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Main ways of decreasing the costs
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2 Main ways of decreasing the costs
Production costs depend on the effective use of economic resources and are determined by the cost of unit of production.
In order to minimize costs, the company shall take the following action:
• what is the best way to organize the production of existing production facilities
• which new production capacities to choose taking into account scientific and technological progress;
• what is the best way to adapt to discoveries and inventions.
Correct solution of these problems should lead to profits.
Fig. 2 Graph showing the number of products in the function of minimum production costs
Isocost - is a graphic representation of the production function with a straight line, which shows all the combinations of factors of production, the use of which requires the same cost.
K - volume of production;
L - labor;
C0, C1, C2, C3 - isocosts;
Q = B * (K * L) – firm’s production function in the long run.
The curve of Q determines the volume of production, in which the enterprise should carry minimal level of costs.
Company can not select C0 isocost, as there is no such combination of factors that would provide the output Q when their value is equal to C0. Given volume of production can be achieved at a cost of C2, where the cost of capital and labor are, respectively: K2L2 at point A and K3L3 at point B, but in this case the costs will be minimal, so the chart shows that the most effective solution - the point N ( K1L1), which ensures minimization of production costs. Since prices on the factors of production change, C1 changes its slope to C3. Since the speed of capital increases, the best option would be the point M (K4L4), which ensures minimization of costs.
The equilibrium is determined by the terms of achieving maximization of profits. To achieve this, the firm must use variable resources in such quantities, that ratio of norms of technological substitution of one resource to another, equal to the ratio of prices of these resources.
Constant effect of production scale growth is characterized by the fact that the volume of production increases in the same proportion as the cost of resources.
P - price realization.
Negative effect of production scale growth is characterized by the fact that the output increases less than the cost of resources.
Positive effect of production scale is characterized by the fact that the volume of production increases in the proportion that exceeds the proportion of the increased costs of resources.
Main directions of reducing the costs of production:
1. The use of scientific and technological progress;
2. Improving the organization of production on the basis of productivity increase through reduction of working time wastes;
3. State regulation of economic processes (http://zubolom.ru/lectures/economy/28.shtml)
There is another essence of costs decreasing. Costs can be decreased if in the company was created the system of effective control over costs. Such system involves classification of costs, depending on how easily they can be adjusted using the alternative solutions, and consists of the following elements:
Cost Accounting.
Sometimes you can reduce costs by simply starting counting them systematically. It was noticed, for example, that when the company begins to record outgoing long distance and international calls to their staff on the date, time and purpose, the total number of calls is reduced due to a decrease of personal calls.
Staff’s support of cost accounting system.
Employees should be attracted to follow the cost accounting system. If there is a strong staff resistance to change cost accounting system the leader should explain the need to reduce costs, make staff understand that their proposals regarding savings are of high importance and will be valued in future (maybe financially).
Analysis of the causes of costs in the company.
Such analysis allows to take the necessary steps immediately to eliminate the causes of an undesirable increase in cost. Thus, if the entertainment expenditures rise, it is useful to determine why employees are spending company’s money in expensive restaurants. Company actively expands its clients base and the number of signed contracts grows? Or because the control over the entertainment expenditures became weak?
Tips to reduce costs could be as follows:
1. Categorization of expenses by clearly defined categories. For example, the cost of raw materials, labor, all direct production and general business
2. Focusing on the most significant costs, determine which of them should be adjusted.
3. Planning and implementation of cost reduction.
Nine approaches to reduce costs
This is general recommendation, the applicability of which is listed in the table. 1 (asterisks shows the relevance of activities from the list for those or other costs)
1. Know the measure. Do not spend more than necessary to your business now.
2. New or old partners. Try to negotiate more favorable terms with suppliers, contractors and other partners with whom you have worked before the crisis. If it is not possible to agree with old partners, find new partners, which may offer more favorable terms for you.
3. Horizontal integration. Develop horizontal integration, which involves joint purchases together with other buyer from one supplier. For example, two commercial companies can join to get discounts for large volume purchases.
4. Vertical integration. Develop vertical integration, which involves the development of close relationships with suppliers to control and possibly reduce the cost of materials and services.
5. To buy or produce. Check what components (materials, raw materials, etc.) your company may produce, and which are cheaper to purchase from other manufacturers.
6. Rent or own. Check what is cheaper: to rent a room (equipment, etc.) or buy it to use on the rights of the owner.
7. Forms of payment. Look for new payment options.
8. Tighter control. Simply create better control: consider the costs and they will be less.
9. Optimization of technological processes. Check whether it is possible to achieve savings through improved technological processes and work organization, for example, spending less raw materials per unit of output.
| Activities or items that incur costs | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 |
| The cost of raw materials | * | * | * | * | * | * | * | * | * |
| Rent payments | * | * | * | * | * | ||||
| Utilities | * | * | * | * | |||||
| Maintenance of equipment | * | * | * | ||||||
| Total economic costs (accounting, purchasing department, sales, training, etc.) | * | * | * | ||||||
| Other costs: | |||||||||
| delivery | * | ||||||||
| storage | * | ||||||||
| loading and unloading, etc. | * | ||||||||
| Marketing and advertising | * |
Fig. 3 Table of activities and items that incur costs
(http://vuzlib.net/beta3/html/1/5575/5639/)
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