Two numbers decide whether a product business survives: the price customers pay and the cost of delivering the product. Most owners spend a lot of time on price, through discounts, competitor comparisons and negotiations, and much less on cost. Yet cost is the number the business controls most directly. A business that understands and manages its costs can price competitively, absorb shocks and still make money. A business that does not is at the mercy of every competitor and every supplier price rise.
This article sets out a practical approach to cost control for small and mid-sized product and manufacturing businesses. It covers understanding cost of goods sold, looking upstream into suppliers’ costs, managing materials, labour, variable and indirect costs, the economics of equipment utilisation, and why cost reduction must never quietly become quality reduction.
Start by knowing your costs
Many small businesses know their total costs from the accounts but cannot say what a particular product, job or customer actually costs to serve. Without that, pricing is guesswork and cost reduction is untargeted.
Cost of goods sold (COGS) is the direct cost of producing what you sell: materials, direct labour and directly attributable production costs. Revenue minus COGS is gross profit, and gross profit as a percentage of revenue is gross margin. Gross margin has to cover all the other costs of running the business, including rent, salaries, marketing, administration and finance, before any profit remains.
Build a simple cost sheet for your main products or job types:
| Element | What to include |
|---|---|
| Materials | Bill of materials quantities × current prices, plus allowance for scrap and offcuts |
| Direct labour | Standard hours × fully loaded labour rate |
| Machine time | Hours × an hourly rate covering depreciation, maintenance and power |
| Outsourced processes | Subcontracted coating, machining, heat treatment and so on |
| Packaging and freight | If included in your price |
Compare actual costs with the standard on real jobs periodically. Differences reveal where money is leaking, such as excess scrap, slow setups, rework or price rises not yet passed on.
Look upstream: understand your suppliers’ costs
There is a useful saying: if you know your cost of goods sold, you can run a business, but if you know your supplier’s cost of goods sold, you can change an industry.
Knowing your suppliers’ cost structures, meaning what their materials cost, where their margin is and what drives their price, gives you powerful options:
- Better negotiation: you can tell when a price is far above cost and challenge it with facts.
- Alternative sourcing: you may find you can buy closer to the source, or a different supplier has a structurally lower cost.
- Make-or-buy decisions: you can judge whether bringing a process in-house would be cheaper.
- Disruptive pricing: occasionally, understanding the whole value chain reveals that an industry’s prices are far above its underlying costs.
One well-known example comes from medical diagnostics. A laboratory founder studied the full cost chain of common tests: what the reagents cost the supplier, what laboratories paid for them and what patients were charged. He found large mark-ups at each step. By sourcing efficiently and running high volumes, his business offered tests at a fraction of prevailing prices. Low prices drove volume, volume lowered unit costs further, and the business grew into a major brand. The lesson for any industry is to understand costs right back to the source.
Control the four main cost areas
1. Raw materials
Materials are often the largest cost in manufacturing, so small percentage gains matter.
- Review sources regularly. Are there alternative suppliers or materials that meet the specification at lower cost?
- Negotiate continuously, not just once a year, and especially when commodity prices fall.
- Order sensible quantities. The economic order quantity balances the cost of ordering (admin, freight, setup) against the cost of holding stock (cash tied up, storage, obsolescence).
- Reduce consumption. Better nesting, less scrap, fewer offcuts and design changes that use standard sizes can cut material use without changing the supplier.
- Consider longer-term agreements at agreed prices with reliable suppliers, in exchange for committed volume.
Be cautious about speculative forward buying, where you commit to large purchases in advance to lock in prices. It ties up cash and turns a manufacturer into a commodity speculator. Unless you have a clear hedging strategy, it is usually better to build a robust business and negotiate fair long-term terms.
2. Labour
The instinct in hard times is to cut headcount. Often a better first step is to improve labour productivity, meaning more output per paid hour:
- Remove waiting, searching and walking through better layout and organisation.
- Reduce setup times so more hours go to productive work.
- Train people to work across several tasks so labour can move where demand is.
- Redeploy people to new products or processes rather than losing their skills.
- Measure labour cost per unit, not just total wages.
Reducing cost per unit while keeping skilled people is usually better for the business’s future than short-term cuts that leave it unable to respond when demand returns. Any changes to hours, pay or roles must, of course, comply with employment law and awards.
3. Variable costs
Utilities, fuel, consumables and freight scale with activity and are easy to overlook:
- Monitor electricity consumption by area or machine where possible. Compressed-air leaks, idle equipment left running and inefficient lighting are common sources of waste.
- Maintain generators, compressors and vehicles for efficiency.
- Re-quote freight and logistics at least annually. Do not simply renew last year’s arrangements. Check current market rates, consolidate shipments and negotiate volume discounts.
- Review packaging: is it protecting the product efficiently, or over-specified?
4. Indirect costs and inventory
Holding inventory costs money in cash tied up, storage space, insurance, handling, damage and obsolescence. Analyse stock using a fast-, slow- and non-moving classification. Clear non-moving stock, reduce slow-moving stock and keep fast movers well managed. Increasing storage density, for example with vertical racking, can reduce the space needed.
Utilisation: idle equipment is expensive
Expensive equipment costs money whether or not it runs: finance or depreciation, insurance, maintenance and floor space. A machine worth a million dollars that runs two hours a day carries a very high cost per hour of use. The same machine running most of the day spreads its fixed cost across far more output.
