Cost reduction

Cost reduction is the process used by organisations aiming to reduce their costs and increase their profits, or to accommodate reduced income. Depending on a company’s services or products, the strategies can vary. Every decision in the product development process affects cost: design is typically considered to account for 70–80% of the final cost of a project such as an engineering project^[1] or the construction of a building.^[2] In the public sector, cost reduction programs can be used where income is reduced or to reduce debt levels.^[3]

Importance

Companies typically launch a new product without focusing too much on cost. Cost becomes more important when competition increases and price becomes a differentiator in the market. The importance of cost reduction in relation to other strategic business goals is often debated.^[4]

Examples of cost reduction strategies and programmes

Commercial businesses

Consultants Deloitte reported in 2006 that over three-quarters of the FTSE 100 listed companies had commenced a cost reduction programme during the preceding 12 months. Cost reduction is most frequently stimulated by recognition that profits and profitability are below expected levels.^[5] Some examples of programmes include:

Supplier consolidation: see examples in the aerospace manufacturing industry
Component consolidation
Low-cost country sourcing
Request for quotations (RFQ)
Supplier cost breakdown analysis
Function cost analysis / Value analysis / Value engineering
Design for manufacture / Design for assembly
Reverse costing
Cost driver analysis
Activity-based costing (ABC), which assigns a cost of each activity undertaken in the production and delivery of each product and service according to the actual consumption by each activity including a share of overheads. Peter Turney in a 1989 article examines the role of ABC in the achievement of manufacturing excellence and the product cost information needed by managers working towards this goal.^[6]
Product benchmarking
Competitor benchmarking
Design to cost
Design workshops with suppliers
Half cost strategies: ambitious strategies which aim to reduce the costs of specific production processes or value adding stages to 1/N of the previous cost.^[7]

Public sector

In a public sector spending review, an overall target for reduction in expenditure may be identified: for example, in the United Kingdom, the 2010 spending review anticipated a reduction of £81bn in public expenditure over the four year budget planning period.^[8] In order to meet the challenges of a significant reduction in expenditure, government departments are expected to look at how they can "take cost out of the business" rather than simply cut services.^[9] One of the main principles expected of government departments in order to reduce costs is a "data-driven approach", i.e. ensuring that staff within the department have "a good understanding of the distribution and profile of costs in their business".^[9]

Centralisation of procurement activity has been hightlighted as a beneficial public sector cost reduction strategy.^[9]^: 6

Scott Brown et al, of "Excellence in Business", note that in most cases, a successful approach to cost reduction which aims to maintain service quality "has at its heart an approach based on the principles of Systems Thinking": a fundamental review of the whole service, its purpose and objectives.^[10] The "Route Map for Change" which they advocate has been used effectively by Kent County Council for their highway maintenance contract, while the decommissioning of various warships and aircraft squadrons following the UK's Strategic Defence Review in 2010 is seen as a good example of a strategic option appraisal.^[10]

References

^ Barton, J. A. et al., Design determines 70% of cost? A review of implications for design evaluation, Journal of Engineering Design, Volume 12, published 1 March 2001
^ Designing Buildings Wiki, Cost control in building design and construction, last updated 15 August 2021, accessed 11 September 2021
^ McKinsey & Company, A smarter approach to cost reduction in the public sector, published 8 June 2018, accessed 19 April 2024
^ Green, W., Growth trumps cost cutting, says survey, Supply Management, published 31 January 2018, accessed 12 September 2021
^ Doherty, P. et al. (2006), The cutting edge: Sound advice for a sustainable approach to reducing costs, Deloitte, p. 1
^ Turney, P., Activity-Based Costing: A Tool for Manufacturing Excellence, Association for Manufacturing Excellence, published summer 1989, accessed 13 September 2021
^ High, P., AstraZeneca CIO Makes IT Twice As Good At Half The Cost - Here Is How, Forbes.com, published 3 January 2017, accessed 10 January 2021
^ BBC News, Spending Review 2010: George Osborne wields the axe, published 20 October 2010, accessed 13 February 2024
^ ^a ^b ^c National Audit Office, A Short Guide to Structured Cost Reduction, reference 009328-001, published June 2010, accessed 13 February 2024
^ ^a ^b Brown, S., Hadden, C., Jones, K. and Roddie, R. (2010), Radical Cost Reduction in Public Services, published by Excellence in Business, p. 5