost Reduction:

(a) Since cost reduction results in profit increment, the shareholders of the company get fair dividends from the company.

(b) Cost reduction institutes a balanced wage structure and suitable working conditions, which results in improving the labourer-management relationships.

(c) Since quality goods and services are offered to the customers, it enhances the reputation and goodwill of the concern.

(d) Reduced cost per unit results in productivity in an industry and is an indicator of efficiency.

(e) Since cost reduction leads to increase in profits, the government earns revenue, spends the revenue in public utility works and services, and finally the government may earn huge foreign exchange, since, on account of cost reduction, export prices are reduced, thus resulting in higher exports.

Demerits of Cost Reduction:

(a) A small concern may find it costly to follow and implement the cost reduction plan.

(b) Some concerns may show unwillingness in changing their age-old product designs through which they are earning revenue over the years, thus ignoring the concept of cost reduction.

Cost Reduction – Difficulties

1. Employees resist cost reduction campaign as they are not aware of its purpose. They think that they may lose their jobs.

2. Cost reduction campaigns are often conducted hurriedly instead of carefully introducing them.

3. Efforts to reduce cost of material and labour may erode confidence in established systems used for estimating material usage and labour productivity.

4. They may be confined to a particular department with the result that costs are reduced in one cost centre only to reappear as an additional cost in another cost centre.