Primary navigation:

QFINANCE Quick Links
QFINANCE Topics
QFINANCE Reference
Add the QFINANCE search widget to your website

Home > Operations Management Best Practice > Reducing Costs through Production and Supply Chain Management

Operations Management Best Practice

Reducing Costs through Production and Supply Chain Management

by Vinod Lall
You have recommended this article

Table of contents

Executive Summary

  • There are numerous drivers of production and the supply chain, and there are several processes under each driver. These processes are associated with high overheads and offer opportunities for cost reduction.

  • Cost reduction requires a complete knowledge and mapping of all costs, cycle times, purchases, inventories, suppliers, customers, logistics, and other service providers throughout the supply chain.

  • Cost reduction in the supply chain often requires trade-off analysis amongst conflicting alternatives using the total cost approach.

  • Successfully achieving supply chain cost savings requires the use of cross-functional teams with representation from marketing, design, procurement, production, distribution, and transportation employing an organized approach.

Introduction

IKEA, the Swedish home products retailer, is known for its good-quality, inexpensive products, which are typically sold at prices 30–50% below those of its competitors. While the price of products from other companies continues to rise over time, IKEA claims that its retail prices have been reduced by a total of 20% over the last four years. At IKEA, the process of cost reduction starts at product conception and continues throughout the process of design, sourcing of materials and components, production, and distribution. For example, the “Bang” mug has been redesigned many times to realize shipping cost savings. Originally, 864 mugs would fit into a pallet. After redesign a pallet held 1,280 mugs, and with a further redesign 2,024 mugs could be squeezed into a pallet, reducing shipping costs by 60%.

Organizations today are looking for opportunities to improve operational efficiencies and reduce cost without having a negative effect on customer service levels. Production and supply chain management can help to reduce costs by connecting every unit in the supply chain, fostering collaboration among supply chain partners, and offering visibility into the demand and supply side of the chain.

Production and supply chain management involves a number of drivers through which acquired raw materials are converted into finished goods for sale to customers. In turn, these drivers involve several processes that offer opportunities for cost reduction. Common drivers include procurement, design of the supply chain, inventory, transportation, warehousing, and collaboration. Cost reduction requires timely and improved decision-making for common processes under each driver.

Procurement

Procurement, also known as purchasing, is the process of acquiring raw materials, components, products, services, and other resources necessary either for the production processes themselves or for the support of production processes. Procurement processes ensure that supplies are available in the right place, in the right quantity, and at the right time. Buyers can play a major role in reducing supply chain costs by taking actions to reduce costs incurred in the flow of products from the suppliers to the ultimate customers. Some of the actions are discussed below.

Buyers must increase the flow of information throughout the supply chain, from the customer to the manufacturer and on to the supplier. This will make each entity in the chain aware of the inventory carried by the others and work towards the reduction of inventory without sacrificing customer service levels. Buyers must also take action to reduce cycle times, which will make the supply chain more responsive. To achieve a reduction in lead times, buyers must track and measure supplier lead-times, analyze trade-offs that result from lead time reduction, and then negotiate shorter lead times. Another action buyers can undertake to reduce supply chain cost is to select suppliers on the basis of their total supply chain capability and not just price, lead time, and quality levels.

Design of Supply Chain

There are several principles under design of the supply chain that can help to reduce costs. These include component commonality, component modularity, and postponement.

Component commonality: The principle of component commonality focuses on the design and use of common components for families of products. When there are a large number of products in a supply chain, the inventory of components will naturally be large. Component commonality calls for the use of common components in a variety of products. This reduces costs not only by reducing inventory cost but also through reduced material cost, reduced production cost, and reduced product obsolescence. For example, a computer manufacturer can design common components such as memory and disk drives and use different combinations of these components to produce different finished products.

Component modularity: The principle of component modularity recommends that common subsystems be designed as modules to meet a broad range of feature requirements. This reduces the number of components that must be produced, kept in materials and repair parts inventory, and integrated into the product during the production process. This reduces procurement, manufacturing, and inventory costs, leading to a lower supply chain cost. Manufacturers of electronic products, for example, use the principle of modularity to design and assemble printers, computers, and so on.

Postponement: Postponement means delaying the bringing of products into their final form until close to the point of sale, when customer demand is known with greater accuracy. This results in a better match between supply and demand, leading to reduced costs mainly through inventory reductions. For example, a traditional garment manufacturer might dye the thread before knitting it into sweaters, whereas a garment manufacturer using postponement would postpone dying until the last point in the supply chain, when customer color preferences are known with a greater degree of certainty.

Back to Table of contents

Further reading

Books:

  • Chopra, Sunil, and Peter Meindl. Supply Chain Management: Strategy, Planning & Operations. 3rd ed. Upper Saddle River, NJ: Prentice Hall, 2006.
  • Jacobs, F. Robert, and Richard B. Chase. Operations and Supply Management: The Core. Boston, MA: McGraw-Hill/Irwin, 2008.

Websites:

Back to top

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • Bookmark and Share