A Business Encyclopedia

Cost Reduction

Definition: Cost Reduction can be understood as the perennial decrease in the unit cost of goods produced and services provided by the company, without compromising with its quality and suitability for the use intended, with the help of new and improved methods.

In finer terms, cost reduction is a systematic and corrective technique used by most of the firms to cut the inessential expenses of the goods manufactured and increase the overall profits.

In this process, the essential features and quality of the product are kept intact and is limited to the constant savings in the cost of production, administration, selling and distribution. The basic purpose is to lower down the cost occurring at the time of production, storing, selling etc.

Cost Reduction is not related to fixing targets and standards, but it is about improving the standards. It is an ongoing process, which can be applied to all the activities of the concern. It focuses on the two primary areas:

  • Reduction in Expenses: Decrease in the expenditure in the given volume of output, leads to the decrease in unit cost
  • Increase in Productivity: The overall decrease in unit cost, by increase in the output, for the given expenditure.

Cost reduction can be attained by the integration of these factors. Further, it is a bit difficult to find out the contribution made by each factor to the savings.

Assumptions of Cost Reduction

The three-fold assumptions of cost reduction are described below:

  1. Savings in per unit cost
  2. Savings is long lasting in nature.
  3. Quality and utility of the products and services remain uninfluenced.

Cost reduction is possible by identifying and removing wasteful, unwarranted and unnecessary elements from the design and manufacturing techniques. It results in the maximisation of profit, as the overall cost of production is reduced.

Techniques of Cost Reduction

  • Value Engineering
  • Value Analysis
  • Work Study
  • Material Handling
  • Quality Measurement and Research
  • Operations Research
  • Market Research
  • Quality Control
  • Standardization and Simplification
  • Improvement in Design

Cost Reduction results in the increase in savings of the company, i.e. increased profit margins. The company may pass such savings to the customers as the decrease in the product prices or more quantity in the given price. The decrease in the overall pricing will lead to the increase in demand for the product.

However, while implementing cost reduction techniques, one must keep in mind that the quality of the product or service should not be sacrificed.

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