1. Method Study

(i) Value Analysis:

Value analysis is an approach to cost saving that deals with product design. Here, before buying any equipment or materials, a study is made as to what purpose these things serve? Would other lower- cost design work as well? Is there a cheap material which can serve the same purpose? So value analysis is a procedure which specifies the function of products or components, establishes appropriate costs, determines the alternatives and evaluates them.

Thus the objective of value analysis is the identification of such costs in a product that do not in any manner contribute to its specification or functional value. Thus, it is the process of reducing the cost without sacrificing the predetermined standards of performance. It is a supplementary device in addition to the conventional cost reduction methods.

Value analysis is closely related to Value Engineering. It is very helpful in industries where production is done on a large scale and in such cases even a fraction of savings in cost would help the firm significantly.

Some examples of savings through value analysis are:

1. Discarding tailored products where standard components can do.
2. Dispensing of facilities not required by the customer.
3. Use of newly developed materials in place of traditional materials.
4. To examine the use of alternatives which are available at a lower price.

(ii) Method Study:

Method Study is a systematic study of work data and critical evaluation of the existing and pro-posed ways of undertaking the work. This technique is known as work study and organisation and method Work study helps to investigate all factors which enable the management to get the work done efficiently and economically.

The prime objective is to analyse all factors which affect the performance of a task, to develop and install work methods which make optimum use of human and material re-sources available and to establish suitable standards by which the performance of the work can be measured. Method study aims at analysing and evaluating all those conditions which influence the performance of a task. It is the creative aspect of work study.

Cost Reduction:

Cost reduction refers to bringing down the cost of production. This involves the examination of the purposes for which costs are incurred and by a variety of means, it eliminates or reduces the reasons or spending. The existing standards are closely examined at the broad and detailed levels with a view to improvement. Cost reduction should not be a fire-fighting exercise but a continuing process of improving productivity within the organization.

Any cost reduction service must be based on a full knowledge of the organisation’s use of its resources. To achieve success in cost reduction, the management must be convinced of the need for cost reduction. It is a corrective function. It is just as much concerned with the stoppage of unnecessary activity as with the curtailing of expenditure on that which is essential.

Cost reduction is possible only when the firm makes the optimum utilization of resources. It is possible by incorporating internal and external economies. This means that by economizing the cost of manufacture, administration, selling and distribution, the average cost reduction may be achieved. Cost reduction is thus stated as the real and permanent reduction in unit costs of goods or services rendered without imparting their suitability for the intended use.

Reduction in per unit cost of production can be achieved broadly in two ways:

1. Reducing expenses, given the volume of output.
2. Increasing the volume of output through increased productivity, given the same level of expenditure.

Cost reduction is achieved only through a process of analytical appraisal of all aspects of using resources, carried out on a continuous basis from the moment the product is conceived to the moment the consumer uses it. This calls for specialist knowledge, often of a technical nature.

Cost Reduction Techniques:

Techniques for reducing the cost cover a wide range of activities are:

(i)Organisation and Methods:

Organisation and Methods are defined as, “The systematic examination of activities in order to improve the effective use of human and other material resources”. It is generally accepted to be concerned with improving the administrative work, the way it is organised and the way methods and procedures are used.

O & M services include the following activities:

1. Organization analysis
2. Activity analysis
3. Information analysis
4. Interviewing
5. Systems design
6. Flowcharting
7. Form design
8. Paper workflows.

(ii)WorkStudy:

Work study in its broadest sense is the application of systematic analysis to the work of men and machines so as to improve methods and to establish proper time values for that work.

The three main objectives of the work study are:

1. The most effective use of plant
2. The most effective use of human effort
3. A reasonable work load for those employed.

Value analysis is defined as the identification and elimination of unnecessary cost without reducing the quality, reliability, and aesthetic appeal of the product or service concerned”.

The objectives of value analysis are:

1. To analyse the value of the product and its components parts,
2. To establish the cost of materials and production involved in creating the value.
3. To determine whether the same or greater value can be created with a reduction in cost.

(vi)Variety Reduction:

Variety reduction can be applied to any production process. Although in theory this is true, the technique certainly has more effect if applied in the right place and the right time. Variety reduction has several stages each of which involves a considerable amount of detailed, sometimes tedious work.

There are four stages:

1. Materials and components schedule
2. Product analysis into components
3. Identification of common components
4. Product redesign for production

Benefits of Variety Reduction:

The benefits of variety reduction are felt in many areas of the business. These are the following:

1. It reduces prices and administration and makes control easier.
2. It improves efficiency and simplifies the assembly procedures.
3. It reduces the production period considerably.
4. Consumer may benefit from a reduction in the price and an improvement in the availability of parts.

(vii)Production Control:

Production control is not a technique. It is an attitude of mind towards the efficient organization of men, machines and materials with the objective of producing a product of the right quality in the shortest time at the least cost.

