Article series on How to Reduce Manufacturing Costs – Part 1
We see it all! Companies that thrive in the most competitive environments, and companies that should be thriving but just can’t get there for various reasons. They all come to us looking for better ways to do things, streamline systems, reduce manufacturing costs and increase profitability.
The companies that thrive and succeed have many things in common. We are going to share these common success traits over the next few months. First, we are going to start off with a topic that is near and dear to everyone in the manufacturing sector – effective ways to reduce manufacturing costs. Of course, this is a huge topic, so we are simply highlighting what we see as the most effective manufacturing cost reduction strategies that our clients have implemented.
The 10 Most Effective Methods to Reduce Manufacturing Costs
Our most successful clients focus on ways to improve costs, profits, and flexibility by reducing manufacturing costs. Manufacturing cost reduction efforts can result in significant product cost savings, manufacturing cost saving, and life cycle cost saving especially when companies implement all ten of the following strategies for manufacturing cost reduction:
Costs associated with Product Design
Since product development determines 80% of product cost it makes sense to start here when looking at reducing manufacturing costs. In fact, the concept/architecture phase alone determines 60% of the cost. Product architecture determines product definition, technology, team composition, technology, part combinations, and off-the-shelf parts.
This phase also determines strategies for manufacturing, supply chain, vendors, quality, reliability, service, variety, configuration, customizations, and derivative products. These decisions have the highest impact of all manufacturing cost reduction strategies. It is a lot to consider, so focusing on the top strategies to lower cost is a good place to start. These include:
- Design to minimize part cost and material overhead, a huge component of which is buying off the shelf parts
- Designing out quality costs, where the return on investment doesn’t warrant the cost of the quality
- Eliminating change orders by focusing more time on the planning stage
- Focus on vendor-partnerships that can build value and ultimately reduce manufacturing costs
Implement Lean Manufacturing/Production Principles
Adopting lean manufacturing principles can reduce manufacturing costs by increasing labor productivity, cutting production through-put times, reducing inventories, and cutting errors and scrap by as much as half. The core principle of lean production is to do more with less, and the first place to focus on is eliminating waste.
Waste is defined as any activity that does not add value from the customer’s perspective. According to research conducted by the Lean Enterprise Research Centre (LERC), 60% of production activities in a typical manufacturing operation are waste – they add no value at all for the customer. The good news is that just about every company has an opportunity to cut manufacturing costs using lean manufacturing techniques and other best practices.
A great place to start implementing lean production is by understanding the forms of waste (waiting, transportation, inventory, motion, over-production, over-processing, defects, and wasting talent) and how to eliminate them. We will cover this in more detail next month.
Reduce overhead manufacturing costs with build-to-order and mass-customized inventory
Several key components to cutting overhead costs in manufacturing is to produce standard products that can be built to-order without forecasts or inventory, and produce special products through mass-customization on-demand. In both approaches, once a confirmed order for products is received, products are built.
The results can be staggering. Inventory Carrying Costs can be eliminated (the standard “rule of thumb” for inventory carrying cost is 25% of the inventory value on hand), and procurement costs can be reduced with automatic, on-demand resupply. In theory, better responsiveness leads to more sales, and although not a manufacturing cost cutting measure, certainly a happy by-product.
Standardize parts to reduce manufacturing costs
In Build-to-Order and Mass Customization manufacturing cost reduction is realized at the parts and raw materials level. Standardization supports the fundamental concept of build-to-order and mass customization in that all parts must be available at all points of use which eliminates the setup to find, load, or kit parts.
Standardization makes it easier for parts to be pulled into assembly, instead of ordering and waiting, by reducing the number of part types. Fewer types of parts ordered in larger quantities will reduce part and material overhead cost. Additional benefits are floor space reduction, overhead cost cuts, and time saved in setup, logistics and supply chain management. Other types of standardization which can also affect cost include tools, features, raw materials, and processes.
