This paper presents hierarchical compensation technique for loss minimization in distribution system by optimum location of capacitor. The electric distribution system serves an important role in achieving satisfactory power supply. The power quality is measured by good voltage profile and voltage stability. In addition the distribution system should be operated under optimum loss condition. In view of recent power sector reforms lot of emphasis has been given to these aspects. In order to get optimized operating condition the reactive compensation methodology is adapted. The proposed approach identifies the proper location & size of compensation depending on the main feeder, laterals, and sub laterals owing to their hierarchy. The cost analysis gives the amount of saving achieved per annum. The approach is tested on 15 bus test distribution system. The technique serves as a useful tool for optimized distribution system operation.