Cost Reduction-A Key to Survival and Success:

Cost reduction is the key word for success in today’s global competitive market scenario. It is the new economic mantra. Gone are the days; where the vendor can pass on the cost of his inefficiency, low productivity and bureaucratic way of functioning to the customer, as he used to often do in the old sellers market’s hay days.
Today’s customer has a wide choice in a Net connected global market, where one or the other market savvy vendor is ready to offer the required quality of products and services at competitive rates, often for strategic reasons of capturing the unconquered market.

Perceiving Opportunities in Problems:

The recent threat faced by Indian manufacturers in certain market segments from China (Indian toy industry) is the ground reality and learning lesson for Indian manufacturers. This reflects the industry’s inability to compete in today’s global environment. At the same time if the same threat is converted into opportunity by building up business partnerships with them, it will be fruitful to both the stakeholders’ – as evidenced by the risk taken by a few Indian industrialists. In the present scenario, the production base of many Indian manufacturers will be shifting to China, which offers advantages of reduced cost and increased productivity. We should take this as a learning lesson; as a self- introspection to make the Indian industry cost effective i.e. ready to offer quality products and services at the right price and place.

Slow / negative growth rate in certain key sectors like steel, cement, fertilizers, textiles, engineering, energy, light truck vehicles and the near death knell of SSIs have lead to closures, mergers, de-mergers, acquisitions and hiving off the prime Indian brands reflects the mirror on our inherent weaknesses. At the same time it provides an opportunity to carry out SWOT analysis, recognise our limitations and encash on our strengths.

Most of the successful Old Economy giant organisations; who could not quickly adapt to the changing environment are reported to be sick, slowly going to the death bed – mainly surviving on the oxygen of manpower reduction, VRS and downsizing, the medicines often prescribed by Western consultants. These are only the half-hearted short-term measures; which can serve as a shock treatment. But these measures alone definitely cannot turn the organisation to its past glory; unless all facets of cost reduction are explored with heads and hearts together, with a vision of a dedicated team, wedded to the cause of improving an organisation’s productivity and profitability in the overall interest of all stakeholders.

Challenging and redefining the existing business objectives based on reengineering of business processes with a goal to rebuild the old, sleepy giant into a new energetic, vibrant organisation is the need of the hour. Cost reduction measures hence need to be explored in right earnest, not restricted to half-hearted cost saving measures of economising just on administrative costs of conveyance, staff welfare, stationery and telephone, but should be backed up with harsh cost saving measures in all major cost areas.

We will show the Way

Shri Nani Palkhiwala often addresses, “Indians have the most fertile brains”. We have often excelled as individuals in respective fields – as individual islands of excellence, but always fail as a team, as we have more leaders than followers.

But if we as Indians have to survive:
• We will have to learn and work as a team; with increased productivity to share the common goal and vision.
• Explore ways and means to reduce the cost to save our jobs and enjoy sustained life styles.
• Unlike the West, we will have to think of harvesting human capital, build the idle non-productive asset into a productive asset base by nurturing, motivating, investing and retaining the best human brains.

These measures alone will help the industry to regain its health and competitive edge. There is no other alternative solution in the Indian scenario, with an ever increasing population as a continuous threat to the stability of the organisation, economy and society tself. Otherwise ever widening gaps in the life styles and income levels will lead us to social discord, disharmony and social unrest; as observed in a few under developed economies.

Survival Strategy:

• Clear shared vision.
• Well set goals and objectives.
• Committed organisation aligned with the company’s goals and vision.
• Global cost consciousness.
• Well structured policies and procedures to back up the same and to deliver the said objectives at minimum costs.
• Produce and market quality products and services at the right price, time and place as per the customer’s requirements.
• Ensure that systems are in place to deliver the said objectives at minimum costs and that the key performance indices are identified and tracked with mapping of end results (e.g. data on repeat orders indicating brand/ customer loyalty, market share, cost of service etc.)

