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8/8/2019 SCMLectureNo1

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Cost Management:Strategic versus ConventionalApproaches

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


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EXHIBIT 1

The Management Accounting versus the

Strategic Cost Paradigm

Management Accounting Strategic Cost ManagementWhat is the most

useful way toanalyze costs?

What is theobjective ofcost analysis?

How should wetry to understandcost behavior?

xIn terms of products,customers, and functions

xStrongly internal focusxValue added is a key

concept

Three objectives all applywithout regard to thestrategic context: scorekeeping, attention directing,and problem solving.

Cost is primarily a functionof output volume: variablecost, fixed cost, step cost,mixed cost

xIn terms of the various stages of the overall value chain of which the firm is a partxStrongly external focusxValue-addedconsidered a dangerously

narrow concept

Although the three objectives are alwayspresent, the design of cost management

systems changes dramatically dependingon the basicstrategic positioningof thefirm, i.e., a cost leadership or productdifferentiation strategy.

Cost is a function ofstrategic choice aboutthe structure of how to compete and

managerial skill in executingthe strategicchoices: in terms of structural cost driversand executional cost drivers


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EXHIBIT 2Contrasting Cost Management Paradigms:

Conventional Cost Management vs Strategic Cost ManagementConventional Cost Management Strategic Cost Management

Standard cost system with normal allowancefor scrap, waste, rework; zero defect standardis not practical.

Overhead variance analysis; maximizeproduction volume (not quality) to absorb

overhead.

Variance analysis on raw material price;procedure from multiple suppliers to avoidunfavorable price variance; low price/low-quality raw materials

No emphasis on nonfinancial performancemeasure

No allowance for scrap, waste, rework; zerodefect is the concept

Overhead absorption is not the key; standardcosts and variance analysis are

deemphasized, in general

No control on raw material price; certifyvendors who can deliver right quantity, rightquality, and on time

Heavy use of nonfinancial measures(part-per--million defects, percentage yields, scrap,unscheduled machine down-times, first-passyields, 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 Strategic Cost ManagementNo tracking of customer acceptance

No cost of quality analysis

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

CONTROL PHILOSOPHY

The goal is to be in the top tier of thereference group

The annual target is to meet thestandards

Standards are to be met, not exceeded

A regularly exceeded standard is not

tough enough

The goal is kaizen

Industry norms set the floor

The annual target is to beat last years performance

Each achievement level sets a new floor for future

achievement


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SCMs Three Underlying

Themes

x Value Chain Analysis

x Cost Driver Analysisx Strategic Positioning Analysis


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Value Chain Analysis(concerned with the focus of Cost Management efforts)

x Strategic View a linked set of value-creatingactivities from basic raw material sources to the finalconsumer. External focus identifies places in activity

chain to enhance customer value or reduce costs inorder to achieve sustainable competitive advantage.

x Conventional View a linked set of value-creating

activities taking place within the boundaries of anorganization. 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

Logging and Chipping

Pulp Manufacturing

Paper Manufacturing

Converting Operations

Distribution

End-Use Customer

Compet i

torD

Compet i

torC

CompetitorB

Compet i

torA

Compet i

torG

Compet i

torE

C

ompet i

torF


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EXHIBIT 4A Summary of Value Chain Versus Conventional

Management AccountingConventional

Management AccountingValue Chain Analysis

in the SCM Framework

FocusPerspective

Internal Value added External

Entire set of linked activities from raw materialsuppliers to ultimate end-used customers

Cost driverconcept

A single fundamental costdriver pervades theliteraturecost is afunction of volume

Applied too often only atthe overall firm level

Multiple cost driversStructural drivers(e.g., scale, scope, experience,

technology, complexity)Executional drivers(e.g., participativemanagement,

total quality management)Each value activity has a set of unique cost drivers

Costcontainmentphilosophy

Cost reduction approachedvia responsibility centersor product cost issues

Cost containment is a function of the cost driver(s)regulating each value activity

Exploit linkages with suppliersExploit linkages with customersExploit linkages within the firm


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EXHIBIT 4 (Continued)A Summary of Value Chain Versus Conventional

Management Accounting

Conventional Management

Accounting

Value Chain Analysis

in the SCM Framework

Insights forstrategicdecisions

None are readily apparent.This is a major reasonwhy strategy consultingfirms typically throw away

conventional reports as theybegin their cost analysis

Identify cost drivers at the individual activitylevel; develop cost/differentiation advantageeither by controlling those drivers better thancompetitors or by reconfiguring the value chain

For each value activity, ask strategic questions

pertaining to make versus buy and forwardversus backward integration

Quantify and assess supplier power and buyerpower; exploit linkages with suppliers and

buyers


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Strategic Positioning Analysis(concerned with role of Cost Management in the firm)

x Firms choose to compete either through cost

leadership or product differentiationx Strategy chosen influences cost management

perspective


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Exhibit 5Differences in Cost Management Caused by Differences in

Strategy

Primary Strategic Emphasis

Product Differentiation Cost Leadership

Role of engineered product costs inassessing performance

Not very important Very important

Importance of such concepts as

flexible budgeting formanufacturing cost control

Moderate to low High to very high

Perceived importance of meetingbudgets

Moderate to low High to very high

Importance of marketing costanalysis

Critical to success Often not done on a formalbasis

Importance of product cost as aninput to pricing decisions

low high

Importance of competitor cost

analysis

low high


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Cost Driver Analysis(concerned with analyzing cost behaviorin a mannersupportive to

strategic choices)

x Understanding cost behavior requires identifying

the cost drivers present in any given situation

x 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

Output Volume

Total Cost


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Cost Driver Categories

x Structural -- related to strategic choices

that drive costs

x Executional related to an organizations

ability to execute successfully


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Structural Cost Drivers(Related to organizational choices)

x Scale: Investment size in manufacturing,R&D, and marketing

x Scope: Degree of vertical integration

x Experience: Previous repetitions of currentwork

x Technology: Process technologies used at

each step in value chainx Complexity: Broadness of product line


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Executional Cost Drivers(Related to organizational skills)

x Work Force Involvement: participation; empowerment;commitment to continuous improvement

x

Capacity Utilization: given scale choices on plantconstruction

x Plant Layout Efficiency: compared to current norms

x Product Configuration: design or formulation

effectivenessx Exploiting Linkages with Suppliers/Customers: in

relation to the value chain


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Cost Driver Analysis Some Key

Ideas

x Volume is usually not the best way to explain cost

behavior

x

More useful to explain cost position in terms ofstructural choices and executional skills

xNot all strategic cost drivers operable or equally

important all the time but some are probablyvery important in every instance


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