Manufacturing businesses incur a wide range of costs. As with any business, there are many fixed costs associated with manufacturing, such as salaries, maintenance, rent and the like. If you really want to sustainably reduce the cost of your manufacturing operations however, the costs you need to be focusing on are variable costs. In this post I’ll explain why, and how to go about reducing these costs.
Variable costs are costs that vary with the level of production, and include costs incurred for materials, energy, water and waste management charges. Some of these costs, such as energy for example, may have a fixed or “baseload” component as well as a variable component. There are few manufacturing businesses where fixed costs are anywhere near as large as variable costs. In high-margin manufacturing businesses, such as those producing branded products, variable costs can be over 100 times as large as fixed costs! And in South Africa there is a divergence in these costs as we experience large increases in the costs of inputs such as electrical energy, imported materials and dollar-denominated local raw materials. So it is clear that if we want to make the biggest impact on cost reduction, this is where to direct our efforts.
Having worked in manufacturing management for 10 years of my career, I have long been fascinated with the simple power of variable cost reduction, and have seen this first hand. There is a fundamental difference between cost reduction that focuses on fixed costs and variable cost reduction. Consider paycosts and maintenance costs as two examples. Retrenching staff has an impact on capacity, and impacts on the morale of those left behind. Cutting maintenance budgets can have knock-on impacts in terms of equipment life and failure frequencies. This is not to say that organisations cannot be profitably and sustainably restructured, or that improved maintenance practices cannot deliver maintenance at a lower cost while still increasing reliability. The problem is that such approaches require careful planning and investment to enable their success, and since it is generally in times of distress that such areas are targeted for cost reduction, these elements are lacking from most fixed-cost reduction strategies. The point I’d like to make here, is that variable cost reduction, while not without risk, is generally easier and less painful to implement. And in many instances, significant variable cost reduction is possible without investment, or with very little investment. So what is this “magic” about variable cost reduction that I am trying to explain to you? Let me illustrate with an example.
Reducing Electroplating Chemical Losses – a simple example of “no-cost” variable cost reduction
Say you are operating an electroplating plant, and your plating chemical costs are R5M/annum. You need to achieve specified minimum chemical concentrations in your plating baths, and you add chemicals routinely as they are depleted. The plant is highly automated, and the workpieces being plated are mounted on jigs and then dipped into individual baths using robots, with the entire process controlled by a PLC. You need to reduce your plating chemical consumption, and one way to do this is to minimise the quantity of chemicals carried over from the pre-treatment and plating baths to the rinse baths between these baths. A good way to do this is to have a sufficient drip time once the workpieces have been lifted out of each bath. Instead of being carried over, most of the chemicals adhering to the workpieces can then drip back into the bath. Increasing the drip time is only a matter of changing a timer in the PLC for the appropriate process step, and is an example of a “no-cost” intervention. By paying careful attention to overall cycle time, you are able to make this change without compromising throughput. In addition to reducing chemical costs at electroplating, you are also able to reduce rinse water volume, effluent volume and chemical costs at your effluent treatment plant, all of which amount to savings of R600,000/annum. This is at your current production level. Production volumes are projected to increase by 35% in the coming year, and this will increase your savings to R810,000 at constant prices. You will however not have to lift a finger to realise those additional savings, and they will continue to multiply as your business grows and flow straight through the bottom line as they come at no cost. This is not a pipe dream, but an example of what can actually be achieved in the manufacturing environment. I have seen it with my own eyes.
Not all variable cost reduction is as simple as the above example. How then should you be approaching the challenge of variable cost reduction? These are a few fundamental steps you should take.
1. Understand your variable cost profile
Which are the major variable costs in your business? I am often surprised by how few companies conduct a simple analysis of their variable cost split. Ideally you would like to know what this split looks like per unit of production, but for a start, simply take your last financial year and construct a simple pie chart, with each variable cost included. You will very quickly be able to identify the 5 or so largest costs in our business, which will focus your efforts. This exercise can be repeated each year as your cost profile changes.
