In this article, we cover the difference between cost control and cost reduction. This starts from the overview of costs structure of a business and continue to the key definitions of both cost control and cost reduction. Then, we will jump to the key differences between cost control and cost reduction. Now let’s go through together.
Overview
For any business, the term cost means the amount of money it spends on the production of goods or provision of services. For instance, costs for businesses may include items such as material, labour, utilities, rent, wages, etc. There are several reasons why businesses determine the cost of their products. The first reason is that the cost of a product is necessary when deciding its price. If a product costs more than its selling price, then it is not worth producing. Similarly, determining the cost of a product is also important for internal decision-making purposes.
Overall, the costs of a business determine its profits as well. This is because the lower the costs of the business are, the more profits it will make. Therefore, the management of a business must use different tools and techniques to ensure that the costs of the business do not exceed its income. Among these techniques, two of the most commonly used ones are known as cost control and cost reduction. While the goal of both techniques is to maximize the profits of a business, they are different in their nature and how businesses use them.
Definition
Before understanding the differences between cost control and cost reduction, it is important to understand their definitions.
Cost Control
Cost control is a technique that focuses on controlling the total costs of business through different tools. The practice of cost control is very common in stable industries where there are no further costs to reduce. The practice of cost control involves maintaining the actual costs of a business in line with the budgeted costs or standard costs established beforehand. Cost control is an important technique in ensuring that the costs incurred on a specific project or operation do not exceed the expectations of the business. This involves steps by step approach to planning and control cycles that a business should carry out.
The cost control process of a business starts with planning. As mentioned above, the management of a business needs to establish expected costs of operations, often known as standards costs. Once it establishes standard costs, the process includes comparing actual results with the standard to identify any variances and calculate the difference. Once variances are calculated, the management identifies the reason for them. Lastly, it implements corrective actions to correct the variances identified.
There are several tools that the management of a business can use to control costs. These may include standard costing and budgets to establish standards, and variance analysis to compute any variances. Cost control is a continuous process and requires effort and strict monitoring to be effective. Furthermore, it can help a business identify any deviations from standards on time and control it before it starts affecting other areas of the business.
Cost Reduction
Cost reduction is a process that focuses on reducing or lowering the costs of products. In this process, the management of a business start by identifying a cost unit. A cost unit is a product that a business manufactures or service that it provides. Once the management identifies a cost unit, it works towards reducing its costs. However, the process of cost reduction does not compromise the quality of the product. This means the business reduces the costs of a product without affecting its quality. Cost reduction focuses on saving costs at a higher level, thus, resulting in higher profits.
Cost reduction aims to reduce or eliminate any expenses that are unnecessary in producing a single unit of product or service. Furthermore, the cost reduction process does not only focus on production process but also focuses on reducing costs in other areas of the business as well, such as storing, administrative, and selling and distribution expenses of a product. For cost reduction to be successful, a business must thoroughly identify its costs first and work on it at the most basic level.
Businesses can use many tools in their cost reduction process. These tools include quality operation and research, improving product design, job evaluation and merit rating, variety reduction, etc.
Cost Reduction vs Cost Control – Key Differences
While the main goal of both cost control and cost reduction is the same, to maximize the profits of a business, they achieve the goal through different methods. Therefore, there are some differences between the two processes. These key differences between cost control and cost reduction are as below.
Process
To maximize the profits of a business, both cost control and cost reduction use different processes. Cost control establishes standard costs for businesses to compare them with actual results. On the other hand, cost reduction involves maximizing profits by reducing costs by altering processes within a business. Both of the processes also focus on efficiency, but cost control tries to set standards for efficiency, while cost reduction identifies inefficient processes to save costs.
Frequency
Cost control and cost reduction also differ due to their frequency. As mentioned above, cost control is an ongoing process in businesses, which never ends. Whereas, businesses perform cost reduction whenever needed to produce permanent results. However, just because businesses don’t perform cost reduction process regularly, it does not mean that they don’t continuously look for new ways to improve processes and operations for better efficiency.
Aim
Cost control and cost reduction also differ according to the aims of each process. Cost control aims to establish targets or standards, control actual performance, perform variance analysis and take corrective actions. On the other hand, cost reduction does not establish any targets or standards but aims to bring efficiency to inefficient business processes.
Function
Cost control focuses on ensuring the actual costs of a business do not exceed the standards set. Therefore, the cost control process acts as a preventative function in a business. In contrast, cost reduction focuses on fixing an inefficient business process, thus, acting as a corrective function. This is because cost reduction does not focus on a standard cost but rather focuses on improving the performance of the operations of a business by reducing inefficiencies.
Application
As mentioned above, cost control is a process that focuses on cost units, which is the smallest unit of a business for which costs can be determined. Usually, a cost unit is a product or service that the business provides. Therefore, cost control applies to cost units for which standards can be determined. On the other hand, cost reduction does not deal with cost units but focuses on the operations or processes of a business. Therefore, cost reduction applies to business activities which is a higher level than cost unit.
Tools
As mentioned above, the tools used for both processes are also different. Cost control uses tools such as budgets and standard costing to set expectations. Similarly, once expectations are set, cost control uses variance analysis to identify differences between actual and budgeted performance and determine the reason for it. On the other hand, cost reduction uses tools such as value engineering or value analysis, work-study, simplification and standardization, ABC analysis, operation research, etc.
Success
The success of cost control depends on whether the actual costs of business exceed its standard costs. In contrast, the success of the cost reduction process depends on several factors, such as whether costs savings were achieved, and whether savings affected the quality of the product. Furthermore, to determine whether cost reduction was successful or not, a business must wait for while as the results are not apparent in the short term.
Orientation
Cost control is a process that focuses on the operations of a business and is, therefore, operation oriented. This means cost control happens at a lower level as compared to cost reduction. Contrastingly, cost reduction does not occur at a low level but is more concerned with the processes of the business, as mentioned above. Therefore, cost reduction is research-oriented as it requires the business to conduct proper research to determine which areas to fix.
Conclusion
Determining the costs of a product is a crucial part of any business, whether it manufactures products or provides services. This is mainly because the lower the costs of a business are, the higher its profits are. Therefore, businesses must control their costs to ensure the maximization of profits. There are two main processes that businesses use to minimize costs, namely cost control and cost reduction. While both these processes focus on maximizing profits, both of them are very different. Some key differences between the two include their process, frequency, aim function, application, tools used, success and orientation.
