November 25th, 2016

The Six Principles of Effective Cost Management

By Yinka Popoola
The first is the simple truth that people who are not involved will not easily give their commitment.

Cost management includes effective strategy implementation as well as providing the resources and process discipline to ensure the highest possible level of quality, reliability and productivity at the lowest overall cost. It is not about “cost” in the sense of “cutting cost.” Rather, cost management is the process of optimizing performance. It is as much strategic as it is operational.


Passionately embraced and implemented, the following six principles provide a road map to business success.


  • Provide Knowledge and Tools to Succeed


Each individual’s level of knowledge and capability becomes the essential component of the employee’s ability to perform well. For example, if an organization wants to optimize the trade-offs between volume, margin and manufacturing cost, THE SALES TEAM must have a solid understanding of manufacturing, standard cost, and the impact of their product and customer-related decisions on the broader organization.


This same principle applies to the management ranks, managers need to know the specific cost drivers of their business. They need to understand the difference between efficiency and structural cost.

The deeper the executive knowledge of their organization’s cost drivers, the greater the opportunity for effective cost management.


  • Understand True Costs


Standard cost is the basic component in a vast majority of business decision-making, from budget preparation, pricing and variance reporting, to strategy formulation and performance-based incentive plans. Standard cost data drives most new product pricing, advertising, marketing and capital investment decision making. The importance of accurate standard cost data cannot be overstated.


In order words, the computation of standard costing in determining product cost needs to be accurate to avoid distortion of cost which may result in either overstating or understating cost.


It is extremely difficult to accept that the base data used for many years of decision making may be the root cause of many business shortfalls. This is especially true in product costing and pricing and in new product justification and introduction.


  • Excellence: The Only Acceptable Performance Target


Organizations once based performance improvements on a simple comparison of past and current performance, what most call continuous improvement. Today, customers do not expect nor do they accept performance defects, they expect performance excellence.

One of the most important keys to effective cost management is to set the bar at excellence.

Technical knowledge, well-understood and aligned performance systems and absolute data integrity are all adding up to a performance culture, a cost management behavior ethos.


  • Challenge the status quo


Organizations with the most effective cost management are constantly and boldly applying the test of relevance and value to every daily activity. They question everything. What does this activity do to create and maintain sales or improve margins? What additional costs will this activity add? What does this investment do to improve quality or provide added production flexibility?


For instance, if a sophisticated maintenance management system is not working, it is often better to shut it down and go back to the basics than to add the ongoing cost of fixing and maintaining a low value system.


  • Commit to Broad-Based, Knowledge-Driven Involvement


There are two very important reasons to focus on knowledge and involvement. The first is the simple truth that people who are not involved will not easily give their commitment. The second is that the ability to truly lead is not positional. It is earned through knowledge and respect. These two success elements, leadership and commitment, are central keys to cost-effective excellence.


Standard cost, complexity reduction, and maintaining a valued and credible performance system are all driven by the common denominator of knowledge-driven involvement. Only employees with the knowledge and opportunity to be successful decision-makers can pave the way for future business success.


  • Management Decisions Impact Organizational Cost


The most important principle of effective cost management is leadership’s understanding and acceptance of the reality that the majority of all organizational cost is structural. That is, costs are built into an organization by management decisions.


Decisions about the number of products, the customers they serve and the way the business is run all drive cost. It is “What We Do” versus “How Well We Do It” that determines the vast majority of an organization’s cost.


In the end, effective, process-driven cost management is founded in the culture of the company. It is a way of life. In many cases it is also the only path to organizational survival.