Strategic Cost Management

Prof. Ahindra Chakrabarti

Concept of Cost Accounting

Cost accounting system accumulates cost data for use in both managerial and financial accounting for example production cost data is used both for setting prices (managerial ) and to value inventory ( financial ). Cost accounting data could be looked at from the perspective of decision making as : by nature: direct and indirect by function: finance or marketing by behavior: fixed and variable

Concept of Cost Accounting (contd)

This approach is generally adopted from the Ex -post perspective where recording and reporting were the prime focus .In a competitive environment organizations look for Ex -ante decision making where froward looking planning needs to be done , Cost management is a better tool than cost accounting.

Cost Management
A cost management system is a management planning and control system with the following objectives: To measure the cost of the resources consumed in performing the organizations significant activities. To identify and eliminate non value added activities To determine the efficiency and effectiveness of all major activities in the enterprise To identify and evaluate new activities that can improve the future performance of the organization

Strategic Cost Management Accounting System

OBJECTIVES

Cost Accounting

Cost Management

Strategic Cost Management

FUNCTIONS
Inventory Valuation Process Control Ad Hoc Issues Techniques Tools

OUTPUT
Financial Statements Inventory Cost of Sales Attention a Directing Variances Feedback Internal Reports Scorekeeping Profitability Budgets Make/Buy Decisions Internal Reports Bench Marking Total Quality Management Activity Based Costing Activity Based Management Re-engineering Theory of Constraints Mass Customization Target Costing Life-Cycle Costing Balanced Score Card Cost Leadership Differentiation Focus

Cost Management Information

Cost Management Information is the information the manager needs to effectively manage the firm or non profit organization--both financial information about costs and revenues,and relevant non-financial information about productivity,quality and other key success factors for the firm.

Cost Management Techniques

Benchmarking

Total Quality Management Continuous Improvement Activity Based Costing Activity Based Management Value Chain Analysis

Cost Management Techniques

Reengineering Responsibility Accounting Theory of Constraints Mass Customization Target Costing:Value Engineering Life Cycle Costing The Balanced Scorecard

Benchmarking
It is a process by which a firm identifies its critical success factors,studies the best practices of other firms (or other units within the firm) for these critical success factors,and the implements improvements in the firms processes to match or beat the performance of those competitors

Tyre Companies
Apollo Revenue PBT Assets ROE 800Cr 100 1200 11 JK 900Cr. 117 1285 12 Goodyear 1000Cr. 110 1320 11.5

Total Quality Management

It is a technique in which management develops policies and practices to ensure that the firms products and services exceed customers expectations.This approach includes increased product functionality,reliability,durability and serviceability. Cost management is used to analyse the cost consequences of different design choices for TQM and to measure and report many aspects of quality.

Continuous Improvement
Kaizen or continuous improvement is a management technique in which managers and workers commit to a program of continuous improvement in quality and other critical success factors.Its origin is attributed to Japanese manufacturers with their tireless pursuit of quality.Continuous improvement is very often associated with benchmarking and TQM.

Activity-Based Costing
Many firms found they can improve planning ,product costing,operational control and management control by using activity analysis to develop a detailed description of the specific activities performed by the operation of the firm. Activity-Based costing (ABC) is used to improve the accuracy of cost analysis by improving the tracing of costs to cost objects

Volume Driven Distribution

OVERHEAD

MATERIAL

LABOUR

Activity Driven Distribution

ACT1 ACT2 ACT3 ACT4

MATERIAL

LABOUR

Activity-Based Management

Activity-Based Management(ABM) emphasises a companys ability to measure activities that create costs as the key to performance improvement.

Reengineering
It is a process for creating competitive advantage in which a firm reorganizes its operating and management functions,often with the result that the jobs are modified,combined or eliminated. It has been defined as the fundamental rethinking and radical design of business to achieve dramatic improvements in critical,contemporary measures of performance such as cost,quality,service and speed.

Responsibility Accounting
An important objective of cost management is to assist managers in controlling costs. Sometimes cost control is facilitated by tracing costs to the department or work centre in shich cost was incurred.Such tracing of costs to departments is known as responsibility accounting. They can be Cost Centre,Revenue Centre, Profit Centre and Investment Centre.

Balance Score Card

Financial perspective
How should we appear to our shareholders?

Customer perspective
How should we appear to our customers?

Vision and strategy

Business and production process perspective

At what business practices must we excel?

Learning and growth perspective

How should we sustain our ability to change and improve?

Economic Value Added

Economic Value Added is an investment centers after tax operating income minus its total assets (net of its current liabilities) times the companys WACC.

Theory of Constraints
Theory of Constraints is a strategic technique to help firms effectively improve the rate at which raw materials are converted to finished product. The key concept in TOC is throughput,the rate at which the firm generates cash through sales,which is equal to sales less the materials required in product sold.Tput is improved directly by increasing the speed at which product is moved through the plant and sold.

Mass Customization

It is a management technique in which marketing and production processes are designed to handle the increased variety that results from delivering customized products and services to customers.This redesign involves a larger number of smaller production runs in manufacturing and specially designed marketing and service functions.

