To improve efficiency, reduce costs and increase profitability, learn these 6 effective methods can help your enterprise.
To be honest, if an enterprise comprehensively adopts these six cost management methods and uses them more skillfully. Its cost can be greatly reduced. The problem is that many cost managers I know don’t understand that there are so many cost management methods available. They usually use only one or two of them. Although a very small number of enterprises use these six methods together, or adopt the main methods of them.
Cost Reduction Methods:
(1) Practical approach to cost management
(2) The cost management control method is based on historical data
(3) Budget-based target cost management control method
(4) The target cost management control method is based on benchmarking
(5) Target cost management control method based on market demand
(6) Cost management control method based on value analysis
Due to the influence and constraints of the multifaceted implementation environment, they do not use professional and handy, so their due effect is greatly reduced. This article describes these six methods.
Practical approach to cost management
This is a cost control method that is the most basic and low-level, but the most widely used, and the effect is also very good under certain conditions.
This is where most companies’ cost management begins, and the bottom layer of every other costing approach is actually made up of it.
It is the process by which managers use past experience to realistically control the management object, so as to pursue high quality, efficiency and avoid or reduce waste.
For example, experience tells us that in the procurement process, “shopping around, repeatedly bidding, and bargaining as much as possible” can reduce procurement costs. So, managers require their subordinates to “shop around, bid repeatedly, and bargain as much as possible” when purchasing.
For example, experience warns us that in the process of external procurement, if there is no necessary supervision mechanism, some procurement personnel may have selfish behavior, resulting in enterprise losses. So a large number of enterprises often sacrifice efficiency and cost to set up “checkpoints” to prevent the selfish behavior of procurement personnel.
Example
People have noticed that as long as they pay close attention to employees. The efficiency of employees will be correspondingly improves. So companies generally emphasize the supervision of employee behavior.
There is no doubt that empirical cost management methods are sometimes the most effective measures to improve efficiency, ensure quality and control costs.
A manager who starts from the lowest level of salesman and works all the way to the position of deputy general manager of marketing. The salesperson he manages generally has less opportunity to make mistakes that directly and deliberately harm the interests of the enterprise.
However, experience is sometimes unreliable. A general manager of a company use to manage staff with a lower level of culture told him that strengthening the punishment of employees who make mistakes may reduce the number of employees making mistakes.
Thereby reducing or avoiding losses for the enterprise. But if he now manages staff with higher cultural levels and are only children. Then his experience may not only not work, but even go the other way.
Experience-based cost management sometimes does not work, generally for two reasons:
First, experience has a serious personal dimension, and experience may lose its usefulness when changing environmental problems exceed the scope of experience.
Second, experience is often “on a case-by-case basis“, not the result of systematic thinking, so experience may have systemic negative consequences in the practical process. That is, for specific objects, they help to control or even reduce costs.
But on the whole, they may not help to control costs, or even cause systemic costs to rise. In addition, the implementation of empirical cost management may leave a historical shadow in the future.
The cost management control method is based on historical data.
The vast majority of enterprises have consciously or unconsciously adopted this cost-containment approach, fully or partially.
The rationale is that, based on costs that have been incurred historically, take their average or minimum value (managers usually require a minimum value) as the highest cost control standard for the current or next stage.
For example, in the past three or three months, the average or minimum purchase price of a certain food raw material was 8.13 dollar per kilogram, and the relevant departments or individuals of the enterprise determined this 8.13 dollar as the highest purchase limit of the same grade of raw materials in the current or future period to control. This method is most commonly used in engineering and construction enterprises and manufacturing enterprises.
One assumption of this approach is that prices usually keep falling while remaining relatively stable. Therefore, one of the disadvantages of using this method is that when prices rise cyclically and the firm’s mechanisms are inflexible or slow to respond. Overemphasis on historical lows may miss the best time for transactions or lead to a decline in procurement quality or quantity shortages.
The increasing quality of products in some areas is not as good as it was initially, to some extent related to the continuous pursuit of purchases below historical lows.
In addition, when prices fall more than enterprises expect, and the mechanisms of enterprises are not flexible enough, or the personnel concerned are not strong in responsibility or selfishness, or respond slowly, emphasizing historical low prices may cause enterprises to suffer losses in the short term.
