By OLANIYI OPANUGA
Dr. Opanuga
COST REDUCTION TECHNIQUES IN
PRODUCTION | QUALITY | MAINTENANCE | LOGISTICS
SUPPLY CHAIN| PURCHASING | MATERIALS MANAGEMENT
DR. OLANIYI OPANUGA, PhD, FNIPM, FCIAM, FCMA, CPSCOMP, COMP, COPOM©, FIMC, CMC
Dean/Faculty Head
NIGERIAN INSTITUTE OF PRODUCTION MANAGEMENT (NIPM)
Academy of Operations and Supply Chain Management Professionals
Introduction
Production involves creating value for the customers from limited resources. Producers including manufactures utilize resources called the factors of production or inputs such as land, labour, capital, entrepreneurship and technology.
In business and especially in production, money is used to make money. For instance manufacturers use investment capital through equity, credit or other forms of funding to acquire assets such as land, building and allied facilities, machines and equipment, furniture and fixtures, energy, raw materials, personnel and so on in furtherance of their objectives, chiefly profit making.
Therefore, in production costs are naturally incurred to transform inputs into e.g. raw materials into finished goods.
Costs and wastes are induced both externally and internally. All production inputs are costs. Costs are transferred along the value chains and supply chain processes whether global, regional or local. As implied earlier, costs are necessary components of value.
Costs are incurred to generate revenue through production of goods and services. And it is important to emphasize that as part of the general business process typical manufacturing organizations spend money acquiring assets, setting up plant or facilities, engaging labour, procuring/purchasing raw materials, storing, manufacturing transporting, distributing and selling their products to meet customer requirements at a profit.
Profit is the chief motivating factor in business. Manufactures and service providers seek reasonable return on shareholder’s investment. They also seek growth and expansion. Even non-profit oriented organizations cannot afford to allow costs and wastes to mount unchecked because we live in a world where resources are scarce and limited.
As a matter of commonsense management attempts to reduce cost in order to fix appropriate product prices and make reasonable profit. Because, the difference between cost and revenue is profit we can
increase profit by either reducing cost or increasing revenue. While we are focusing on cost and waste reduction in this training it is important to state that organizations can (and, should) optimize profits by increasing revenue and reducing cost simultaneously.
However, trying to increase revenue especially through price increases in a competitive market will amount to attempting business suicide because customers will shift their loyalty to competitors. Hence, companies take solace in looking inwards to reduce cost to optimize value.
CONCEPTS OF COST AND WASTE
Cost is a monetary or non-monetary value expended in anticipation of profit or some other benefit. Costs incurred in a business have direct impact on product prices fixed by a business organization. Technically speaking, cost is a component of value.
Cost is a leading attribute of value. Nothing is valuable without associated cost. Diamond and gold have great value because of the cost associated with their production. Luxury goods are generally expensive.
But ironically, cost can drive product value up or down. Product value may become an order loser rather than being order qualifier or winner simply because its cost goes up. But when other product attributes such as quality,
personalization, customer care, convenience, delivery speed, reliability, after sales service and response time are on the increase, nothing negative happens!
Therefore, cost behaviours (in terms of fixed, variable, mixed costs and so on) deserve meticulous study and analysis.
Production cost is the cost of direct materials, direct labour and direct expenses and may include manufacturing overhead but excludes administrative, selling, distribution and general expenses.
Waste means unproductive cost. It is a cost that yields nothing or zero value. A waste is an undesirable loss of resource. Waste is the result of excessive use or underutilization of money, time, energy or any other resource. Waste is any action or step taken in any process that is not necessary to successfully complete the process.
There are different types and forms of wastes. Certain wastes are inevitably associated with every production activity or process. Some wastes are recoverable or avoidable while others are not. Also, process wastes (unwanted materials) have their cost, safety and environmental dimensions and implications.
Avoidable wastes are linked to cost. Unavoidable wastes “so called” are also linked to cost such as expenses incurred in waste treatment and disposal as well as the hazards involved or the environmental impacts of effluents and pollution-which would require reduction, treatment, recycling and other technological, engineering or scientific options.
3.0 DEALING WITH WASTE FORMS
Waste forms which are popularly called “mudas” in Japanese and popularized by Toyota Production System (TPS) and as part of Lean Manufacturing are as follows:
Waste of Overproduction
Waste of Waiting
Waste Transportation
Waste of Processing
Waste of Stocks
Waste of Motion
Waste of Making Defective Products.
Wastes are useless. Wastes are futile. Waste translate into additional cost. Any efforts made at reducing the above forms of waste will automatically reduce production and business cost.
