K.Sreekumar Professor (Finance & Control)

FISAT Business SchoolAngamaly Campus

Cost Management – Retrospect and Prospect

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“The economic goal of a nation should be to produce a high and rising standard of living for its citizens. To do this a nation, or rather the industries of a nation, must become more productive .Hence the studies what makes an industry and then later an economy productive. Upgrading is the key. Improving factor productivity allows firms to compete in sophisticated industrial segments and new industries while maintaining full employment. A failure to upgrade results in slower productivity growth, declining Competitiveness and eventually unemployment. Porter uses these concepts to create a "diamond, "the four forces that determine success of an industry.” - Michael Porter

The Competitive Advantage of Nations

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Indian Competitiveness: Where Does the Nation Stand?

Prof.Michael E .Porter made a presentation on India in Mumbai on

21st January 2004

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Porters Diamond Model for the Competitive Advantage of Nations

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"The essence of formulating competitive strategy is relating a company to its environment .”

-Michael Porter [Competitive Strategy -1980]

Michael Porter asks:

Why do some nations seem to specialize in certain industries with lots of competitors, while other nations do not seem to know that an industry exists? [Competitive Advantage of Nations -1990]

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Accounting

Strategy Management

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China

Thailand

Malaysia

Mexico

India

0 5 10 15 20 25 30 35 40

0%

3500%

3400%

3100%

1900%

1700%

Industry environment -Share of Manufacturing in GDP

Target – 35% in GDP by 2016 Prime Minister’s message – 2006 Source: National Manufacturing Competitiveness Council ‘s National Manufacturing Strategy document

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Increased Competition: Example of Commercial Vehicle Segment

Before 1990 After 1990

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Four-Stage Model of Cost System Design

System Aspects Stage I Systems Broken

Stage II Financial Reporting Driven

Stage III Systems Specialized

Stage IV Systems Integrated

Data Quality ●Many Errors ●Large Variances

●No surprises ●Meets audit standards

●Shared data bases ●Stand alone systems Informal linkages

●Fully linked databases and systems

External Financial Reporting

●Inadequate ●Tailored to financial reporting needs

●Stage II system maintained

●Financial reporting systems

Product/Customer Costs

●Inadequate ●Inaccurate ●Hidden costs and profits

●Several stand-alone ABC systems

●Integrated ABM systems

Operational and Strategic Control ●Inadequate

●Limited feedback ●Delayed feedback

●Several stand-alone performance measurement systems

●Operational and Strategic performance measurement systems

Cost and Effect -Robert S Kaplan and Robin Cooper,1998 (p.12)

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STRATECY GAP?

We often come across companies that have set an ambitious long term goal, perhaps to double revenue and profits over five years, or to dramatically increase the proportion of revenues coming from new businesses, but have devoted almost no intellectual effort to thinking through the medium-term capability-building program that is needed to support that goal. In too many companies there is a grand, and overly vague, long-term goal on one hand . . . And detailed short-term budgets and annual plans on the other hand . . . with nothing in between to link the two together. . . . There seems to be, in many companies, an implicit assumption that the short term and long term abut each other, rather than being dovetailed together. But the long term doesn’t start at year five of the current strategic plan. It starts right now! —Gary Hamel and C.K. Prahalad,

Annual Business Plan 11

Cost Management Kaleidoscope –Different Tools of Management Accounting

RETROSPECT

1.Activity Based Costing2.Value Chain Analysis3.Target Costing4.Quality Costing5.Life Cycle Costing6.Balanced Score Card

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Contd….

PROSPECT (FUTURE)

• Business Analytics & Predictive Modeling– Big

Data & Cloud Computing

• Business Model Reporting

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The Changing Cost EnvironmentCo

st (R

s) N

ot A

ctua

l Sca

le o

nly

to u

nder

stan

d th

e tr

end

Overheads

Labor

Raw Materials

1960's 2000 +

14

76

6

18

Material Cost Employee Cost Overheads

Typical Manufacturing Cost – in %Dominant Cost - Material

15

Typical IT Services Cost in %Dominant Cost : Employee

4

80

16

Material Cost Employee Cost Overheads

16

Chemical Industry State Sector

33

22

45

11 Years' Mean

Raw Materials Consumed Labour CostOverheads

Source : Review of Public Enterprises -CMD 17

Kerala Minerals and Metals Ltd

2008-09 2009-10 2010-11

Raw Material 21707 23898 24892

Labour 6359 9736 8937

Overheads 2018 2371 5674

25007500

12500175002250027500325003750042500

Cost Elements' Trend

Rs in

lakh

s

Source : Review of Public Enterprises -CMD

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• What is the full form of SAP?

