Constant Need to Reduce Costs

The successful president of a large corporation told a group of business
acquaintances how he had changed his company from red to black figures in two
short years. He stated, "In all functions of our organization, I simply sought
answers to these three questions:

1. Do we have to do it at all?
2. Do we have the right person doing it?
3. Could we do it better in some other way?

No. 1. His company found that, by enclosing a bill with each shipment, about
half its customers would pay immediately. So it had its money earlier, was saved
rendering half its monthly statements.

No. 2. Attending their information desk was a shy, introvert girl who was
frequently affronted by brash salesmen. In the shop, a talkative, dominant girl
was repeatedly neglecting her duties as a line inspector to "visit" with other
employees. When the two girls were interchanged, two problems disappeared.

No. 3. Branch stores hand-wrote sales slips of deliveries to regular customers.
Because of clerical errors and illegibility, the accounting department had to
check names and addresses against a master file. This clerical check became
unnecessary when customer addressing plates were provided to the stores. Saved:
1200 clerical hours per year.

There's wisdom in the three questions. Try them in your own company. Interesting
things will happen.

The Five Roads

Every management is faced with a continuing need to effect cost reduction.
Somehow or other we think of these reductions as available principally in the
manufacturing process, but this is not the sole area for expense reduction.
There are at least five channels through which important savings can be
effected.

These are:
1. Raw materials.
2. The costs of capital equipment.
3. Manufacturing costs.
4. Sales expense.
5. General and administrative overhead expense (including the office).

Although there are some procedures in common which you can use in endeavoring to
reduce expenses along these five avenues, for the most part the approaches must
be different. You need therefore to be alert in your thinking about cost
reductions in these five major areas.
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Road 1: Raw Materials
Raw materials costs vary greatly with industries. Most companies have long
since worked out the average percentage of the sales dollar paid for raw
materials and supplies. If you can make a comparison of this percentage for your
company against other companies in your industry, you may have an excellent
starting point. And even where you can't do this, or where the comparison is
favorable to your company, it nevertheless may pay you to study ways of lowering
the cost of basic raw materials. Here are the principal devices which companies
have used:

1. Development of carefully prepared purchasing specifications, which demand raw
material that is good enough for your manufacturing process but not of such high
quality that your costs go up without a compensating increase in the price of
your ultimate product.
2. Inspection of incoming materials to make certain
that they meet these specifications.
3. Tracing back difficulties in the manufacturing process to raw material
imperfections; alteration of specifications if indicated.
4. Modifications of manufacturing processes to eliminate the necessity for
certain raw materials and supplies.
5. Substitution of other kinds of raw materials.
6. Control over the sources of raw materials either by
purchase of the supply sources (vertical integration) or by
long term contractual arrangements which may take advantage of low price situations.

So many concerns take their raw materials for granted that you may make a
startling contribution to your company by applying the basic viewpoints here
spelled out.

Road 2: The Costs of Capital Equipment

Piled upon manufacturing labor and material costs must be costs of the
capital equipment used. Typical of such costs would be depreciation,
replacement, maintenance and interest on borrowed capital. Generally this field
is thought to be so specialized that only financiers can study it, but this is
not necessarily true.

Some managements feel that the die has been cast when the company capitalization
has been set up, and there is not much which can later be done about it. This is
not necessarily true, either.

A great many companies tie up a lot of money in semi-finished or finished
inventories. It is useful to make an occasional check as to the amount so tied
up and to compare this with previous checks. In fact some companies make these
comparisons weekly or monthly.

Because of inventory pricing policies used by accountants at the close of the
year, many a company goes through the year thinking that it has had a profitable
operation, only to discover that the inventory pricing has sharply reduced the
expected profit; by the same token many a company enjoys a fictitious profit
through pricing of inventories and lulls itself into a false sense of security.

In Chapter 4 we shall consider capital financing in more detail, so we will not
make further comment here.

Road 3: Manufacturing Costs

Manufacturing costs normally consist of labor plus material plus
manufacturing overhead.

Labor cost opens up a large area for study. It includes proper original
selection, adequate training of workers, financial and non-financial incentives,
quality of supervision, use of standards for control of labor costs. It may
involve techniques of aptitude testing, skill training, time and motion study,
work simplification, job evaluation, performance rating, delegation,
recognition, participation, etc.

