Strategic Cost Management Notes

Strategic Cost Management Notes

Introduction to Strategic Cost Management

Learning Outcomes

• Understanding Strategic Cost Management (SCM): Recognize the necessity of SCM and differentiate it from traditional cost management.
• Competitive Advantage: Identify sources of competitive advantage, and apply the Value Proposition Canvas and Osterwalder's Business Model Canvas.
• External Environment Analysis: Analyze the external environment to evaluate industry profitability, understand customers and markets, the basis of competition, and key success factors.
• Information Technology in Strategy: Evaluate the role of IT in strategy making, particularly in the context of Porter’s Five Forces and the Value Chain.
• Management Accountant as Leader: Assess the role of the management accountant as a leader, understanding communication, decision-making, and business ethics.

Managing Cost Strategically

• Anything that can be measured can be controlled and managed; cost control and cost management are applied realities for optimization.
• Cost accounting focuses on ascertaining and recording costs, while management accounting empowers the management to control and manage costs.
• The emphasis has shifted from cost containment (maintaining the status quo) to cost reduction (cost management).
• Cost management aims to reduce cost while maintaining quality or increasing value at the same or reduced cost level.
• Strategic Cost Management (SCM) involves practicing cost management as a strategic driver in the context of organizational objectives and vision, aligning costs with business strategies.

Traditional Cost Management & Its Limitations

• Traditional Cost Management aims at cost reduction, assuming that cost-cutting always results in enhanced profits.
• Limitations include:
  • Ignoring competition, market growth, and customer requirements, focusing primarily on internal quantitative factors.
  • Excessive focus on cost reduction, potentially leading to inferior quality.
  • Ignoring marketing and economic dynamics, relying on static and historical financial accounting data.
  • Limited review and investigation of variances and deviations, focusing only on quantitative aspects.
  • Reactive approach as a corrective function rather than a preventive one.
  • Short-term outlook.

Need for Strategic Cost Management

• Detailed cost analysis is essential to gain an in-depth understanding of cost structure.
• Strategic use of cost data to gain and sustain a competitive advantage.
• Integration of cost management into strategy and vice versa.
• Comprehending the big picture (business model canvas) for a holistic analysis of cost relations among different activities.

Strategic Cost Management (SCM)

• Implementation of cost management techniques to sustain and improve the organization’s strategic position as well as reduce costs.
• Collection, processing, analysis, and dissemination of cost data to feed information to the system for decision-making to support the organizational strategy.
• Application of cost management techniques that simultaneously improve the strategic position of a firm and reduce costs.
• Assimilation of both quantitative and qualitative information in decision making.

Pillars of Strategic Cost Management

Strategic Positioning

Cost Driver Analysis

Value Chain Analysis

• Understanding the value chain helps in defining the optimal strategic position, and both help in identifying relevant cost drivers.

Value Chain Analysis

• Advocated by Michael E. Porter in 1985 to gain a competitive advantage.
• The Value Chain is the sequential chain of activities that leads to the delivery of the final product to the customer, depicting how value (utility) accumulates for the customer.
• The Value chain comprises primary activities (directly involved in the transformation of a product or provisioning of a service) and support activities (ensuring support to perform primary activities).
• Margin is the excess of the value that a customer is willing to pay over the cost incurred by the firm for the product.

Primary Activities:

• Inbound Logistics: Receiving, storing, and handling raw material inputs (excluding purchase or procurement), deeply impacted by the location of business operations. Example: Most Indian sugar mills are operating in specific states to generate value through low cost on inbound logistics.
• Operations: Transformation of raw materials into finished goods and services. Organizations may outsource activities that are not their core competences. Example: Apple only designs and sells the iPhone; it doesn't manufacture its components.
• Outbound Logistics: Storing, distributing, and delivering finished goods to customers. This includes how, when, and where for customer reference. Example: Many e-retail platforms offer delivery at a shipping address that may be different than the billing address; they also offer contactless delivery, and the buyer is free to select the time frame within which delivery shall be attempted.
• Marketing and Sales: Conducting market research to determine the marketing mix comprises product, price, place, and promotion (the 4Ps) and is further developed into the 7Ps by adding People, Process, and Physical evidence. The 4Ps can be replaced by the 4Cs, which are consumer wants and needs (for products); Cost to satisfy (for price); convenience to buy (for place); and communication (for people). Example: A fast-food restaurant chain modified its marketing mix for Indian operations.
• After Sales Service: Includes all those activities that occur after the point of sale, such as installation, training, and repair. More important in the case of durable products in comparison to products falling into the FMCG category. Example: Service station network in the automobile industry.

