Cost reduction is a challenging subject in logistics and distribution and too often we’ve seen companies just try to cut headcount in order to achieve quick cost reductions. This is often completely the wrong strategy.
Cost reduction starts with fully understanding all costs and separating them into variable and fixed costs.
Variable costs fluctuate with volume (truck fuel, direct labour, packaging, etc.) while fixed costs don’t (rent).
Some costs, such as electricity and management overhead may be mostly fixed, but with a variable component if volume changes significantly (e.g. adding an additional shift).
As we have seen in previous classes, it is critical to measure the right parameters and processes and ensure that measurements are meaningful and pegged against appropriate volume indicators.
Start with the big picture and then gradually work down to more detail. The major cost components we will review in this class include:
- labour (direct, indirect and temporary staff vs. permanent staff),
- stock loss,
- the cost of low productivity,
- the cost of poor quality,
- utilities (electricity, heat, water).
Before we get into the detail of how to save money on each of these though, let’s start with the big picture.
Why do you need to reduce costs? By how much do you need to reduce them? How do you know?
Is the revenue line headed south? Do you have accurate data from competitors which indicates that your costs are higher than theirs? Or are you just looking for a quick fix, just to brighten the P&L for the next quarterly results?
Make sure that your reasons are valid, based on hard data and plan for a lengthy (several month) project.
Quick fixes often lead to disasters elsewhere whereas properly planned and implemented performance improvement projects can have lasting results, both financial as well as in terms of quality and staff satisfaction.
After you have established the basis for the project, as always, start with the data.
It is likely that while cost data exists, it is not in the format you need. The closer you can get to the following formats, the better, but if you can’t, get what you can, work with it, and then try to get the data in the format you need at a later time.
Ideally, you should have 1-3 years of data, split out by month.
- Labour costs should be split into direct (hourly staff who do the work) and indirect (hourly supervisory staff or salaried management). Further, the cost of direct hourly staff should be broken down into employed staff and temporary (contract) staff.
- Distribution costs should be averaged as cost per order and per item. Ideally, they should also be split out by customer (by order, by item) for the top 10-20 customers (80% of your volume is likely from 20% of your customers). Service type (overnight, 3 day, etc.), should also be logged, so that you can understand the cost of each type of service. If distribution is not outsourced, then costs should also be split by type of cost (fuel, truck maintenance, labour, etc.). The cost of orders lost/damaged in transit should also be logged.
- Stock losses should be calculated by month, shift, section/aisle and type of product.
- Packaging costs should be split by type (overpack boxes, cushioning material, tape, etc.)
- Direct labour productivity should be calculated and if possible, split by temporary and permanent staff, by shift and by similar departments/sections.
- The cost of quality issues (damages, wrong orders, etc.) should be calculated including the time spent investigating, reporting on and resolving quality issues. Any customer rebates should also be logged.
- Utility costs should be tracked by type and month. If electricity and heat are major cost components, then they should also be tracked by shift and section/department.
All of the above costs can be factored over the volume of orders or items, and compared to revenue per order/item.
Graphically representing the components of total cost in a pie chart also helps to decide where to start your reduction efforts.
For example, if utilities costs are only 5% of the total cost, you will probably want to start with distribution costs, which may be 30% of the total.
1. Labour cost reduction
Labour cost will likely be one of the more significant cost components and is often the one which seems easiest to reduce. However, drastic changes here can have significant negative effects on productivity (yes, productivity), quality and stock loss. In depth analysis, scenario planning and a gradual implementation plan are all critical to success. Consider your costs by shift and by section and analyse how direct labour costs fluctuate with volumes. Is volume processed equally on each shift or do you receive more volume on the first shift which may artificially lower your cost per item/order? If so, can you even out the volume among shifts or crew to reflect expected volumes and improve productivity? How about cross-training—are staff sufficiently multi-skilled enough so that you can move them around in response to volume fluctuations? How much lower are your contract staff costs per hour than your employed staff costs per hour? What is the rotation of contract staff and what is their productivity compared to your employed staff? How much time do you spend training contract staff and what is the cost of poor quality when they make mistakes?