2. Understand the nature of each individual significant variable cost
Individual variable costs can impact on each other. Skimping on cleaning chemicals can cause microbiological contamination in a food processing plant, for example. This can mean significant increases in variable cost as product has to be destroyed. Understanding these types of relationships is therefore vital. You also need to understand the structure of individual costs. Electricity may be one of your largest cost items, but what do you pay for? Do you pay for both energy consumption and demand? Are you liable for time of use charges for the energy that you do use? If you do pay for demand, do you also pay for network access based on your maximum demand, and how far away are you from your monthly allowance? How does your electrical energy bill vary over the course of a typical year? Do you use energy carriers other than electricity, and if so, which costs more per unit of energy delivered to your process users. Is there any scope for interchangeability between energy carriers? How do your offtake agreements work? Are there penalties for low offtake from suppliers? I could go on, but the point is that you really need to get into detail for each significant variable cost. You need intimate knowledge of each cost prior to devising strategies for reducing it.
3. Develop cost-reduction strategies for each variable cost
This is where the “rubber hits the road” as far as variable cost reduction is concerned. The scope of the actions you can take to reduce variable costs is wide, and you need to get involved in various approaches if you are to be successful. Here are a few simple examples
i. Work practice changes
Introducing a new task, changing how an existing task is carried out and/or changing the frequency of a task all fall under this approach to cost reduction. An example would be the scheduling of machines to operate at times of the day when electricity costs are lower at a site which is subject to time of use charges. Another example would be a change in procedure designed to improve product quality and reduce rework.
ii. Equipment setup changes
Often equipment can be made to operate more cost-effectively simply by changing settings. Examples would be operating a boiler at lower excess air levels, or running a shrink wrapping machine at a lower temperature.
iii. Equipment modifications
Existing equipment can often be modified and thereby be made to operate at a lower cost. For example, introduction of a simple filtration process could make otherwise unusable effluent a source of water for a process, thereby reducing freshwater purchases.
iv. Technology changes
Technology can be employed in a range of ways to reduce costs, from making existing processes more efficient to fundamentally changing the nature of a manufacturing process to reduce its cost profile. Be sure to apply technology appropriately, regardless of the promises made by technology suppliers. A VSD compressor, while potentially being your most efficient option under specific circumstances, can actually use more energy than your current compressor should it be fully loaded. Energy-efficient motors, due to their slightly higher operating speed, can increase your energy consumption rather than decrease it in some circumstances e.g. if used to drive a fan with no further modifications to the fan system. A technology intended to reduce costs can lead to product quality problems and ultimately hurt your business. The point here is that you need to understand what you are buying into when introducing technology, and this should entail some form of risk assessment.
v. Material and fuel changes
One approach to reducing material input costs is to use alternative materials. Carefully controlled trials are essential when making such changes. I’m referring here to a change in material as opposed to sourcing similar material from an alternative supplier.
As regards fossil fuels, significant savings can sometimes be achieved through use of alternative fuels. A fuel such as paraffin is more expensive than light fuel oil, which is more expensive than heavy fuel oil, which is in turn more expensive than coal. There are variants within some of these fuel types which can offer cost advantages. Some plant changes may be required to make a fuel switch.
vi. Procurement efficiencies
It may be possible to find a reliable supply of materials or fuel at a lower cost than what you are currently being supplied at. As regards lower-priced options, be aware that the purchase price of one material may be less than that of another, but the overall cost of using it may in fact be higher, or partially offset the benefits of the price differential. The “cheaper” material may result in higher in-process losses for example.
4. Implement appropriate strategies, monitor results and take fresh action
It will be important to assess if there are any unintended consequences arising from implementation. This could be in areas outside of cost management, such as product quality, throughput, safety or environmental performance, and could occur in a process areas other than where the change was introduced. Sound performance monitoring systems are therefore vital. Once results become evident, take appropriate action quickly as required.
The complexity of cost reduction generally means that there are always further cost reduction opportunities, even in the most well-managed businesses. The key to unlocking those opportunities is to take a structured, holistic approach, and to appreciate that the journey to cost leadership is about continuous improvement.
Without ongoing monitoring and almost fanatical attention to detail, variable costs can easily slip, or in fact go totally haywire. You absolutely need robust short-interval cost monitoring systems to be in place in order to detect variances quickly, enabling a rapid response. Raw material, water and energy carrier properties change over time. Product mix changes with demand, and individual products have their own cost characteristics. Plant operators may not operate machines in exactly the same way. As components wear, machine performance changes. Climatic conditions impact on process performance. A well-intentioned change aimed at improving product quality, throughput or some other measure of performance can have massive cost implications. Don’t expect cost reduction to be a one-off exercise that once undertaken, can be banked and forgotten about.
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