Reduction of manufacturing overhead may involve studies of supervision,
maintenance and other indirect labor; of inspection and quality control; of
fuel, light and power; of fire, safety, police and insurance protection; of idle
equipment charges; of proper utilization of the space available; of other
charges directly allocated to the product.

Design of new equipment for production involves consideration of manufacturing
methods and the capital investment required.
Proper lighting has been responsible for worthwhile increases in productivity
and reduction of accidents. In some companies, improvements have resulted from
painting of walls and machines, reduction of noise, better ventilation,
introduction of music, etc.

Materials handling is usually another fertile field for investigation. The
movement and storage of raw materials, work in process and finished goods can
add considerably to the final cost of manufactured goods.

Studies of productive operations may readily include operations research,
whereby mathematics is applied to determine the optimum or best manufacturing
conditions. Typical would be job lot sizes to derive the greatest advantage from
manufacturing operations; proper inventories of raw materials, partial
assemblies, semi-finished products and finished products. Studies of this kind
can sometimes lead to complete revisions of manufacturing methods, changes of
layout, mechanization, conveyor lines, use of production feedback, automation,
different methods of inspection and control. In our present era of rapid change
in manufacturing methods, no idea is too fantastic to be rejected without proper
consideration.

Road 4: Sales Expense

Over the present century there has been a reversal of the relationship of
manufacturing costs to marketing costs. At one time manufacturing costs
represented more than half the sales price of an article, but these costs have
relatively receded so that today, in most companies, the sales costs represent
more than half the selling price. Contributing to this increase in sales cost
have been such items as warehousing, transportation, advertising, packaging,
direct sales costs and the constant price attrition of competition. Sales
overhead, too, has increased through the addition of market research, sales
promotion specialists, automatic vending equipment, more sales supervision, etc.

Many sales managers have virtually become sales controllers. Their functions
increasingly are those of analysis and control. They need both the accountant's
figures as to sales expense and the statistician's figures as to sales analysis.
The latter will normally show dollar and quantity sales by salesmen, by
territory, by customer and product. Wherever the sales manager detects a falling
off in some one of these areas, or an increase in sales expense, he applies
effort to change the condition.

If you are in a sales department, you will do well to become thoroughly
acquainted with figures of this kind.

Gross Profit. Deduct the manufacturing costs of an article from its sales price
and you get its gross profit. From this must come:

1. Sales expense.
2. General and administrative expense.
3. Net profit before taxes.
a. Taxes
b. Net profit after taxes.

Usually it is easier to compute total gross profit than the gross profit on a
single item. This is so because it is difficult to know how much manufacturing
overhead, sales expense and general and administrative expense should be
allocated against a given product. Differing assumptions in these allocations
can lead to different conclusions. Hence if you are making product studies of
gross profit, be sure to question the accounting assumptions that have been
used.
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Road 5: General and Administrative Expense

The fifth avenue of cost reduction consists of analysis of general and
administrative expenses. In the normal company these cover such items as
salaries of executives and office employees, office expense, interest, property
depreciation, taxes, insurance, donations, legal fees, consultants,
investigation of possible mergers, economic services and other general business
expenses.

Here is a delicate and difficult area to study, particularly for younger
executives. It contains a lot of sacred cows. Hence it may well be that you will
make observations in this area for a long time before presenting any
suggestions. Moreover, you have to be certain of your ground before you make any
recommendations. Quite often jealousies among top executives will be involved.

Nepotism, relationships with important stockholders, special arrangements with
suppliers, relationships with banks, conditions of long standing, "empire
building" by high officials and emphatically expressed viewpoints of top
executives may well be the unseen opponents of any bright ideas you may have for
reducing expense in this area.

However, this may not be true of the entire area. Office costs, for example.
Mechanization, including electronic computing equipment, is taking such a fast
hold on the office that it may well provide a field in which you can become a
specialist and make important recommendations.

