STRATEGIC COST MANAGEMENT TOOLS

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STRATEGIC COST MANAGEMENT TOOLSDECISION MAKING

• Presentation
• By
• A.MADHAVAN
• MANAGEMENT CONSULTANT

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EFFECTIVE COMMUNICATION

• IF THE LANGUAGE IS NOT CORRECT WHAT IS SAID IS
  NOT WHAT IS MEANT.
• IF WHAT IS SAID IS NOT WHAT IS MEANT WHAT OUGHT
  TO BE DONE REMAINS IS UNDONE

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RELEVANCE OF STRATEGIC COST MANAGEMENT TOOL
TECHNIQUES

• The strategic cost management practices like
• - Activity based Costing
• - Target costing
• can be well appreciated within the Total Cost
  Management perspective which is part of the
  overall management process of an enterprise

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TOTAL COST MANAGEMENT

• TCM is the effective application of professional
  and technical expertise to plan and control
• - resources
• - costs
• - profitability and
• -risk
• It is a systematic approach to manage cost
  throughout the life cycle of any enterprise,
  program, facility, project, or service

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TOTAL COST MANAGEMENT

• This is accomplished through the application of
  cost engineering and cost management principles,
  proven methodologies and the latest technology in
  support of the management process
• TCM is part of the overall management process of
  an enterprise

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TOTAL COST MANAGEMENT

• TCM is a collection of technical cost management
  practices and an integrated process that any
  enterprise can use to manage its assets.
• Costs in TCM include any resource invested in the
  enterprises assets including time, monetary, and
  human resources.

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TOTAL COST MANAGEMENT

• Total refers to TCMs comprehensive approach to
  evaluating and controlling the total resource
  investment during the total life cycle of the
  enterprises assets
• The evaluation aspect of TCM is referred to as
  strategic asset management and
• The control aspect is referred to as project
  controls.

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MANAGEMENTACCOUNTING

• MA IS A SYSTEM TO THROW TIMELY RELEVANT
  INFORMATION FOR
• -CORPORATE PLANNING
• -DECISION MAKING
• -OPERATIONAL CONTROL

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DECISION MAKING

• DECISION MAKING IS THE PROCESS OF CHOOSING AMONG
  ALTERNATIVES AVAILABLE TO RESULT IN
• -THE JUDICIOUS UTILISATION OF INPUT REOURCES TO
  GET OPTIMUM RETURN ON INVESTMENT
• -ON GOING ECONOMIC VALUE ADDITION TO THE STAKE
  HOLDERS

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TYPES OF DECISIONS

• PRICING RELATED
• PRODUCT MIX RELATED
• INVESTMENT RELATED
• OPERATION RELATED

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LEVELS IN DECISION MAKING

• CORPORATE PLANNING
• BUSINESS UNIT
• OPERATING LEVEL

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CORPORATE LEVEL

• CORPORATE LEVEL
• -MARKETS
• -PRODUCTS
• -CUSTOMERS
• -JOINT VENTURES
• -MERGERS ACQUISITION
• -INVESTMENTS
• -INHOUSE VS OF LOADING

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BUSINESS UNIT

• BUSINESS UNIT
• -ASSET DEPLOYMENT
• -IN HOUSE VS OFF LOADING
• -QUALITY
• -PROCUREMENT
• -DELIVERY
• -FUNDING
• -MAN POWER DEPLOYMENT

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OPERATING LEVEL

• OPERATING LEVEL
• -PRODUCTIVITY RELATED
• -SUPPLY CHAIN RELATED
• -MAINTENANCE
• -QUALITY
• -DELIVERY
• -AFTER SALES SERVICE

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RELEVANCE OF MA IN DECISION MAKING

• MA HAS MEANING TO THE DECISION MAKER ONLY WHEN
  RELEVANT INFORMATION IS MADE AVAILABLE FOR THE
  RELEVANT PURPOSE
• IN A COMPETITIVE MARKET ENVIRONMENT THE TOP LINE
  IS DRIVEN BY MARKET FORCES .
• HOLDING THE BOTTOMLINE CALLS FOR JUDICIOUS
  DECISIONS IN DEPLOYING CORPORATE INPUTS.
• SCIENTIFIC TRANSPARENT COST INPUTS PLAY A
  VITAL ROLE IN TAKING DECISIONS