That is why some businesses describe a standing machine as a liability and a running machine as an asset. Higher utilisation, through more shifts, more customers or more products on the same equipment, lowers unit costs and builds the volume that improves purchasing power, keeps teams engaged and generates profit.
There is an important caveat. Running equipment only makes sense to meet real demand. Producing stock nobody has ordered just to keep a machine busy is waste. It ties up cash, consumes materials and may never be sold. The goal is to fill capacity with profitable work, for example by winning more orders, offering capacity to other businesses or combining work onto fewer machines, not to overproduce.
Bundling and volume to spread fixed costs
Some costs are incurred once per transaction regardless of how much is sold, such as setup, collection, delivery or customer onboarding. When those fixed per-transaction costs are high, bundling can transform the economics. In the diagnostics example, collecting and handling a sample was expensive, but running additional tests on the same sample cost very little. Offering packages of many tests at an attractive price gave customers more value and the business much lower cost per test.
The same principle applies elsewhere. Combine small orders into one delivery, offer kits rather than single parts, schedule similar jobs together to share setups, or bundle service visits.
Cash: let customers fund growth where possible
How cash flows through the business matters as much as profit. When customers pay before you pay suppliers, you have negative working capital: customers’ money finances your operations. Franchisors that take deposits, subscription businesses billed in advance and manufacturers that take deposits on custom orders all benefit from it.
Low, fair prices and a strong value proposition make customers more willing to pay in advance. By contrast, a business that offers long credit terms while paying suppliers quickly must fund the gap itself, often with expensive borrowing.
Reduce costs, not quality
Cost reduction has a dangerous shortcut: quietly reducing quality. Using cheaper materials, skipping inspection, thinning coatings or removing components may cut costs in the short term, but customers notice. Returns rise, reputation suffers and the price advantage disappears.
There is a telling pattern. If a competitor can make a product for $100 and you can only make it for $110, cutting your price to $100 without changing your process means something has been compromised, usually quality. Genuine cost reduction comes from better processes, smarter sourcing, less waste and higher utilisation, not from giving the customer less.
Margin before expansion
Growth magnifies whatever economics a business already has. If each sale makes a healthy gross margin, growth multiplies profit. If each sale makes little or no margin, growth multiplies losses and consumes cash. Expanding without an adequate gross margin is one of the fastest ways to destroy a business. Fix unit economics first, then grow.
A worked example: finding savings in a fabrication business
A fabrication business turns over $4 million a year, with materials around 40% of revenue, direct labour 25% and overheads 25%, leaving about 10% profit before tax. The owner wants to improve profit without raising prices in a competitive market.
The team reviews costs systematically over a quarter:
- Materials. The top fifteen purchased items account for 70% of material spend. Re-quoting them with three suppliers and agreeing a twelve-month price arrangement on steel sheet saves about 3% on those items. Improved nesting software and a rule to use offcuts before cutting new sheet reduce sheet consumption by about 4%. Together these save roughly $70,000 a year.
- Labour. Measuring time on the most common jobs shows that fabricators spend significant time searching for tools, waiting for material and walking to a distant saw. Rearranging the layout, shadow boards for tools and kitting material before jobs start recover the equivalent of about 6% of direct labour hours. Those hours absorb growth without new hiring, worth about $60,000 a year.
- Variable costs. A compressed-air leak survey finds and fixes several leaks. Freight is re-quoted for the first time in four years. Savings are about $25,000 a year.
- Inventory. A fast-, slow- and non-moving analysis identifies $80,000 of non-moving stock, much of it for discontinued products. Selling or scrapping it frees space and cash. Tighter reorder points cut slow-moving stock by a further $50,000.
In total, annual costs fall by around $155,000 and $130,000 of cash is released, without reducing quality or headcount. Profit before tax rises from about 10% to nearly 14% of revenue. None of the changes was dramatic. Together they transformed the business’s margin.
Frequently asked questions
Where should I start if I have limited time? With your largest cost category, usually materials in manufacturing, and within it the few items that account for most spending.
Should I always choose the cheapest supplier? No. Consider total cost, including quality, reliability, lead time, payment terms and the cost of problems. A slightly dearer supplier that delivers on time and right first time is often cheaper overall.
How do I involve staff without making them anxious? Explain that the aim is to remove waste and protect the business, not to cut jobs, and ask for their ideas. People on the floor usually know where the waste is.
How often should costs be reviewed? Margins monthly, major purchases quarterly and contracts such as freight and insurance annually.
A cost-control routine
- Monthly: review gross margin by product or customer group and investigate any decline.
- Quarterly: review the top ten purchased items by spend, and negotiate or source alternatives.
- Quarterly: review scrap, rework and machine utilisation.
- Annually: re-quote freight, insurance, utilities and major services.
- Annually: review inventory and clear non-moving stock.
- Ongoing: encourage staff to suggest cost savings, and recognise those that work.
Summary
Cost control starts with knowing your costs: build cost sheets and understand gross margin. Look upstream to understand suppliers’ costs, because that knowledge supports negotiation, sourcing and sometimes disruptive pricing. Manage materials, labour productivity, variable costs and inventory deliberately. Keep expensive equipment busy with real demand, use bundling to spread fixed per-transaction costs, and structure cash flows so customers help fund operations where possible. Above all, reduce costs through better processes, never by quietly reducing quality, and secure healthy margins before you expand.
Sources: small-business training notes on controlling costs and recovering from losses, including lessons shared by founders of established Indian manufacturing and diagnostics businesses, together with general cost-management practice. Examples are illustrations. This article is general information, not financial advice.