It can be examined in four main sections:

1. Planning
2. Programming
3. Scheduling
4. Control

(viii)Design:

A product which performs the function, for which it was intended, is easy to use and is pleasing in appearance, is said to be well designed. Design is fundamental to the effectiveness of every product produced.

The principles of good design are:

1. Durability and reliability must be a basic part of the design
2. Quality of the product should standout
3. Safety features must be included
4. It should be simple
5. Easy to maintain

Main Approaches to the Design:

There are four main approaches to the design and they are listed below:

1. New product design
2. Redesign of an existing product
3. Specific design to meet customer needs
4. Design changes

(ix)Materials Control:

Materials control is a key activity which covers a wide range of different tasks from the moment the product is designed up to and including its final delivery.

Taking these tasks in the logical sequence in which they occur we have:

1. Buying or resourcing
2. Receipt and storage
3. Preparation
4. Handling
5. Warehousing and despatch

(x)QualityControl:

The main role of quality control is to ensure that no defective products leave the company. This can be achieved by checking every one, by sampling, and by automated control. There are many products where quality is vital and where defects may cause their death. There are other cases where quality is unimportant. For every product there is a range between rejection and over-quality.

There are two aspects to the problem:

1. What is the required standard of quality?
2. How can we ensure that all products achieve this standard with the minimum of waste?

(xi)Terotechnology:

Terotechnology is defined as “a combination of management, financial, engineering and other practices, applied to physical assets in pursuit of economic life-cycle costs.” The cost of obtaining, operating and maintaining physical assets for their productive life is known as the life-cycle cost. The benefits claimed for terotechnology cover a wider area than cost reduction.

But this aspect is covered by reduction in the following costs:

1. Cost of ownership of physical assets
2. Lower material costs
3. Reduced breakdown costs
4. Improved quality and efficiency

(xii)Cost-BenefitAnalysis:

The Cost-Benefit (C/B) analysis is the most popular and appropriate method of appraisal. It makes the business executive in making correct investment decisions to achieve optimum allocation of resources. This analysis involves the enumeration, comparison and evaluation of benefits and costs. In this criterion, the cost-benefit ratio is the measure for the evaluation of the business firm.

Evaluation can be undertaken on the basis of the following factors:

1. Evaluation on the basis of benefits
2. Evaluation on the basis of costs

If we indicate the ratio by C/B, then if C/B is less than one, the benefit is more than costs and hence the business can be undertaken. In fine, cost reduction is possible if the factors determining the cost behaviour are properly identified and handled. A business economist or manager while thinking of cost reduction has separate approach to the problem than the accountant would suggest on the basis of costs.

Essentials for the success of a Cost Reduction Programme are:

1. Every individual within the factory should recognize his responsibility.
2. Employee resistance to change should be minimised.
3. Cost reduction efforts should be continuously maintained.
4. Efforts should be concentrated in the areas where the savings are likely to be the maximum.
5. There should be routine business meetings with the employees to review the cost reduction programmes.

(xiii) Economic Value:

For the successful operation of the business, cost management is vital. Therefore, the firm should aim at doing “whatever is done” at the minimum cost. The management should search for better and more economical ways of finishing each operation. Cost management is and will continue to be a perpetual process.

It is a systematic inter-disciplinary examination of factors affecting the cost of a product. It emphasizes the identification and elimination of unnecessary cost without reducing the quality, reliability or aesthetic appeal of the product.

The value of a product lies in the benefit obtained by the user in relation to price. If the benefit in increased at the same price then the value is increased. If the benefit remains the same and the price falls then again the value is increased. A product’s value stems from its usefulness.

The objectives of this analysis are:

1. To determine the quantum of value created with a reduction in cost.
2. To know the cost of materials of production involved in creating the value.
3. To examine the value of the product and its component parts.

The analysis should be applied to any situation where resources are consumed to produce value. The analysis will always be an important part of the approach to create improved value at lower cost. The impact of this analysis is generally found in the following four main areas—redesign, alternative materials, elimination of unnecessary features and changes in procedures.

This analysis is generally operated as a team activity. This technique is more popular in those cases, where large quantities of a good are produced. The analysis seems to be treated now as an established fact.

Cost Estimation:

Business managers make use of the cost figures for the determination of profits and other allied matters like payment of tax, bonuses and dividends.

Definition and distinction of cost concepts are necessary to stress:

1. The cost estimates by conventional financial accounting are not appropriate for all managerial uses, and
2. that different business problems call for different kinds of cost.

Hence, different continuation of cost ingredients is right and appropriate for different kinds of management problems. Cost estimation is the process of pre- determining the cost of a certain product, job or order. Such pre-determinants may be required for several purposes such as budgeting, measurement of performance, efficiency preparation of financial statement, make or buy decisions, fixation of sale prices of the products, etc. In short, computation of future cost is cost estimation.

Management is vitally concerned with future costs for the simple reason that they are the only costs over which managers can exercise any control. Future costs are those that are reasonably expected to be incurred in some future period. Their actual incurrence is a forecast and their management is an estimate.