Need for Strategic Sourcing at Optimum Cost:

One of the major costs in any organisation is the procurement cost of materials, fabrication & services ranging from 40% to 70% of the total turnover. The next area as a fall out of the manufacturing activity in any organisation is scrap accounting, monitoring disposal & realisation.
Optimisation of cost benefits in the above- mentioned areas through strategic sourcing by establishing vendor chain management under each major category, is a key to achieve global competitiveness.
The traditional Indian idea of sourcing from the cheapest source by way of quotations often required and insisted upon from the internal control point of view, has lost relevance due to the following reasons:

• Quotations can be fabricated.
• Vested persons can share rates quoted by the lowest bidder to interested vendors (Author’s Query).
• Lowest rates can be at the cost of quality.
Therefore it is essential that the organisation should:
• Develop a business partnership module and vendor chain relationship based on mutual trust and benefit.
• Define corporate sourcing strategy in consultation with all stakeholders to achieve optimum cost benefit for required quantity and quality of materials at the right time and place.
• Reduce inventory-carrying cost on one hand and avoid stock out situation on the other.
• Explore global sourcing initiatives.

Internal Audit for Cost Cutting Measures:

Materials and Internal Audit (IA) both being staff functions can definitely play a complementary proactive role in providing cost effective solutions based on team efforts in the areas of:

• Vendor selection and registration process.
• Procurement policies, pricing methodology.
• Making decisions.
• Identifying non- moving inventory and how to avoid further building up of the same
• Optimisation of scrap realisation.
• Reviewing materials consumption based on input-output norms etc.

The traditional definition of an internal audit: IA is an independent appraisal function established within an organisation to examine and evaluate its activities-financial or otherwise, as a service to an organisation.

Traditional envisaged role: IA is a watchdog of the company to ensure compliance to the established systems and procedures. In the good olden days IA was thus considered as the torchbearer of ethics and the moral guardian of business values. No doubt, auditors and especially the IA were always considered as bloodhound, management’s spy and hence an unwelcome guest.

This situation did not help the organisational interests and over a span of time the IA function underwent a big change to meet current expectations and fulfill the role of an in-house consultant and management’s partner.

Current definition of IA: IA is an independent, objective consulting activity designed to add value and improve an organisation’s operations. This revised definition reflects the paradigm shift in the role and focus of IA.

• IA is expected to bring in a systematic disciplined approach to evaluate and improve the effectiveness of risk management, control and governance process.
• It reflects the epoch making strides made by the IA profession to meet today’s international business requirements.
• IA is a mindset. If we believe that we can improve quality, processes, procedures and systems to meet organisational objectives, we all play the role of internal auditors.
• In a sense all line and staff managers thus play the role of IA, as the emphasis has shifted from What has gone wrong to Why and how.
• The moot question is how to improve the processes by analysing and focusing on business risks by understanding the business needs and issues.
• IA helps to build a robust system, which operates efficiently and effectively by associating in system development and its review to meet the envisaged objectives within the set parameters.
• The end result of IA is value addition. It causes and contributes to significant beneficial changes in improving the measures for efficiency, productivity, profitability and cost control by playing a collaborative and participative role.
• Thus, today’s role of IA is not that of a spy or a detective- who is on a fault finding mission, but that of an in-house consultant, who not only diagnoses organisational health, but also helps the line managers in discharging their functions efficiently and effectively, by becoming their business partners.

Business Partnership between Multi-Disciplinary Teams:

There is a success story achieved by one of the business organisations; based on team based business solutions in an effort to build bridges instead of walls, wherein the internal audit findings were used to provide cost effective solutions in the above-mentioned areas.

• The organisation was able to save 10% of the procurement cost approximately valued @ Rs. 5 crores (to be on a lower side) by following the multi-disciplinary team approach.
• Further, the organisation was able to realise better rates, value for scrap realisation compatible with the market trends and bring in the transparency in the area.

This was achieved by taking an in-house consultant.

Methodology:

