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Strategic Cost Management – A Profitability Tool, Bp, Fla, November 20, 2010
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Strategic Cost Management – A Profitability Tool, Bp, Fla, November 20, 2010

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  • 1. Presented to Finance Leaders Association November 20, 2010 Buffalo Grove, Illinois Barrett Peterson, C.P.A. Manager, Accounting Standards, Procedures & Analysis TTX
  • 2.   Political risks – laws, regulations, changes in officials  Global financial system  Central bank actions and agreements; the impossible trinity  “Hot capital “flows  Global trade  Wage rates and wage arbitrage – outsourcing/off-shoring  Comparative advantage  Emerging consumer markets’ growth rates  Commodity distribution and economic power  Oil  Gas  Coal  Rare earths minerals  Cadmium [think batteries]  Fresh Water – a problem now and growing Strategic Cost Management – Global Drivers
  • 3.  Quantitative Easing 2 and U.S. long-term interest rates: advantage commodity prices  U.S. Health care act [including 1099 political error]  US deficit reduction committee chairmen’s “proposal”  U.S. new consumer protection agency  U.S. near term legislative prospects and the budget  Basel III increased capital requirements  Swiss capital requirement increases  Turkey capital increases aimed to reduce “hot capital”  Bank capital {equity and near equity} requirements  Global Trade  G-20 “rebalancing” and trade discussions  South Korea trade agreement  Commodity prices, including “rare earths” Strategic Costs – Select Current Considerations
  • 4.  Product and Service Design Product Line Planning Process Design and Planning Capacity Management Market Segment Decisions Sales and Marketing Channel Decisions Logistics and Distribution Outsourcing The Role of Strategic Cost Management – Impacted Decisions
  • 5.   Single product entities can use just about any costing method reliably  Entities with few products with little difference in resource consumption patterns can use simple cost allocation methods: Activity Based Costing will add little or no value Cost Management Simplification
  • 6.   Price is an input unit measure  Driven by units acquired  Usually denominated as amount per unit acquired  Cost is an output measure  Usage inefficiency can drive waste, reducing output volume, and dramatically increasing cost both directly and by slow-down  Quality can affect waste and customer perception of price, perhaps lowering price realization, reducing margin [“increased cost”] Cost –Key Reminder: Cost is not equal to resource price
  • 7.  Cost objects – key for today  Resources  Processes  Products  Cost Management Objectives  Effectiveness – doing the right things  Efficiency – doing things right  Economy – maximizing margin [can include cost reductions, or improving revenues] Strategic Cost Management Key Aspects
  • 8.  Resource Elements  People – employees, consultants, advisors  Facilities, owned or leased  Equipment, owned or leased  Materials  Services – insurance, banking, etc.  Capital – Equity, debt, leasing, hedging, etc. Cost of Business – Elements & Drivers
  • 9.  Cost Management Resources - People
  • 10.  Cost Management Resources – Facilities, Equipment
  • 11.  Cost Management Resources – Technology Improvement
  • 12.  Cost Management Resources - Capital
  • 13.  Drivers  Product Design, including features [market segments], appearance, materials, packaging, and expected life  Process Design  Technology – Operations, Support Functions  Logistics Requirements  Marketing and Sales Methods  Capital Markets  Value Chain Position  Cultural Expectations and customs  Legal Compliance  Tax  Regulation  Financial Reporting  Conduct and Social Responsibility Cost of Business – Elements & Drivers
  • 14.  Cost Management - Drivers
  • 15.   Products  Product Lines  Processes  Customers  Distribution Channels  Facilities  Departments  Individual Machines Cost Accounting Objects
  • 16.   Strategic/Long-Term  Target Costing  Activity Based Management (ABM)  Intermediate  Activity Based Costing/Management (ABC/M)  Marginal Analyses – direct costing  Tactical/Short-term  Margin Oriented – Grenzplankostenrechnung (GPK)  Full Absorption – Traditional or ABC Cost & Profit Management Time Frames
  • 17.   Economic Trade-off based  Target Costing  Life Cycle Costing  Allocation Based Methods  Traditional Product Based Allocation – Fixed vs. Variable  Driver Based Allocation  Resource Consumption Accounting  Activity Based Costing (ABC) applied to product objects  Theory of Constraints (TOC)  “Costed” resource consumption analysis [“Pure RCA]  Allocation Free or Limited – Direct/Attributable Costing Oriented  Marginal Analyses [Direct/Attributable Costing]  Grenzplankostenrechnung (GPK) [marginal plus fixed] Cost Practices & Techniques
  • 18.   Full absorption focused  Traditional – organization structure centered, organized around organizational, often “siloed”, departments  Process /Activity focused – relies on assigning costs directly when possible, and using process drivers to allocate indirect cots  Production Management focused  Marginal costing and process focused – GPK, although GPK also contains a strong cost center focus Cost Practices & Techniques
