Resolving cost-related issues in any organisation calls for an uncluttered understanding of the root cause of the cost and focus on that. This can happen, if there is a clarity on the sources and causes of cost. There are four drivers of Cost, Economic, Design, Operational and Attitudinal. Tackling cost is not the domain of an accountant.This is an article written by me in 2011

1. Money matters
Resolving cost-related issues in any organisation calls for an
uncluttered understanding of the root cause of the cost and focus
on that. This can happen, if there is a clarity on the sources and
causes of cost. Read on for more insights...
M Hariharan
T
he normal practice, if a company
is not doing well, is to demand
that every employee cut costs by
15 per cent. It is akin to telling
each employee, ‘take 15 per cent less
food’, or ‘restrict the number of words in
a report to 85 per cent of the intended
length’. What many of us call as cost
control is nothing more than expense
control. The expenses appearing in
the profit and loss account are listed,
percentage of the expenses on sales is
calculated and aspirational targets to
reduce the expenses are set.
Expense appearing in the profit
and loss accounts is the result of the
management decisions taken. These
decisions impact revenue, cost and
investments. Addressing costs call for
addressing the causes of cost, while
reduction in expenses involves cutting
them down, often without understanding
the impacting factor of the cost. For
example, material cost is considered as
a percentage of sales and compared
across periods. Then the attempt is made
to reduce the material cost in isolation
by forcing the purchase in-charge to
look for alternative sources. Without any
concern about the repercussions on the
delayed material delivery, adverse impact
on conversion cost & material losses
and on the post-sales utilisation by the
customer, the purchase in-charge ends
up cutting the material purchase price.
Material costs might have changed from
the previous accounting period due to
myriad reasons including change in
material prices, product mix, input mix,
material wastes and operating practices.
If an increase happens, the blame
is on factors beyond one’s influence
and control (global meltdown); and
in reverse situation, the credit goes
to superior operating practices. Either
way, companies sweep the reasons for
variation under a singular major cause.
There are four sources of causes for
cost which are as follows:
Economic factors: These include
price level changes, government policies,
social issues and other factors beyond
one’s control and influence.
Design factors: These include
design of product, process, supply chain
structure and organisation structure. They
are normally within one’s influence and
control.
Operational factors: These revolve
around the fulfillment of design and are
influenced by the economic factors and
design. These factors are normally within
influence and control.
Attitudinal factors: These involve
the way people react to a situation and
the culture of the organisation. These
are also influenced by the design of
organisation structure and may or may
not be within influence.
Now let us analyse these factors
in detail.
Economic factors
This is the often seen ‘pass-the-buck’ for
any cost increase. For instance, reasons
like ‘input prices have gone up’; ‘our
suppliers are in a monopoly market’;
‘wages have gone up’, ‘government has
changed the rules’; or ‘The green lobby
is creating lot of problems’ are the most
common. Hence, it is essential to isolate
the economic factors first. Addressing
Tackling root causes of cost
MANAGEMENT MANTRAS
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these factors call for a more strategic
focus than a simplistic operational
focus. The following is an inclusive list of
economic factors:
Changes in price level: Prices are
influenced by many factors, both macro
and micro-economic. Macro-economic
factors include demand-supply gaps,
speculation of commodity prices, cost
of living index going up leading to
labour cost changes. The impact of
these on the bottom line is to be isolated
before comparing costs across periods.
Otherwise, this will vitiate the sense of
direction. Addressing these causes is to
be at a strategic level of freezing the
sources for longer duration. However,
the flip side is when the prices fall.
Micro-economic factors of an
individual firm impacting the prices
due to their monopoly position in the
market, union level wage agreements,
normal trend being followed within the
company for salary increase (this drives
the attitude) are again to be addressed at
a strategic level. Developing alternative
sources (design), relook at the practices
within the organisation for salary hikes,
relook at the agreements are some ways
of influencing these causes.
