Cost reduction - incremental or breakthrough?

Cost reduction is a common practice used by companies to improve their profitability. While it yields good results initially by plucking various low hanging fruits, the benefits get marginalised over a period of time. How do we ensure that the momentum of cost reduction is maintained year after year? Is there a better way of looking at such initiatives?

Brian Joiner has rightly said ‘Real benefits come when managers begin to understand the profound difference between cost cutting and eliminating the causes of costs’. What a profound insight! Let’s elaborate it with the help of three examples, each one in a different area.

The first one relates to product quality. Companies spend a good amount of time, effort and money in their Quality Inspection process covering various input materials, intermediates and finished goods. Cost reduction projects in this area look at optimizing the test parameters, tolerance limits, sample size and inspection frequency. While these can be tightened every year to yield some incremental cost benefits, the real savings would come when we eliminate the need for quality inspection itself. This can be achieved through online measurement of intermediate product quality at various stages, coupled with an efficient feedback loop to adjust the process parameters in real time. Some of the Industry 4.0 technologies like IOT and Computer Vision come in quite handy to put such a system in place. If we step up another notch, even these can be eliminated by building Poka Yoke (mistake-proofing) features in the machine design itself.

Let’s take another case in an entirely different area. Most companies have some form of performance-linked incentives for the shop floor employees. Cost reduction in this area aims at designing more efficient incentive programs and limiting its spread to a few key groups of people. The inherent assumption here is that money motivates people to perform better. If we challenge this assumption and instead address the real root cause of low productivity through Total Quality Management (TQM) pillars, we get much higher levels of employee engagement, productivity, safety and morale without the need for cash incentives. Improvement in Overall Equipment Efficiency (OEE) leads to not only reduction in operating costs but also the need for additional capital expenditure to augment the production capacity.

I will now come to the last example, which is also my favourite. Most FMCG companies struggle with bimodal inventory distribution, i.e. stockouts of certain products and excess stocks of others. This leads to the opportunity cost of lost sales on one side, and incremental freight, storage, insurance and obsolescence cost on the other. Cost reduction projects in these areas typically focus on improving forecast accuracy, better coordination, cheaper trucks, efficient warehouses and tighter execution through control towers. However, if we look deeper, the real root cause of all these costs is the mismatch between supply and demand. If we eliminate this root cause through the replenishment process of TOC and DDMRP, and align supplies to real consumer demand on an ongoing basis, the resulting cost benefits are higher by several orders of magnitude.

So, the next time you undertake a cost reduction project, my sincere advice would be to look for not the manifestation of costs but their real root cause drivers. We need to change our own mindset from incremental cost reduction to cost elimination in order to achieve breakthrough results.