Budget-based target cost management control method
Among domestic companies, it is rare for companies to adopt strict budget management. Although some business managers are aware of the benefits of budget management from various sources. They always ask for finance at the end of each year.
The department, or the sales department, or the “general manager’s office” to make a budget for the coming year. However, because everyone knows little about how to make a budget, the company usually does not accumulate the various data needed to make a budget.
The corresponding organizational environment required to make a budget, coupled with a very tight time (usually they will require relevant personnel to complete it within 1-7 days) and other reasons. The budget they make is actually just a plan for spending money for the next year after the budgeted figures out the leader’s intention.
And the person who makes this plan usually knows that this spending plan is just to do it and meet the boss’s current requirements.
In most businesses, few people think that budgets will be useful, not that they are theoretically useless, but that they are not useful in their business.
It is widely believed that “plans do not change quickly”. “Plans don’t change fast,” is a phrase that can be understood in a variety of ways.
One understanding is that the boss himself will not execute the budget he asks, and no matter how good the budget is, it is useless. One understanding is that our businesses simply can’t come up with a realistic, workable budget.
There is also an understanding that interpersonal relationships are too complicated and there are too many people in charge, and even if the boss insists on doing things on budget, maybe one person will destroy him that day.
There may also be an explanation that environmental factors change too quickly, and there are too many variables in the development of enterprises, and it is impossible to predict what will happen in two or three months. So the budget cannot be done, and it will not be practical to do it.
However, the experience of successful foreign companies shows that budget management is an effective method of cost control.
The so-called budget, in layman’s terms, is to determine in advance how much to spend tomorrow? Where to spend the money? Who will spend the money? How to spend money? Who controls the spending of money? Answering these questions requires not only having a sense of the whole picture, but also knowing where the money is coming from (and guaranteeing it) and knowing the future price movements of the various things that need to be bought.
Because it is to spend money according to the plan, it is natural that money will not be spent indiscriminately and unjustly. Why is it said that spending money according to the plan in advance will not be spent unjustly? Because the plan is usually discussed and negotiated in advance with the participation of various departments.
Of course, just as there is absolutely nothing good in the world. Budget-based target costing method.
It’s not 100% good either, because there’s always something unpredictable. However, this does not negate the ineffectiveness of budget management, and once the budget is implemented, it is not monolithic, and appropriate adjustments can be made when necessary.
Most importantly, having budget management is definitely better than not having budget management at all.
The target cost management control method is based on benchmarking.
The so-called benchmark is a model, that is, others do better than themselves in some respects, so we must take others as a model to do it, even better than others, or say that others have achieved that effect, so I also require myself to achieve or even exceed that effect.
The meaning of “others” here is threefold:
For one, it can be another business. When a company achieves a certain degree of good in some aspects, there are usually a group of enterprises to follow it. Such as an automobile manufacturing plant, because of a new process to promote the production of each of its vehicles.
The cost has been reduced by 1%, so many car manufacturers have adopted this process. For example, if a company’s per capita contribution reaches a certain level, a company begins to study how it has reached that level, and when the company is convinced that it has the answer. It targets that company and takes steps (not necessarily exactly the same as the company’s approach) to try to achieve the same per capita contribution rate, or even higher per capita contribution rate.
Taking other companies as benchmarks, there are three main ways to learn:
1. Through certain media (television, newspapers, journals, books, networks, management consultants) know that a certain enterprise is doing better than itself in one or several aspects, so it is determined to learn it.
2. It is to visit and study the company or be introduced in person by the personnel of that company, so they decide to learn it. Third, the people who worked in that company bring the experience of that company and promote it in the enterprise.
Use some of the past performance of the enterprise as a standard to control it as a future goal. For example, in the history of the company, the highest per capita profit contribution is 50000, 8 dollars, or the selling expense ratio is only <>%, so we decided to control it in the next year. This is basically consistent with the target costing approach based on historical data.
3. The third is to aim for a record set by a certain department or person in the enterprise, and to use it as a benchmark for other departments or others and strive to surpass him. For example, a department has set a record of no more than 10-dollar per capita office supplies for three consecutive months, and after analysis, it is believed that other departments in the company can achieve this effect if they try to control the use of office supplies.