Support Activities:

• Firm Infrastructure: Activities pertaining to legal, general management, administrative, accounting, finance, public relations, and quality assurance.
• Technology Development: How the firm uses technology, including research and development, IT management, and cybersecurity.
• Human Resource Management: Management of human capital, including hiring, training, building and maintaining organizational culture, and maintaining positive employee relationships.
• Procurement: Purchasing, vendor relationships, negotiating prices, and activities related to bringing in necessary materials and resources.
• Increasing the performance of one of the four secondary activities can benefit at least one of the primary activities.
  Value Chain Analysis is a process of identifying Key Value Drivers (can be referred to as equivalent to CSFs) that add substantial value and contribute most towards a firm’s competitive advantage by categorizing the activities into value-added and non-value-added activities, with the objective of eliminating non-value-added activities to obtain cost leadership and focusing (by further resource deployment) on value-added activities to improve product differentiation.
  Value Chain Analysis requires a framework (strategic framework), which can collect a variety of information strategically. Three essential analyses to collect such strategic information are: Industry Structure Analysis, Core Competencies Analysis, Segmentation Analysis

Value Shop Model (or Service Value Chain)

• Can resolve the customer’s hardship for service providers.
• Conceptualized by Mr. James D. Thompson in 1967. It was named and defined by Mr. Charles B. Stabell & Mr. Oystein D. Fjeldstad in 1998.
• Value Shop Model is oriented to mobilizes resources (man, machine, money, and knowledge) to solve the problem by service sector firms.
• It is similar to the value chain, but with differences in two aspects
  • Rather than focusing on creating value, the value shop model focuses on solving problems.
  • Primary activities are described as Problem Finding and Acquisition, Problem Solving, Choice, Execution, Control, and Evaluation.
  • These activities are cyclic in nature, and the cycle will run until a solution reached.
  • Examples: management consultancies, BFSI sector, telecom services, internet service providers, subscriptions to some software or data processing solutions.
• For a professional services firm, an alternate representative of a value chain is the value shop, which is essentially a problem resolution model. The primary activities are problem finding and acquisition, problem solving, choosing among solutions, execution, control, and evaluation. Hence, the value shop principle is not concerned with value addition; instead, it deals with the resolution of customer’s hardships.

Strategic Position and Strategic Positioning Analysis

• Understanding the strategic position is concerned with the impact of the external environment, internal resources and competences, and the expectations and influence of stakeholders on strategy.
• Strategic Capability, expectations, and purposes within the cultural and political framework of the organization provide a basis for understanding the strategic position of an organization.

Strategic Positioning Analysis:

• Analysis of the company's relative position within that strategic segment of industry that matters for the purpose of establishing performance targets (while attaining competitive advantage) in addition to determining the means (strategies and plans) of attaining the same and then the measurement of performance as well as the evaluation thereof.
• Strategic positioning reflects choices a company makes about the kind of value it will create and how that value will be created differently than rivals.
• Strategic positioning should translate into either one of two things: a premium price (i.e., differentiation) or a lower cost (i.e., cost leadership).

Elements of Strategic Positioning analysis includes the study of:

• Culture, beliefs, and assumptions of the organization help in appraising the vision and values (Denison Organizational Culture Survey (DOCS))
• Stakeholders’ influence and expectations (Mendelow’s Matrix)
• Strategic capabilities in terms of resources and core competences assess the strengths and weaknesses (positive or negative)
• The macro environment assesses Opportunities and Threats (SWOT, PESTEL, Porter’s Five Forces, Porter’s Diamond Studies)

Cost Driver Analysis

• Cost driver is the unit of that activity that causes costs to be incurred.
• Cost Driver Analysis includes the examination, quantification, and explanation of the monetary effects of cost drivers associated with an activity.
• Types of Cost Drivers:
  • Structural cost drivers relate to business strategic choices about an organization’s underlying economic structure, such as scale and scope of operations, use of technology, and complexity of products.
  • Executional cost drivers relate to the execution of the business activities.

Key Tools of Strategic Cost Management

• Activity Based Costing: To provide accuracy in allocating indirect costs.
• Benchmarking: To determine critical success factors and study the ideal procedures of other organizations in order to improve operations and dominate the market.
• Competitive Advantage Analysis: Defining strategies that an organization could adopt to excel over rivals.
• Just-in-Time: A comprehensive system to buy materials (JIT Purchase) or produce commodities (JIT Production) when needed at the appropriate time.
• Kaizen - Continuous Improvement: Conducting continuous improvements in quality and other critical success factors.
• Target Costing: Cost that an organization is willing to incur according to a competitive price that could be used to achieve the desired profit.
• Theory of Constraints: A tool to improve the rate of transferring material into finished goods.
• Total Quality Management: Adapt the necessary policies and procedures to meet customers’ expectations.
• Value Chain Analysis: Add value to customers, reducing costs and understanding relationship between business organization and customers.

Traditional vs. Strategic Cost Management

Organizational Context

• Strategic Cost Management is the analysis of cost in a broader context (Organizational as well as External Environment Context), where the strategic elements become more conscious, explicit, and formal.

Gaining Competitive Advantage

• A Competitive advantage is the ability of an organization to outperform its competitors and make more profits than its competitors do from an equivalent set of activities through superior performance.

Strategies:

Differentiation

• Driving up prices by delivering distinctive value to customers through quality, innovation, or customer relations.

Cost Leadership

• Driving down costs by reducing the cost of individual value chain activities or reconfiguring the value chain. Cost effective inputs, process innovation or re-engineering, low-cost distribution channel, superior operation management, learning curve, and the economics of scale.

