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John Spacey, August 14, 2017 updated on October 13, 2018
Cost reduction is the process of identifying and implementing ways to reduce the opex and capex of a business. In some industries, cost per unit falls on a quarterly basis and firms must continually find cost reductions to remain competitive. The following are common types of cost reduction.
Waste EliminationIdentifying and eliminating waste such as materials that go wasted in a production process.Modernization of equipment. For example, old computing hardware may be energy inefficient and slow as compared to new models.Finding ways to use less physical resources. The classic example is an office that goes paperless.
The output you get for a unit of input. For example, improving the energy efficiency of a data center.The output you get for an hour worked. Typically improved with automation and tools. For example, farming robots may improve the productivity of a farm as work is shifted from physical tasks towards knowledge work.
SourcingOutsourcing things in areas where you're not particularly efficient. For example, a small business that decides to outsource its financial accounting and tax preparation tasks.ConsolidationConsolidating things to make them easier to manage or to gain negotiating power. For example, a manufacturer consolidates its suppliers and demands steep discounts for the greater volume of orders.
Renegotiating costs. For example, a retail outlet that renegotiates rent during an industry downturn. Looking at processes, procedures, capabilities and structures that aren't adding much value and restructuring them.
PerksReducing perks such as business class air travel and stays at luxury hotels.Looking at the scale or volume of your business. For example, unit costs may fall until an existing factory reaches its capacity. In this case, increasing sales through marketing efforts may result in declining cost per unit.ImprovementMeasuring things and improving them continuously. For example, measuring processes to detect expensive bottlenecks and exceptions and finding ways to remove them.
Cutting back on quality. This can easily backfire as it may result in lower sales volume and revenue. In some cases, improving quality can result in long term cost reduction in areas such as marketing costs. For example, a hotel with high ratings may be fully booked without need to advertise.ServicesCutting back on service levels such as a restaurant that cuts back its business hours. This can also backfire. For example, customers may avoid a business that they perceive as often closed.Retiring business units, products, capabilities and processes that aren't working out. For example, an Australian bank expands to Asia but finds that it is a money losing venture year after year. The decision is made to cut and run.ProximityReducing transportation costs by putting things closer together. For example, an ecommerce company that moves from 12 regional distribution centers to 1200 distribution partners closer to the customer.PartnershipsFinding partners who can reduce your costs. For example, a cloud platform that eliminates the need to own and operate your own computing infrastructure.Designing processes, services, products and practices to be more efficient and productive. This can include subtle improvements or innovation that changes your entire cost base.Asking your people for ideas for cutting cost and engaging them in the effort. This requires setting a tone at the top of financial discipline. For example, a CEO who regularly travels by economy may encourage others in the organization to spend responsibility.|
| Type | | | Definition | The process of identifying and implementing ways to reduce the opex and capex of a business. | | Related Concepts | |
Business Costs
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