  • 19.  The Importance of Strategic Cost Management
  • 20.   External Financial Reporting – GAAP: focused on aggregate inventory levels and consistency to inform investment decisions by investors  Income Tax Compliance – generally similar focus as external financial reporting plus “full absorption” to establish tax liability  Profitability Management – Product, Channel, Customer or Customer Class Focused  Performance Management – Operating Function, Department, Process, Channel, Customer or Customer Class Focused Costing Method Objectives
  • 21.   External parties  Capital provision determinations – costing at entity level aggregation is all that is needed  Tax compliance – aggregate compliance at the tax paying entity/group level to establish tax liability  Entity management  Allocations of resources among entities, products, geographic operating areas  Planning and controlling performance management  Profit maximization/optimization Costing Method Customers
  • 22.   Assignment to accounting/management periods – some large costs are inherently imprecise as to period; depreciation; loss contingencies; pensions; facility variable rentals and escalation provisions; hedging costs.  Assignment within accounting periods become increasingly difficult as the level of the costing object becomes smaller in size or time duration, as with products.  Allocation techniques sufficient for entity level results are not reliable for more detailed levels at which management must plan and operate – the driver of “drivers”. The Cost Management Challenge – Assigning/Allocating Costs
  • 23.   Direct costing always works, but many large dollar costs are often not direct, particularly at the product or product line level , introducing a level of uncertainty to detail level decisions.  Time horizon improves the relative amount of costs that are direct, but longer horizons provide reduced tactical flexibility.  Direct margin analyses, at multiple levels, enables comparison of long horizon planning and tactical decision making. The Cost Management Solution to Assigning/Allocating Costs
  • 24.   GAAP – ASC 330 [formerly FAS 151 & ARB 43]  Production [manufacturing]or acquisition [retail] costs  Full absorption  Consistency  IRS – Full Absorption [of production costs] focused  Code section 471 – Inventory  Code section 472 – LIFO [elimination considered]  Code section 263 – UNICAP [some costs in addition to production costs] Inventory Costs – GAAP & IRS
  • 25.   Product [Inventory] and Product Line  Direct Costs  Identification of and allocation of indirect costs  Determine need, if any, to “tie” to financial reporting  Profitability Management  Operations Performance Management  Product design  Production Operations  Logistics, including Warehouse and Material Handling Product Costing – Today’s Focus
  • 26.  What do these have in common? Close is sufficient Product Costing Method
  • 27.   Product Design – Coordination with Manufacturing and Marketing/Sales  Product Mix/Product Line Variations  Process Design  Complexity  Product Design  Manufacturing Techniques  Logistics and Material Handling Choices  Regulation and Compliance  Manufacturing Technology and Performance  Distribution and Logistics Product Cost Drivers
  • 28.   Utilization Factors  Number of shifts – hours/day of use  Time paid not worked – holidays, vacations  Operations Performance Factors  Set-Up vs. Run Time  Speed/Quality Control of Set-Up and Run - Throughput  Maintenance – time used vs. production failure costs  Waste Driven Slowing of Production Process  Loss of time [slowdown, rework]  Waste  Defective Material  Production Losses Costs Drivers to Analyze/Reflect
  • 29.   Assign costs directly as much as possible  Determine costs pools for variable type indirect costs for cost management and control  Define around key drivers for allocation based on resource consumption  Include costs which reasonably attach to the pool category  Consider two [or three] allocation layers,” indirect” indirect functions like tools, patterns, printing plates  Determine if “reciprocal” relationships will be used  Consider collecting assigning fixed type indirect costs separately using best available allocation basis  Establish Operating Departments for management responsibility evaluation – variable and fixed indirect costs Effective Cost Accounting
  • 30.  Effective Cost Accounting - Drivers  Machine hours  Direct labor hours  Material costs  Pallets handled  Printing plates used  Tool forms used  Patterns used  QC tests performed  Cubic feet of compressed air  Mixing tank hours  Mixing tank hours  Labels issued  KWH used  Orders processed  Space used  Miles traveled  Warehouse insertions/extractions  Maintenance labor hours  Chiller hours
  • 31.   “Methods” – Resource Consumption Accounting (RCA), Grenzplankostenrechnung (GPK)  Based on consumption of resources (drivers)  Applied to indirect costs  The big differences in “pure” application – will not “tie” to conventional financial reporting  Replacement cost depreciation , w/o added output  Capital charge based largely on the depreciation [capital] consumed or similar measures Cost Accounting Methods – Resource Consumption Methods
