Cost reduction is the process used by organisations aiming to reduce their

cost Cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it i ...

s 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 New product development (NPD) or product development in business and engineering covers the complete process of launching a new product to the market. Product development also includes the renewal of an existing product and introducing a product ...

process affects cost: design is typically considered to account for 70–80% of the final cost of a project such as an engineering project or the

construction Construction are processes involved in delivering buildings, infrastructure, industrial facilities, and associated activities through to the end of their life. It typically starts with planning, financing, and design that continues until the a ...

of a building. In the

public sector The public sector, also called the state sector, is the part of the economy composed of both public services and public enterprises. Public sectors include the public goods and governmental services such as the military, law enforcement, pu ...

, cost reduction programs can be used where income is reduced or to reduce

debt Debt is an obligation that requires one party, the debtor, to pay money Loan, borrowed or otherwise withheld from another party, the creditor. Debt may be owed by a sovereign state or country, local government, company, or an individual. Co ...

levels.

Importance

Companies typically launch a new product without focusing too much on cost. Cost becomes more important when

competition Competition is a rivalry where two or more parties strive for a common goal which cannot be shared: where one's gain is the other's loss (an example of which is a zero-sum game). Competition can arise between entities such as organisms, indi ...

increases and

PRICE A price is the (usually not negative) quantity of payment or compensation expected, required, or given by one party to another in return for goods or services. In some situations, especially when the product is a service rather than a ph ...

becomes a differentiator in the market. The importance of cost reduction in relation to other strategic business goals is often debated.

Examples of cost reduction strategies and programmes

Commercial businesses

Consultants Deloitte reported in 2006 that over three-quarters of the

FTSE 100 The Financial Times Stock Exchange 100 Index, also called the FTSE 100 Index, FTSE 100, FTSE, or, informally, the "Footsie" , is the United Kingdom's best-known stock market index of the 100 most market capitalisation, highly capitalised ...

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.Doherty, P. ''et al.'' (2006), ''The cutting edge: Sound advice for a sustainable approach to reducing costs'', Deloitte Some examples of programmes include: *Reductions in staff numbers (head count). Doherty refers to staff reduction exercises as "a quick and easy method" whose use often means that companies lack the resources they need when business activities recover. * Component consolidation * Function cost analysis / Value analysis /

Value engineering Value engineering (VE) is a systematic analysis of the functions of various components and materials to lower the cost of goods, products and services with a tolerable loss of performance or functionality. Value, as defined, is the ratio of func ...

* 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 Manufacturing is the creation or production of goods with the help of equipment, labor, machines, tools, and chemical or biological processing or formulation. It is the essence of the secondary sector of the economy. The term may refer ...

excellence and the product cost information needed by managers working towards this goal. * Product

benchmarking Benchmarking is the practice of comparing business processes and performance metrics to industry bests and best practices from other companies. Dimensions typically measured are Project management triangle, quality, time and cost. Benchmarking is ...

*Competitor benchmarking * Design to cost *Property portfolio reviews addressing whether the estate occupied by a business continues to meet its needs, and also reviewing the

tenure Tenure is a type of academic appointment that protects its holder from being fired or laid off except for cause, or under extraordinary circumstances such as financial exigency or program discontinuation. Academic tenure originated in the United ...

which it holds on the estate: Deloitte's survey of British companies noted that "smaller firms in particular" rarely take advantage of the cost reductions they can secure through sale-and-leaseback and similar deals. *Incorporation of "low-cost thinking" into an organisation's

culture Culture ( ) is a concept that encompasses the social behavior, institutions, and Social norm, norms found in human societies, as well as the knowledge, beliefs, arts, laws, Social norm, customs, capabilities, Attitude (psychology), attitudes ...

*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. Examples specifically focussed on the use of suppliers and the costs of goods and services supplied include: * Supplier consolidation: see examples in the aerospace manufacturing industry * Low-cost country sourcing *

Outsourcing Outsourcing is a business practice in which companies use external providers to carry out business processes that would otherwise be handled internally. Outsourcing sometimes involves transferring employees and assets from one firm to another ...

: experience in the United States suggests that businesses primarily outsource to reduce peripheral and "non-core" business expenses. *

Request for quotation A request for quotation (RfQ) is a business process in which a company or public entity requests a quote from a supplier for the purchase of specific products or services. RfQ generally means the same thing as Call for bids (CfB) and Invitati ...

s (RFQ) * Supplier cost breakdown analysis * Design workshops with suppliers

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.BBC News
Spending Review 2010: George Osborne wields the axe
published 20 October 2010, accessed 13 February 2024 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. National Audit Office
A Short Guide to Structured Cost Reduction
reference 009328-001, published June 2010, accessed 13 February 2024 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". Centralisation of

procurement Procurement is the process of locating and agreeing to terms and purchasing goods, services, or other works from an external source, often with the use of a tendering or competitive bidding process. The term may also refer to a contractual ...

activity has been highlighted as a beneficial public sector cost reduction strategy. 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 Systems thinking is a way of making sense of the complexity of the world by looking at it in terms of wholes and relationships rather than by splitting it down into its parts.Anderson, Virginia, & Johnson, Lauren (1997). ''Systems Thinking Ba ...

": a fundamental review of the whole service, its purpose and objectives.Brown, S., Hadden, C., Jones, K. and Roddie, R. (2010), ''Radical Cost Reduction in Public Services'', published by Excellence in Business, p. 5 The "Route Map for Change" which they advocate has been used effectively by

Kent County Council Kent County Council is a county council that governs the non-metropolitan county of Kent in England. The non-metropolitan county is smaller than the ceremonial county, which additionally includes the Unitary authorities of England, unitary auth ...

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.

Importance

Examples of cost reduction strategies and programmes

Commercial businesses

Public sector

References

Further reading

See also