Cost reduction

Cost reduction (or cost level management) is part of the operational cost management of organizations and aims to reduce the overall level of costs or to generally reduce the amount of costs.

General Information

The basic goal of economic companies is to increase profit. This can be achieved either by increasing sales revenues without increasing costs or by reducing costs without increasing sales revenues. Cost reduction can be achieved through various methods. Possible solutions may include lowering:

• the level of total costs,
• the level of costs in individual organizational units,
• the level of unit costs.

Some companies generally compete by replacing resources to reduce costs or making cost-cutting investments. Another method is new product development with a more cost-effective outcome. This can be achieved by eliminating operationally unnecessary services or production factors. As a result of this method, costs can be saved very effectively. New product development can even have the same effect as direct cost reduction. A lowering of costs, at the same time, can also lead to a change in performance.

In companies, the demand for cost reduction is particularly common in the area of personell controlling. In principle, larger companies often have separate cost management for each individual department.

Implementation of a cost reduction strategy

Companies that continuously pursue cost reduction usually have this goal anchored in their corporate strategy and have also adapted their organizational culture to it. This can lead to further benefits, such as direct profit growth from cost reduction and rapid adaptation in times of crisis.

The use of the cost reduction strategy in connection with the general corporate strategy can be carried out as a 5-step process in a modern company:

1. Cost estimates
The strategic direction is set by correctly estimating the costs that need to be reduced. For this purpose, information from all departments is collected and interpreted.

2. Alignment with the company's global business strategy
The cost reduction strategy must be adapted to the global business strategy. In doing so, it should retain certain flexibility in order to be able to shift the focus to different areas.

3. Selection of cost reduction tools
Based on the defined strategy and the situation, appropriate tools and methods are selected to reduce costs.

4. Implementation of the cost reduction strategy
In implementing the strategy, particular attention must be paid to resistance to implementation by employees and trade unions, and countermeasures should be taken in plenty of time.

5. Measuring the impact and cost of the cost reduction strategy
A cost reduction program that is to be successful in the long term involves a precise analysis of the business areas that are critical to the survival and success of a company and in which the cost reduction is to be implemented.

Methods and instruments of using cost reduction

Typical measures to reduce the cost level:

1. Reduction of throughput times
2. Exploiting automation potential
3. Also choosing more cost-effective locations
4. Conclusion of service contracts for in-house services
5. Furthermore, the avoidance of duplication of work
6. Introduction/use of the company suggestion scheme
7. Choice between in-house production and external procurement (outsourcing)

Instruments provided by strategic cost management with a view to reducing the cost level include in particular:

• Activity-based costing (intended to reduce costs in indirect areas)
• Target costing (should explicitly lead to a reduction in unit costs)
• Product life cycle costing (to minimize life cycle costs)
• Cost benchmarking (can be used for all approaches)

References

• Figar, N., & Ivanović, V. (2015). Cost reduction strategy–process and effects. Facta Universitatis. Series: Economics and Organization, 12(1), 15-26.
• Institute of Management and Administration (2006). Cost Reduction and Control Best Practices, John Willey and Sons, Inc., New Jersey.
• Kremlin book, B. (2007). Strategic cost management: fundamentals and modern instruments. Gabler, 13-15.
• Spence, M. (1986). Cost reduction, competition and industry performance. New developments in the analysis of market structure. International Economic Association Series, (77), 475-518.

Further Readings

• Akeem, L. B. (2017). Effect of cost control and cost reduction techniques in organizational performance. International business and management, 14(3), 19-26.
• Gopalakrishnan, M., Libby, T., Samuels, J. A., & Swenson, D. (2015). The effect of cost goal specificity and new product development process on cost reduction performance. Accounting, Organizations and Society'', 42, 1-11.
• Rust, R. T., Moorman, C., & Dickson, P. R. (2002). Getting return on quality: revenue expansion, cost reduction, or both?. Journal of marketing, 66(4), 7-24.
• Tomic, I., Tesic, Z., Kuzmanovic, B., & Tomic, M. (2018). An empirical study of employee loyalty, service quality, cost reduction and company performance. Economic research-Ekonomska istraživanja, 31(1), 827-846.

Author: Alexandra Schulze