Cost Management


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Cost Management

  1. 1. Cost Management:Strategic versus ConventionalApproaches Wali Memon
  2. 2. EXHIBIT 1 The Management Accounting versus the Strategic Cost Paradigm Management Accounting Strategic Cost ManagementWhat is the most In terms of products, In terms of the various stages of the overall useful way to customers, and functions value chain of which the firm is a part analyze costs? Strongly internal focus Strongly external focus Value added is a key Value-added considered a dangerously concept narrow conceptWhat is the Although the three objectives are always objective of Three objectives all apply present, the design of cost management cost analysis? without regard to the systems changes dramatically depending strategic context: score on the basic strategic positioning of the keeping, attention directing, firm, i.e., a cost leadership or product and problem solving. differentiation strategy.How should we Cost is primarily a function Cost is a function of strategic choice about try to understand of output volume: variable the structure of how to compete and cost behavior? cost, fixed cost, step cost, managerial skill in executing the strategic 2 mixed cost choices: in terms of structural cost drivers Wali Memon and executional cost drivers
  3. 3. EXHIBIT 2Contrasting Cost Management Paradigms:Conventional Cost Management vs Strategic CostManagement Conventional Cost Management Strategic Cost ManagementStandard cost system with normal allowance No allowance for scrap, waste, rework; zero for scrap, waste, rework; zero defect standard defect is the concept is not practical.Overhead variance analysis; maximize Overhead absorption is not the key; standard production volume (not quality) to absorb costs and variance analysis are overhead. deemphasized, in generalVariance analysis on raw material price; No control on raw material price; certify procedure from multiple suppliers to avoid vendors who can deliver right quantity, right unfavorable price variance; low price/low- quality, and on time quality raw materialsNo emphasis on nonfinancial performance Heavy use of nonfinancial measures(part-per- measure -million defects, percentage yields, scrap, unscheduled machine down-times, first-pass yields, number of employee suggestions) 3 Wali Memon
  4. 4. EXHIBIT 2 (Continued) Contrasting Cost Management Paradigms: Traditional Cost Management vs Strategic Cost Management Conventional Cost Management Strategic Cost ManagementNo tracking of customer acceptance Systematic tracking of customer acceptance (customer complaints, order lead time, on-time delivery, incidence of failures in customers’ locations)No cost of quality analysis Quality costing as a diagnostic and management control tool CONTROL PHILOSOPHYThe goal is to be in the top tier of the The goal is kaizen reference groupThe annual target is to meet the standards Industry norms set the floorStandards are to be met, not exceeded The annual target is to beat last year’s performanceA regularly exceeded standard is not Each achievement level sets a new floor for future tough enough 4 Wali Memon achievement
  5. 5. SCM’s Three Underlying Themes Value Chain Analysis Cost Driver Analysis Strategic Positioning Analysis5 Wali Memon
  6. 6. Value Chain Analysis(concerned with the focus of Cost Management efforts) Strategic View – a linked set of value- creating activities from basic raw material sources to the final consumer. External focus identifies places in activity chain to enhance customer value or reduce costs in order to achieve sustainable competitive advantage. Conventional View – a linked set of value- creating activities taking place within the boundaries of an organization. Objective is to maximize value added, i.e., the difference between sales and purchases.6 Wali Memon
  7. 7. EXHIBIT 3 Value Chain in the Paper Products Industry Silvaculture and Timber Farming Competitor B Logging and Chipping Competitor C Pulp Manufacturing Competitor D Paper Manufacturing Competitor GCompetitor A Converting Operations Competitor E Competitor F Distribution 7 Wali Memon End-Use Customer
  8. 8. EXHIBIT 4A Summary of Value Chain Versus ConventionalManagement Accounting Conventional Value Chain Analysis Management Accounting in the SCM FrameworkFocus Internal Value added ExternalPerspective Entire set of linked activities from raw material suppliers to ultimate end-used customersCost driver A single fundamental cost Multiple cost driversconcept driver pervades the Structural drivers(e.g., scale, scope, experience, literature—cost is a technology, complexity) function of volume Executional drivers(e.g., participative management, Applied too often only at total quality management) the overall firm level Each value activity has a set of unique cost driversCost Cost reduction approached Cost containment is a function of the cost driver(s)containment via responsibility centers regulating each value activityphilosophy or product cost issues Exploit linkages with suppliers Exploit linkages with customers 8 Wali Memon Exploit linkages within the firm
  9. 9. EXHIBIT 4 (Continued)A Summary of Value Chain Versus ConventionalManagement Accounting Conventional Management Value Chain Analysis Accounting in the SCM Framework Insights for None are readily apparent. Identify cost drivers at the individual activity strategic This is a major reason level; develop cost/differentiation advantage decisions why strategy consulting either by controlling those drivers better than firms typically throw away competitors or by reconfiguring the value chain conventional reports as they begin their cost analysis For each value activity, ask strategic questions pertaining to make versus buy and forward versus backward integration Quantify and assess supplier power and buyer power; exploit linkages with suppliers and buyers 9 Wali Memon
  10. 10. Strategic PositioningAnalysis(concerned with role of Cost Management in the firm) Firms choose to compete either through cost leadership or product differentiation Strategy chosen influences cost management perspective10 Wali Memon
  11. 11. Exhibit 5Differences in Cost Management Caused byDifferences in Strategy Primary Strategic Emphasis Product Differentiation Cost Leadership Role of engineered product costs Not very important Very important in assessing performance Importance of such concepts as Moderate to low High to very high flexible budgeting for manufacturing cost control Perceived importance of meeting Moderate to low High to very high budgets Importance of marketing cost Critical to success Often not done on a analysis formal basis Importance of product cost as an low high input to pricing decisions 11 Importance of competitor cost Wali Memon low high analysis
  12. 12. Cost Driver Analysis(concerned with analyzing cost behavior in a manner supportiveto strategic choices) Understanding cost behavior requires identifying the cost drivers present in any given situation Understanding cost behavior depends on understanding the complex interplay among the relevant cost drivers in any given situation 12 Wali Memon
  13. 13. Conventional Approach to Cost Driver AnalysisLevel and Behavior of Costs Total Cost 13 Wali Memon Output Volume
  14. 14. Cost Driver Categories Structural -- related to strategic choices that drive costs Executional – related to an organization’s ability to execute successfully14 Wali Memon
  15. 15. Structural Cost Drivers(Related to organizational choices) Scale: Investment size in manufacturing, R&D, and marketing Scope: Degree of vertical integration Experience: Previous repetitions of current work Technology: Process technologies used at each step in value chain Complexity: Broadness of product line15 Wali Memon
  16. 16. Executional Cost Drivers (Related to organizational skills)Work Force Involvement: participation;empowerment; commitment to continuousimprovementCapacity Utilization: given scale choices onplant constructionPlant Layout Efficiency: compared to currentnormsProduct Configuration: design or formulation effectivenessExploiting Linkages withSuppliers/Customers: in relation to the valuechain16 Wali Memon
  17. 17. Cost Driver Analysis – SomeKey Ideas Volume is usually not the best way to explain cost behavior More useful to explain cost position in terms of structural choices and executional skills Not all strategic cost drivers operable or equally important all the time but some are probably very important in every instance 17 Wali Memon
  18. 18. Linkages Among Value ChainAnalysis, Strategic PositioningAnalysis and Cost Driver Analysis Understanding the value chain helps define the optimal positioning strategy Understanding the value chain and positioning strategy helps identify the relevant cost drivers 18 Wali Memon