Hence, waste level in any organization is a serious performance measure. Setting realistic standards based on critical analysis and sound executive judgment would be a
welcome development. This is to ensure that only Value Adding steps or actions are allowed in every process.
Dealing with the above named wastes must done in a proactive manner using appropriate tools and techniques. Wastes are paid for by the customers and the general public. They are also paid for by the investors and the workers. Waste makes production systems and processes inefficient and the entire management of the business ineffective.
As pointed out earlier, bringing down cost would enable an organization to increase profit. However, in practice the need to reduce cost may have to do with survival or the need to “break-even” and to stay afloat!
UNDERSTANDING COST STRUCTURE
Let’s take a look at a typical manufacturing cost structure to enable us appreciate how the battle for profit can be won or lost:
N
Direct Materials xxxxxxx
Direct Labour xxxxxxx
Direct Expenses xxxxxxx
Prime Cost xxxxxxx
Manufacturing Overhead xxxxxxx
Total Manufacturing Cost xxxxxxx
At this point we have the cost of goods sold or cost of sales. In order to arrive at the selling price per unit we need to consider additional costs such as selling and distribution costs, general administration costs, interest and taxation. Below are measures of efficiency and profitability:
Net Income = Net Sales-Cost of Goods Sold – Selling, Distribution, Administration Costs-Depreciation-Interest-Taxes.
Profit Margin = Net Income
Sales
Return On Assets = Net Income
Total Assets
Return On Equity = Net Income
Total Assets
From the above illustration, we can see clearly that total manufacturing cost or the cost of goods sold is carried over to the next level where net income, profit margin, return on assets and return on equity will be determined respectively.
The basic thing is for us to understand that revenue must exceed cost in business for profit to be made. The lower the cost, the higher the profit, and the higher the cost the greater the possibility of loss and at best, the lower the profit.
Where costs are not properly controlled and reduced the investor stand little or not chance of earning reasonable dividends on their investment. The value of their equity may even diminish. Low earning per share and low dividends can be so devastating, leaving an investor to wonder about how other investment options may have paid off. Also, it is doubtful and most unlikely for workers to earn higher wages or keep their jobs in an unprofitable business.
5. COST REDUCTION TECHNIQUES
WHAT IS COST?
Cost is simply the price tag the manufacturer places on his goods. This price is a function of money expended to make the product and the manufacturers’ margin. Total Cost include:-
Cost of materials
Cost of labour
Cost of equipment / facility
Cost of overheads.
Cost of manufacturing, generally
(a) Material Cost: Can be reduced by-
(i) Reducing wastage of raw material
(ii) Recycling of waste
(iii) Reducing material content
(iv) Not exceeding specified wrights and sizes
(v) Keeping minimum stock levels-Nigerian problem
(vi) Locating cheaper sources of materials
(vii) Avoid Parts Failures
(b) Cost of Labour: Can be reduced by-
(i) Eliminating over manning
(ii) Use of skilled labour
(iii) Proper training
(iv) Work study/Work methods to improve handling, balance the lines, improve layout and reduce bottlenecks etc.
(c) Cost of Manufacturing Facility/Equipment:- This being huge and of a long term nature, overhead costs related to it can be reduced by-
(i) Adequate maintenance
(ii) Preventive planned maintenance
(iii) Purchasing Quality Machines
(iv) Cost-effective Replacement
(v) Total Productive Maintenance (TPM)
(d) Cost of Quality Control System:- This aspect compliments quality maintenance and should be viewed with great importance. However its cost could be put in check or reduced through avoiding unnecessary quality standards or unusually strict standards. Go beyond inspection and testing. Adopt TQM and improve on ISO/QMS.
(e) Cost of Plant Process: Can be reduced by changing nature of process or by adopting a cost effective plant or process. Transform your operational processes and subject them to regular audits.
(f) Cost of Overheads: Generally more of top/ general management responsibility but you have a part to play. Certain overheads are not beyond your control but its implications on the cost of products makes it worthwhile to mention. Control of it can also reduce cost-normal factory overheads like administrative expenses, power generation/energy consumption and so on.
(g) General Cost of Manufacturing: Can be reduced by-
(i) Value analysis/value engineering – Designs, functions, etc.
(ii) Factory layout – Line Balancing, etc.
(iii) Production Planning – Reducing Idleness, etc.
(iv) Work Study – Reduce Wastages and delays etc.
(v) Cybernetics – Eliminate gaps
(vi) Operations Research – For Optimal Decisions, etc.
(vii) Operations and Supply chain strategy, alignment etc.
