Cost Reduction in Managerial Economics

The Institute of Cost and Works Accounts of London has defined cost reduction as “the achievement of real and permanent reductions in the unit costs of goods manufactured or services rendered without impairing their suitability for the use intended”. Thus, cost reduction is confined to savings in the cost of manufacture, administration, distribution and selling by eliminating wasteful and unnecessary elements from the product design and from the techniques and practices carried out in connection with cost control.

Cost Reduction in Managerial Economics

Cost Control and Cost Reduction

According to the Institute of Cost and Works Accounts, London, “cost control, as generally practiced,  lacks the dynamic approach to many factors affecting costs, which determine the need of cost reduction.” In fact, cost control also known as cost management or cost containment; it controls the costs of the organization at the given level. Besides, cost control emphasis on ensuring that the cost does not exceed the standard budget of the organization. Businesses use cost control methods to monitor, evaluate, and ultimately enhance the efficiency of specific areas, such as departments, divisions, or product lines, within their operations. For example, under cost control, the tendency is to accept standards once they are fixed and leave them unchallenged over a period. In cost reduction, on the other hand, standards must be constantly challenged for improvement. And there is no phase of business, which is exempted from the cost reduction. Products, processes, procedures and personnel are subjected to continuous scrutiny to see where and how they can be reduced in cost.

There are two different concepts between cost control and cost reduction. Cost control is achieving the cost target as its objective while cost reduction is directed to explore the possibilities of improving the targets or company profitability. Therefore, cost control will end the exercise when achieved the organization target or objective. While cost reduction is a continuous process and it has no visible end. Furthermore, cost control try to attain the lowest possible cost under existing conditions whereas cost reduction does not recognize any condition as permanent since a change will result in lowering the cost.  If the cost control emphasis is on past and present, while the cost reduction emphasis is on the present and future.  Besides, cost control is a preventive function whereas cost reduction is a correlative function. It run even when an efficient cost control system exists.

The difference between both of it can be summarized as cost control ensuring the costs is in accordance with established standards whereas cost reduction is concerned with try to improve the cost by continuous and without accordance with any of the standard.

To achieve success in cost reduction, the management must be convinced of the need for cost reduction. The formulation of a detailed and coordinated plan of cost reduction demands a systematic approach to the problem. The first step would be the institution of a Cost Reduction Committee consisting of all the departmental heads to locate the areas of potential savings and to determine the priorities. The Committee should review progress and assign responsibilities to appropriate personnel. Every business operation should be approached in the belief that it is a potential source of economy and may benefit from a completely new appraisal. Often, it may be possible to dispense entirely with routines, which, by tradition, have come to be regarded as a permanent feature of concern. Cost reduction is just as much concerned with the stoppage of unnecessary activity as with the curtailing of expenditure. It is imperative that the cost of administering any scheme of cost reduction must be kept within reasonable limits. What is reasonable must be determined in all cases from the relationship between the expenditure and the savings, which result from it.

Essentials for the Success of a Cost Reduction Programme

Following are the some of the points that firms should take care in order to achieve success in the cost reduction programme:

  • Every individual within the firm should recognize his responsibility. The co-operation of every individual requires a careful dissemination of the objectives and interest of the employees in the achievement of the firm’s goals.
  • Employee resistance to change should be minimized by disseminating complete information about the proposed changes and convincing the employees that the changes are concerned with the problems faced by the firm and that they would ultimately benefit.
  • Efforts should be concentrated in the areas where the savings are likely to be the maximum.
  • Cost reduction efforts should be continuously maintained.
  • There should be periodic meetings with the employees to review the progress made towards cost reduction.

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