Cost Management:

Strategic versus Conventional

Approaches

Constantine Konstans, Ph.D., CPA, CMA, CIA CFE

Professor of Accounting and Information Management
University of Texas at Dallas

These materials are drawn heavily from

Shank and Govindarajan
Strategic Cost Management
 EXHIBIT 1
The Management Accounting versus the
Strategic Cost Paradigm

Management Accounting Strategic Cost Management

What is the most ◆In terms of products,
useful way to customers, and functions
analyze costs? ◆Strongly internal focus
◆Value added is a key
concept
What is the
objective of Three objectives all apply
cost analysis? without regard to the
strategic context: score
keeping, attention directing, firm, i.e., a cost leadership or product
and problem solving.
◆In terms of the various stages of the overall
value chain of which the firm is a part
◆Strongly external focus
◆Value-added considered a dangerously
narrow concept
Although the three objectives are always
present, the design of cost management
systems changes dramatically depending
on the basic strategic positioning of the
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
mixed cost choices: in terms of structural cost drivers
and executional cost drivers
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 EXHIBIT 2
Contrasting Cost Management Paradigms:
Conventional Cost Management vs Strategic Cost Management
Conventional Cost Management Strategic Cost Management
Standard 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 general

Variance 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 materials

No 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
 EXHIBIT 2 (Continued)
Contrasting Cost Management Paradigms:
Traditional Cost Management vs Strategic Cost Management
Conventional Cost Management Strategic Cost Management
No 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 PHILOSOPHY
The goal is to be in the top tier of the The goal is kaizen
reference group
The annual target is to meet the Industry norms set the floor
standards The annual target is to beat last year’s performance
Standards are to be met, not exceeded Each achievement level sets a new floor for future
A regularly exceeded standard is not achievement
tough enough
4
SCM’s Three Underlying
Themes
◆ Value Chain Analysis
◆ Cost Driver Analysis
◆ Strategic Positioning Analysis

5
 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.

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 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 G
Competitor A

Converting Operations

Competitor E
Competitor F
Distribution

End-Use Customer 7
 EXHIBIT 4
A Summary of Value Chain Versus Conventional
Management Accounting
Conventional Value Chain Analysis
Management Accounting in the SCM Framework
Focus Internal Value added External
Perspective Entire set of linked activities from raw material
suppliers to ultimate end-used customers

Cost driver A single fundamental cost Multiple cost drivers

concept driver pervades the Structural drivers(e.g., scale, scope, experience,
literature—cost is a technology, complexity)
function of volume Executional drivers(e.g., participative
Applied too often only at management,
the overall firm level total quality management)
Each value activity has a set of unique cost drivers

Cost Cost reduction approached Cost containment is a function of the cost driver(s)
containment via responsibility centers regulating each value activity
philosophy or product cost issues Exploit linkages with suppliers
Exploit linkages with customers
Exploit linkages within the firm

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 EXHIBIT 4 (Continued)
A Summary of Value Chain Versus Conventional
Management 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
 Strategic Positioning Analysis
(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
perspective

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 Exhibit 5
Differences in Cost Management Caused by Differences in
Strategy
Primary Strategic Emphasis
Product Differentiation Cost Leadership
Role of engineered product costs in Not very important Very important
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 formal

analysis basis

Importance of product cost as an low high

input to pricing decisions

Importance of competitor cost low high

analysis 11
 Cost Driver Analysis
(concerned with analyzing cost behavior in a manner supportive to
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

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 Conventional Approach to
Cost Driver Analysis
Level and Behavior of Costs

Total Cost

Output Volume
13
 Cost Driver Categories
◆ Structural -- related to strategic choices
that drive costs
◆ Executional – related to an organization’s
ability to execute successfully

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 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 line

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 Executional Cost Drivers
(Related to organizational skills)

◆ Work Force Involvement: participation; empowerment;

commitment to continuous improvement
◆ Capacity Utilization: given scale choices on plant
construction
◆ Plant Layout Efficiency: compared to current norms
◆ Product Configuration: design or formulation
effectiveness
◆ Exploiting Linkages with Suppliers/Customers: in
relation to the value chain

16
 Cost Driver Analysis – Some Key
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
Linkages Among Value Chain Analysis,
Strategic Positioning Analysis 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

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