STRATEGIC COST MANAGEMENT

Introduction
Imperative for business concerns engaged in Services or production of goods
to reduce costs and enhance quality of goods and services to provide better
INTRINSIC VALUE to the customer.
Entities providing better value & enhancing Customer satisfaction can hope
to increase market share

Introduction
Today emphasis of industry is on reduction in COSTS while improving
internal efficiencies & product quality. Strategies should be adopted to
indulge in Cost reduction and maintain/ increase level of excellence in
production and services.
Quality and Costs are not INVERSELY RELATED. Strategy is to
MINIMIZE COST for GIVEN QUALITY or OPTIMIZE QUALITY for
GIVEN COSTS.

Introduction

SCM has gained because of spiraling costs of manufacturing, marketing,

selling and other related functions. It is difficult for industry to survive and
thrive unless costs are CORRECTLY ACCOUNTED FOR, CONTROLLED
AND REDUCED so as to remain solvent.

Strategic Cost management consists of :-

Strategic Analysis of the business is to identify unprofitable products,
customers, marketing and distribution channels etc.
An evaluation of the business from a value chain perspective
It is optimisation of business processes and activities instead of functions
and evaluation of decisions
It is implementation of continuous cost improvement programmes instead of
comparisons with standard costing approaches
The use of performance measurement systems that are early indicators of
Corporate success in critical areas like time, quality and cost.

Improvements in activities that add value while value-destroying activities

are identified and eliminated
Elimination of constraints
Helps in implementation of Productivity Management programmes.
Value Engineering and Value Analysis are used as important tools to
restructure costs.
Helps in thorough understanding of Costs behavior and Cost drivers

STRATEGIC DECISION REGARDING MANAGEMENT OF COST

“HOW MUCH COST TO ALLOCATE TO EACH ACTIVITY”
NO FIRM DECISIONS GIVEN/TAKEN
A SUBJECTIVE EVALUATION OF BUSINESS CLIMATE AND
ALLOCATION OF COSTS ACCORDINGLY

WHY STRATEGIC COST MANAGEMENT ?

THE PREVAILING COST ACCOUNTING SYSTEM AND PRACTICES
DO NOT GIVE TIMELY AND ADEQUATE INSIGHT INTO THE
RAPIDLY EVOLVING BUSINESS CLIMATE FOR EFFECTIVE
DECISION MAKING.

CURRENT ACCOUNTING PRACTICES, PRIMARILY THE BALANCE

SHEET AND PROFIT AND LOSS STATEMENT TELL WHAT HAS
HAPPENED IN THE COMPANY IN THE PAST (AND EVEN THAT
CAN BE SUCCESSFULLY PADDED UP TO REFLECT THE DESIRED
RESULT) BUT GIVE NO CLUE ABOUT “WHY” IT HAPPENED. MORE
IMPORTANTLY, IT GIVES NO CLUE AS TO WHAT CAN BE
EXPECTED IN THE NEAR FUTURE.

FINAL COST OF THE PRODUCT INCLUDES RAW MATERIAL

COSTS, PRODUCTION COSTS, ADMIN OVERHEADS,
DEVELOPMENT COSTS, ADVERTISING /MARKETING COSTS,
COST OF CAPITAL, ETC. “HOW MUCH COST TO INCUR ON WHICH
HEAD” LARGELY DEPENDS ON THE NATURE OF PRODUCT,
MARKET CONDITIONS, COMPETITION, ETC.

EG – COST OF BOOST – HOW DO YOU ALLOCATE PROFITS TO

MAREKETING TEAM EFFORTS OR TO SACHIN TENDULKAR OR
RECEIVABLES OR PAYMENT CYCLE ENSURED BY SALES TEAM
ANY PRODUCT TO SURVIVE IN THE MARKET MUST HAVE ONE
OF THE FOLLOWING ATTRIBUTES :-

- COST (TOPAZ VS GILLETE BLADES)

- FUNCTIONALITY (GILLETE VS TOPAZ BLADE)
- QUALITY (ROLEX VS OTHER WATCH BRANDS)
- VALUE (PERCIEVED VALUE OF A LIFESTYLE
PRODUCT VS COMMODITY PRODUCT)