• A multi-disciplinary team consisting of members from actual users (Production/ Exports, Materials, Quality Inspection, Stores, Security) was constituted with Head, Internal Audit as a team leader- (audit being an independent/unbiased functionary).
• A common objective of cost reduction based on mutual trust and sustained business partnership (unless found detrimental to the organisational interests) was agreed upon by all the stakeholders.
• Procurement activity was segregated based on three major categories:
• Chemicals
• Stores & Spares (common part numbers were worked out by the sub-committee of the actual users)
• Packing Materials
• Three individual teams were then constituted with IA as a team leader of all the three teams.
• Actual consumption data for the last three years was collected, and used as a basis for better commercial bargaining.
• A common circular explaining the objective and rationale was then drafted under the joint signature of Head – Internal Audit, Head-Materials and the Head, Production – as users.
• The circular focused on the need of establishing a sustainable business partnership with vendors based on mutual trust and transparent business transactions.
• The quantum of likely future business was given for items they intended to deal in, with an assurance that once the rates/commercial terms were finalised and frozen, the business relationship would continue for at least a year, unless any unethical practice was detected.
• As an assurance for transparency, all vendors were asked to share the basis of their price (whether based on cost plus/ market price/ or any other basis).
• An annexure detailing the questionnaire on cost data, their overheads and their in built profit margin was sought, based on the concept of transparency and sharing information as the business partner.
• It was agreed that as a fair business practice, both the partners would share any upward/ downward impact of cost for major raw materials, based on actual data, once in a quarter.
• All major vendors were jointly visited by the multi-disciplinary team to check the accuracy of the feedback received, ensure the genuineness of the manufacturing facilities and declaration on SSI, excise and ST status (Author’s Query).
• Vendors were asked to declare if they were directly or indirectly related to any officials of the company and also the names and the style of all related business entities; to serve as future data bank (Author’s Query).
• All existing/ new interested vendors were asked to present themselves to the screening joint committee and offer their best current prices for the quality required by the users.
• The practice of obtaining quotations and placing orders on the lowest bidder was replaced by the more transparent and open price fixation declaration policy on best rates offered by vendors based on economies of scale on quantities for the full year.
• Vendors were asked to offer prices for the quality indented without compromising on the quality.
• In order to safeguard against the monopolist tendency, two vendors were selected by the screening team for each major item, the decision on individual share was left to the Head, Materials.
• A clause declaring the company’s policy on business ethics was printed on the reverse of each purchase work order to make the vendors conscious of the same and bring in transparency in the system.

End Result:

Vendors thus were given their due share in the business partnership and assured of business for a year with a chance of continuing the relationship in the succeeding years provided it was mutually beneficial to both the parties and they offered the best rates.

This in turn brought in user’s ownership, participative team approach, better rates and overall saving of 10% of the procurement cost and above all created an atmosphere of mutual trust and enhanced the company’s image and less of Investigative Role for an IA (Author’s Query).

Scrap Realisation:

• Another team success between IA and the user department was improvement in scrap identification, authorisation, detailed classification/ segregation for better realisation and bringing in transparency in the entire operations.
• Better realisation of a few lakh rupees led to the improvement in the bottomline on one hand, system improvement on the other hand brought in the sustained benefits arising out of transparency, involvement of all stakeholders and encashing on the users’ ownership concept.

Thought Process:

• IA again in its traditional role highlighted the differential rates fetched for the same/similar items by two different units. Rates fetched by one of the units were always lower than the other.
• Quantum of lower realisation on an annual basis ran into a few lakhs of rupees.
The management then thought about improving the process by involving IA as a catalyst of thought process with the involvement of all users and owners.

Methodology:

• A multidisciplinary team was set up with the IA Head as a team leader. The team was drawn from Production, Stores, Quality Assurance, Security and Officials from Materials department who were directly involved with disposal.
• Different items of scrap generated by both the units were studied with the help of industrial engineering and uniformly coded and classified.
• Items were again classified under more categories with an aim to fetch better realisation.
• Scrap yard too was accordingly redesigned to store increased categories in separate enclosures.
• All operating departments, which were generating the scrap were instructed to classify the scrap under each category correctly and ensure that the same was dumped in the correct bin.
• All scrap was to be dumped in the enclosure with the permission of the departmental head.
• The scrap was to be accompanied by a scrap generation slip giving the particulars of items and the approximate quantities.
• A revised format for vendor registration was prepared based on the team’s feedback, on the concept of trust and business partnership and each vendor location was to be visited before its registration.
• Bids rates were to be based on the current market rates as evidenced from newspapers, trade journals etc. and any rates below the current rates (above the tolerance limits) were to be rejected.
• A representative from the QC/ IE dept. was to remain present whilst the selected vendor was lifting the scrap and technical help was required, or else the security staff remaining present would certify the weight and the items moving out of the factory.
• Scrap vendor’s access inside the factory was restricted to the scrap yard.
• Vendor registration and appraisal process was to be done every year as detailed above.
• The vendor was thus assured of the yearly off take at the prevailing rates without bidding at the quarterly bids as earlier.
All these measures brought in increased revenues, openness in the system and the involvement of all.

Conclusion

Cost reduction for competitive edge is the guru mantra, which we all should religiously implement in all walks of our life to meet global competitiveness. Let us bank on our own success stories to achieve these goals, as the art of living within one’s means is a part of our Indian tradition. Let us practice it in our professional life too, by implementing simple logical things with an overall cost consciousness to reach solutions in complex situations.