Systems Applications and Products in Data Processing – Renamed in 1977– Before 1977 : Systems Analysis and Program Development (German :

Systemanalyse und Programmentwicklung)

• When was SAP founded?Founded in 1972 by Wellenreuther, Hopp, Hector, Plattner and Tschira (all ex-IBM

employees)

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• SAP R/3 client server architecture evolved in year 1992

• Which is the latest SAP product?

– mySAP Business Suite

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Flow Of Overhead in M. Affiliates

Company General

ProductionVariances

Executive M’gement

Projects

Profitability Segment

ServiceCostCenter

Admin. C.Centers

UtilityCostCenter

Prod. S. C. Center

Production C. Center

Production Order

Over/Underabsorption

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Module SAP CO – Controlling

• Represents the flow of cost and revenue

• Instrument for organizational decisions

• Key elements of the CO application module include :• Cost center accounting

• Product cost Planning

• Product Costing

• Profitability analysis

• Profit center accounting

• Activity based costing

• Enterprise controlling

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• A similar story was seen between Ambassador cars and Maruti cars. Recently, Mahindra Scorpio’s weight reduced (by 60 kg) to 2140 kg and Maruti Swift (by 30 kg) to 970 kg. Maruti has saved Rs.147 crores by working on weight reductions on components – less fuel and less pollution, for consumers.

Why classification between fixed and variable?

• If the Variable Cost of a product is more than 50%, it is better to reduce the cost than to increase the volume and when the Variable Cost is less than 50%, volume increase will result in higher profits.

EXAMPLE 1VARIABLE COST 60%

Particulars Actuals 5% Cost Reduction

5% Volume Increase

Sales Value Less: Variable CostContributionLess: Fixed CostProfit

10060402020

10057432023

10563422022

% Increase in Profits 15% 10%

Particulars Actuals 5% Cost Reduction

5% Volume Increase

Sales Value Less: Variable CostContributionLess: Fixed CostProfit

10040602040

10038622042

10542632043

% Increase in Profits 5% 7.5%

EXAMPLE 2VARIABLE COST 40%

mySAP Industry Solutions (Some Examples)

• SAP for Aerospace & Defense

• SAP for Media

• SAP for Automotive

• SAP for Mill Products

• SAP for Banking

• SAP for Mining

• SAP for Chemicals

• SAP for Oil & Gas

• SAP for Consumer Products

• SAP for Pharmaceuticals

• SAP for Engineering, Construction & Operations

• SAP for Professional Services

• SAP for Healthcare

• SAP for Public Sector

• SAP for High Tech

• SAP for Retail

• SAP for Higher Education & Research

• SAP for Service Providers

• SAP for Industrial Machinery & Components

• SAP for Telecommunications

• SAP for Insurance

• SAP for Utilities

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The Value Chain Defined

The idea of a value chain was first suggested by Michael Porter (1985) to depict how customer value accumulates along a chain of activities that lead to an end product or service. Porter describes the value chain as the internal processes or activities a company performs “to design, produce, market, deliver and support its product.” He further states that “a firm’s value chain and the way it performs individual activities are a reflection of its history, its strategy, its approach to implementing its strategy, and the underlying economics of the activities themselves.”