Relation between strategies and cost management Emphasis

Conducting Value Chain Analysis:

• Requires a strategic framework.
• Three steps involved in conducting value chain analysis: Identify Value Chain Activities, Determine the Cost and Value of Activities, Identify Opportunities for Competitive Advantage.

Business Model

• Explains how a business works and the economic logic behind it.
• Needs a value proposition; a business model should contain three components - Customer value proposition Profit formula Key resources and processes.

Osterwalder’s Business Model Canvas

• A nine-element business model canvas where four elements pertaining to cost are connected to another four elements pertaining to revenue through the ninth element. Canvas helps the firm (map, discuss, design, and develop) robust business models

Key Partners
Key Activities
Value Proposition
Customer Relationship
Customer Segments
Key Resources Channels
Cost Structure
Revenue Streams

Value Proposition Canvas

• Describes the benefits that customers can expect from a product and the bundle of products and services that business offer to specific customer segment to create value

Customer Segment Profile

• The customer segment profile describes the characteristics of the business’s customers in more detail. Jobs Pains Gains
  *

Value Proposition Map

• A value proposition map describes the features of a business’s value proposition that it has designed to address its customers’ jobs (through products and services), pains (through pain relievers); and gains (through gain creators). Products and Services Pain Relievers Gain Creators

External Environment Context

Industry Profitability

Porter’s Five Forces:

1. Bargaining Power of Buyers
2. Bargaining Power of Suppliers
3. Threat of Substitute Products or Services
4. Threat of New Entrants
5. Rivalry among Existing Firms

• All five competitive forces jointly determine the intensity of industry competition and profitability, and the strongest force or forces govern and become crucial from the point of view of strategy formulation.

Understanding Customers and Markets

• Market, Market Segment and Market Segmentation Analysis.
• Basis of Segmentation
  Product segmentation
  Demographic segmentation
  Psychographic segmentation
  Behavioural segmentation
  Geographic segmentation.

Basis of Competition

• Competition is a situation where two or more people or organizations are trying to achieve, obtain, etc. the same thing or to be better than somebody else. It can be natural or strategic.
• The basis of competition is the reason why customers of particular business choose it over its competitor.

Industry Key Success Factors

• There are certain factors in every industry that are critical to the success of any business organization in generating and sustaining a competitive advantage
• Core-Competencies Analysis
• Core Competency is a unique preposition that helps a firm stand out in the industry by providing value to its customers.

Test of Core Competency

• Relevance
• Difficulty of imitation
• Breadth of application
  Exploiting Core Competencies

Information Technology The Strategic Context

• There are three concepts that are involved here: Information Technology (IT), Information System (IS), and Information Management (IM). All three are interconnected; but not the same.
• Information technology techniques are used as part of an information system to manage information.
• Organizations develop strategies to ensure alignment among these three and an overall organizational strategy.

Basis IS Strategy
IT Strategy
IM Strategy
Resolve (Scope)
What
How
Where
Driven Force
Business Driven
Technology Focused
Management Driven
Directional
Top-Down
Bottom-up
Multi-directional
Orientation
Demand Oriented
Supply Oriented
Relationship Oriented
Organisational Level Division/ SBU/ Function based
Activity based
Organisation-wide

Impact of IT and IS:

IT/ IS and Porter’s Five Forces

1. The Threat of New Entrants
2. Suppliers’ Bargaining Power
3. Buyers’ Bargaining Power
4. Threat of Substitutes
5. Competitive Rivalry

IT/ IS and the Value Chain

IT/IS has bearing on each activity in a number of different ways through 2.1 Primary Activities and 2.2 Secondary Activities

The Role of Management Accountant as a Leader

• Responsibilities of business managers changed dramatically. The role of management accountant has also undergone a substantial transformation.
  Traditionally, the roles of a Management Accountant prominently include Today businesses require a management accountant whose role now also includes:

Role # 7. Analysis
Role # 8. Planning
Role # 9. Innovation
Role # 10. Leadership
Management Accountant is at the crossroads of technology, financial analysis and strategy, and leadership

Leaders create a vision; managers create goals; manager don’t. Leaders are change agents; managers maintain the status quo Leaders are unique; managers do copy
Leaders take risks; managers control risk Leaders are in it for the long haul; managers think short-term
Leaders grow personally, and managers rely on existing proven skills Leaders build relationships, and managers build systems and processes
Leaders coach; managers direct Leaders create followers; managers have employees (subordinates)

• Management Accountant - In the Role of a Leader Who Drives the Strategy. Leadership is required to develop an organizational strategy, drive change, and align the organization’s structure, resources, and culture with the strategy

Communication

• Communication is a two-way process that involves the transfer of information or messages from one person or group to another.

Decision-Making

• Decision-making is the process of making choices by identifying a decision, gathering information, and assessing alternative resolutions. Being part of the strategy development process, the management accountant is required to either make decisions or assist the C-suite in making decisions.

Business Ethics

• Ethics deals with moral philosophy that involves systematizing, defending, and recommending concepts of right and wrong behavior, whereas business ethics is a form of applied ethics or professional ethics that examines ethical principles and moral or ethical problems that can arise in a business environment.