So, they advocate or enforce the implementation of this result of that department as a standard in the whole company to implement a plan to reduce the cost of office supplies.
For example, if a pieceworker sets a high production record that month, the company calls on others to learn from him, which is also a benchmark management method.
Target cost management control method based on market demand
Target cost management control method based on market demand (I sometimes call it “cost control method based on the will of the decision-maker”, because the will of the decision maker will play a leading role in the use of this method).
Below is a typical operation example of a target cost control approach based on market demand.
A company planned to develop and produce a new product – A type coating, and the company’s technical personnel finally developed the formula for this coating after tackling key problems.
Research – Example
The production of this coating requires four raw materials: clear lead powder, black lead powder, clay, and syrup, which account for 35%, 45%, 14% and 6% respectively.
Through market research, the company found that the market price of this type of coating is a competitive market price of 0.50 US dollars / kg, and the company has determined that the target gross profit after the product variety production is put on the market is 0.25 US dollars / kg.
This puts the target cost of Type A coatings at $0.25/kg ($0.50/kg to $0.25/kg).
However, the company learned through market research that the cost of the above four raw materials is 0.45 US dollars / kg, 0.18 US dollars / kg / kg and 0.15 US dollars / kg respectively.
According to this, the cost of Type A coating is: 1.00×0% + 45.35×0% + 18.45×0% + 05×14% = 1.6 US dollars / kg.
In other words, although this design scheme is technically feasible, its cost does not meet the requirements of the target cost.
In order to achieve the set target cost, the company’s technical staff decided to re-study the existing formulation of Type A coatings in order to achieve the cost target.
By applying the principles of value engineering, they found that the high temperature resistance of Type A coatings was somewhat excessive, while the suspension stability was slightly insufficient. For this reason, the scientists decided to improve the formulation while guaranteeing the necessary functions of Type A coatings.
The new formula uses only three raw materials, clear lead powder, black lead powder and bentonite, which account for 0%, 31% and 15% respectively, while the cost of bentonite is only 80.5 US dollars / kg.
The cost of this new Type A coating formulation is: 0.09×0% + 45.15×0% + 18.80×0% = $09.5/kg.
The cost of the new formula meets the requirements of the target cost and can be officially put into production.
Prove Method
This method has been adopted by many enterprises, that is, it has proved to be a very effective means of controlling costs. Initially, this method may have been created by a company forced by competition.
It is now also widely adopting mainly in highly competitive industries. However, in practice, in industries where competition is not fierce. The implementation of this method can still achieve peculiar management results.
Human potential is infinite, sometimes seemingly unattainable goals, if there is a powerful person who must let people achieve it, sometimes it can really get what it wants. Many companies often do not know whether there is room for cost reduction in their business, and this approach can sometimes wring out all the water in the sponge.
Cost management control method based on value analysis
This method is use by some large companies in the excellent manufacturing industry. Such companies often have a dedicate department responsible for “cost reduction“, they analyze existing jobs, matters, materials, processes, standards, and by analyzing their value and finding corresponding alternatives, they can reduce costs accordingly. For example, after careful analysis, the cost management personnel of an enterprise found that outsourcing the cleaning work in the enterprise to a professional cleaning company outside the company was lower than the cost of raising cleaners by the enterprise itself, so they put forward a proposal, and the company leaders thought it was okay after reading it. They entrust the company’s cleaning work to a professional cleaning company.
This method is often using in advance companies, where specialize personnel (usually engineers) are assign to this job. However, almost all companies seem to use this method to a greater or lesser extent, but in fact do it unprofessionally.
Specific analysis will find two situations:
First, the value analysis carrying out by some enterprises is actually learning from the experience of other enterprises. For example, I heard or saw that an enterprise outsourced cleaning work, reducing cleaning and management costs, so it also adopt the cost management method of outsourcing cleaning. This is really applying benchmarking, rather than the process and results of independent value analysis.
Second, some enterprises often conduct value analysis on certain work, matters, business, processes, etc., and sometimes may find a good alternative, and the implementation effect is indeed ideal. However, this process of value analysis is more due to the behavior of certain important people on a whim.