Manufacturing Cost Reduction – A Practical Guide For Small Manufacturers

Managing costs is the crucial other end of maintaining profitability, alongside a proper pricing strategy. In this guide, we provide a practical overview of reducing manufacturing costs. We cover the main types of manufacturing costs (materials, labor, overhead), outline ways to reduce them, and explain how going lean can support cost control.

Where to start with manufacturing cost reduction?

1. Understand the three types of manufacturing costs

In manufacturing, costs are usually divided between three distinct types. These are:

• Direct materials are the materials you use to make a final product. If you’re a small furniture manufacturer making dining tables, then direct materials might include timber, screws, brackets, and packaging materials.
• Direct labor is any labor linked directly to production. Using the example of a furniture manufacturer, labor would be a factory worker cutting, assembling, or finishing the table. 
• Manufacturing overhead is any cost associated with running your manufacturing operations that can’t be tied to producing a specific good. Some examples of manufacturing overhead include utilities, property taxes, and insurance. Indirect materials (such as safety equipment) and labor (such as administrative) are also usually deemed overhead.

2. Identify your main cost drivers

Next, identify where your costs are generated and what to focus on first. For most businesses, a small number of issues tend to have the biggest impact on costs. This follows the Pareto principle, which suggests that roughly 80% of outcomes come from 20% of causes.

Taking the time to identify where your costs are coming from helps focus on the areas where changes can have a larger impact on cost efficiency. Failing to identify your main cost drivers may mean you end up making broad cuts that do little to improve your bottom line.

3. Pinpoint cost

Once you understand the source(s) of your biggest cost pressures, the next step is to attempt to reduce them. Before we move into specific cost reduction strategies, it’s helpful to use lean as a framework for identifying where time, materials, and effort are being wasted in your operation.

Lean is a management system that predominantly focuses on eliminating waste from the manufacturing process, while maintaining product quality and prioritizing customer satisfaction. The lean methodology lays out the most common forms of waste in manufacturing as the 8 wastes of lean:

• Defects – the lost time and opportunity resulting from poor product quality.
• Overproduction – making more than is needed or making it too early, which ties up resources and often creates more waste elsewhere.
• Waiting – idle time caused by delays in materials, information, approvals, or equipment availability.
• Not utilizing talent – failing to make full use of employees’ skills, ideas, knowledge, and problem-solving ability.
• Transportation – the unnecessary movement of materials or products between locations, which adds time and risk without adding value.
• Inventory excess – holding more raw materials, work-in-process, or finished goods than needed, which increases storage costs and hides underlying problems.
• Motion waste – unnecessary movement by people, such as walking, reaching, or searching for tools and materials, that reduces productivity.
• Excess processing – doing more work, using more steps, or applying tighter standards than the customer actually requires.

The goal with lean is to identify where these wastes appear in your operation and then try to reduce them systematically and continuously. For example, if you notice operators are spending a lot of time waiting because materials are not available on time, you might take steps to improve scheduling to reduce the delay, which lowers labor waste.

Next, let’s take a look at distinct ways to address extra costs arising from materials, labor, and overhead.

How to reduce material costs in manufacturing?

Tighten control over inventory

Poor inventory management can quickly drive up material costs. Excess inventory increases storage costs and ties up warehouse space, while too little inventory can cause production stoppages, missed deliveries, and rush orders.

A comprehensive inventory management system is one of the best ways to tighten control over inventory. By linking sales, procurement, inventory, and production, it helps you make sure you always have the right stock on hand to complete orders and prevents overbuying. This reduces storage and handling costs while freeing up working capital.

Dedicated inventory software also makes it easy to identify aging, expired, or obsolete inventory before it turns into a larger financial loss. It can also give you real-time data on material usage, turnover, and lead times, so that you can place orders with more accuracy. This is especially important for manufacturers with long lead times and multi-level BOMs. 

Review your bills of materials

Inaccurate material quantities in a product’s bill of materials can also drive up manufacturing costs. If quantities are too low, you may run into shortages and delays. If they’re too high, you may end up carrying excess inventory and unnecessary storage costs. To avoid this, review your BOMs regularly and compare them against actual production usage.

