Business

Study Notes

Cost Minimisation

Level:
AS, A Level
Board:
AQA, Edexcel, OCR, IB

Cost minimisation is a financial strategy that aims to achieve the most cost-effective way of delivering goods and services to the require level of quality.

It is important to remember that cost minimisation is not about reducing quality or short-changing customers – it always remains important to meet customer needs.

The low-cost or "no-frills" airlines are some of the best examples of businesses where cost minimisation has been taken to an almost obsessive level. Airlines like Ryanair and Easyjet have either removed or charged customers for many non-essential parts of the airline service.

Similarly, the discount retailers such as Poundland, Lidl and Aldi base their business around a relentless focus on minimising costs and operating efficiently.

In theory a reduction in costs results in higher profits and better cash flow. But not always! The trick is to identify cost-reduction actions which do not adversely affect revenues, quality or customer service.

Businesses tend to go through phases of cost minimisation.

During an economic boom or when a business is enjoying rapid growth in revenues, cost structures do not necessarily get the attention they deserve. A business that is adding new locations, launching new products or entering new markets will often see revenue expenditure as a kind of "investment". Before too long, and often not spotted by management, the business has substantially grown its cost base and added much complexity to the organisation.

It sometimes takes a severe economic downturn to prompt a business to take a hard look at its costs to see where savings could be made. The recession of 2008/09 saw nearly every well-managed business look for ways to reduce overheads, improve efficiency and reduce production capacity.

Popular sources of cost reductions in a well-established business include:

  • Eliminating waste & avoiding duplication (note the link to lean production)
  • Simplifying processes and procedures (the acronym KISS – "keep it simple, stupid" is always worth applying in business)
  • Outsourcing non-core activities (e.g. transaction processing, payroll administration, call handling)
  • Negotiating better pricing with suppliers
  • Improving communication (often by cutting out unnecessary communication)
  • Pruning product ranges and customer accounts to eliminate unprofitable business
  • Using the most effective methods of training and recruitment
  • Introducing flexible working practices that benefit both the employee and employer
  • Aggressive control over non-essential overheads (e.g. banning first or business class travel unless essential)

Actions aimed at minimising costs need to be taken with care. The danger is that over-aggressive pruning of overheads, using cheaper raw materials or cutting pay rates might have a detrimental effect on quality and customer service.

Being too aggressive with cost minimisation has several other potential disadvantages. For example:

  • The business can be left with insufficient capacity to handle unexpected or short-term increases in demand
  • Cost reductions by one department may surprise and/or annoy other functions if they are not properly communicated and coordinated

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