CLASSIFICATION OF COSTS
Costs may be classified as follows :-
(a) By Nature – Material. Labour, Expenses
(b) In relation to Cost Centre – Direct material, Direct labour, Indirect
material, Indirect labour
(c) By Function/Activities – Production, Admin, Selling, Distribution Cost
(d) By Time – Historical Cost, Pre-determined Cost, Standard Cost
(e) For Management Decision Making – Marginal Cost, Opportunity Cost,
Replacement Cost
(f) By Nature of Production Process – Batch Cost, Process Cost, Operating
Cost
(g) By Behaviour – Fixed, Variable and
Semi-Variable Cost

TARGET COSTING
It is a system where-in the cost of the final product is fixed before putting
the product on the drawing board. Thereafter, the raw material, production
processes, functionality (Features), quality, etc are selected to meet the cost
objective. This system is relevant for products made for extremely price
sensitive segment. It is also used as a market penetration strategy by the new
entrants in a matured product’s market.

As companies begin to realize that the majority of a product's costs are

committed based on decisions made during the development of a product,
the focus shifts to actions that can be taken during the product development
phase.
Until recently, engineers have focused on satisfying a customer's
requirements. Most development personnel have viewed a product's cost as a
dependent variable that is the result of the decisions made about a products
functions, features and performance capabilities. Because a product's costs
are often not assessed until later in the development cycle, it is common for
product costs to be higher than desired

TC IS BASED ON THREE PREMISES: -

Orienting products to customer affordability or market-driven pricing
Treating product cost as an independent variable during the definition of a
product's requirements
Proactively working to achieve target cost during product and process
development.

Target costing builds upon a design-to-cost (DTC) approach with the focus
on market-driven target prices as a basis for establishing target costs.
Following steps required to required to install a comprehensive target
costing approach within an organization :-
a. Re-orient culture and attitudes
b. Establish a market-driven target price
c. Establish a market-driven target price
d. Balance target cost with requirements
e. Establish a target costing process and a team-based organization
f. Brainstorm and analyze alternatives
g. Establish product cost models to support decision-making
h. Use tools to reduce costs
i. Reduce indirect cost application
j. Measure results and maintain management focus

PRODUCTIVITY CONCEPTS
Productivity is defined as ratio between “Output of Work” and “Input of
Work” used in process of creating wealth.

Productivity = Output
---------------
Input
Productivity is simply the ratio between amount produced & amount used in
course of production
These resources can be :-
(a) Land (Area)
(b) Material (Metric Ton)
(c) Plant & Machinery (Machine Hours)
(d) People (Man Hour)
(e) Capital (Rupees)

PRODUCTIVITY CONCEPTS
Productivity is different from Performance

Productivity = Output = Performance Achieved

Input Resources Consumed

Performance = Actual Work done

Ideal or Standard expected work

Partial Productivity = Ratio of output to one class

of input. At one time it considers only one input
and ignores all other inputs. It tells us utilization
of one resource.

Labour Productivity is measured using utilization of

Labour hours whereas Capital Productivity is measured in Rupees.

Total Productivity Factor = Ratio of output to two input factors – labour and
capital
Eg – When a firm installs a new machine, productivity of labour goes up
whereas capital productivity decreases
Eg – Production worth Rs 1000 was manufactured
And it consumed Rs 200 worth labour hours and
Rs 550 worth capital so
TPF = 1000 = 1 .33
200 + 550

Total Productivity Model developed in 1979 by David J Sumanth. This

considers 05 inputs like Human, Material, Capital, Energy and an
item called Other Expenses. It is applied in Service and Manufacturing
organisations.
Total Productivity = Total Tangible Output
Total Tangible Input

Hard and Soft Factors of an Organization. Hard Factors such as costs,

quality and availability of resources and raw materials are part of traditional
organisation’s evaluation and are reasonably quantifiable. Soft factors
include issues like political and social issues( anti-growth movements,
environmental restrictions, labour laws) and factors like Job satisfaction,
Incentives, Recognition, Job Morale, Safety etc

Hard and Soft Factors of an Organization. Hard Factors in Productivity are

concerned with physical comforts and other quantifiable elements desired by
employees like :-
(a) Plant conditions
(b) Ergonomics
(c) Transportation and Canteen Facilities
(d) elimination of hazard
Hard and Soft Factors of an Organization. Improving Soft Factors will lead
to higher morale and improved Productivity in a firm. A manager can do the
following :-
(a) involve workers in development of new methods of working
(b) Asking for suggestions from workers
(c) Understanding employees through Maslow’s Hierarchy of Needs

Total Quality Management (TQM) is defined as an integrated approach

in delighting the Customer (both internal and external) by meeting their
expectations on continuous basis, through everyone involved with the
organisation, working on continuous improvement alongwith proper
problem solving methodology.

