Strategic cost

management
Relevant cost v/s Irrelevant Cost
Relevant cost - it refers to costs specific to management
decisions. Imp for the purpose of decision making. It includes
Future cost - decisions are made for the future. Decisions
made now cannot alter the past.
Incremental cost - A relevant cost is one which arises as a
direct consequence of a decision.
Irrelevant cost- irrelevant cost may be irrelevant for decision
making. Example : sunk cost, fixed overheads and book
values
Traditional cost management
Traditionally cost management is viewed as a process of assessing the financial
impact of alternative managerial decisions
Establishes budget and actual cost of operation, processes, depts and the a
analysis of variances, profitability or social use of costs
Important tool used is variance analysis to show the differences between actual
cost and standard cost ( volume variation, material cost variation, labour cost
variation)
Limitations felt in using variance analysis:
Why costs were different from what was planned
Lack of integration with organisational goals
Traditional cost management is internal in focus
What is strategic cost management
It is cost analysis in the broader context, where the strategic elements
become more conscious, explicit and formal.
Cost data used to develop superior strategies in route to gaining
sustainable competitive advantage.
SCM gives clear understanding of the firm's cost structure.
SCM is the managerial use of cost information explicitly directed at one or
more 4 stages ( strategy formulation, communicating the strategy,
implementing and controlling) of strategic management
Here cost analysis is in terms of overall value chain of which the firm is
part. It is strongly external in focus.
The design of cost management systems changes dramatically
expending upon the strategic positioning of the firm - cost leadership or
product differentiation.
Composition of SCM
Strategic positioning analysis
Value chain analysis
Cost driver analysis
Value chain analysis
A systematic approach to examine the development
of competitive advantage
The chain consists of a series of activities that
create and build value
It helps to determine which type of competitive
advantage to pursue and how to pursue it
Value is referred as the price that the customer is
willing to pay for a certain offer offering
Value chain...continue
External focus perspectives, linked with activities
from raw materials suppliers to ultimate user.
Multiple cost driver concept:
Structural drivers (scale, scope, experience,
technology, complexity)
Executional drivers (participative management,
TQM)
Tools used in VC
analysis
Discounted cash flows
Return on assets
Supply chain management
Life cycle costing
Life cycle costing
Product's cost over its entire lifetime when deciding whether to introduce a new
product.
Stages of product life cycle:
Product development & planning - R&D cost! product testing cost
Introduction phase - promotional cost
Growth phase - flexible and capacity related cost
Maturity phase - product margin is low due to high price competition
Decline and abandonment cost - abandonment cost
It not necessary that all the product follow the same cycle. Some products will fail
early and have a truncated life cycle.
Supply chain management
SCM is the management of the flow of goods. It
includes movement and storage of raw materials,
work in process inventory and finished goods from
point of origin to point of consumption.
SCM draws heavily from the areas of operation
management, logistics, procurement and information
technology.
Strategic positioning
Threats of substitutes
Threats of new entrants
Bargaining power of buyers
Bargaining power of suppliers
Rivalry among competitors
Cost drivers
Third key to strategic cost management.
Cost driver is any factor which causes a change in the cost of an
activity. A cost driver is the unit of an activity that causes the
change in activity's cost.
Ex - in marketing, the cost drivers are no of advertisements,
number of sales personnel.
Cost drivers in SCM is classified as
Structural drivers
Executional drivers
Structural cost drivers
These drivers drive the product cost of the organisation.
Factors that affect this driver:
Scale - how big an investment to make in manufacturing, R&D, and in marketing
resources
Scope - degree of vertical integration
Experience - how many times in the past firm has already done what it is doing
again
Technology - what process technologies are used at each stage of the firm's
value chain.
Complexity - how complex is a products or services that has been offered to
customers
Executional cost drivers
Executional cost drivers determine the firm's cost position to execute
the strategy successfully.
These cost drivers are scaled with performance
Basic Executional cost drivers:
Workforce involvement - workforce commitment to continual
improvement
TQM, capacity utilisation, layout efficiency and product
configuration.
Not all the strategic drivers are important all the time, but some of
them are very important in every case.
Tools in SCM
Activity based costing- an accounting method that identifies the activities that a firm
performs and then assigns indirect cost to products. Assigns indirect cost to products less
arbitrarily than traditional methods.
Competitive advantage analysis- defining strategy that an organisation could adopt to excel
over rivals.
Target costing - cost that an organisation is willing to incur according to competitive price
that could be used to achieve desired profit.
TQM - adopt necessary policies and procedures to meet customer expectations.
Just in time - a comprehensive system to buy materials or produce commodities when
needed in appropriate time.
SWOT analysis - systematic procedure to identify the critical success factors of an
organisation.
Benchmarking- process performed to determine critical success factor and study the ideal
procedures for other organisation in order to improve operations and dominate market.
Balanced scoreboard- accounting report of critical success about the organization. It is
divided into four dimensions - financial performance, customer satisfactions,internal
operation and innovation and growth.