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40% 3% 20%5% 10% 3%

Raw Material

Sales & Marketing

Distribution

Manufacturing

Engineering

R & D

Stocking

Purchasing

6% 13%

Internal Value Chain Analysis – Manufacturing

Value Added

Managing with Dual Strategies – Derek F.Abell 30

Value Chain for the Petroleum Industry

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VALUE CHAIN COMPARISON BETWEEN PEOPLE EXPRESS AND UNITED AIRLINESCOST PER 100000 Seat Miles

People Express United Airlines $1,000 Advertising & Publicity $1,300 Ticketing Offices Ticket Counter Operations $9,000 $13,200 Gate Operations

Baggage Handling

$4,900 Fleets Maintenance $6,700 $11,600 Aircraft Operations $15,600 On-board Service $1,500 $4,700

$28,000 $41,500

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Adobe Acrobat Document

CMA Competency Map

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PROSPECT (FUTURE)

• Business Analytics & Predictive Modeling– Big

Data & Cloud Computing

• Business Model Reporting

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What is a Business Model ?

A system of inputs, value-adding activities and outputs that aims to create value over the short, medium and long term.Source: CIMA Integrated Reporting Prototype Framework (2012)

Business Model

Cost Structure Revenue Model

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Understanding your Business Model

The Business model must answer the following questions: How does the organisation create value? How does it deliver value? How does it preserve some of the value for its owners?

Know where value is being created or destroyed - helps to identify opportunities and risks

Understand how your business model interacts - within the organisation - with the external environment

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Integrated Reporting Framework

Creation of Value Over Time through Cost Management

Source :CIMA Presentation 37

Building Resilience into your Business Model

• Short-term actions + long-term aspirations• Cost leadership• Durable supply chain• Satisfied customers• Innovation• Motivated staff

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PROSPECT (Future) of Cost Management

• Business Analytics & Predictive Modeling– Big Data & Cloud Computing

In a sense, a key economic driver for IT would be the use of remote capacity popularly known as cloud computing (elasticvapor.com)/(onestopclick.com).

IBM has already come out with Smart Cloud Enterprise Services.(COGNOS,SPSS) Oracle Hyperion and Peoplesoft

• Resilient Business Models

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What’s Driving IT Priorities?

Cloud

BPM

83%

74%

68%

60%

58%Security

Intelligence

Analytics

Mobility

BPM is a discipline that leverages software and services to provide total visibility into your organization. Discover, document, automate, and continuously improve business processes to increase efficiency and reduce costs. Source:IBM

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What Business Executives Expect From Next Gen Analytics

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Cloud Computing

Cloud computing is the use of computing resources (hardware and software) that are delivered as a service over a network (typically the Internet). The name comes from the use of a cloud-shaped symbol as an abstraction for the complex infrastructure it contains in system diagrams. Cloud computing entrusts remote services with a user's data, software and computation.

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There are many types of public cloud computing

Infrastructure as a service (IaaS)Platform as a service (PaaS)Software as a service (SaaS)Network as a service (NaaS)Storage as a service (STaaS)Security as a service (SECaaS)Data as a service (DaaS)Desktop as a service (DaaS - see above)Database as a service (DBaaS)Test environment as a service (TEaaS)API as a service (APIaaS)Backend as a service (BaaS)Integrated development environment as a service (IDEaaS)Integration platform as a service (IPaaS), see Cloud-based integration

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Cloud Computing – Logical Diagram

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“Do you currently have a cloud computing initiative or strategy in place within the organization?”

12%

22%

26%

28%

33%

36%

42%

20%

40%

21%

24%

17%

26%

12%

68%

38%

53%

48%

50%

38%

47%

Malaysia (N = 60)

China (N = 100)

India (N = 150)

APEJ (N = 530)

Hong Kong (N = 60)

Australia (N = 100)

Singapore (N = 60)

Yes, have already adopted cloud solutions or approaches

No, but currently planning to implement cloud computing

No current plans to adopt cloud solutions or approaches

Manage with Cloud:- Cloud adoption continues to accelerate

47%

52%

13% adopters

44% adopters/ planners

2010

Source:-Forrsights Strategy Spotlight: Cloud In Asia Pacific Excluding Japan, Q3 2011

Base: IT and business decision-makers from companies with 20 or more employees

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Future of Cost Management

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“Data is the New Oil”Ann Winbald,

Co-founder Hummer Winbald Venture Capital

In its raw form, oil has little value.Once processed & refined, it helps

power the world.

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