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RELEVANCE OF MA IN DECISION MAKING

• STRATEGIC COST MANAGEMENT TOOLS PLAY A VITAL ROLE
  IN PROVIDING TRUE PRODUCT/SERVICE COST TO BE
  APPLIED IN DECISION MAKING PROCESS
• DECISIONS TAKEN USING MEANINGFUL TRACEABLE COST
  DATA ENHANCE THE QUALITY OF DECISION MAKING
  

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STRATEGIC COST MANAGEMENT TOOLS

• ACTIVITY BASED COSTING
• TARGET COSTING
• LIFE CYCLE COSTING

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DECISION MAKING-PRICING

• PRICING FOR COST LEADER SHIP
• -ABC RELATES THE COST OF THOSE RELEVANT
  ACTIVITIEVS TO GAIN COST LEADERSHIP, TO THE
  PRICING OF THE PRODECT
• -TARGET COSTS THROW LIGHT ON AREAS TO TRIM COST
• -LCC INDICATES THE LIFE CYCLE COSTS AND REVENUE
  EARNINGS

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DECISION MAKING-PRICING

• PRICING FOR PRODUCT DIFFERENTIATION
• -ABC THROWS LIGHT ON THE ACTIVITIES NEEDED FOR
  DIFFERENTIATION
• -TC HELPS IN SCOUTING FOR NON VALUE ADDING
  ACTIVITIES IN THE VALUE CHAIN
• -LCC INDICATES THE LIFE CYCLE COSTS AND REVENUE
  EARNINGS

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DECISION MAKING-PRODUCT MIX

• ABC PROVIDES
• -PRODUCT COST
• -PRODUCT MARGINS
• TC IDENTIFIES SCOPE FOR PRICE CUT COST
  REDUCTION
• LCC GUIDES EXPECTED EVA COMPUTATION

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DECISION MAKING-INVESTMENT

• LCC- HELPS IN COLLECTING LIFE CYCLE COSTE AND
  REVENUES IN COMPUTING PROJECTED EVA
• TC - SUPPORTS PRICING DECISIONS IN THE DIFFERENT
  STAGES OF PRODUCT LIFE CYCLE
• ABC- CAN BE USED TO IDENTIFY NON VALUE ADDING
  ACTIVITIES AND THEIR COST THROUGH THE PRODUCT
  LIFE CYCLE

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ACTIVITY BASED MANAGEMENT INFORMATION SYSTEM

• Objective
• To put in place an activity driven cost
  information system which will provide relevant
  cost information in supporting the strategic as
  well as the operational activities of the
  management facilitate the process of reducing
  or controlling the cost of non value adding
  activities.

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ACTIVITY BASED MANAGEMENT INFORMATION SYSTEM

• Significance
• Activity based cost inputs are very relevant for
  a business unit operating in a competitive market
  catering to a wide range of customers and
  offering a variety of products. The reliability
  of the cost data is very high as it is the result
  of a rigourous exercise in establishing a cause
  and effect relationship in translating the cost
  of resources to end products through designated
  resource and activity drivers

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ACTIVITY BASED MANAGEMENT INFORMATION SYSTEM

• Advantages
• Strategic
• -product pricing
• -product and customer mix
• -investment decision on product and customer
  lines
• -segment wise EVA analysis
• -new product development

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ACTIVITY BASED MANAGEMENT INFORMATION SYSTEM

• Operational
• -Effective activity management
• -business process reengineering
• -total quality management
• -six sigma projects for cost reduction

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ACTIVITY BASED MANAGEMENT INFORMATION SYSTEM

• AN ABC MODEL IS AN ECONOMIC MAPOF THE
  ORGANISATIONS EXPENSES AND PROFITABILITY BASED
  ON ORGANISATIONAL ACTIVITIES
• THE ABC COST MODEL LEADS TO A RATIONAL
  DISTRIBUTION OF THE COST OF INPUT RESOURCES
  CONSUMED IN THE VARIOUS ACTIVITIES IN THE
  STRATEGIC MANAGEMENT CYCLE TO END PROUUCTS/
  SERVICES/CUSTOMERS USING A TWO STEP COST TRANSFER

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ABC APPROACH IN DESIGNING A COST SYSTEM