Costs going up due to this factor
are normally not a worry, if it impacts
all the players and the given product is
a necessity for the customer. Companies
palm off the cost impact to the customers.
However, if it impacts only a particular
firm, then it indicates that the company
is in trouble. Design plays a crucial
role here; if a modular design can be
created to change the dependence on
any one input, which thereby minimises
the impact, or design a supply chain
where the company is integrated with the
upstream sources (holding the mining
rights, and thereby minimising the price
level changes).
Government policies: Changes in
tax structures, money market policies,
restrictions and removal of restrictions on
import play a significant role in adding to
costs. For example, the design of supply
chain is influenced by not only distances
and nearness to sources, but also as
a result of speculation on introduction
of GST. These again, in the ultimate
analysis, will impact the whole industry
and not only a specific firm. However, it
will certainly impact differently, if various
players are in different impact zones like
a SEZ or FTZ. Even if competing within
the domestic competition does not impact
differently, if a firm competes globally or
with global competition internally, then it
has a huge impact on the cost structure.
Triple bottom line (TBL)
requirement: Global concern for
measuring a firm’s performance based on
people and profit makes the environment
and society a non-negotiable necessary
condition for survival of the business.
Firms are expected to avoid exploitation
and spend on creating carbon credits
as they grow. It certainly impacts the
costs internally for the firm. However,
over a period of time, it hopefully, will
impact all the firms. Whatever may be
the situation, the impact of focussing on
TBL will certainly impact the internal cost,
mostly in an adverse way. But, it is often
worth it.
Design factors
Design can create or destroy. More than
90 per cent of the costs are committed by
the time a firm goes for a detailed design
(of the product, process and supply
chain or organisation structure). Trying
to reduce the cost after the damage is
done is more like catching the bull by the
tail. Once committed, a company should
address the design issues to achieve
significant cost impact.
Design of the product: Product
design plays a major role in the lifecycle
cost of the product and the process.
Any attempt to reduce the cost after
the design is complete can have only a
limited impact. For example, in the case
of material costs, design has the greatest
impact on the cost. Methodologies
like target costing (in conjunction with
value engineering and quality function
deployment) can help the firm to design
tomorrow’s cost through today’s design.
Design of the process: Design
of the product plays a significant role
in the design of the process as well.
Still process design independent of the
product design impacts the operations
cost significantly. Outdated technology,
unreliable process due to faulty process
design, inappropriate processes are
capable of playing havoc with the cost
structure.
Design of the supply chain: If a
customer wants online delivery directly, a
company will need to keep stock nearer
to the customer. This is essentially a supply
chain design driving the cost structure.
Creating supplier clusters, cross docking,
milk run design, choice of the channel of
distribution and sourcing, etc, all play a
major role in the cost structure.
Design of the organisation
structure: For men may come and men
may go; but I go on forever. (The Brook
by Tennyson). Similarly, men may come
and men may go, but the organisation
structure goes on forever. Many firms
still follow the pyramidal organisation
structure created by DuPont Plc in the
early 20th century. Organisations may
be divided as functional or strategic
business unit (SBU) or matrix or flat as it

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is called for minimal levels of hierarchy.
The structure drives the communication
channel & the decision-making process,
and ultimately the cost as well.
Operational factors
This is the favourite ‘scapegoat’ for any
cost increase. Bosses often are heard
saying, ‘cut the cost everywhere; we
need to tighten our belt’. Operations can
only control cost and cannot reduce or
manage cost beyond the boundaries of
economic and design factors. Operations
can fulfill and destroy, but cannot create.
Design can create a far greater damage.
But, operational inconsistencies, strains
and penchant for creating waste all
make a heady cocktail of cost increase.
The three Ms – Muda, Mura and Muri –
emerge out of operational inefficiencies.