Future is uncertain. Therefore, future costs have to be estimated and they cannot be expressed in absolute current figures. Management accountants are more interested in future costs. Future costs are expectations rather than accomplished facts. Hence, their measurement and estimation depend upon conjectures concerning future situations.

A forward looking management mostly needs cost information on forecasts of future costs for the purpose of expansion, control, appraisal and business decisions. Many of the forecasts are based on future costs because managerial decisions must always be forward looking.

Cost estimation is not a question of recognition but a requirement. It is essential for selling scientific standards that will realistically reflect the operating conditions that will govern the level of costs during the future accounting period. Profit-loss projections need estimates of cost behaviour under assumed future conditions. Cost estimation is necessary for price policy also.

Cost estimation calls for knowledge of the functional relationship of costs with output rate, technology, and product mix and factor price. Many managerial decisions require quantitative information about the firm’s cost functions. In the short run, some costs are fixed.

Although these fixed costs should be identified and measured, the usual procedure is to estimate the total or average variable cost functions and then, if necessary, add the fixed cost component to obtain the total or average cost function. In the long run, all costs are variable.

The theory of cost estimation is a fundamental concern of managerial economics. Thus the knowledge of the firm’s short run and long run cost functions is very essential for management to make many important decisions.

This requires the estimation of both short run and long run cost functions, which are discussed asunder:

Estimation of Short-Run Cost Function:

One of the initial steps in estimating a cost function is to choose the mathematical form of relationship between output and cost. For this, managers use time-series data and relate the total cost of a firm in each time period to its output level in that period. Regression analysis is often used to estimate this relationship.

In estimating the short-run cost function on the basis of time-series data, the following problems arise:

1. The time period used for accounting purposes generally is longer than the economist’s short run.
2. Accountants often use arbitrary allocations of overhead and joint costs.
3. The problem of technical homogeneity of both inputs and output.
4. Many inputs are valued at historical costs rather than opportunity costs.
5. Difficulty of adjustment of cost data in the face of inflation.
6. Determination of depreciation of an asset over a period of time on the basis of tax laws rather than economic criteria.

A number of empirical studies have found that a linear function often fits the data for particular firms and plants in the short run. The data used in these studies also do not cover periods when the firm was operating near its peak capacity, that is, when its marginal cost was expected to increase substantially.

Estimation of Long-Run Cost Function:

Estimation of the firm’s long-run cost function is required for forward planning decisions by management.

2.The Survivor Technique:

This technique for measuring the relative efficiency of difficult sizes of firms was suggested by Prof. Stigler. Stigler used this method to study the steel and automobiles industry in USA. This technique is based on the fact that if there are advantages in the large scale production in a particular industry and if the industry is fairly competitive, one would expect firms in the lowest size range to increase their share of the market overtime.

For the application of this technique, firms in an industry are classified into groups by size in order to estimate an implied shape of the long run cost curve. The share of the industry output coming from each size group is then calculated over time.

An increase in the share over the specified time means it is efficient if not inefficient. Assuming that market forces work efficiently, firms in the most efficient size category take an increased share of the market and firms in less efficient size category take a small share of the market.

In Stigler’s study of the US steel industry, the shares of the largest and smallest categories of firms both declines in the long run, while the shares of firms in a range of medium-sized categories increased, thereby implying a U-shaped long-run cost curve with a large flat range, as shown in Figure 1.

Limitations:

The survivor technique fails to adequately estimate the cost curve due to a number of unrealistic assumptions:

1. All firms should have the same set of objectives.
2. They should be operating under similar environments.
3. Technology and factor prices must remain unchanged overtime.
4. Market forces should be free from collusive agreements and barriers to entry.
5. This technique takes into account size and costs only.

As a result of these conditions which are unlikely to be fulfilled, the survivor technique has not been used in the estimation of cost function.

3.Statistical Techniques:

• This technique is also known as econometric approach to measure the economies of scale. Under this approach, the ex-post data on cost and output is used to estimate the cost function for the firm or industry. In the statistical method of cost estimation, statistical techniques are used.
• The objective is to find a functional relationship between changes in costs and the factors upon which costs depend such as output rates, sales quantity, etc. Under this method, the historical data on cost and output are used to estimate the cost- output relationship.
• The alternative mathematical forms of the function are to be specified first and then fitted to the data using least-squares method.
• The function which explains the maximum variation of the cost with the level of output will be the best one. It may be linear or nonlinear in shape from which we can derive the conclusions about the economies of scale. The linear total cost function would give a constant marginal cost and a monotonically falling average cost curve.
• The quadratic function could yield a U-shaped average cost curve and a rising marginal cost curve. The cubic cost function is consistent both with a U-shaped average cost curve and U-shaped marginal cost curve. Thus to check the validity of the theoretical cost-output relationship one should hypothesize a cubic cost function.
• The statistical method is more suitable for estimating this function at the industry or national level, there has been a growing application of the statistical method at the macro level. It has the advantage of isolating fixed cost elements from the total cost.

Limitations

This technique suffers from the following defects: