There are various strategies that businesses can employ to minimise or stabilise costs, including: maximising economies of scale; integrating into the supply chain; outsourcing; offshoring; entering long-term contracts; using Just-In-Time production strategies and utilising derivatives.
Economies of scale: the cost advantage gained as output increases. This cost advantage arises when fixed costs are spread across a greater quantity of sales. When organisations place larger orders with suppliers, suppliers will usually pass on a proportion of the cost savings they receive through economies of scale to that firm, in turn reducing that firm’s input costs.
Integrating into the supply chain: the supply chain is comprised of contributors involved in the process leading up to the sale of a product (e.g. manufacturers). Typically, each contributor will charge prices that include a profit margin. If one company takes control of two or more stages in the supply chain, it will not have to pay this additional margin and costs may consequently decrease.
Profit margin: the amount of profit generated per item after deducting the average cost of producing each item.
Outsourcing: this involves a business hiring a third party to deliver specific services rather than performing those services in-house. For example, a business might outsource its manufacturing needs to a company that specialises in manufacturing, or outsource its marketing needs to a marketing agency. Outsourcing can help companies to cut costs (for example, if they outsource to companies in jurisdictions where wages are generally lower), benefit from expertise that isn’t available in-house, and access flexible staffing options (it is usually easier to stop working with a third party company than it would be to make employees redundant).
Offshoring: shifting elements of the business (e.g. production) abroad, usually to jurisdictions where costs are lower.
Long-term contracts: these can enable companies to more accurately predict future costs, or to mitigate the risk of price increases if, for instance, the price of raw materials increases globally. Participants in the supply chain may also provide more favourable rates to businesses willing to commit to long-term relationships.
Just-In-Time production: a strategy that involves companies receiving goods (e.g. raw materials) right before they are required for the production process and/or producing goods for sale right before they are required by customers. These strategies can increase efficiency, decrease the costs of storing inventory and minimise waste (if inventory does not exist, then it cannot break/expire etc.). However, if a company does not accurately forecast demand or coordination breaks down between that company and its suppliers (meaning supplies are not promptly delivered), this could result in delays that impact upon that company’s ability to meet customer demand (and thus generate profit).
Derivatives: these are financial contracts relating to underlying assets (such as securities or commodities). Examples include futures, which are agreements between parties to engage in a transaction on a predetermined future date at a specified price; and options, which give one party the right (but do not obligate them) to purchase or sell a product on a predetermined future date at a specified price. Derivatives can help companies to better predict future costs and mitigate the risk of adverse price movements reducing profitability (this is known as “hedging” risk). This can in turn facilitate more accurate financial planning.