Regularly reviewing BOMs also helps spot components that have gotten more expensive, identify potentially over-specified materials, and assess whether lower-cost alternatives could be used without affecting product quality. It’s also a good opportunity to check whether products are using more material than necessary, or whether common parts could be standardized across multiple products to simplify purchasing.

BOMs should always be up to date if you want to be sure that purchasing, production, and costing are based on accurate information. Using bill of materials software with version control and revision tracking makes it easier to record changes, update material costs, and maintain consistency across production.

Improve quality control

Quality control should not be overlooked when trying to reduce manufacturing costs. While quality control initiatives do require an initial investment, they are sure toi reduce costs like scrap, wasted material, and replacements in the long run.

One of the best ways to ensure your quality management process is on par is to look into getting ceritified with manufacturing ISO standards. For example, companies that follow ISO 9001 must improve their internal processes, which often leads to fewer defects and less scrap. Another example is ISO 14001. This standard focuses on minimizing environmental impact, and typically leads to more efficient use of resources and reduced waste.

Strengthen your supply chain

Your sourcing strategy can have a major impact on your manufacturing costs. Relying too heavily on one supplier can increase costs if that supplier decides to raise prices, extend lead times, or fails to deliver on time.

+To reduce these risks, review supplier performance regularly and avoid depending too much on a single source for raw materials. Diversifying supplier partnerships can improve resilience and give you more flexibility when prices or lead times change. 

When comparing suppliers, look at the total cost of ownership, not just the unit price. This helps ensure you’re reducing costs without creating new problems elsewhere. For example, consider additional costs like:

• Shipping and freight
• Minimum order quantities
• Lead times
• Defect rates
• Handling costs 

How to reduce labor costs in manufacturing?

Improve production processes

One of the fastest ways to reduce labor costs is to remove wasted time from the production process. In many factories, labor hours are lost not because employees are underperforming, but because the workflow itself is inefficient. Workers may be waiting for materials, switching between jobs too often, looking for the latest instructions, or dealing with avoidable disruptions caused by poor planning.

Start by looking for the biggest sources of labor waste on the shop floor. These often include bottlenecks between workstations, unclear priorities, unnecessary movement, frequent schedule changes, or missing materials that stop work mid-process. Even small fixes in these areas can add up to major labor savings over time.

It also helps to review how jobs are scheduled. If production plans do not match actual capacity, labor gets wasted through stoppages, overtime, and constant reprioritization. Better scheduling improves the flow of work, keeps people productive, and makes labor needs easier to predict.

Manufacturing software can support these improvements by giving teams better visibility into schedules, materials, and task priorities, but the biggest gains usually come from fixing the underlying workflow first.

Standardize workflows

Informal production processes can quickly drive up costs. 

Consider a small machine shop with no standardized storage system. Workers routinely waste time walking around the facility looking for parts, tools, or drawings. This increases labor costs while adding no value. These labor costs could be reduced by standardizing your manufacturing processes. 

Standardization begins with identifying the most efficient way to carry out a process, then documenting that method and making it repeatable for all workers through clear manufacturing SOPs. 

Standardization can effectively streamline production, reduce your costs, and improve your bottom line, but it requires organizational buy-in. All employees must learn the new processes through established SOPs, understand why they’re important, and actively follow them. 

How to reduce manufacturing overhead costs?

Cut equipment downtime

Downtime is a major cost driver for small manufacturers. An unexpected breakdown can lead to direct costs such as repairs, parts, and labor. However, the impact rarely stops there. Downtime also reduces output and disrupts production. For small manufacturers, the cost of lost production from unplanned downtime averages between $1,000 and $3,000 per hour.

While some downtime is inevitable in manufacturing, its cost can be reduced by taking a proactive approach. For example, preventive maintenance can help you catch problems early, which lowers overall maintenance costs by 15 to 20%. Predictive monitoring tools such as IoT sensors can help detect failures before they happen. 

Downtime can also be reduced by training employees on how to use equipment correctly, keeping clear maintenance records to identify recurring problems, and performing consistent inspections.

Reduce energy consumption

Energy consumption accounts for a significant portion of manufacturing overhead. This is especially true for businesses like machine shops or food processing plants, which require a lot of energy to run equipment. To reduce energy consumption, first look for inefficiencies in your manufacturing process. 