Target Costing
Target costing determines the desired cost for a product on the basis of a given competitive price, such that the product will earn a desired profit. Extensive use of value engineering

Schedule for Automobile Lab design Development and Production Months before production 36 Product Planning Design Drawings
Development proposal

30

24

18
Production arranged

12
Instructions on mass production

6 0

Styling approval First test model

Design Review
Second test model Third test model Final prototype

Test Model Production

Target cost

First test model

Second test model

Third test model

Final prototype

Value Engineering
Facility and equipment construction
Parts procurement Metal molds procurement

Costing
Equipment investment plan

Retooling

Production preparations

Mass production

Source : Taken from Japanese Cost Management

Value Chain Analysis

Value Chain Analysis is a strategic analysis tools used to identify where value to customer can be increased or cost reduced and to better understand the firms linkages with suppliers, customers and other firms in the industry. The value chain analysis focuses on the total value chain of the product from the design of the product, to the manufacture of the product to service after the sale. The underline concept of the analysis is that each individual firm occupies a selected part/s of this entire value chain.

Value Chain Analysis

FIRM INFRASTRUCTURE

SUPPORT ACTIVITIES

HUMAN RESOURCE MANAGEMENT

TECHNOLOGY DEVELOPMENT PROCUREMENT

OPERATIONS OUTBOND MARKETING SERVICE INBOUND LOGISTICS LOGISTICS & SALES

PRIMARY ACTIVITIES

Value Chain (contd)

Value Chain analysis has 3 steps:(a) Identification of the value chain activities (b) Identification of cost driver at each value activity (c) Developing a sustainable competitive advantage by reducing cost or adding value.

Life Cycle Costing

It is a management technique used to identify and monitor the costs of a product throughout its life cycle

Strategic Cost management

Porters competitive Strategies Cost Leadership Differentiation Focus

Cost Leadership
Cost leadership is a strategy in which a firm outperforms competitors by producing products or services at the lowest cost. The cost leader makes sustainable profits at lower prices, thereby limiting the growth of competition in the industry through its success at price wars and undermining the profitability of competitors which must meet the firms low price.

Cost Leadership (contd)

Cost advantages usually arise from productivity in the manufacturing process, in distribution or in overall administration. Technological innovation in the manufacturing process and labour savings from overseas production are common routes to competitive productivity

Cost Leadership (contd)

A potential weakness of the cost leadership strategy is the tendency to cut costs in a way that undermines demand for the product or service i.e. very often key feature of the product might be deleted. The cost leader remains competitive only as long as the consumer sees that the product or service is at least nearly equivalent to competitors product.

Differentiation
It is a competitive strategy in which a firm succeeds by developing and maintaining a unique value for the product as perceived by consumers. The differentiation strategy is implemented by creating a perception among consumers that the product or service is unique in some important way usually by being of higher quality. This perception allows the firm to charge higher prices and outperform the competition in profits without reducing cost significantly.

Differentiation (contd)
The appeal of differentiation is especially strong for product lines for which the perception of quality and image is important. A weakness of the differentiation strategy is the firms tendency to undermine its strength by attempting to lower costs or by ignoring the necessity of having a continual and aggressive marketing plan to reinforce the perceived difference. If the consumer begins to believe that the perceived difference is not significant, then lower cost rival products will appear more attractive.

Focus
It is a competitive strategy in which a firm succeeds by targeting its attention to a specific segment of a market. It is implemented by a firms targeted to a specific segment of a market i.e. by a type of customer, segment of the product line, or geographic area. This strategy is used to choose market niches where competition is the weakest or where the firm has a strong competitive advantage.

Focus (contd)
The focussed firm succeeds by avoiding direct competition. It has either strong differentiation or low cost advantage or both for its market segment. An important disadvantage of focus strategy is that the niche may suddenly disappear because of technological change in the industry or change in consumer tastes.

Critical Success Factors...

Financial factors Profitability,Liquidity,Sales, Market value Customer FactorsCustomer Satisfaction,Dealer and distributor,Marketing and Selling ,Timeliness of Delivery,Quality

Critical Success Factors

Internal Business processesQuality,productivity,Flexibility,Equipment readiness and Safety Learning and InnovationProduct Innovation,Timeliness of new product,Skill Development,Employee Morale,Competence Other factors governmental

Measurement of CSFs
Financial Factors:Key Financial Ratios & Cash Flow Customer Factors : Customer returns and Complaints , Sales & Delivery performance Internal Business process : Number of Defects & Cycle Time Learning & Innovation :Employee morale and competence , Employee Turnover

Distinctive Aspects of the Three Competitive Strategies

Aspect
Strategic Target

Cost Leadership
Broad cross-section of the market

Differentiation Focus
Broad cross-section of the market Unique product or service Narrow market segment Uniqueness or low cost in a specific market segment

Basis of Competitive Lowest cost in the advantage industry Product Line Production emphasis Limited selection

Wide Variety, Targeted to selected differentiating features market segment Appropriateness for Innovation in selected market differentiating products segment Firms unique ability to Premium price and innovative, differentiating server the selected market segment features

Lowest possible cost with high quality and essential product features
Low price

Marketing emphasis

Source: Based on Information from A.A.Thompson and A.J.Strickland, Strategic Management (Burr Ridge, III,: Irwin 1993),p.104

.In My View The value delivery system TRADITIONAL

MFG THE PRODUCT
Research & design Product/ Service Process design Procuremen t Production

SELLING THE PRODUCT

Advertise promote Marketing Distribution Customer Serivce

COST MANAGEMENT INFORMATION SYSTEM

Design Value Offering

Positioning Value

Develop Value
Production of Value Product/s Procurement

Deliver Value
Distribution After Sales

Sales Promotion Sales Force

Focus Market Niche

Customer Segmentation

Advertising

THE INNOVATIVE