  • 32.   GPK in its fundamental form is a marginal costing system  Use “margin” level definitions, with differing levels of allocation of indirect and fixed costs  Product margins  Contribution to production costs, including production functions’ depreciation  Most useful for production scheduling  Use for channel scheduling  Calculate direct costs for both production or manufacturing and for warehousing, distribution, and logistics Cost Related Decisions and Marginal Costing
  • 33.   Use, carefully, throughput measures – profitability, not optimization, is the business objective  Minimize down time – set-up, maintenance, materials not ready  Speed and efficacy of machine operation  Optimize margin dollars per month  Be very aware of system constraints [bottlenecks] & consider Theory of Constraints – margin dollar optimization will usually require optimizing the constraint process, not all processes Cost Measurement & Performance Management
  • 34.   Direct [final] departments – product volume variable costs only  Separate each process containing different cost/operations/unit output characteristics  Identify relevant output units  Fixed costs are separately collected and not assigned to products  Indirect [primary] departments – variable costs only  Separate departments with different cost incurrence or output patterns  Identify application basis or bases  To extent possible organize indirect cost pools with the department structure Product Cost System Design Considerations – RCA/GPK
  • 35.   General design aspects –  Consider replacement cost depreciation as more realistic despite not readily reflecting potential process improvements such as faster set-ups, or increased throughput speed and accuracy/quality  Minimize design complexity by not allocating costs from one indirect department to another indirect department, unless significant to the product  Consider a cost of capital charge, as a function of replacement cost depreciation  Derive a “full absorption” estimate by using percentage reduction for capital charge and replacement cost depreciation ratio to recorded depreciation [by included processes] Product Cost System Design Considerations – RCA/GPK
  • 36.  Best used for – Product pricing decisions Outsourcing evaluations Product design evaluation Manufacturing process improvements Cost Design System – RCA/GPK
  • 37.   Similar to GPK, except that the system is “full absorption” focused and thus assigns depreciation – usually actual book depreciation – to direct and indirect departments  Costs are the sum of:  Direct costs  Direct operating departments costs – including fixed costs - assigned by a relevant driver  Indirect departments costs – including fixed costs - assigned by one or more drivers consumed by the product or the direct process Cost System Design – Activity Based Costing (ABC)
  • 38.   Target Costing – cost management and planning, follows six principles:  Price-led costing  Customer focus  Focus on design of products and processes [point at which most life cycle costs are effectively committed]  Cross-functional teams [for comprehensive perspective]  Life cycle cost reduction  Value chain involvement Costing – Other Important Applications
  • 39.   Attempts to address:  What are the sources of idle capacity?  How much unused capacity is assigned to product cost?  How large of a threat is the hidden unused capacity?  Who is responsible for capacity management?  How are manufacturing activities communicated in a common language?  How can we obtain more capacity without buying it? Costing – Capacity Management
  • 40.   Productive  Good production  New product  Process development  Non-productive  Standby, waste, maintenance, and setup  Process balance & variability; scrap; rework and yield  Scheduled & unscheduled maintenance: time, volume, changeover  Idle  Marketable (idle) and non-marketable (excess)  Off limits; legal, contractual, management policy Costing – Capacity Management – Categories of Capacity Utilization
  • 41.   Hydrox Laboratories: production and purchasing  Production planning and scheduling  Waste reduction through process improvement  Capital to improve quality – capping equipment  Bulk purchasing of hydrogen peroxide  Components purchasing  Hydrox Laboratories: logistics – per pallet shipping cost reduction by altering truck load factor [per pallet, LTL, truckload]  Graphic Direct  Printing press speed  Scheduling by cut-off and color similarity  Personalization sizing test [MWWWWM]  Sorting and envelop filling speed improvements with more experienced personnel Cost and Margin Management Examples
  • 42.   www.goldratt.com  www.tocc.com  www.cam-i.org  www.bpminstitute.org  www.supplychainmetric.com  www.rcainstitute.org  http://www.focusedmanagement.com/knowledge_base /articles/fmi_articles/middle/German_Cost_Accounting _pt2.pdf  Google text string: GPK accounting  Google text string: Resource consumption accounting Cost Management Resources