7 ways to decrease your cost of goods sold

What is the cost of goods sold?

The total cost of inventory sold during a given period of time. The expenses that are directly related to getting that product sold.

COGS = opening inventory + purchases during a period - closing inventory

Components of COGS 

• Cost of raw materials
• Direct labour costs for products
• Inbound shipping costs
• Overheads that can be directly attributed to production

It does not include sales salaries, marketing costs or insurance expenses. 

What we just discussed is the accounting definition of cost of goods sold. This definition exists mostly in part, to assist businesses to manage inventory and determine taxable and non-taxable expenses. As the cost of goods sold is tax-deductible. 

However, we think that business owners need to also take into account other indirect expenses related to getting their products sold. Such as marketing, transaction fees and value-added expenses. For an in-depth discussion on this, check out our article on the real cost of sales in your business.

For the purpose of this discussion, we will only be looking at the accounting definition of COGS and how you can decrease this figure. 

How to decrease it?

1. Automation

Are there aspects of the production process that you can automate? The initial outlay of machinery will incur costs but in the long term, it will reduce the cost of production.

2. Outsource manufacturing offshore

Whether you decide to outsource manufacturing overseas will largely depend on your organisation values and mission. While sending production overseas can significantly reduce costs you need to remember that there is a potential for this to backfire. Due to loose labour regulations in developing countries and a consumer shift towards supporting local manufacturing. Know your audience and what they are willing to accept. 

3. Negotiate with suppliers

Negotiating the cost of raw materials with your suppliers is a great way to reduce your COGS. If they aren't willing to budge, try shopping around to get a better deal. You can also consider buying in bulk to receive discounts. 

4. Don't produce or stock products that don't sell

This one seems kind of obvious but needs to be said. If you have stock that moves slowly or doesn't sell well, you are inadvertently increasing your COGS. Try focusing on products with increased margins and that turn over quickly. Go back to basics on this one remembering who your target market is and what problems you are solving for them.

5. Reduce your waste

Stock shrinkage can be a massive problem for inventory businesses. Whether it be from damage, theft or production mishaps. It's important to find ways to reduce stock shrinkage. Consider increasing security in retail stores and applying loss prevention tactics. Often food production companies will scrap products that are packaged under or overweight. They can overcome this issue by improving their production process. When issues do occur they can sell these products at discounted prices directly or through certain retailers. 

6. Use lower cost materials 

This is something to look into if it doesn't affect the overall quality of your product. Could you use recycled materials that are cheaper to purchase and show your audience that you are environmentally conscious? However, if your brand positioning is all about quality products then it's not a good idea to do this. As it could negatively impact your brand and cost you more than it saves you. Do your homework. 

7. Inventory management 

Last but not least is inventory management. Think about how you can change the way you manage inventory to reduce costs. Aldi, well known for their business model of cutting prices by creating efficiencies is a great example in this regard. They use the just in time (JIT) inventory management approach. Which involves ordering just the right amount of stock and getting it delivered just at the right time. While it has positive benefits in reducing large warehouse costs, it can leave a business vulnerable to supply chain disruptions or increased demand. Other inventory management strategies include production on demand and dropshipping. 

There you have it, seven ways to reduce your cost of goods sold. This discussion of what COGS are and what they are not will help you to see what changes you could make in your business to ultimately increase profits. Be sure to check out our article on calculating the real cost of sales in your business. 

To find out other ways to grow your business, check out our Business Success Map. A free resource (no email address required) that is designed to help business owners work on the right things at the right time.