THERE are costs involved in manufacturing a product or providing a service. In fact, every activity in an organisation costs money. And prudence would have it that money in any business should be well spent or invested.

Cost is, undoubtedly, a key factor in competitiveness. As organisations face the current global economic challenge, the pressure now is even far greater for them to find ways to reduce their operating costs to remain profitable. But it has also become increasingly difficult to compete on price alone.

For businesses to remain profitable and viable over the longer term, companies will have to continue to satisfy the needs of their customers in more efficient ways, demonstrating value for money.

Prominent American quality consultants Armand Feigenbaum and James Harrington have pointed out that 25 to 40 per cent of operating costs result in waste. Separate studies undertaken by the American Society for Quality (ASQ) have also shown that waste can go as high as 40 per cent of sales.

Waste is any resource-consuming activity that adds no value for the customer. For most organisations, customers are the users or consumers of their products, services or both. Clearly, the focus is on external customers. But identifying waste can and must also be applied to the support activities that serve internal customers.

High costs

In the past, there was insufficient information about production and service costs. Hence, there was limited scope for comparisons and benchmarking. Organisations, as a result, were able to pass on their high costs of production and services to their customers and continued to do so for a long time.

Nowadays, customers are more well-informed about processes and the service delivery supply chain. They are now able to analyse and compare the cost structure of their supplier organisations to determine where they might be able to derive the highest value for the money they pay to acquire goods and services.

Limitations

In traditional accounting, organisations may know their total revenues and costs to the penny. But they have no idea how much they throw away every day on plain simple ineffectiveness, inefficiency and waste.

These are not visible on financial reports because traditional accounting methods do not provide a means of separating value-added activity from wasteful or low-value activity. As such, they do not show the high costs of ineffectiveness and inefficiency within the organisation.

Reducing waste

Since traditional accounting methods have their limitations, the management of most organisations attempt to control inefficiency and ineffectiveness the best they can without proper tools and metrics — resulting in much wasteful activity.

If your accounting systems are of little help and your management practices lack the knowledge to be lean and productive, then how do you identify waste and unproductive costs?

There are two approaches. The first is a variation of cost accounting and is called activity-based costing, or ABC. It is an excellent system for identifying low-value activity, but it has drawbacks. It is a formal accounting system that parallels existing systems; it depends on considerable input from large numbers of individuals who already are working at their time capacity limits, and it requires a high level of system support.

The second approach is one with assessment and problem-solving capabilities and is called the cost of quality or COQ.

Improve processes

The biggest opportunity organisations have to boost the bottom line comes from improving their business processes. The survival of many organisations is dependent on these improvements.

In many companies, management can make more profit by cutting unnecessary costs in half than doubling sales. This can be accomplished without hiring one new person, building a new facility, or finding one new customer.

Organisations must therefore identify unnecessary costs in the business processes and take action to improve the company’s bottom line.

Organisations must help their employees recognise wastefulness, maintain a high visibility of what these are, systematically reduce non-value-added activities and reduce costs the smart way.

An organisation that focuses on profit may have maximum profits in the near future. But an organisation that focuses on its reputation of being the highest value provider will provide the best return to its investors in the long haul.