Often, if there is only a 10-15% lower cost per hour differential, this is more than offset by the increased costs of training and lower productivity and quality. So, don’t assume that by making everyone a contractor that you can save a lot of money. What you can do is tightly crew to expected volume and then if you are short a few hours, reward some of your top players with a bit of overtime. You can make sure that your supervisors are working some of the time and supervising some of the time. You can reduce the crewing on expensive night or weekend shifts. You can set and communicate productivity targets to staff and then publically recognise top performers. Ask them to tell everyone else why they achieve such great results. You can make sure that everyone is fully trained and that new staff have mentors with whom to buddy up. You can ensure that your ratios of direct staff to team leaders and supervisors are appropriate. You can work to reduce sick time and accident rates. You can implement flexible working hours, so that staff work more hours in busy seasons and shorter or fewer days in low seasons. You can hire part-timers when you don’t need staff for a full 8 hour shift.
Mixing up men/women and students/second jobbers/Moms with school-aged children often also indirectly helps productivity and makes for a friendly work place. You can determine which staff have the lowest productivity and address the issues: training, not capable of performing to a high level in this position (is there a better position for this person?), motivation, personal problems, not challenged enough by the position, just is not going to make it at your company, etc. If the mid-long term revenue/volume is just not there to keep your workforce gainfully employed (and what is sales doing about this issue anyway?), are there other projects which some of staff can work on at the company? Can they be retrained as customer service agents? Conduct inventory audits? Does the building need painting or landscaping or does the layout need reworking? Does your distribution partner need extra staff? Does anyone want unpaid time off or a 4 day workweek? Do your top performers wish to take classes?
It is always best to remove extra staff from the workfloor to keep the productivity high than to have people lounging around twiddling their thumbs. In sum, without letting a single person go, there is a huge number of initiatives that can be implemented to reduce overall labour costs. Work with your team leaders and supervisors, involve and communicate with staff and you will be surprised at what they can do.
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2. Distribution costs
Hopefully, you will have already negotiated great distribution rates if you outsource transport. But beyond the great rates, what else can you do to reduce costs? Think about the following:
- Order size. How can you increase average order size or encourage your customers to consolidate orders? Will some/all customers accept deliveries three times a week instead of daily so that you can consolidate for them? Depending on how you charge for shipping, there are a number of methods you can use to lower your average distribution cost.
- Shipping destination. Is Sales charging customers for shipping in a way that is consistent with your distribution charges? Beware of the customer who receives daily shipments at a distant outpost and implement mechanisms for certain post codes to encourage order consolidation.
- Service level. Are you delivering premium services for free or almost for free and then being charged at high levels by your distribution partner? This may be appropriate for high revenue orders, but make sure that the minimum order level is appropriate for the service received.
- Loss/damage claims. Are your claim levels on par with the industry average? If not, a claims analysis (including type of item, local depot, who last scanned it, type of damage, type of packaging, etc.) can provide data which can facilitate targeted actions to reduce losses/damages.
Anecdote: A twice daily direct trunk to the nearest large city from one client’s warehouse allowed same day delivery of orders, reduced distribution costs, reduced damages and losses and delighted customers. All that was missing were the pink bows on the boxes….
3. Stock loss
A sensitive subject, not easy to mitigate, but potentially worth the effort.
If you have a non-automated warehouse, then product “misfiling” can be an issue. Separating the high value stock from lower value stock or knowing which is fast moving stock and increasing the frequency of audits can fix the symptoms, but fixing the causes are more challenging. Ensuring that stock is scanned properly into locations and that putaway staff cannot move on to the next task without scanning a location barcode will help. If the last person to touch missing stock crops up again and again, or if it is always lost on the same shift, or in the same section, start with communication and re-training and then move on to breaking up teams, moving people around, buddying up and finally, installing cameras.
Anecdote: One client with a fully automated warehouse was baffled at the high rates of stock loss.
Turns out that there was a bug in the system which resulted in stock disappearing into the high bay and not even showing up for automated auditing.
Only by “picking” all the supposedly empty pallets did the client finally find the missing stock. The challenge then was to figure out where the bug was, under what conditions was it being produced, and fix it.
What criteria do you use to package orders for shipping?
How do your staff know what to pack in what to ship to where?
Is packaging customised to item type, value, size, weight and destination or do you use the same type of packaging for almost all your orders?