Wastes – Muda: Defects,
overproduction, waiting, transportation,
inventory, movement and extra-
processing, the seven wastes identified
by Taichi Ohno, who propounded the
Toyota Production System, are essentially
triggered at the operational level. Though
the structure of the supply chain, process
and product do influence this, these
seven wastes can emerge independent
of the design.
Lean thinking principle of aligning the
process to the purpose (customer value),
and thereby focussing on the six out of
seven zeros (zero defect, zero lot size,
zero lead time, zero breakdown, zero
handling and zero setups) can minimise
the Mudas.
Inconsistency – Mura: Variability
in processes, surges and inconsistencies
force organisations to have capacity more
than what is actually required. It becomes
imperative to commit resources, men,
machine and inventory to minimise the
shock of the variability. Hence, the cost
has a tendency to increase. Focussing
on the seventh zero (zero surging), and
thereby improving the process capability
is critical for minimising Mura. Six Sigma
focusses on this.
Strain – Muri: Strenuous processes,
postures, movements, strain on
machines, men and other resources are
the third ‘M’ of the infamous three Ms
of Muda, Mura and Muri. Many of the
quality initiatives focus primarily on the
operational stability. The major role of
operations is to ensure stability.
Attitudinal factors
Afterall organisations are so-called as
they are made up of people. People
behave in the way their performance
is measured. For example, selling
price is not driven by the competition
or customer or cost; it is driven by the
month-end pressures of the salesman to
achieve the target. Costs are incurred
because there are budgets. The project
completion time gets stretched to
accommodate the padding that had
been done during planning.
Outdated performance measures:
The purpose of a performance measure
is to implement and validate strategy.
Strategy has to be in sync with the
changed environment. If there is a
change in environment, it is believed
to be temporary. This leads to a delay
in formulating a strategy to meet the
changing needs. It is necessary to adapt
one’s performance measure to fulfill the
strategy. Strategy is for the future, but
delayed with reference to the changing
environment; whereas performance
measurement is for the past delaying
to adapt to the strategy. There is an
in-built anachronism among change in
environment, strategy and performance
measure.
Short-term focus: Performance
measures tend to focus on short-term
achievement of targets. Even a CEO’s
shelf-life is not more than three years.
‘Who cares what will happen to my
successor; I need to cover my back
(called as CYA syndrome)’
‘We follow the same attitude with our
environment as well’ or ‘let me focus on
reducing the purchase price; cycle time
reduction is not my area of concern,’
called as not in my back yard (NIMBY)
syndrome. All these attitudinal factors
lead to locally optimising the cost but the
overall cost may tend to increase.
Fulfilling a budget through
reprimand: Discretionary cost is a
cost triggered at the discretion of the
management, like research, sales
promotion, training, CSR, etc. In these
cases, a budget based on a percentage
of sales target is given to the functional
heads. If the budget is not exhausted,
they may get a cut in the next year. We
often find a high surge in these expenses
in the last three months of the year.
Attaining sustainable cost
advantage
Profit is a mind relaxant. People tend
to splurge when they do well, but get
to stingy levels when they do badly. To
consistently address cost, a cost-aware
culture is critical. It is important to realise
that cost is an effect and not a cause.
Addressing the effect by taking one-off
initiatives rarely deliver sustainable and
significant cost advantage. It is essential
to address the sources of the causes
of costs. In many firms cost ownership
is unclear. Sustainable cost advantage
emerges out of tackling, taming,
tracking and trapping the cost. This can
be done only by scientifically addressing
the causes.
M Hariharan practises
consultancy in the field of cost
management, lean thinking,
constraint management,
management control system
and business excellence as Founder Director,
Savoir Faire Management Services. Savoir
Faire develops cost information systems to
support pricing, outsourcing and control
decisions using the cost excellence (CE©)
model. He is also a renowned trainer on the
impact of customer focus, competitor actions
and goal conflicts on the bottom-line of the
business. Email: sfgroup@vsnl.com
Design can create or
destroy. A company
should address design
issues to achieve
significant cost impact.