• DEVELOP THE ACTIVITY DICTIONARY
• DETERMINE HOW MUCH THE ORGANISATION IS SPENDING
  ON EACH OF ITS ACTIVITIES
• IDENTIFY THE ORGANISATIONS PRODUCTS SERVICES AND
  CUSTOMERS

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ABC APPROACH IN DESIGNING A COST SYSTEM

• COST OF INPUT RESOURCES ARE ALLOCATED TO THE
  ACTIVITIES USING APPROPRIATE RESOURCE DRIVERS
• COST BOOKED UNDER THE VARIOUS ACTIVITIES ARE
  APPORTIONED TO END PRODUCTS OR CUSTOMERS USING
  DESIGNATED ACTIVITY DRIVERS

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ABC APPROACH IN DESIGNING A COST SYSTEM

• TYPES OF ACTIVITY DRIVERS
• -TRANSACTION
• -DURATION
• -INTENSITY
• WILLY SUTTEN RULE

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ABMIS Steps in implementation

• Study of the existing systems processes
• -Understand the flow of work and the
  documentation support available
• -Assess the need for providing changes if
  required

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ABC APPROACH IN DESIGNING A COST SYSTEM

• Interaction with functional heads The focus
  during the interaction will be on
• -the way the activities are carried out
• -the level at which the activities are performed
• -the outputs generated in the various functional
  areas
• -The type of information processing
• -the linkages between various sub systems

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ABC APPROACH IN DESIGNING A COST SYSTEM

• Freezing the output requirements of the various
  functional areas. The objective will be to
• Ascertain how the reports planned will help in
  improving the productive efficiency in the
  respective areas
• Fix responsibility to provide relevant data and
  ensure its reliability

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ABC APPROACH IN DESIGNING A COST SYSTEM

• Freeze the bill of activities
• The list of activities against which
  collection of cost needs to be done will be
  finalised. In freezing the list the strategic as
  well as operational requirements will be borne in
  mind. At this stage the hierarchy of activities
  will also be frozen ie unit, batch, product and
  facility level

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ABC APPROACH IN DESIGNING A COST SYSTEM

• Finalise the list of resource and activity
  drivers.
• Resource drivers are used to transfer the
  expenses from the financial accounts to the
  activities that have consumed the resources
• Activity drivers are used to apportion the cost
  of activities to end products

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ABC APPROACH IN DESIGNING A COST SYSTEM

• Functional interface
• -Study the existing interface between the
  various functional sub systems.
• -Identify the necessary changes required to
  comply with the requirements for the
  implementation of ABMIS

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ABC APPROACH IN DESIGNING A COST SYSTEM

• ABMIS design
• Draw out a system flow chart to throw light on
  the
• -sub systems providing inputs
• -type of processing
• -outputs to be generated
• Get the customer approval

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ABC APPROACH IN DESIGNING A COST SYSTEM

• Develop outputs
• -For a chosen period of activity collect the
  cost and other performance parameters
• -Generate the planned outputs in Excel sheets
• -Evaluate the outputs and ensure the contents
  meet with requirements planned

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ABC APPROACH IN DESIGNING A COST SYSTEM

• Package design
• -Specify the hardware requirements
• -Specify the software requirements
• -Hand over the requirement specifications
• to the development team
• -Coordinate with the development team for
  the timely completion of the software package

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ABC APPROACH IN DESIGNING A COST SYSTEM

• Trial run
• -Run the software package
• -Examine the various outputs
• -Carry out corrections and modifications
• that may be required
• -Get the consent of the users as to the
• utility of the outputs generated

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ABC APPROACH IN DESIGNING A COST SYSTEM

• Commercial run
• -Generate the planned outputs on a commercial
  basis
• -Review the outputs with the functional
• heads using the outputs
• -Documentation
• -Handing over

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PROBLEMS FACED

• IDENTIFICATION OF NEED-DIFFICULTIES
• COMMITMENT BUT NO
• INVOLVEMENT
• INTER PERSONAL PROBLEMS
• INADEQUATE SYSTEM EFFORTS
• NO TO CHANGE MANAGEMENT

