Before discussing ways to reduce production costs, let’s first understand the concept of manufacturing.
A manufacturing concern is a business entity engaged in the manufacturing of tangible articles called goods or merchandise. Manufacturing an article essentially entails combining some resources to bring into existence a new article. The article so emerged has a distinct name and possesses unique attributes and utility than those of its constituents.
In order to make a tangible product, first of all, there should be some tangible inputs, called materials, acquiring which does involve cost.
What Is Production Cost?
To combine various resources and to manufacture the desired product, you need for the efforts of some people. And you have to pay these people for their efforts. The cost so incurred is known as labor cost or wages.
Further, in order to process the raw materials, to arrive at the final product and to make these products available to the end users, you incur some other expenses.
All these three types of costs, viz. material cost, labor cost, and other expenses are combinedly known as manufacturing cost or production costs.
In simple words, production costs refer to the resources sacrificed to make or manufacture a product.
What Components Are Included In Production Cost?
Classification of manufacturing cost facilitates the analysis and control of costs and also helps in the determination of selling price. We can have different classifications of costs on different bases. Classifying manufacturing costs into material, labor, and other costs is known as element-wise classification.
Similarly, manufacturing costs can also be classified into direct costs and indirect costs (or overheads).
Direct costs are the summation of all direct components of costs, namely, direct material, direct labor, and direct expenses.
These are the costs which can be directly traced or allocated to a particular cost unit, or a cost center. Examples of direct costs are direct materials, wages of front-line workers, etc.
On the other hand, indirect manufacturing costs or manufacturing overheads are the sum total of three indirect components, namely, indirect material, indirect labor, and indirect expenses.
Manufacturing overheads are the costs that cannot be directly identified with or traced to a particular cost unit, or a cost center. These costs are mostly time-based and are not directly related to the volume of production.
Hence we cannot allocate but apportion manufacturing overheads over the production units. Thus manufacturing overheads include –
Such as lubricants, consumable stores, cotton wastes, small tools, grease oil, nails, etc. These materials though are used in the manufacture of products are not easily identifiable in the final output. These are common to several units of output. For example, the wood used in the manufacture of wooden furniture is a direct material but nails, glue, etc. are indirect materials.
Such as salary of supervisors, factory managers, gate-keepers, sweepers, etc.
Such as rent, rates, insurance, electricity and other expenses required to run the factory.
Manufacturing costs can also be categorized into fixed and variable costs.
Fixed costs, as the name suggests, remain fixed in total amount irrespective of the volume of production, but up to a certain level of activity. Indirect costs are mainly fixed in nature since they are not directly related to the production volume.
Variable costs tend to vary in total amount in direct proportion to the volume of output. Direct costs are generally of variable nature as they are directly proportional to the number of units manufactured.
How To Calculate Production Costs?
Total manufacturing cost = Direct costs + Manufacturing overheads
For example, the raw materials consumed during a period cost $100,000
Direct wages for the period are $40,000
Manufacturing overheads during the same period total $60,000.
Then the total manufacturing cost for the period will be $200,000
WAYS TO REDUCE PRODUCTION COSTS IN A MANUFACTURING BUSINESS
Business being an economic activity runs for maximizing profit.
There are mainly two ways to increase profit, viz. 1. by increasing selling price per unit and 2. by reducing costs. The first one seems a risky and unwise proposition in today’s competitive market conditions.
Thus, most businesses opt for the second one. In a manufacturing concern, total costs can be checked by keeping the manufacturing cost minimum.
The followings are some of the ways to reduce the manufacturing cost.
1. Reduce Material Cost
Material cost constitutes a substantial portion of the total manufacturing costs.
There are a number of techniques to control material cost. One of the popular material control techniques is EOQ(Economic Order Quantity).
EOQ refers to the quantity of material that should be ordered in a single lot. Purchasing at EOQ helps to keep the total of carrying and ordering cost minimum.