The term Customer refers to all those whom we supply products, service
etc. Apart from ultimate users, retailers, stockists etc are external customers
wheras departments within the company are internal customers to each
other.
Eg – Production department is customer to Purchase department and
supplier to Sales and Dispatch department.
QUALITY IS DEFINED AS :-

1. Quality is fitness for use – Lays emphasis on Customer. Customers may

put product or service to multiple use which manufacturer may not have
intended.
2. Quality is establishing Standards and Specifications – Laying down
standards and specifications for products and services offered is very
important.
3. Quality is conformance to standards – Standards laid down have to be
conformed to

Customer satisfaction is unique. Conformance to 99.9% standards

maintained in the product may not rise customer satisfaction to 99.9%
proportionately. Only when Conformance reaches to 100%, customer
satisfaction jumps to 100%. Customer DELIGHT means gaining Customer
satisfaction to 100%.
TQM means “ Meeting the agreed requirements of the Customer at the
LOWEST COST, FIRST TIME AND EVERY TIME”. First time and every
time means without rework or rejection. TQM is not a ONE TIME
ACTIVITY but has to be pursued by all the employees of the organisation
continuously.

A customer needs three things – Quality, Price and Delivery (QCD). There
need not be a tradeoff between Quality and Cost. Costs go up when one
blindly raises the standards and specifications of the products without
analyzing whether it is adding proportional value to the product in eyes of
the Customer. Eg – Gold car.
QFD Matrix helps in designing the product that is oriented towards
customer requirements.

QUALITY FUNCTION DEPLOYMENT. It is a technique to assure that the

product is designed and manufactured to exceed the customer expectations.
It utilizes customer requirements, engineering capabilities and competitive
analysis from customer and technical view point. It integrates product
requirement with product development. It shows interrelation between
engineering requirements and market tests. Helps tell design team on all
issues it should focus on.
QUALITY FUNCTION DEPLOYMENT. All the information is
summarized in a matrix called “House of Quality”. It consists of :-
(a) WHAT – Specifies voice of customer in terms of requirements to be
satisfied. These are termed as Primary, Secondary and Tertiary and ranked
as per relative importance.
(b) HOW – Answers as to HOW customer requirements will be fulfilled.
(c) RELATIONSHIP MATRIX - Joins WHAT and HOW rooms. It
gives relationship between engineering design and voice of the customer

NINE S MODEL OF SCM – HOROSCOPE OF SUCCESS

Success has to be sustainable in any organisation. A comprehensive model
called as the Nine S model has variables which support each other when they
are strategically mixed. These nine variables give a complete view of long
and short term profit and growth management of an enterprise aiming to be
an all time great organization.

NINE S MODEL OF SCM – HOROSCOPE OF SUCCESS

1. Selectivity refers to the most appropriate choices based on firm’s Core
competence. SCM should concentrate on building most flexible core
competence. An enterprise's core competence should not restrict the scope
for more profitable diversification even if it demands a change in its very
nature. Many great firm’s have carried out this diversification keeping a
hawk’s eye on controlling cost.

2. Systems emphasizes the need for a supportive mechanism to make SCM a

success. It refers to technological, accounting, operational and information
systems of a firm. The systems should give the management a true picture of
on goings in the enterprise.

3. SCM refers to micro-level strategy analysis of various cost structures and

cost implications. This area of SCM broadly attempts to indicate the cost
molecules that are of strategic importance. A few theories which are in
vogue are – ABC, Life Cycle Costing, Cost Benefit Analysis etc.

4. Sanctity refers to the “Ethical Economics” of business. An ethical

approach to business offers a long term sustainable brand equity to the
enterprise which ultimately reduces the cost at every stage of product’s life-
cycle. The “Cost of Ethics” may be high initially but would definitely lead to
rise in revenues after break even is achieved.

5. Sensitivity is about Strategic Information Management. A Manager under

SFM must know the strategic use of every piece of information. The highest
degree of sensitivity comes from the most efficient use of strategically
important information. It also depends upon ability to transform “X”
information into “Y” in the minimum possible amount of cost and time.

6. Sustainability of performance is a matter of long term strategic planning.

An enterprise achieving a high ROI during boom times will have to prepare
for “Break Even ROI” in times of recession. The low cost ROI will have to
be supported from low cost investment in depressed markets. It also means
‘managing new competitors’ with extra cost on sustenance.

7. Superiority refers to the position of “Leadership” that a firm must attain in

the market. Sustaining leadership is an expensive affair. A strategic plan has
to offer the financial difference between ‘the cost of leadership and ‘cost of
following others’.
8. Structural Flexibility of an enterprise is the sum total of qualitative and
quantitative adaptability and adjustability. Sunk costs, Committed costs,
Capacity Costs etc could be huge if structural flexibility is absent. All great
firms have shown a tremendous amount of flexibility when facing tough
market conditions. Structural Flexibility gives the required strength to an
enterprise the required strength to reincarnate its products and reinforce its
human resources.
9. Soul Searching is based on continuous bench marking and requires a
tremendous amount of financial alertness, innovation and total exposure to
new variables and parameters. One can’t pursue strategies based on one’s
strength only because one can’t risk under-evaluating one’s competitors. A
firm therefore requires an automatic, self-regulated and self-motivated
system of developing new operational and financial benchmarks. The
exercises like Strategy Audit, Policy Audit and Management Audit could be
very useful for appraising the validity of those benchmarks.

The above Nine tools of SCM ultimately aim for “Wealth Maximization
through the Accelerating Effect” and increasing wealth for every stakeholder
in the organisation. Wealth maximization will be achieved through different
combinations of “Value Chain Contributors”. They may be :-
(a) Leveraging on Brand, Value and People
(b) Borrowing Capacity
(c) Technology Upgradation
(d) Past track Record

The above Nine tools of SCM ultimately aim for “Wealth Maximization
through the Accelerating Effect” and increasing wealth for every stakeholder
in the organisation. Wealth maximization will be achieved through different
combinations of “Value Chain Contributors”. They may be :-
(a) Leveraging on Brand, Value and People
(b) Borrowing Capacity
(c) Technology Upgradation
(d) Past track Record

VALUE CHAIN ANALYSIS

The Value Chain of an enterprise’s business presents an integrated picture of
various stages of ‘Value Contribution’ made by its various contributors. It is
the manifestation of the business process with an emphasis on the “Value
Drivers” that exist both inside and outside the enterprise. It is a technique
that allows us to increase the value of a product or service systematically,
eliminating all the functions that do not add any value or benefit to the
product.
The investment made by a firm in its value chain would start from the time it
procures material from other sources.
VALUE CHAIN ANALYSIS
Value is a function of “Desired Performance” and “Cost”

Value = Desired Performance (P)

Overall Costs (C)

Desired performance is expressed by the term Worth which is defined as the

lowest cost to achieve the Use function and Aesthetic function.
Value Analysis is step by step approach to identify the functions of a
product, process, system or service; to establish a monetary value for that
function and then provide the desired function at an overall minimum cost
without affecting any of the existing parameters like Quality,
Maintainability, Productivity, Safety etc

Value Engineering is where the value of all components used in the

construction of a product from design to final delivery stage are completely
analyzed and pursued.

Value of a function can be increased by following :

Decrease cost while ensuring same level of performance eg – Casettes and
CDs
V=P
C
Enhance the performance at same cost eg – Times of India introduced
Bombay Times at same price
V=P
C

Value of a function can be increased by following :

(iii) Decrease cost and increase performance eg – Intel’s Pentium
chips/Laptops
V=P
C
(iv) Increase both the performance and the cost ensuring performance
increases more than cost eg –Pepsi increased size by 20% & cost by 10%
V=P
C

STRATEGIC BUSINESS UNIT (SBU’s) (VIMP)

In multi-product or multi-location enterprise, cost allocation to various
value-chains cannot be solved by traditional costing approach. The weak
products get protected by the performance of strong products because clear
cost and revenue performance cannot be provided by traditional accounting
approach. Hence, the concept of SBUs. By doing so cost of the support
functions or facilities like accounting, purchase, maintenance and systems
can be separated product or location wise. However, certain common
facilities or processes may not be separated for strategic reasons. Creating
SBUs may be a difficult task and can result in sub-optimal efficiencies.

Traditional accounting does not provide any mechanism for Responsibility

Accounting productwise. Many times undue potion of Headquarters cost are
appropriated to product cost. Also HQs may be overstaffed and may pass
cost of its inefficiency to product division. There is also problem of common
cost or interest cost being allocated to products division. Hence SBUs are
required.

SBUs can also be arranged locationwise if such an arrangement offers

strategic, systematic and accounting advantages. There may be a possibility
that production facility for products A, B and C may not be available at
single location or would not be economically feasible. In such scenario,
“Common Production Centre” may be independent SBU while locational
SBUs mainly carry out the marketing activity. The smooth functioning of
the SBUs also depend on certain notional adjustments like Inter-SBU
Transfer Price, Allocation of cost of non-separable facility etc.
Another possibility for a different “SBU Structure” is based on Value Chain
and on Inter-product dependence. The most important phases or portion of a
value chain would be defined as SBU’s so that concentration of resources,
control, time and efforts is attached to these important portions of value
chain. The nature of the value chain also place an emphasis on the core
competence of an enterprise and supports rational product costing and cost
control. This VC approach also helps backward/forward integration. It helps
the enterprise to stretch its ability to network with outside forces and keep its
competitive advantage intact.

RESPONSIBILITY ACCOUNTING
Creating a SBU structure is not enough until and unless one identifies its
responsibilities clearly and develops realistic parameters to monitor its
performance. Within each SBU each activity or department could be a
“Responsibility Centre”. Responsibilities that are of a importance would
make these independent centres pivotal for planning, empowerment,
accounting and appraisal. There are three types of these responsibility
centres, based on degree of responsibility and authority handled by them :-
A Cost centre is the most restricted version of a Responsibility centre. A
factory or production centre is a classic case of a Cost centre since only costs
are incurred at this centre to produce output or for an activity. This centre
doesnot sell the output & therefore doesnot make profit. The output travels
from Factory to marketing department at “Factory cost”. The marketing
people decide the sale price after adding the sales overheads, corporate &
administrative overheads. So a Cost centre only incurs costs and has limited
powers. Executives working at Cost centres have following problems :-

Feel powerless as they do not make profits directly

Perform thankless jobs without recognition.
Enough parameters do not exist to assess the cost performance of a cost
centre.
Extra performance of a cost centre is not recognized.
Other centres keep pressurizing cost centre for unrealistic cost reductions.
Executives do not enjoy pay & perks like marketing or Headquarters Staff.

The Cost centre can be made into Profit centre by making it more
accountable and giving recognition to Executives of the centre. The output
of Cost centre should be transferred as “Cost + Profit” to the Marketing
department. Eg – Maintenance department can sell its services to other
department at “Cost + Profit” to other departments. This price is called as
Transfer Pricing. The profit charged may be collected by it or transferred to
its account by Headquarters. Further, the maintenance department can sell its
services/idle capacity to outsiders for profit.

The key question is as to who decides the “Transfer Price. The user
department may want outside agency to do its maintenance or the
maintenance department may not be satisfies with the Transfer price decided
by Headquarters. These questions are required to be answered Strategically
and Quantitatively. This is known as Responsibility Accounting.
The ultimate stage of total empowerment given to a Responsibility centre is
with the birth of “Investment Centre”. A profit centre may be given greater
authority to decide on size and scope of its investments.

It should be allowed to decide about routine and special investments for its
expansion, diversification and improvement in systems.

The gradual increase in the authority and responsibility of a responsibility

Centre would depend fundamentally on the degree of control of operations
desired by the firm, nature of business and accuracy of product-costing
desired.

COST BENEFIT ANALYSIS (CBA)

A good Strategist is recognized by his ability to do Cost Benefit Analysis
(CBA) quickly and correctly for every decision he takes. The CBA could be
fully quantitative or qualitative or a mixture of both. The CBA becomes
complex when costs and benefits are intangible or notional or long term.
Many a times costs and benefits may not be known till execution phase of a
project.
For eg - A socially relevant project which involve a lot of public
intervention. However, the public may not be very professional in
converting their perceptions about project into quantifiable expressions. It is
the job of the strategic analyst to convert the public’s qualitative remarks
into quantitative measures and carryout CBA. Indices, scales and other
statistical techniques are employed for such translation. CBA demands
weightages be attached to absolute figures of costs and benefits so gathered
based on the changing significance of the figures in different circumstances,
regions and organisations.

Incremental Cost Benefit Analysis are required for quick conclusions on

ongoing business decisions where one cannot waste time because of nature
of business.
Eg – Extra credit for a week’s time to a retailer may lead to much higher
sales and subsequent profits. In such case the incremental amount of gross
profit will have to be compared to incremental or extra cost of credit
incurred by the firm. As long as the incremental cost of credit is less than
incremental cost of sales the firm can allow extra period for credit.

Sustainable Net Incremental Benefit – It is very often a key Strategic

decision. One may agree to incur a loss for initial periods of time with an
ultimate eye on large sustainable long term profit.
Eg –Power projects, road projects, Communication projects are some of
examples where a firm applies concept of Sustainable Net Incremental
Benefit.
COST BENEFIT ANALYSIS (CBA)
Sustainable Net Incremental Benefit –

Eg – A long term project will have to be assessed with an Average CBA for
the project’s life cycle.

Pre-operative CBA (negative incremental , Break-even point CBA, CBA at

market leadership, CBA at times of boom and recession will all have to be
considered separately and also collectively for an integrated appraisal of a
project. CBA of a single project or activity may indicate negative results but
its strategic importance to the organisation may offset these negative results.
Hence CBA in totality or CBA with strategic perspective is of significance.

Quantitative and Qualitative factors in CBA. It is difficult to quantify all

decisions in monetary terms. Many a times decision is not dictated by
Quantitative but Qualitative factors.
For eg – Decision to purchase from outside supplier can result in closure of
company’s facilities for manufacturing of a component. This may lead to
redundancies and decline morale of employees resulting in low output. Also
company may become dependent on outside employer who may not always
supply on time. This may lead to the company’s reputation to suffer and may
lead to loss of customer goodwill and decline in future sales.
Quantitative and Qualitative factors in CBA.
The following non-quantitative factors are to be considered while taking a
decision :-
(a) Make/Buy decision
- Quality reliability
- Adherence to delivery schedule
- Continuous source supply
- Availability of space if company decided to start operations in
future.
(b) Special order Risk of lost orders if customers or wholesalers learn of
special selling price.
(c) Overtime vs additional shift
- Quality of work on second shift
- Training problems of new workers if they are assigned the second
shift
- Balancing trained and new workers in second shift
(d) Expand or Contract
- Quality should not go down
- Workers with required level of experience may not be available

(e) Continued operation vs Temporary Shut down

- Loss of trained personnel
- Regular customers may be lost
- Resumption of Continuous source supply
- Other alternative to increase off-season business

LIFE CYCLE COSTING

Concept of Life Cycle Costing (LCC) is notional if considered for a short
duration of time. LCC is a strategic approach for tracking data regarding the
performance of a product or an enterprise. LCC is commonly used for the
“Life Cycle Strategic formulations” of a product.
The active life cycle of a product starts from the stage of its commercial
launch in the market. It is very significant to watch the performance of the
product at its entry level, its take-off point, its stage of consolidation, market
leadership, its revival and finally death. At every stage, there is a significant
cost incurred.
LIFE CYCLE COSTING
The life cycle of a prime product very often mirrors the life cycle of a firm.
The cost incurred at various stages of the life cycle are as follows :-
A new product would require great efforts to be made on the “Concept Sale”
in order to create a market for the product. Hence, cost of launching the
product would be huge and be treated as “Deferred Revenue Cost” to be
written of over a period of time. The cost of launching a product and concept
sale would be much less if the enterprise already enjoys a very high brand
equity in the market. The existence of launching errors demands early
corrections in a company’s product design, promotional approach,
distribution network etc. The cost of such early corrections should be
minimized with a carefully conducted market survey.

A smooth launch gives the product reasonable market share. However, it

also requires costs to be incurred on establishment of supply-demand links,
creation of automated system to support the product, restricting threats faced
from other products, developing crisis management solutions etc.
Once launched the product should attempt to consolidate its market share.
The market share would depend on how much the product has been
promoted an how many supply-demand chains are being managed.
Consolidation also requires using certain strategies to combat the restrictive
tactics of the competitors. The cost of consolidation could be huge if
appropriate strategic plans are not designed.

Such a plan is supposed to establish a “Sustained Competitive Advantage”

over one’s competitors so that the enterprise can think about future growth.
Cost of consolidation may include cost incurred in attracting new dealers,
vendors and partners.
Natural extension of consolidation is leadership. Leadership is expensive
though inevitable. Cost of leadership may include expenses on :-
(a) Initiatives for making innovations in the market, systems, products and
human resources.
(b) Market penetration and new market development
(c) Aggressive promotion of an organisation’s brands, culture, business
systems and styles.
(d) Active support to vendors, distributors, contractors and other market
makers.
(e) Business lobbying and using one’s influence in the government.
Leadership ultimately supports all attempts made for sustaining one’s
market advantage for stretching the core competence of an organisation. It
also arranges the inexpensive launch of new products and their entry into
new markets. It reduces every operational cost in the long run as every
stakeholder would like to join a leader, even if it means compromising his
own demands. Eg- Bharati & TATA Nano, Reliance Industries

New competitors enter market with lot of operational and cost flexibility and
threaten the leader’s position in their respective markets. Eg – Telecom wars
happening in India. The leader therefore has to continuously worry about his
“Sustained Competitive Advantage”. His SCA gets continuously replaced
with newer and stronger competencies of other newer market players. Eg –
Microsoft. Hence the only way to retain leadership is to retain one’s market
share and develop newer markets and competencies.
Eg –Bharati and Nestle (Maggi noodles)

ACTIVITY BASED COSTING

The traditional cost accounting approach allocates the common overheads of
an enterprise to various products or activities or divisions based on logical
but inaccurate assumptions. An enterprise always tries to convert the
common or unidentifiable overheads into ‘product’ or ‘activity specific’ or
‘identifiable overheads’. This approach has limited scope since certain
common overheads cannot be analyzed further or separated due to lack of
proper information. This may lead to a strong product subsidizing a weak
product. Faulty allocation makes ‘product costing’ too imperfect, leading to
irrational product pricing. The traditional allocation of common costs also
makes the divisions and territories unhappy as a major portion of such cost
is the cost incurred at the head office.
Every cost-competitive firm must know the minutest details of operational
costing so that every change in the business process can be expected to bring
in a cost advantage. Under Activity Based Costing (ABC), costs are
minutely identified by each activity and sub-activity. These activities are
carefully related to the end products so that ultimately activity costs are
identified by the products. ABC is an engineer’s approach to identify costs
more closely and accurately. The product costing is fairly accurate if ABC is
applied. ABC is an attempt to convert common costs into identifiable cost.

A numerical example is shown separately.

Thus we see that the overall use of ABC would depend on the engineering
details of activities carried out and the ‘per activity capacity’ enjoyed by
each product. Thus we have to upgrade our ‘cost information systems’ for
accurately capturing activity wise data.
Objection to ABC :-
(a) ABC could be very expensive, as it requires lot of initial technical
analysis and incurs recurring costs on the use of sophisticated information
systems
(b) ABC depend on transparency of cost data. It may create false results if
each activity is not mapped properly.
(c) It may not be always feasible to decide on the depth of the activity
analysis and therefore too much of an activity based approach to costing
may prove to be complex and unmanageable.
(d) Labour intensive operations, multipurpose systems and plants and multi-
skilled employees used for different activities simultaneously do not offer
adequate scope for identifying costs activity wise.

OBJECTIVE BASED COSTING

Objective Based Costing (OBC) is an entrepreneurial approach to costing.
ABC forms vital input for OBC. OBC is s strategic approach to costing and
not an accountants approach.
Eg – In order to restrict entry of a new competitor or to increase one’s
market share, one has to offer discounts to customers. Such discount has to
be adjusted in the cost of product or loaded to some other product which has
ability to absorb this cost. For OBC it is best that accountants and managers
act as entrepreneurs who can look at every aspect of financial management
strategically.

COST ANALYSIS AND REDUCTION

Every dollar saved not only adds to an enterprise’s profit but also gives one
a competitive edge over one’s rivals. However, in a booming economy or
when the firm is doing well emphasis on cost control or cost reduction is
lost. Strategic reasons that a firm should continuously focus on cost control
are:-
(a) Such efforts make one think innovatively about business process
reengineering and value analysis
(b) Product innovation carried out for the customer’s ultimate benefit are
appreciated by him; more so when they come at no extra cost.
Strategic reasons that a firm should continuously focus on cost control are:-
(c) Cost reduction efforts keep the firm and its employees always on guard
against inefficiencies and complacency. These provoke the employees and
the management to think differently and strategically. It prepares a firm well
to face the recessionary environment and extended durations of cyclical
downturns.
Assessment of Cost.
Cost is associated with the product normally only for pricing purposes as the
product alone reaches the customer and brings in the profits. One should
never forget that :-
(a) The customers look for quality of delivery and after sales services.
(b) Costs are to be identified with processes, activities, time units, people,
variuos value driven inputs, markets, brands, types of customers etc.

