Optimisation of costs

Cost optimisation is a term that is regularly on the agenda of every company. However, the cost side is often neglected in good economic times. When the first “warning lights” show up in controlling and profit targets are in danger, hectic activities break out in many places. Ad hoc measures are taken that may lead to a short-term improvement, but in the long run may even cause damage. It is therefore clear that professional cost management must not only take place in an “emergency”, but must be understood as an ongoing process. What should be the optimal approach?

This article provides you with basic information on the topic of cost optimisation. You will learn how to implement forward-looking cost management, identify potentials to optimise, introduce suitable optimisation measures and thus enhance the long-term competitiveness of your company.

Cost optimisation is by no means reduced to cost reductions or savings by “applying a red pen”. Rather, the term refers to a comprehensive management process in which the costs of a company are subjected to a precise analysis and positively affected by suitable methods. This is why the term cost management is often used. The primary goal is to increase the economic efficiency of the organisation. Simply put, this is achieved by avoiding activities that do not contribute to added value. In addition, all value-adding activities are designed in such a way that they can be used as cost-effective as possible to ensure of the same or even a better performance.

Cost management can be divided into two categories depending on the time line. Strategic cost management is designed from medium to long term. Operational cost management, on the other hand, has a short-term character and relates to the day-to-day operations.

Cost management can not only be divided into the areas of “strategic” and “operational”. It is also possible to differentiate between reactive and proactive cost management. Although the proactive variant is naturally to be aimed for, reactive cost optimisation is often the rule in practice. Companies usually only react when a failure to meet profit targets is foreseeable. Classic scenarios that cause this reaction are the following:

• Unexpected decline in sales
• Significant decrease in sales prices
• Rising purchase or raw material prices
• Missed cost optimisation despite cost superior competitors

A compulsion to improve results arises, which often leads to unstructured approaches. For example, it can be observed in hiring freezes, across-the-board cuts in budgets, reductions in important investments and the cancellation of projects. The survival of the company may be secured in the short term by such measures, but the future viability is put at risk. It is possible that strategically important activities (e.g., research and development, marketing, training) are neglected or that future opportunities are not (or no longer) been developed. If a company misses important developments, it risks its competitiveness. Moreover, the actual cost problems are usually not eliminated. Because of all these reasons, reactive cost optimisation should be at the very most an emergency solution.

A reactive approach is always inferior to a proactive approach. What it generally trues also applies to cost management in a company. It is therefore important to have a lever on costs at an early stage and on an ongoing basis. In addition, future results should be determined as accurately as possible and be included in cost planning. This can increasingly be supported with software. Furthermore, proactive cost management should not only include internal company departments. It should include the entire value chain, including suppliers and customers.

Often the potential for cost optimisation is not always visible and must first be identified. At the start, it is therefore important to receive an overview the company’s cost situation. You need to be aware of the following factors:

• Absolute magnitude of the costs
• Cost structure
• Cost trend

This information is primarily available from your cost accounting. An internal analysis can already reveal initial cost priorities. The historical trends of the values can also provide starting points for cost optimisation. However, more transparency results when the data is put in relation to the competition and best practice companies (benchmarks).

You ensure sustainability in particular by targeting the causes of costs. You need to identify the factors that have an impact on your costs (identification of the so-called cost drivers). However, this is not a trivial task due to the wide variety of interdependencies. To get a better overview, divide your cost drivers into three different categories:

Operational cost drivers: Explain short-term cost dependencies, often refer to production parameters (e.g., workforce)

Tactical cost drivers: Explain mostly fixed costs and medium-term cost dependencies (e.g., number of order transactions)

Strategic cost drivers: Explain long-term cost dependencies and also affect the two previously mentioned categories (e.g., product complexity)

Regardless of the industry, there are three starting points for cost optimisation in every company:

• Products
• Processes
• Resources (especially personnel, material and equipment)

Let’s take a closer look at how to optimise costs in these three areas.

On average, 70 to 80 per cent of the subsequent manufacturing costs of a product are already defined in the development phase. The focus must be therefore on the product development process when optimising costs. The future design of products must be in in such a way that they cause the lowest possible costs in production and marketing, but without neglecting customer requirements. The following measures are helpful in this regard:

• Implementing only product functionalities with a high level of customer benefit
• Design the product so that it is suitable for production and assembly
• Limiting the variety of products and variants to the necessary extent

Process-oriented cost management does not focus on optimising individual cost centres (company departments), but also on cross-departmental process flows. In particular, processes that have grown historically over a long period of time are often offer a lot of cost reduction potential. New technologies and holistic business software open up numerous possibilities. After a systematic process analysis, the following measures are conceivable:

• Eliminate non-value adding process steps
• Changing processes (process reorganisation)
• Relocation of processes or individual activities within the value chain (e.g., outsourcing of certain tasks to suppliers)

Every resource in the company incurs a certain fixed and variable costs. In terms of value, personnel and material costs are usually the most significant, which is why your focus and measures should first concentrate on these areas. Classic examples are:

• Optimisation in purchasing and procurement (e.g., global sourcing, demand bundling, strategic partnerships)
• Reduction of staffing levels, more flexible working hours

As already mentioned, the subsequent costs of a product are largely already defined in the development phase. In the “design to cost” process, the most cost-effective solution is therefore already determined for all known components during the development phase. Follow-up costs such as distribution, service and disposal costs are also considered in detail. The finally it is to identify the best technical solution within the framework of a given cost target.

Basically, with design to cost, which is closely related to target costing, you attain a strong market orientation, as budgets are set based on concrete market requirements.

Cost optimisation and cost reduction are often used synonymously, but this is not correct. In some cases, it can even be advantageous to initially accept higher expenses in order to reduce costs in a later phase. This applies, for example, to higher development costs that later lead to a disproportionate reduction in production costs. Investments in ongoing training of employees or the hiring of new staff can also initiate cost reductions in the long term. The same applies to the acquisition of modern (new) equipment and IT systems.

In essence, good cost management requires a continuous, integrated process that analyses potentials, derives in correct measures (do not save costs at the “wrong end”) and ensures consistent implementation. It is therefore advisable that the task must be set at a senior level – ideally with the company’s leadership, the management.