Cost reduction is a challenging subject in logistics and distribution and too often we’ve seen companies just try to cut headcount in order to achieve quick cost reductions. This is often completely the wrong strategy.
Cost reduction starts with fully understanding all costs and separating them into variable and fixed costs.
Variable costs fluctuate with volume (truck fuel, direct labour, packaging, etc.) while fixed costs don’t (rent).
Some costs, such as electricity and management overhead may be mostly fixed, but with a variable component if volume changes significantly (e.g. adding an additional shift).
As we have seen in previous classes, it is critical to measure the right parameters and processes and ensure that measurements are meaningful and pegged against appropriate volume indicators.
Start with the big picture and then gradually work down to more detail. The major cost components we will review in this class include:
- labour (direct, indirect and temporary staff vs. permanent staff),
- stock loss,
- the cost of low productivity,
- the cost of poor quality,
- utilities (electricity, heat, water).
Before we get into the detail of how to save money on each of these though, let’s start with the big picture.
Why do you need to reduce costs? By how much do you need to reduce them? How do you know?
Is the revenue line headed south? Do you have accurate data from competitors which indicates that your costs are higher than theirs? Or are you just looking for a quick fix, just to brighten the P&L for the next quarterly results?
Make sure that your reasons are valid, based on hard data and plan for a lengthy (several month) project.
Quick fixes often lead to disasters elsewhere whereas properly planned and implemented performance improvement projects can have lasting results, both financial as well as in terms of quality and staff satisfaction.
After you have established the basis for the project, as always, start with the data.
It is likely that while cost data exists, it is not in the format you need. The closer you can get to the following formats, the better, but if you can’t, get what you can, work with it, and then try to get the data in the format you need at a later time.
Ideally, you should have 1-3 years of data, split out by month.
- Labour costs should be split into direct (hourly staff who do the work) and indirect (hourly supervisory staff or salaried management). Further, the cost of direct hourly staff should be broken down into employed staff and temporary (contract) staff.
- Distribution costs should be averaged as cost per order and per item. Ideally, they should also be split out by customer (by order, by item) for the top 10-20 customers (80% of your volume is likely from 20% of your customers). Service type (overnight, 3 day, etc.), should also be logged, so that you can understand the cost of each type of service. If distribution is not outsourced, then costs should also be split by type of cost (fuel, truck maintenance, labour, etc.). The cost of orders lost/damaged in transit should also be logged.
- Stock losses should be calculated by month, shift, section/aisle and type of product.
- Packaging costs should be split by type (overpack boxes, cushioning material, tape, etc.)
- Direct labour productivity should be calculated and if possible, split by temporary and permanent staff, by shift and by similar departments/sections.
- The cost of quality issues (damages, wrong orders, etc.) should be calculated including the time spent investigating, reporting on and resolving quality issues. Any customer rebates should also be logged.
- Utility costs should be tracked by type and month. If electricity and heat are major cost components, then they should also be tracked by shift and section/department.
All of the above costs can be factored over the volume of orders or items, and compared to revenue per order/item.
Graphically representing the components of total cost in a pie chart also helps to decide where to start your reduction efforts.
For example, if utilities costs are only 5% of the total cost, you will probably want to start with distribution costs, which may be 30% of the total.