Cost Structure · Cost Reduction
Cost Structure & Cost Reduction
What is cost structure?
- Understand the cost makeup first to see where to cut
- Focus on the top 20% of items (Pareto)
- Cut costs that don’t affect customer value first
Lay the cost structure out on a single page and the agenda of the meeting itself changes. Statements like “let’s cut SG&A by 10% this year” disappear, and the question becomes “can we bring materials, 48 of every 100 in revenue, down to 45?” Once you look at share, not amount, you can separate items that are visible but worth 1, like team dinner costs and supplies, from items that are invisible but worth 20. Half the success of a cost-reduction effort is decided when you choose the targets.
Cutting the same 1% has completely different effects depending on where you cut. A company with a 4% operating margin and a 50% materials share that lowers materials costs by just 1% sees profit rise to 4.5, a 12.5% increase. By contrast, cutting a supplies expense that makes up 2% of costs by 10% adds only 0.2 to profit. So first split costs into variable costs and fixed costs, calculate the contribution margin ratio, and separate money that grows with volume from money that goes out regardless of volume. For a company with a high share of fixed costs, raising utilization is far faster than cutting costs.
You also need to distinguish the level at which you intervene. Unit-price negotiation and consolidated ordering can yield a few percent within 3 months, but they are hard to repeat the following year. Yield improvement and waste elimination take more than six months, but the gains compound every year. Redesigning specs and processes can take over a year, yet it can move costs by double digits. The more urgent the pressure, the more teams keep repeating only the first lever, and three years of price negotiation alone will break your suppliers first.
The most common mistake in practice is an order for an “across-the-board 10% cut in every department.” Apply the same rate to cost items of different sizes, and a department that is already lean cuts quality inspection and training, while a bloated one still has slack left. Another frequent problem is savings that never show up in the income statement: unit prices fell but volume rose, or the money saved leaked into another account. Always verify savings projects against actuals by account, and put anything the customer pays for on the exclusion list first.
Kwangdong MinExpert in business models, revenue models, and market research
Jinho DanAccounting instructor who makes financial statements, costing, and tax easy to graspCost management began in the early 20th century with scientific management and standard costing, and later evolved into activity-based costing (ABC) and the Toyota-style concept of waste elimination.
Consider a hypothetical case: Company A, a precision-parts manufacturer with 180 employees and KRW 42 billion (≈ US$31,423,000) in annual revenue. Raw material prices rose for two years in a row, and its operating margin slid from 5.4% to 3.1%. The CEO had ordered a “10% cut in SG&A across all departments.” The management team spent three months re-examining the cost structure from the ground up.
- When the head of management restated the past three years of P&L per 100 in revenue, raw materials came to 52, outsourced processing to 14, and labor to 18. The SG&A items targeted for cuts added up to less than 4.
- When the purchasing manager went through order history, three business units were buying the same steel plate spec from three different suppliers. After bundling annual volume and re-bidding, the unit price dropped 5.8%.
- The production manager brought in the scrap ledger and said, “Throwing less away is faster than squeezing material prices.” They reworked the cutting program and the rules for reusing offcuts, raising yield from 91.2% to 94.1%.
- While checking drawings, the quality team found that the company had been applying a plating thickness no customer required for 10 years. When they asked the client’s quality manager, the answer was “that spec isn’t in our drawings,” so they adjusted the spec.
- Instead, they decided to exclude incoming-inspection staff and preventive equipment maintenance from the cuts. The head of management had made the case: “Cut here, and a single customer claim wipes out all the savings.”
- Nine months later, the materials share fell from 52 to 48.6, lifting operating margin from 3.1% to 5.0%. Over the same period, customer complaints actually dropped from 4.2 to 3.8 a month.