For example, manufacturing in small batches can introduce inefficiency. Every time you start, shut down, and clean your equipment, extra energy is consumed. You could improve efficiency by grouping similar products into longer runs. This would reduce unnecessary changeovers and lower energy use, without affecting output. 

You can also reduce energy costs by using an energy management system to monitor consumption and implement best practices. These systems highlight when you’re using peak energy and which equipment is using more than needed. Access to real-time consumption data can also help you shift energy-intensive work away from peak tariff periods.

KPIs to track when reducing manufacturing costs

A key part of reducing manufacturing expenses is using manufacturing KPIs to measure your current production processes and identify room for improvement. The following metrics can help you understand which parts of your operation have the most potential for cost savings:

Running cost per hour: This metric tells you the total cost to run a machine or workstation for one hour. This means all costs related to the workstation, including maintenance, labor, and energy consumption.

Scrap ratio: Scrap ratio measures how much material or output is lost as scrap during production. It is usually calculated as the percentage of total material input or total units produced that cannot be sold or used. A high scrap ratio increases material costs, labor waste, and disposal costs.

Energy ratio: This KPI measures the amount of energy used to produce a certain quantity of goods. Energy ratio is typically measured as kilowatt-hours per unit of output. Energy ratio can help you spot where energy is being wasted and make better production decisions to lower utility costs.

Downtime: This is any period when production stops, planned or unplanned. This could be maintenance, changeovers, breakdowns, and idle time. Tracking downtime can help you spot where interruptions occur, reduce avoidable stoppages, and improve equipment reliability. 

First pass yield: This metric shows the percentage of units produced that didn’t require rework. If the first pass yield is low, this means you’re producing a lot of defective products, which leads to costs like wasted material, labor for performing reworks, and delayed shipments.

Get better cost visibility with ERP software

Reducing manufacturing costs is easier if you have systems in place that let you see all your costs. Manufacturing ERP software can give you clear, real-time visibility into your production costs, so you have all the information you need to reduce expenses. 

For example, MRPeasy tracks material, labor, and overhead costs as production happens, calculates actual manufacturing costs for finished goods, and calculates the cost of goods sold (COGS) as products are being sold. Because this information automatically flows into financial reports such as the balance sheet, income statement, and cash flow, it becomes much easier to monitor costs, spot budget overruns, and reduce manual accounting work.

For Technodynamics, improved cost visibility has been a core benefit of implementing manufacturing software. Here’s what Alfred Neufeld, Senior Production Engineer, had to say:

“With MRPeasy, we can go back to a manufacturing order and see a full cost breakdown, exactly which parts were unusually expensive, which routing steps were more labor-intensive, and so on,” Neufeld says. “That level of detail is incredibly valuable.”

While it’s still possible to achieve cost savings with spreadsheets or manual processes, manufacturing software can make it much easier to spot inefficiencies, control spending, and make better decisions based on real-time data.

Key takeaways

• Before deciding where to cut costs, manufacturers should look at costs in three categories: materials, labor, and overhead. Once those categories are clear, it becomes much easier to identify the small number of cost drivers that have the biggest impact.
• Material cost reduction depends on better control over inventory, BOMs, quality, and sourcing. Excess inventory, inaccurate BOMs, poor quality control, and weak sourcing decisions can all quietly drive up material costs. Improving these areas reduces waste, prevents shortages, and improves purchasing decisions.
• Labor costs often increase because of poor planning and inconsistent processes. When production is not planned well, workers spend more time waiting, searching for information, or dealing with avoidable disruptions. Optimizing scheduling, process standardization, and automation can reduce wasted labor.
• Manufacturing overhead can be reduced by tackling downtime and energy use. Equipment breakdowns, inefficient maintenance, and unnecessary energy consumption can all add costs. A more proactive approach to maintenance and energy management helps lower overhead.
• Better cost visibility makes it easier to control spending and improve profitability. Manufacturing ERP software helps connect production, inventory, purchasing, and finance data so that costs can be tracked in real time. This gives manufacturers a clearer view of where money is being lost and where corrective action will have the greatest effect.

Frequently asked questions (FAQ)

You might also like: 7 Real-Life Manufacturing Challenges Resolved with MRP Software