Strategic cost management

Relevant cost v/s Irrelevant CostRelevant cost - it refers to costs specific to management decisions. Imp for the purpose of decision making. It includesFuture 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 managementTraditionally cost management is viewed as a process of assessing the financial impact of alternative managerial decisionsEstablishes budget and actual cost of operation, processes, depts and the a analysis of variances, profitability or social use of costsImportant 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 plannedLack of integration with organisational goalsTraditional cost management is internal in focus

What is strategic cost managementIt 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 managementHere 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 SCMStrategic positioning analysisValue chain analysisCost driver analysis

Value chain analysisA systematic approach to examine the development of competitive advantageThe chain consists of a series of activities that create and build valueIt helps to determine which type of competitive advantage to pursue and how to pursue itValue is referred as the price that the customer is willing to pay for a certain offer offering

Value chain...continueExternal 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 analysisDiscounted cash flowsReturn on assetsSupply chain managementLife cycle costing

Life cycle costingProduct'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 costIntroduction phase - promotional costGrowth phase - flexible and capacity related costMaturity phase - product margin is low due to high price competitionDecline and abandonment cost - abandonment costIt not necessary that all the product follow the same cycle. Some products will fail early and have a truncated life cycle.

Supply chain managementSCM 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 positioningThreats of substitutesThreats of new entrantsBargaining power of buyersBargaining power of suppliersRivalry among competitors

Cost driversThird 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 driversExecutional drivers

Structural cost driversThese 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 resourcesScope - degree of vertical integrationExperience - how many times in the past firm has already done what it is doing againTechnology - 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 performanceBasic Executional cost drivers:Workforce involvement - workforce commitment to continual improvementTQM, 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 SCMActivity 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.