Can durable packaging (for example plastic bins) be used for large customers or large orders and be subsequently reused?
Can you ship large quantities of items on trolleys or carts without any packaging?
Must all orders be overpacked?
Are you using the same weight of cardboard boxes for all orders when you should be using light weight boxes or even bags for light items and heavier boxes for heavy items?
Think about what your customers do with the packaging—can you recycle it for them or better yet, reuse cardboard boxes?
Think also about the environment when selecting packaging and try to avoid Styrofoam or large quantities of plastic. There are plenty of cheaper alternatives which are also greener.
Anecdote: One organic food delivery company delivered food orders in boxes using their own trucks. The boxes could be folded up and left on the doorstep, so that when the next order was delivered, the previous order’s boxes could also be collected. Much better than the supermarket’s delivery system that seemed to deposit 20 plastic bags on the doorstep each week.
Anecdote: One company removed the original packaging and delivered large orders of high value goods on a custom-made trolley. Fewer items went missing in transit, the customers were pleased they didn’t have to worry about recycling the packaging, and the trolley was picked up when the next order was delivered.
5. Cost of Low Productivity
Related to labour cost, permitting low levels of productivity within your workforce can also affect overall motivation, quality and employee satisfaction. Try to assess each person’s work rate either quantitatively or visually and then look in detail at the highest performers and the lowest performers. What differentiates them? Is it training, sloppiness or self-organisation, or a simple difference in speed of movement?
Some staff may move slowly because they are concerned about making mistakes, while others are just naturally slow movers and may need to be placed in a different position. Where possible, set meaningful department productivity targets and encourage staff to help each other to improve. Buddying up the highest performers with lower performers who seem to have potential for a few days will instil improved levels of organisation. Assessing the workplace for correct placement of tools and equipment will also help. Additional training on the correct processes will embed these in the person who didn’t quite understand everything the first time(s). If volume is low for a period of time (shift, day, week, month), get the excess staff off the work floor and give them something else to do. If you allow low levels of productivity sometimes, that’s what you will tend to get more and more of the time.
6. Cost of poor quality
The cost of poor quality not only affects productivity and customer satisfaction, but also has a direct financial cost. Quality performance indicators should be developed, reported on regularly and discussed with staff frequently. Reworked orders, items shipped/not shipped in error, and stock putaway incorrectly all take time and cost to fix.
Unless your quality levels are stellar, you will need one person to focus on quality part time or on a project basis for a few months at a time (a good project for a top notch supervisor when volumes are low). Analysing the root causes and tweaking processes/layout/systems/training with staff involvement will foster improved quality.
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7. Utilities Cost
While the cost of water, heat/cooling and electricity may not represent a significant percentage of total cost, reductions in consumption are often among the easiest to implement. Further, reducing environmental impact can reduce your carbon taxes or the requirement to purchase allowances and can give you a marketing/sales edge over competitors who have not done so. All this, in addition to doing the right thing for the environment.
If your operation consumes considerable electricity, you first need to understand where and when. Installing submeters or at least reading your meter more frequently should give you the data you need to begin to reduce consumption. There are organisations in many countries which will provide free/low cost lighting, motion detectors to automatically switch on/off the lights and subsidies to install more efficient air conditioning. Further, with the subsidies and deals available for solar panels, these should be a serious consideration at all businesses.
Some offer immediate discounts on your electric bill with no upfront cost. If the potential for a solar array at your site is significantly larger than your current electric bill, you can consider heat pumps or simply take the rebate at the end of the year. If you wash your trucks onsite, consider recycled water systems, in addition to installing low flow sinks/toilets and showers of course.
In summary, here are the key points to remember:
- Don’t assume that you can simply cut labour costs overnight or hire more contractors without any repercussions. Instead, flex your crewing with fluctuating volume, cross-train and use part-timers or offer overtime if required.
- Carefully analyse how much you are charging for each type of delivery and how much you are being charged. Implement mechanisms to encourage customers to consolidate orders.
- The cost of poor quality and utilities costs may be somewhat neglected, but efforts to improve quality and reduce utility costs will reap immediate rewards.
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P.S. This guide is actually one of the weekly eClasses from our Supply Chain School.