Rationalize the product line to focus on the most profitable products
An often-overlooked opportunity to simplify operations and free up critical resources resulting in improved productivity, profit, and cash flow—is rationalization of the product line and all of its component parts. Product line rationalization focuses on the most profitable products and eliminating or outsourcing low-profit products that have high overhead demands and are not compatible with manufacturing cost reduction strategies.
Experience with first-time product line rationalization efforts suggests that more than 60 percent of a product line contributes less than 10 percent of the total margin. Successful rationalization initiatives have cut total supply chain management costs up to 50 percent and improved performance on inventory turns up to 100 percent among top industry performers.
Simplify supply chain management
When designing new products or re-evaluating older products, the products should be designed with standard parts. If there are too many different types of products or materials, a steady flow of the product cannot be arranged due to the variety and unpredictability of demand for that product. The key to designing products with high-volume, easy to find parts is to order parts ahead of time based on the company’s forecasts.
Rationalization also aids in the simplification of supply chain management. The most unusual (often low-profit) products are typically made with hard to find parts. By rationalizing these products away completely, your supply chain is instantly simplified. Establishing Vendor/Partnerships and involving them on product design is another method in supply chain simplification. As part of the design team, vendors can recommend low-cost products that will be readily available for product creation. We frequently see too many vendors for the same products. While this may result in a few pennies in savings, the cost in purchasing and payables time may exceed this savings. When you factor in the extra requirements for put-away (and source traceability if you are in a regulated industry) and picking you are probably in a negative situation.
Overall, simplifying supply chain management can be beneficial in reducing manufacturing costs and improving the manufacturing process. Simplifying all parts of the process—including the planning, sourcing, production and delivery—not only saves costs, but it also improves efficiency and quality of products.
Evaluate the cost/benefit of quality
Quality cost reduction is an important step in reducing manufacturing costs. Without continual assessment of and improvement upon the manufacturing process, the Cost of Quality can be 15% to 40% of total revenue. However, these costs can be greatly reduced, and, in some cases, reducing quality costs can double profits.
The first step to eliminating quality costs involves designing in quality. This method assures high quality and reliability by design of the product, preventing costly errors, defects, reworks and overhead demands. Designing in quality requires a significant amount of planning and preparation, such as taking past quality problems into consideration when designing new products, simplifying designs, automating processes and thoroughly documenting every step of the design.
Quality costs can also be reduced by rationalizing products. Rationalizing away unusual and low-profit, low-volume products raises net factory quality and avoids wasting quality resources on inherently lower quality products.
How not to reduce manufacturing costs
As a side note, it’s also important to avoid cost reduction attempts that can substantially raise many less-obvious costs and compromise other important goals. We see attempts to do this often with companies that don’t have good measurement, tracking, and/or reporting in place.
Total cost measurement
Total cost measurement focuses on calculating the total cost savings to encourage and support continual savings.
Implementing total cost measurement begins with the cost driver approach. Cost drivers are the root causes of a cost, or the things that drive the cost. Recognizing the factors behind the costs will provide you with more accurate and relevant information, as well as encourage further efforts to lower or eliminate manufacturing costs.
Identifying the major cost drivers and measuring the costs to those drivers is the key to total cost measurement. A compan’’s overhead expenses can give significant insight into cost drivers. Even though the drivers may not be directly linked to the overhead costs, the overhead contains costs related to the most important cost drivers. For costs that are defined as neither direct material nor direct labor, you can start looking at the drivers behind those costs and how they impact the total expenses.
Until the total cost can be quantified, everyone must make decisions with total cost in mind. Linking cost with the behavior and characteristics of products or customers will reveal areas that need cost and investment reduction. Senior management must understand the importance of quantifying total cost, implementing total cost measurements and encouraging every cost decision to be made on the basis of total cost. This will not only reduce manufacturing costs; it will transform your company.
Use the RIGHT Manufacturing System
The most important tool needed in your cost reduction efforts is a way to measure, manage and analyze the data associated with each of these processes. However, choosing the right system to do this can be daunting, so we developed a free guide on how to choose a Manufacturing system. Download your free copy today to see if your current system is a help or a hindrance to reducing your manufacturing costs.