Similarly, some other techniques are level setting, ABC, JIT, FNSD, VED, etc.
Purchasing raw materials in bulk can also reduce raw material cost if quantity discount is provided by the seller.
2. Increase Workers’ Efficiency
Reducing employees’ remuneration so as to reduce labor cost results in employee dissatisfaction and ultimately in hiring and retaining unskilled employees.
Thus, the organization should aim at enhancing employee efficiency by hiring efficient employees and also by providing with adequate training and cost reducing techniques.
You can reduce the time taken to produce an average unit by providing specialized training that allows employees to work at a faster rate.
Also, offer incentives to the workers who produce an average unit at less than the standard time.
3. Control Manufacturing Overheads
You have to set budgets for these costs and review and them periodically. Necessary steps are to be taken for their control. Costs such as depreciation are mostly time-based. You have to decide whether to own these assets or to acquire them on a lease basis.
4. Diligently Choose Raw Material Suppliers
You should explore cost-effective sources of raw materials. This certainly does not mean only purchasing lower quality material to lower the material acquisition cost. Rather you invite quotations from accessible suppliers for the quality of material that your business requires.
Choose the supplier who agrees to supply the required materials at least cost or offers discounts. Besides searching for the suppliers locally, you can also explore online marketplace.
There are a number of B2B e-commerce websites that provide platforms to find suppliers and customers. Some of the leading ones are Alibaba, Global Sources, eWorldTrade,
5. Eliminate Non-Value-Adding Processes
Frequent innovations are occurring in the methods of production. Periodical review of manufacturing processes is necessary to diagnose the deficiencies in them. There may be some redundant processes in the manufacturing cycle that are no longer required and are unnecessarily consuming costs.
Hence you should analyze the value added at each stage of production and determine whether that activity is actually required in the present scenario.
Dropping non-value adding activities in the manufacturing cycle can assist in cutting unnecessary costs and keeping the manufacturing cost minimum.
6. Leverage Automation
The automation of processes makes the processes more efficient. It gives more opportunity to save in terms of cost. How? First of all, machinery does not result in defectives unless the input is inserted incorrectly.
Human beings are more prone to mistakes than machinery. Hence with the use of technology, it is possible to lessen errors. Further, you won’t have the liability in terms of warranty or refunds to customers who have been served with defective products.
Thereby the customers will be contented and the reputation of the business will improve due to the low error rate.
You have to use sophisticated and advanced machinery which will process the products at a faster rate and minimize the firm’s manufacturing cost in the long run.
7. Optimize The Production Output Level
It refers to an output level at which the per unit cost of production is the least.
Since all costs are not directly proportional to production level, we have to determine a level at which the per unit cost of production reaches the minimum. Making various cost analyses can help to arrive at the optimum level.
The optimum level of output is reached when the marginal cost(MC) is equal to marginal revenue(MR) or the market price.
Further, at this point, marginal cost curve should be cutting the marginal revenue cost from below(as shown below). At this point, the firm maximizes its profits.
8. Reduce Waste
Wastes may be in different forms such as
- Early production– producing products before they are needed leads to unnecessary blockage of funds and also some of them may get damaged by the time they are demanded.
- Waiting– products, people, and machinery waiting unnecessarily during the manufacturing cycle due to avoidable reasons delays the production process.
- Overstocking– Maintaining inventories in excessive quantity than required also leads to unnecessary blockage of funds.
Motion – Unnecessary movements of people and products during production cycle delays it.
defectives – As already discussed, these are the finished units that rank below the standard quality and need repair even during the warranty period.
In order to reduce such wastes, your business needs to have a strong internal control system. Conduct periodical checks should be conducted to minimize wastes. As we know prevention is always better than cure. Thus you should detect the areas of wastes and implement measures to prevent them. Tighten the quality control measures, so that only those units are offered to the market that meet the quality standards.
What do you think of the aforesaid ways to reduce production costs in a manufacturing business?. Please comment below.