STRATEGIC COST MANAGEMENT

QUESTIONS FOR WRITING AND DISCUSSION

1. A competitive advantage is providing better
customer value for the same or lower cost
or equivalent value for lower cost. The cost
management
system
must
provide
information that helps identify strategies that
will create a cost leadership position.
2. Customer value is the difference between
what a customer receives and what the
customer gives up (customer realization
less customer sacrifice). Cost leadership
focuses on minimizing customer sacrifice. A
differentiation strategy, on the other hand,
focuses on increasing customer realization,
with the goal of ensuring that the value
added
exceeds the costs of providing the
differentiation.
Focusing
selects
the
customers to which value is to be delivered.
Strategic positioning is the choice of the mix
of cost leadership, differentiation, and
focusing that a company will emphasize.
3. External linkages describe the relationship
between a firms value chain and the value
chain of its suppliers and customers.
Internal linkages are relationships among
the
activities within a firms value chain.
4. Organizational activities are activities that
determine the structure and business
processes of an organization. Operational
activities are the day-to-day activities that
result from the structure and processes
chosen by an organization. Organizational
cost drivers are the structural and
procedural factors that determine a firms
long-term cost structure. Operational cost
drivers are the factors that drive the cost of
the day-to-day activities.
5. A structural cost driver is a factor that drives
costs associated with the organizations
structure, such as scale and scope factors.
Examples include number of plants and
management style. Executional cost drivers
are factors that determine the cost of
activities related to a firms ability to
execute
successfully. Examples include degree of
employee participation and plant layout
efficiency.

6. Value-chain analysis involves identifying

those internal and external linkages that
result in a firm achieving either a cost
leadership or differentiation strategy.
Managing organizational and operational
cost drivers to create long-term cost
reductions is a key element in the analysis.
Value-chain analysis is a form of strategic
cost management. It shares the same goal
of creating a long-term competitive
advantage by using cost information.
7. An industrial value chain is the linked set of
value-creating activities from basic raw
materials to end-use customers. Knowing an
activitys relative position in the value chain
is vital for strategic analysis. For example,
knowing the relative economic position in
the industrial chain may reveal a need to
backward or forward integrate in the chain.
A total quality control strategy also reveals
the importance of external linkages.
Suppliers, for example, create parts that are
used in products downstream in the value
chain. Producing defect-free parts depends
strongly on the quality of parts provided by
suppliers.
8.

The three viewpoints of product life cycle

are the marketing viewpoint, the production
viewpoint, and the consumption viewpoint.
They differ by the nature of the stages and
the nature of the entitys life being defined.
The marketing viewpoint has a revenueoriented viewpoint, the production viewpoint
is expense oriented, and the consumption
viewpoint is customer value oriented.

9.

The four stages of the marketing life cycle

are introduction, growth, maturity, and
decline. The stages relate to the sales
function over the life of the product. The
introduction stage is slow growth, the growth
stage is rapid growth, the maturity stage is
growth but at a decreasing rate, and the
decline stage is characterized by decreasing
sales.

10.

Life-cycle costs are all costs associated with

the product for its entire life cycle. These
costs correspond to the costs of the
activities associated with the production life

cycle:
research
and
production, and logistics.
11.

development,

The four stages of the consumption life

cycle
are
purchasing,
operating,
maintaining, and disposal. Post-purchase
costs are those costs associated with
operating, maintaining, and disposing of a
product. Knowing these costs is important
because a producer can create a
competitive advantage by offering products
with lower post-purchase costs than
products offered by competitors.

12.

Agree. According to evidence, ninety

percent of a products costs are committed
during the development stage. Furthermore,
$1 spent during this stage on preproduction
activities can save $8$10 on production
and post-production activities. Clearly, the
time to manage activities is during the
development stage.

13.

Target costing is the setting of a cost goal

needed to capture a given market share and
earn a certain level of profits. Actions are
then taken to achieve this goal usually by
seeking ways to reduce costs to the point

where the plan becomes feasible (often by

seeking better product designs). This is
consistent with the cost reduction emphasis
found in life-cycle cost management.
14.

Cells act as a factory within a factory.

Each cell is dedicated to the production of a
single product or subassembly. Costs
associated with the cell belong to the cells
output. By decentralizing services and
redeploying equipment and employees to
the cell level, the quantity of directly
attributable costs increases dramatically.

15.

Backflush costing is a simplified approach

to accounting for manufacturing cost flows.
It uses trigger points to determine when
costs are assigned to inventory or
temporary
accounts. In the purest form, the only trigger
point is when the goods are sold. In this
variation, the manufacturing costs are
flushed out of the system by debiting Cost
of Goods Sold and crediting Accounts
Payable and Conversion Cost Control.
Other trigger points are possible but entail
more journal entry activity and involve
some inventory accounts.

EXERCISES
111
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.

Structural
Operational
Executional
Executional
Structural
Structural
Operational
Operational
Structural
Executional

k.
l.
m.
n.
o.
p.
q.
r.
s.
t.

Executional
Operational
Operational
Executional
Structural
Operational
Executional
Structural
Structural
Executional

112
Inspecting products, reworking products, and warranty work: These are all
quality-related activities. This suggests a strategic change in the organizational
activity, providing quality, (an executional activity). The associated executional
cost driver is quality approach. The cost of all three quality activities can be
reduced by changing the driver from acceptable quality level (AQL) to total
quality management (TQM). TQM emphasizes zero defects. As the organization
strives to achieve a zero defect stage, the demand for inspecting products,
reworking, and warranty work diminishes. As less activity demand occurs,
resource spending on these activities can be reduced. Changes in other
organizational activities may also bring about cost reductions. Both using
employees (executional activity) and grouping employees (structural activity)
can be beneficial. Multitask training and strong employee involvement can
produce reductions in the cost of the three quality-related activities. Teams,
known as quality control circles, can be beneficial.
Moving materials: The driver is distance moved. This suggests that some
attention needs to be given to the executional activity of providing plant layout.
The driver is plant layout efficiency. Changing to a cellular format could bring
about significant reductions in the cost of materials handling.

112

Concluded

Setting up equipment: Setup time is the driver. Designing processes, selecting

and using process technologies, and providing plant layout are all organizational
activities that can affect the setup activity. By choosing a cellular arrangement
where the cell is dedicated to a product, setup time can be reduced to zero. For
product families, a flexible manufacturing cell can also reduce the time to an
insignificant level. Finally, it may be possible to redesign the setup activity so
that it becomes much more efficient.
Purchasing parts: This activity is driven by the number of different parts. This is
a driver that also relates to complexity, a structural activity. This suggests that
reducing complexity will reduce the number of different parts needed and the
cost of the purchasing activity. Additionally, the cost of this activity can be
reduced by selecting the JIT process technology with its methods that reduce the
need for parts inventories.
Storing goods and materials: Reducing days in inventory reduces the cost of this
activity. This suggests the possibility of looking at the structural activity:
selecting and using process technologies. There are process technology choices
such as JIT and theory of constraints that produce very low levels of inventory.
Expediting orders: Reducing the number of late orders (increasing the number of
on-time deliveries) will reduce the cost of this activity. This suggests a need to
decrease production time, perhaps by looking at organizational activities such as
plant layout and providing capacity. Increasing plant layout efficiency can
decrease cycle time. Utilizing capacity efficiently can also decrease the number
of late orders.

113
1.

