As a brand owner, it stands to reason that maximising profits depends a great deal upon how inexpensively your company can produce its products. At the same time though, reducing your cost of goods sold is an exercise that requires some care, lest you sacrifice quality, which would be completely counterproductive.
I’ve seen companies slash their COGS by 20% and celebrate, only to watch their customer returns triple over the following quarter. The maths doesn’t work out in their favour. So before we get into the tactics, I want to be clear: this is about smart cost reduction, not indiscriminate cost-cutting.
Understanding What Actually Drives Your COGS
Before you start looking for savings, you need to understand where your money is actually going. This sounds obvious, but you’d be surprised how many brand owners I’ve worked with who couldn’t tell me their true cost breakdown with any confidence.
Your cost of goods sold typically comprises three main elements: direct materials, direct labour, and manufacturing overhead. The weighting between these varies enormously depending on your industry. A company producing handcrafted furniture will have a completely different cost profile to one manufacturing plastic containers.
Get granular with your analysis. Look at costs by product line, by SKU if you can manage it. Often, you’ll find that 80% of your COGS problems are concentrated in 20% of your product range. That’s where you start.
Ways to Reduce Cost of Goods Sold
To help your understanding and prepare you for future COGS reduction challenges, here are a few options to consider, which can help to drive down your company’s cost of goods sold and improve profit margins:
- Use less expensive materials in production
- Find ways to reduce waste in manufacture and in the supply chain
- Investigate ways to reduce material storage and transportation costs
- Negotiate ceaselessly on every materials order you place: If you can’t get a price discount, seek other benefits, such as free or reduced-rate shipping
- Join with other organisations in your industry to form buying cooperatives (larger orders, greater discounts)
A Note on Material Substitution
The first point deserves some expansion because it’s where I see companies get themselves into trouble. Using less expensive materials doesn’t mean using inferior materials. It means finding materials that deliver the same functional performance at a lower cost.
I worked with a packaging company a few years back that was using a particular grade of cardboard because, honestly, they’d always used it. Nobody had questioned it. When we actually tested alternatives, we found a supplier offering material that performed identically in their application at 15% less cost. The original specification had been set years ago for a slightly different product line.
The lesson? Challenge your assumptions about what you actually need versus what you’ve always bought.
Move Manufacturing Offshore
Another possible way to reduce the cost of goods sold for your company is to outsource manufacturing to a country where material and labour costs are cheaper than at home.
In recent years, China has become a favourite offshoring destination for western brand owners, although today its popularity may be waning as Chinese labour costs have been increasing fairly dramatically. However, the principles are the same, whichever foreign nation is chosen for manufacture.
The Hidden Costs of Offshoring
I should mention that offshoring decisions are rarely as straightforward as comparing labour rates. You need to factor in longer lead times, increased inventory holdings, quality control challenges, intellectual property risks, and the sheer management overhead of coordinating production across time zones.
A guy I know who runs a consumer electronics brand moved manufacturing to Southeast Asia, saved 30% on production costs, then spent the next two years dealing with quality issues that probably cost him more than he saved. He’s still offshore, but with much better supplier management processes in place now.
The point is: offshore manufacturing can absolutely reduce your COGS, but go in with your eyes open.
You can learn a lot more about outsourcing manufacturing to countries like China, including the traps and pitfalls that await the unwary and of course, all the advantages and benefits, in my informative and entertaining business novel China Sourcing. If you’d like to find out more about this revealing read and other titles that I’ve authored, check out the full book listing here at Supply Chain Secrets Books.
Where to Start
If you’re feeling overwhelmed by the options, here’s my suggestion: start with waste reduction. It’s usually the lowest-risk, highest-return initiative. You’re not changing suppliers, you’re not moving production overseas, you’re simply doing what you already do more efficiently.
Map your production process end to end. Where does material get scrapped? Where do you have rework? Where are you holding excess inventory that ties up cash and sometimes ends up obsolete? These are your quick wins.
