When companies set out plans to reduce their cost structure, they invariably concentrate solely on hard costs and ignore their soft costs. They often don’t see the link between how concentrating on soft costs helps to pave the way to reducing those hard costs. A number of you may be reading this and immediately be confused between soft and hard costs. After all, what’s the difference between the two and isn’t reducing costs, no matter what they are, a good thing? While reducing all costs is an essential aspect of business success, there is a difference between soft and hard costs and most businesses make a clear distinction between the two. We’ll clarify the difference and explain how concentrating on soft costs leads to huge hard cost reductions.
What are Hard Costs?
When thinking of soft and hard costs, it’s important to understand that both are different. Hard costs pertain to costs associated with physical assets. Those assets could be a company’s inventory, the machinery and equipment the company uses, or even their computers and office furniture.
Reducing pricing on the parts and raw materialsa company buys is an example of reducing hard costs. Another example is reducing the costs to operate machinery by adopting regular maintenance schedules, thereby reducing the number of spare parts purchased over a year. Hard costs relate to reducing the usage or the costs associated with such assets.
What are Soft Costs?
Most companies classify soft costs as those expenses that simply can’t be immediately identified, or included on a company’s balance sheet. For instance, there’s no space on a company’s balance sheet to track the costs of writing a check, signing the check, the time needed for approvals or the day to day costs of poor efficiency and redundant work processes.
Everyone in business knows that it costs money to write a check. Everyone understands that wasting time on confusing work processes is simply wasting money. Unfortunately, because these are deemed soft costs and are difficult to measure, they’re often not classified as important as other cost reduction initiatives.
Understand That Soft Costs are Costs Themselves
The first hurdle is to understand that soft costs are real. Being inefficient and unproductive has a cost. Sometimes it’s the result of the employee not having the capabilities to perform the job, but in a large number of cases it’s because the company’s operations, business approach, management and work flow are outdated and antiquated. It’s how the company conducts business that raises its soft costs. So, how can reducing soft costs pave the way to allowing people to reduce hard costs?
The answer to this aforementioned question is relatively simple. Freeing up time allows employees to concentrate on reducing hard costs. A seamless work flow allows employees to improve efficiencies and spend more time on problem solving. Less time spent on redundant work processes, means more time spent trying to reduce those aforementioned costs associated with inventory, equipment and machinery. To illustrate this, consider the following example concerning vendor consolidation.
To learn more about the benefits of vendor consolidation, please see: Supply Chain Management Best Practices: Vendor Consolidation
Company Uses Vendor Consolidation to Reduce Soft Costs
Imagine a situation where a company purchases a number of different parts and materials from a myriad of different vendors in different locations. For example, every month a company buys 10 units each from 100 separate vendors for a total of 1000 parts. Each of these 100 vendors charges a different price. Each vendor ships their parts in different boxes and each shipment is received by the company at different periods. Each box is unloaded and packed in the company’s warehouse. Each vendor provides an invoice that must be paid within 30 days and the company must therefore approve and write 100 separate checks.
It doesn’t take a genius to see that it’s not only a logistics nightmare, but also an incredible waste of both the company’s time and its money. How would this compare to buying 100 units each from only 10 vendors? It would not only be a savings in time, but in money as well. This is the essence of reducing soft costs. Vendor consolidation is one of the most common methods a company uses to reduce its soft costs. Here is a summary of the soft cost reductions and benefits of consolidating the company’s vendors from 100 to 10.
- Fewer orders placed.
- Fewer shipments managed & tracked.
- Fewer shipments received, unloaded and packed on the company’s shelves.
- Fewer invoices received and fewer checks to write.
- Less time waiting for approvals on payments.
- Less incidence of credit issues with vendors as there are fewer credit lines to manage.
How Does This translate Into Hard Costs?
How does reducing soft costs help inventory & procurement professionals reduce hard costs? Well, by reducing the number of vendors the company buys from, they have increased their purchasing power and volumes with the 10 vendors that remain. This allows inventory & procurement to negotiate hard cost reductions in lower pricing and lower freight on incoming parts. Freeing up time will now allow the warehouse employees to properly pack those parts. Fewer shipments to unload will help decrease the probability of damage to inventory or mistakes in receiving.
Taking it a Step Further
Vendor consolidation is the most common method companies use to reduce both soft and hard costs. However, there is another common method. A number of companies not only consolidate their vendors, but they also consolidate their customer base. This is done when the company has a hard time managing the costs associated with selling, servicing and invoicing too many customers.
This is the reason why a number of companies decide to use distributors as their channel to market. Instead of selling to one industry of over 1000 customers, they sell their product through one distributor who then services the 1000 customers. Other examples include companies who decide to improve operations by removing redundant work processes and procedures.
Companies that actively try to reduce their soft costs are able to improve efficiencies and productivity. It helps to free up valuable time, conserve company resources and streamline operations so that employees can do what they do best. When looking to reduce your company’s costs, start first with the mindset of tackling those soft costs. It will help pave the way for further cost reductions.
The importance of choosing a supply chain strategy.
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