Supplier cost:
First, calculate the activity rates for assigning costs to suppliers:
Inspecting components: $1,200,000/1,000 = $1,200 per sampling hour
Expediting work: $960,000/100 = $9,600 per order
Reworking products: $6,844,500/1,500 = $4,563 per rework hour
Warranty work: $21,600,000/4,000 = $5,400 per warranty hour
Next, calculate the cost per component by supplier:
Supplier cost:
Grayson
Purchase cost:
$144 200,000......................
$129 800,000......................
Inspecting components:
$1,200 20............................
$1,200 980..........................
Expediting work:
$9,600 10............................
$9,600 90............................
Reworking products:
$4,563 90............................
$4,563 1,410.......................
Warranty work:
$5,400 200..........................
$5,400 3,800.......................
Total supplier cost....................
Units supplied............................
Unit cost................................

Lambert

$28,800,000
$103,200,000
24,000
1,176,000
96,000
864,000
410,670
6,433,830
1,080,000
$30,410,670
200,000
$
152.05*

20,520,000
$132,193,830

800,000
$
165.24*

*Rounded to the nearest cent.

The difference favors Grayson; furthermore, when the price concession is
considered ($135 $144), the cost of Grayson is $143.05, which is much less
than the Lambert component. Zavner should give serious consideration to
accepting the contractual offer made by Grayson. The savings are in the
millions.

113
2.

Concluded

To assign the lost sales cost, it would be helpful to know the number of
defective units using the Grayson component versus those using the Lambert
component. Warranty hours would act as a very good substitute driver. Using
this driver, the rate is $4,500,000/4,000 = $1,125 per warranty hour. The cost
assigned to each component would be:
Grayson
Lost sales:
$1,125 200............
$1,125 3,800.........

Lambert

$225,000
$4,275,000

This increases the cost of the Lambert component by $4,275,000/800,000 =

$5.34 *.
*Rounded.

114
1.

Sales revenue = $0.75 10,000,000 = $7,500,000 for each customer type.

(Note: The total number of parts is the average order size times the number
of sales orders.) Thus, the total customer-related activity costs are split
equally:
Cost allocation = 0.50 $5,900,000 = $2,950,000
The profitability of each category is calculated as follows:
Sales revenue.............................................................................
Less: Noncustomer-related cost ($0.40 10,000,000)...........
Less: Customer-related activity costs.....................................
Customer profitability..........................................................

$7,500,000
4,000,000
2,950,000
$ 550,000

This profitability measure is suspect because the customer-related costs are

assigned using revenues, a driver that is not causally related to the customerrelated activity costs. This approach may actually have one set of customers
subsidizing the other.

114
2.

Concluded

Activity-based customer costing:

First, calculate the activity rates for assigning costs to suppliers:
Processing sales orders: $1,100,000/11,000 = $100 per order
Scheduling production: $600,000/20,000 = $30 per scheduling hour
Setting up equipment: $1,800,000/15,000 = $120 per setup
Inspecting batches: $2,400,000/15,000 = $160 per inspection
Next, assign the costs to the customers (those who place frequent orders
and those who place infrequent orders):
Frequent
Processing sales orders:
$100 10,000...........................
$100 1,000.............................
Scheduling production:
$30 17,500.............................
$30 2,500...............................
Setting up equipment:
$120 12,500...........................
$120 2,500.............................
Inspecting batches:
$160 12,500...........................
$160 2,500.............................
Total customer cost.....................

Infrequent

$ 1,000,000
$ 100,000
525,000
75,000
1,500,000
300,000
2,000,000
$ 5,025,000

400,000
$ 875,000

Frequent
$ 7,500,000
4,000,000
5,025,000
$(1,525,000)

Infrequent
$7,500,000
4,000,000
875,000
$ 2,625,000

Profitability:
Sales revenue................................
Less: Other costs.........................
Less: Customer-related costs.....
Customer profitability.............

This outcome reveals that customers who place smaller, more frequent
orders are not profitable. Actions must be taken to make this segment
profitable, or this category of customers could be dropped. One possibility is
to impose a charge for orders below a certain size, thus reducing the
demands on the four customer-related activities with a subsequent reduction
in cost. Another possibility is to offer quantity discounts to encourage larger
orders.