Strategic Cost Analysis.

Modern or strategic cost analysis doesnot and should not advocate a single
approach to cost analysis, as costs and profits are to be viewed as per
changing circumstances and strategies. It is therefore important that an
enterprise must use all flexible techniques to ascertain, absorb, analyse and
allocate costs as per objectives. SCA offers an angular view of the cost
performance and not just the product alone.
COST ANALYSIS AND REDUCTION
Strategic Cost Analysis.

Strategic Cost Analysis. SCA contains the following steps :- (VIMP)

(a) Identify the firm’s Value Chain. The first step is to identify the firm’s
value chain by breaking down a firm’s strategically relevant activities in
order to understand the behaviour of cost. Value chain of a firm comprises
of primary activities like Raw material, Operations, finished goods
Marketing and sales and Services. These activities are supported by
“Support activities” like firm’s infrastructure, HRM, Technology
Development etc. This is known as Porter’s Value Chain Analysis.

(b) Assigning Costs and Assets to Value Chain. Each activity in the value
chain has operating costs and assets. The amount of assets assigned to an
activity, alongwith the efficiency of their utilisation influence that activities
costs. Assigning assets and operating costs to the activities constituting the
value chain involves similar problems to those in any allocation exercise.

(c) Diagnosis of cost Drivers of each value Activity. Any enterprise’s cost
position relative to its competitors is derived from the cost behaviour
patterns associated with the activities constituting its value chain. These cost
behaviour patterns in turn depend upon a number of cost drivers. Some cost
driver’s are within the firm's control, but some are not. A particular firm’s
position on any value activity will depend on whichever cost drivers are at
play, but the impact of different cost drivers will vary among firms – even
within the same industry.

(d) Identification of Competitors Value Chains. The next step is to do the

above analysis for one’s competitors. A given enterprise will have a cost
advantage of its cumulative costs of carrying out all activities within the
value chain are less than those of its competitors. Therefore identification of
competitors value chain is very important at all stages to judge ones own
competitiveness.

(d) Development of Strategy. The next step in the SCA is to develop a

strategy to achieve lower relative cost position through controlling cost
drivers or reconfiguring the value chain and ensuring that cost reduction
efforts do not erode differentiation.

(e) Testing Cost Reduction strategy for Sustainability. The cost advantage
of an enterprise will be more of its competitor when the cumulative costs of
carrying out all the activities are less than that of competitor.
COST ANALYSIS AND REDUCTION
Strategic Cost Analysis. SCA contains the following steps :-

(F) Testing Cost Reduction strategy for Sustainability. This advantage will
only have strategic significance if it can be sustained. This requires that
competitors are unable to readily imitate it. The cost advantage (which also
means cost leadership) needs to be maintained and this requires determined
efforts on a day to day basis in improving cost effectiveness.

Strategic Cost Analysis. SCA model is as follows :-

Costing of products, processes and allied activities becomes difficult due

to :-
(a) Multi-purpose production facilities
(b) Multiple-skills of employees
(c) Market variables affecting cost references
(d) Cross functional relationship between servicing departments
(e) Input-Output relationship between two end products or semi-
finished products
(f) Absence of sophisticated data capturing devices
(g) Notional costs of internal services not accounted for correctly

Despite these practical difficulties, SCA has to be carried out at

four different decisions and control levels:-

(a) Costing for formal reporting and tax computation

(b) Costing for product pricing based on market forces
(c) Costing for internal cost control and continuous benchmarking
 (d) Costing of all value driven inputs for the end calculations of
owners targets.

ZERO BASED BUDGETING

Strategic Cost Analysis.
Despite these practical difficulties, SCA has to be carried out at four
different decisions and control levels:-

(a) Costing for formal reporting and tax computation

(b) Costing for product pricing based on market forces
(c) Costing for internal cost control and continuous benchmarking
(d) Costing of all value driven inputs for the end calculations of
owners targets.

BALANCED SCORECARD
Balanced Scorecard gives more information than routine accounting
ledgers. It gives the status of various vital parameters like manpower
(attrition rate, comparative worth of various key employees), product life
cycle, status of competition, technological movement, opportunities and
risks, etc.