If your organization does not now have budgetary control, this may well be a
management device in which you should interest yourself. There can be budgets
for capital needs as well as expense budgets applicable to manufacturing, sales
and administration. Budgeting is not merely a control device, nor a mathematical
confirmation of management errors. It must be wanted by the operating heads,
they must contribute to its formation, must believe in its soundness and must
change their actions in accordance with its findings. Only then can budgetary
control be of value.
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An interesting variant of budgeting is the profit budget. It sets a reasonable
profit goal, then works backward to reveal what sales, production and
administration must do in order to bring the profit about.

Savings through determined effort can be large, indeed.

Some years ago, a well known radio company was heading for bankruptcy. In
desperation the Board of Directors brought in a new executive vice president,
gave him a free hand. After intensive analysis of the cost data, he set the
following cost reduction goals:

Items	Percent
Raw materials	2
Investment in buildings and equipment	1
Manufacturing labor	10
Manufacturing overhead	15
Administrative overhead	15

He then initiated vigorous steps which
increased sales expense somewhat The company broke even within six months, was
extremely profitable within two years.

Work Simplification

One of the most useful devices for effecting economy which I have worked with is
the "STEM-analysis" plan. It derives its name from the fact that it seeks
economies in:

S-pace,
T-ime,
E-nergy, and
M-aterials.

Moreover, it is applicable to plant, office and sales, because all four factors
involve expenditures in these three subdivisions of a business.

Each factor may in turn be subdivided as shown in the first column of Figure 3.
Also shown are some typical investigations conducted under this twelve-point
attack. These factors are interrelated. Better storage may reduce

waiting time; a changed layout may make
possible use of conveyors; studies of working methods may suggest use of new
equipment. Here are some usual aims:
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1. Flow of work should be in a forward direction, with a minimum of
backtracking.
2. The flow of work should determine the layout, and not the reverse, as so
often happens.
3. Use shelving to reduce floor space congestion.
4. Reduce waiting time of people and materials.
5. Reduce traveling time of people and materials.
6. Make repeated studies of production methods.
7. Select the best man for the work to be done; train, motivate and supervise
him.
8. Substitute mechanical for human energy.
9. Substitute electrical for mechanical energy.
10. Use raw materials consonant with the ultimate quality of your product.
11. Look for waste and carelessness in utilization of supplies.
12. Keep abreast of new developments in tools and equipment; design your own for
special purposes.

Managing Improvements

A great opportunity lies ahead for young executives to learn how to manage
improvements. At any given period of time most companies have a number of
improvement programs in effect. Some of these die aborning; others just wear
themselves out and never accomplish much. Some programs initiate important
research which results in a series of recommendations about which no action is
taken. In some instances, carrying out improvements rests with executives who
will merely make great sacrifices. There is frequently need for a "lictor."

In the days of the vanquishing Roman armies, there existed a job known as "lictor."
It was the duty of the man who held this job to follow the Roman general into
battle. When the general hesitated, the lictor would lash said general as though
he were an unwilling horse, to remind him that it was the job of a commander to
win battles, not to retreat.

Every organization has an important potential for making improvements in
products, production, distribution and administrative procedures. Provincial
thinking and resistance to change are likely to interfere with getting these
improvements.

Conventional administration is concerned with the necessary planning, direction,
coordination and control of the organization to carry out the avowed objectives.
But too seldom are questions raised about the objectives or the methods of
achieving the objectives. Change is the essence of progress.

You can't push yourself ahead by patting yourself on the back. But if you will
persistently and consistently work toward methods improvement and cost
reduction, you will inevitably be selected for promotion, provided you have not
made important enemies on the way. The future is necessarily filled with doubt
and complexity. Executives who are able to project their organizations into the
nebulous future, to sell their ideas to others, to do that kind of creative
thinking which proves right against the actualities as they unfold, must
inevitably be the executive leaders of that future.
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High Lights

1. Ask: Need it be done? Is the right person doing it? Could it be done better?
2. Study the five roads to cost reduction: raw materials, capital equipment,
manufacturing, sales and administration.
3. Studies of changes in gross profit can often point the way to cost reduction.
4. Learn to apply STEM-analysis in work simplification leading to cost
reduction.
5. Once possible economies have been uncovered it is necessary to prosecute them
vigorously, lest they fail of accomplishment through inertia and resistance to
change.

Obviously, if your company can't sell certain products it won't continue to make
them; piled up inventories will cause profits to become the "little man who
wasn't there." So let's consider the problem of marketing.