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Cost Reduction Strategy for a Manufacturing Set-up

In most of the companies, it is expected that procurement department should bring cost reduction in raw
material. Now since this is the department which arranges material based
on production requirement, follow-up with finance for payment of suppliers, manage day-to-day supplier
related issues, a purchaser will hardly get any time to move out from day-to-day fire-fighting and focus
on cost reduction activity. Moreover, most of the time the performance indicator for a buyer are set as on-
time delivery and inventory reduction which reduces the focus of purchaser from cost reduction activity.
Hence, the foremost importance is to form a dedicated team for cost reduction, whose prime focus will be
only to do cost reduction and sourcing projects. It will be the responsibility of this team to identify the
opportunities for cost reduction, develop new parts, they will do internal follow-up regarding part
development, and after part approval, they will hand over the material to procurement department, who
will manage the procurement related activity of the part.
To synergize the efforts in a direction of cost reduction, a company has to adopt a cost reduction strategy
and communicate this to the people to ensure that efforts of all are in line with a particular strategy only.
Following strategies can be adopted for material cost reduction: -
Vendor Consolidation
Value Engineering
Assembly Outsourcing
1. Vendor Consolidation: It is always desirable to have less number of vendors with more business per
vendor rather than having more number of vendors with less business per vendor. The prime focus of this
activity is to realize economies of scale by minimizing the vendor base for a particular category, with due
consideration given to capacity and financial constraints of vendor.
Vendor consolidation not only provides a volume discount but it also reduces the other overheads
pertaining to vendor management, e.g., a buyer will have to do less follow-ups, with vendor, finance will
have to manage accounts of less vendors, and quality department will have to manage less vendors for
quality-related problems.
Following are the steps which should be followed to kick-start vendor consolidation activity: -
Identify the categories of raw materials which are used for manufacturing a product, e.g., resistors,
capacitor, integreated circuits (IC), transformers etc.,
Identify the suppliers for the above categories.
Analyze annual buy for each of the category; this will help us to focus on the category which comprises
major portion of raw material purchase. (Figure 1)
Analyze annual purchase from individual vendor for each of the category, e.g., integreated circuit (IC).
(Figure 2)

Based on the above analysis, try to re-distribute business between vendors to realize economies of

Figure 1: Annual Material Purchase Categorywise
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Figure 2: Category 4 Purchase from Vendors
2. Value Engineering: This activity should be carried out jointly by a team comprising of people from
purchase and R&D. Value Engineering can be change in design of product, use of alternate material,
change in process, etc. To have a focused approach towards this, it should be carried out with following
steps: -
Identify the running products, i.e., the products from which maximum revenue is generated.
Explode the Bill of Materials to the lowest level.
Identify the items which contribute maximum to the product cost.
Focus on the item which contributes maximum to the cost of bill of material.
Analyze how does a particular dimension effects functionality of the product; if the functionality is not
critical, then can the tolerance be increased which in turn will reduce manufacturing cost of the
component; can the raw material be changed without changing the functionality of product; can the
fastening be replaced by snap fit; can CNC machine be replaced by conventional machining, etc. I have
discussed very basic examples; the best decision can be taken only by the person who is expert in this.
3. Assembly Outsourcing: This is a very effective measure of cost reduction for an electronic
manufacturing industry. To know how important it is, please consider following actions, which are to be
carried out to manufacture a product: -
1. Production planning has to keep a track of consumption and receipt of raw material so that they can
raise purchase requisition on time for raw material to enable purchase department to take timely actions.
2. Purchase department has to release purchase orders and follow-up with vendors for on-time delivery of
raw materials.
3. Stores has to handle stock keeping and material handling for all raw materials.
4. Quality department has to ensure quality of all raw materials, which implies they have to check all raw
5. Production has to assemble all raw materials, and will often face problem of raw material shortage,
which will cause stoppage of assembly lines and loss of production hours.
The more variety of raw materials a company handles, more will be its overheads, and more will be in-
efficiency in the system, which will further escalate the product cost.
Now to have a different perspective, consider this, every product comprises of different assemblies which
when assembled together forms the product, at the same time these assemblies are independent from
each other, i.e., each assembly can be made independent of each other.
If an organization outsources its assemblies and buys ready-made assemblies, and assembles them at
own end to make a product, one can perceive the immense benefits that will be accrued by this. Same
are mentioned below to provide more clarity: -
1. Production planning now has to keep track of consumption and receipt of only assemblies, which may
mean that now they will have to take of may be 10 number of assemblies instead of 1000 number of
2. Purchase department will now have to release purchase orders of only assemblies and has to follow-
up with less number of vendors.
3. Material handling and stock keeping at stores will reduce dramatically.
4. Quality department has to check now only assemblies, hence, number of items to check will reduce
drastically, thereby, enhancing the efficiency of quality checks. 5. Manufacturing set-up will reduce,
material availability will increase, and production efficiency will shoot up.
6. Inventory is to be kept for only assemblies, hence, the probability is high that the system will always
have balance inventory, which will further reduce the capital required and, hence, the cash blocked in
inventory will be released.