Cost Reduction

‘Cost-reduction’ is the kind of thing that makes many an engineer’s eyes glaze over.

It’s not sexy. It won’t shine on your resume. And it’s a lousy path to promotion.  But if your aim is to deliver a working product to a paying customer and make money at it, the need will arise.

Like anything in engineering, cost-reduction is an art requiring a mastery of trade-offs, in this case between the costs for raw materials, labor, assembly and test processes, and the needs of the supply chain. But there are certain pitfalls, mistaken ideas that keep coming back like zombies, no matter how many times they’re killed.

The zombie that I have encountered most over the years is the use of fully-burdened labor costs in evaluating a cost reduction.

Companies have to account for various fixed costs that represent necessary expenditures, like depreciation, rent, utility bills, etc. For various reasons they often find it convenient to account for these costs by adding a simple factor to labor costs. The reasoning is that, if one product or process requires more labor than another, then it also consumes more of the fixed costs than the other.

But you have to remember that your individual cost-reduction project probably does not change any fixed costs. Even if you cut the labor to test a manufactured assembly to zero, all that rent and depreciation in the company’s P&L statement is still there. (If your company will actually be able to close a facility or recover an asset due to your efforts, well that’s another case entirely.)

In fact, if your cost-reduction is 10% or so of the labor expended by an individual, then you haven’t saved anything at all, unless a new product (for example) can take up the slack!

There is a converse to this zombie, which is the use of fully-burdened labor costs when doing a make-versus-buy analysis, or when making a business case for a new hardware product. You have to be conscious of unused capacity. If you can build more without adding more space to rent, or buying more equipment to depreciate, then you should exclude those fixed costs from your analysis.

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