Think-it - Cost Management

Today’s competitive economy demands that we must watch our costs very carefully. For small entrepreneurs it is even more important in the face of market forces that are favourable to large corporations with big advertising budgets. Because through advertising these large corporations create brand image and demand higher prices which is not possible for the new entrants or small entrepreneurs. Since the selling price is mostly controlled by the market so most entrepreneurs are left with to manage their costs to be profitable.

Cost has three elements viz. (1) Raw Material Costs (2) Labour Costs and (3) Overhead Expenses. Raw material costs can be controlled through efficient buying and also through substitution i-e using substitute materials. Efficient buying includes exploring sources i-e buying directly from the first source that will not include the cost of intermediaries profit margin. Another option is to buy a discount quantity. Yet another option is to buy in quantity that does not require large storage space because that attracts additional storage costs, this technique is called JIT - Just in Time. But that requires coordination between you and your supplier. You can also use negotiation techniques to get a better price from your supplier. Finally, you can use online comparison sites to find the best deals for the items you need. Another way to reduce raw material cost is to control wastage. This can be done by tracking and managing your inventory, as well as analyzing your production process to identify any areas where waste is occurring. Additionally, you can implement quality control measures to ensure the quality and quantity of raw materials used. 

Labour costs can be controlled by streamlining production processes and automating processes where possible. Training your labour force goes a long way in reducing your labour cost through productivity enhancements. Better working environment e.g adequate rest time and good behaviour of supervisors also help in increasing productivity. It is said that rest is a weapon that we must use. Additionally, providing incentives for employees to be more productive can also help in reducing labour costs. Finally, creating a culture of open communication and feedback will help employees feel engaged and valued, leading to higher productivity.

Raw material and direct labour cost are direct costs that can be traced to products relatively easily. But other costs such as support services cost e.g. supervision, quality control, utility costs etc. are difficult to trace to products and its management. Therefore, it is important for businesses to track these costs accurately in order to monitor them. This data can then be used to make decisions about pricing, budgeting, and product performance. For this purpose ABC - Activity Based Costing system is used. The rationale behind this technique is that cost does not occur on its own. Its occurrence is due to some activity. If we trace these costs to activities that cause it to occur then if these activities are managed then the costs would automatically be managed. This gives us a better understanding of where costs are occurring and allows us to make better decisions about how to manage them. ABC also allows us to identify potential cost savings and opportunities for improvement. 

First track all activities that a firm undertakes to manage its affairs such as production, accounts, management, selling etc. Take all these expenses from accounts books and then distribute these costs to activities using activity cost drivers i-e what drives these costs e.g. salary expense can be distributed using cost drivers such as direct production, quality control, supervision etc. If you design your production system in such a way that each subsequent process is responsible for the quality of its previous process then there is no need for quality control and you can save this cost. 

Once you have successfully determined activities then you can analyse your activities by categorising it such as value added, non- value added and further analysing non-value added activities into necessary and can be deferred. In this way you can also reduce your costs by deferring activities not required right now and also reducing activity level of non-value added.

Here is the graphical representation of Activity Based Costing:

Next step is analysis of activities:

Besides Activity Based Costing, quality control techniques are also essential for becoming competitive. For example Fishbone Diagram - for finding product defects, KJ Method for solving production process inefficiencies etc. There are seven basic tools of quality control that are popularised by the Japanese.  They used these tools extensively to become world no. 2 economy just behind the USA. These are (1) Fishbone Diagram (2) Check Sheets (3)Control Charts (4)Histogram (5)Pareto Chart (6) Scatter Diagram (7) Flow Chart. 

The phrase "Quality is free" is a concept popularized by Philip Crosby in his 1979 book of the same name. It essentially means that the costs associated with improving quality are outweighed by the savings gained from reduced defects, rework, and waste.

Here's a breakdown of the core idea:

• Cost of Poor Quality (COPQ): This includes all the expenses related to producing something that doesn't meet the required standards. Examples:

  • Internal Failures: Scrap, rework, machine downtime

  • External Failures: Warranty claims, customer returns, lost sales due to reputation damage

  • Appraisal Costs: Inspections, testing

  • Prevention Costs: Training, quality planning, process improvement

• Investing in Quality: By focusing on prevention and early detection of issues, companies can significantly reduce COPQ. This might involve:

  • Employee Training: To improve skills and understanding of quality standards

  • Process Improvement: To streamline operations and minimize errors

  • Robust Quality Control Systems: To identify and address problems quickly

• The "Free" Aspect: While there's an initial investment in quality improvement activities, the long-term savings from reduced COPQ often far exceed these costs. This is where the idea of "quality being free" comes from.
   

By embracing a culture of quality, businesses can gain a significant competitive advantage, improve customer satisfaction, and ultimately increase profitability.

We ignore this important factor of cost saving. ABC + Quality Control will lead to cost saving.