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STRATEGIC COST MANAGEMENT

specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives Strategic Cost Management focuses specifically on the cost dimension within a firms overall strategy
Strategy
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STRATEGIC COST MANAGEMENT


Strategic

cost management is the development of cost management information to facilitate the principal management function--strategic management.

STRATEGIC COST MANAGEMENT


Costs should be the most controllable part of the profit equation, yet many organizations struggle to effectively control costs and respond appropriately in volatile market conditions. Complexities in infrastructure, diverse product offerings, and the constant evolution in electronic commerce further complicate our ability to pinpoint the causal drivers of expense. In the face of a challenging market with limited top line growth opportunities, organizations must advance their capabilities to strategically manage costs and effectively prioritize spend in pursuit of profitable growth. Improved measurement alone is not enough. Only those organizations who leverage the information to 'run the business' versus 'report the business' will be rewarded in the emerging economic environment.

EXHIBIT 1

The Management Accounting versus the Strategic Cost Paradigm


Management Accounting In terms of products, customers, and functions Strongly internal focus Value added is a key concept Strategic Cost Management 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

What is the most useful way to analyze costs?

What is the objective of cost analysis?

Although the three objectives are always Three objectives all apply present, the design of cost management 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. Cost is primarily a function of output volume: variable cost, fixed cost, step cost, mixed cost Cost is a function of strategic choice about the structure of how to compete and managerial skill in executing the strategic choices: in terms of structural cost drivers and executional cost drivers
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How should we try to understand cost behavior?

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 production volume (not quality) to absorb overhead. Overhead absorption is not the key; standard costs and variance analysis are deemphasized, in general

Variance analysis on raw material price; procedure from multiple suppliers to avoid unfavorable price variance; low price/lowquality raw materials No emphasis on nonfinancial performance measure

No control on raw material price; certify vendors who can deliver right quantity, right quality, and on time

Heavy use of nonfinancial measures(part-per-million defects, percentage yields, scrap, unscheduled machine down-times, first-pass yields, number of employee suggestions)
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EXHIBIT 2 (Continued)
Contrasting Cost Management Paradigms: Traditional Cost Management vs Strategic Cost Management
Conventional Cost Management No tracking of customer acceptance Strategic Cost Management Systematic tracking of customer acceptance (customer complaints, order lead time, on-time delivery, incidence of failures in customers locations) Quality costing as a diagnostic and management control tool

No cost of quality analysis

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 standards Industry norms set the floor The annual target is to beat last years 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
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SCMs Three Underlying Themes


Strategic

cost management has emerged from a blending of three themes:

Value

Chain Analysis Cost Driver Analysis Strategic Positioning Analysis


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Value chain
The industrial value chain The linked set of value-creating activities from basic raw materials to the disposal of the finished product by end-use customers. Fundamental to a value-chain framework is the recognition that there exist complex linkages and interrelationships among activities both within and external to the firm.
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Strategic Cost Management: Basic Concepts


Value-chain framework linkages
Internal linkages: relationships among activities that are performed within a firms portion of the value chain External linkages: the firms value-chain activities that are performed with its suppliers and customers
Supplier

linkages Customer linkages


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Value Chain
Value Chain is the sequence of business functions in which customer usefulness is added to products or services The Value-Chain consists of:

1. 2. 3. 4. 5. 6.

Research & Development Design Production Marketing Distribution Customer Service


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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. 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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Conventional

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 E

Converting Operations Distribution End-Use Customer


Competitor F

Competitor G
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Competitor A

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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Strategic Cost Management: Basic Concepts


Three

general strategies have been identified:


Cost leadership Product differentiation Focusing

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Strategic Cost Management: Basic Concepts


Cost leadership strategy
To provide the same or better value to customers at a lower cost than offered by competitors.
A

company might redesign a product so that fewer parts are needed, lowering production costs and the costs of maintaining the product after purchase
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Strategic Cost Management: Basic Concepts


Differentiation strategy
Strives to increase customer value by increasing what the customer receives (customer realization A retailer of computers might offer on-site repair service, a feature not offered by other rivals in the local market

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Strategic Cost Management: Basic Concepts


Focusing strategy
A firm selects or emphasizes a market or customer segment in which to compete Paging Network, Inc., a paging services provider, has targeted particular kinds of customers and is in the process of weeding out the nontargeted customers.

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Exhibit 5
Differences in Cost Management Caused by Differences in Strategy
Primary Strategic Emphasis Product Differentiation Role of engineered product costs in assessing performance Importance of such concepts as flexible budgeting for manufacturing cost control Perceived importance of meeting budgets Importance of marketing cost analysis Importance of product cost as an input to pricing decisions Not very important Moderate to low Cost Leadership Very important High to very high

Moderate to low Critical to success low

High to very high Often not done on a formal basis high

Importance of competitor cost analysis

low

high
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Cost Driver Analysis


A factor that can causes a change in the cost of an activity. An activity can have more than one cost driver attached to it. For example, a production activity may have the followingassociated cost-drivers: a machine, machine operator(s),floor space occupied, power consumed, and the quantity ofwaste and/or rejected output.

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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Cost Driver Categories


Structural cost drivers: Fundamental choices about the size and scope of operations and technologies employed in delivering products or services to customers Organizational cost drivers: Choices concerning the organization of activities and the involvement of persons inside and outside the organization in decision making Activity cost drivers: Specific units of work (activities) performed to serve customer needs that consume costly resources

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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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Organizational Cost Drivers


Deciding to work closely with a limited number of

suppliers. Providing employees with cost information and authorizing them to make decisions. Deciding to reorganize the existing equipment in the plant so that sequential operations are closer Designing components of a product so they can only fit together in the correct manner. Deciding to manufacture a low volume product on lowspeed, general-purpose equipment rather than high-speed, special-purpose equipment. 22

Activity Cost Drivers


Placing a purchase order for raw materials Inspecting income raw materials Moving items being manufactured between workstations Setting up a machine to work on a product Spending machine time working on a product Spending labor time working on a product Hiring and training a new employee Packing order for shipment Processing a sales order Shipping a product
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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

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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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