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OTHER RELATED ISSUES

• OPEN MIND / POSITIVE ATTITUDE
• MANAGING CHANGE
• COMMITMENT OF TOP MANAGEMENT
• INCENTIVES
• REDUCED MANPOWER
• COST CONSCIOUSNESS

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System Flow chart
Cost inputs
Turnover inputs
Production inputs
Power Fuel etc
Sales Other revenue
Raw matls, Compts,cons
FG wip
Resource
Sal wages
system
Inventory control
Payroll
Gen ledger
Invoice system
Prodn system
Pay records
Cash Bank jvs
Docum ents
Min Mrn
Invoice,dr,cr notes
Job cards wos
Wages, Assets Power tables
ABCIS File
Outputs Cost sheets, Profitability Statements, Bu
dget vs actls
MIS File
Activity cost File
Resource drivers table
Activity driver table
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TARGET COSTING

• TARGET COSTING IS A COST MANAGEMENT TOOLFOR
  REDUCING COST OVER THE ENTIRE LIFE CYCLE OF A
  PRODUCT.
• IT CAN BE USED TO REDUCE INVE STMENTS REQUIRED IN
  
• -DESIGN
• -PRODUCTION
• -DISTRIBUTION

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TARGET COSTING

• TARGET COSTING CAN HELP TRANLSATE CUSTOMER
  REQUIREMENTS INTO ACTUAL PRODUCT FEATURES AND CAN
  BE APPLIED TO BRING ABOUT CONTINUOUS IMPROVEMENT
  THROUGHOUT A PRODUCTS LIFE CYCLE

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TARGET COSTING- THE CONCEPT

• IT IS THE MAXIMUM MANUFACTURED COST FOR A GIVEN
  PRODUCT
• A COST THAT WILL ALLOW AN EXPECTED RETURN TO BE
  EARNED WITHIN A GIVEN MARKET NICHE AND ALSO ALLOW
  THE PRODUCT TO GAIN A MARKET SHARE

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TARGET COSTING- THE CONCEPT

• IT IS NOT A TOOL FOR DAY TO DAY COST CONTROL
  RATHER
• IT FOCUSES ON CONTROLLING DESIGN SPECIFICATIONS
  AND PRODUCTION TECHNIQUES ,THUS CONTRIBUTING TO
  THE GOAL OF DELIVERING A COMPETITIVE PRODUCT TO
  THE MARKET PLACE

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TARGET COSTING-BENEFIT TO COST PLANNING

• TARGET COSTING IS A METHOD USED IN PRODUCT DESIGN
  TO
• -ESTIMATE A TARGET COST FOR A NEW PRODUCT AND
  THEN
• -DESIGN THE PRODUCT TO MEET THE COST

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TARGET COSTING-BENEFIT TO COST PLANNING

• TARGET COSTING CAN YIELD THREE BENEFITS TO COST
  PLANNING PROCESS.THEY ARE
• -REDUCED PRODUCT COST
• -A FASTER PRODUCT DEVELOPMENT PROCESS
• -LESS RISKY NEW PRODUCT INTRODUCTIONS

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MEANS TO REALISE THE BENEFITS

• USING INFORMATION AND TARGET COST FACTORS DURING
  PRODUCT CONCEPTUALISTION DESIGN
• LINKING CUSTOMER REQUIREMENTS TO DESIGN COST
  PRODUCTION PERFORMANCE SPECIFICATIONS
• EMPHASIZING CONTINUOUS PRODUCT PROCESS
  IMPROVEMENTS

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TARGET COSTING-BASIC CONCEPT

• TARGET COSTING STARTS WITH THE IDENTIFICATION OF
  FOUR ITEMS
• -CUSTOMER REQUIREMENTS
• -FUTURE COST STRUCTURES
• -PRODUCT DESIGN
• -CONTINUOUS IMPROVEMENT

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TARGET COSTING-CUSTOMER REQUIREMENTS

• UNDERSTANDING CUSTOMER REQUIREMENTS BY GATHERING
  MARKET INFORMATION RELATING TO CUSTOMER
  EXPECTATIONS ABOUT
• -PRICE
• -QUALITY
• -DELIVERY
• -SERVICE
• -TECHNOLOGY
• PRODUCT PERFORMANCE

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TARGET COSTING-CUSTOMER REQUIREMENTS

• USE A STRUCTURED METHOD TO DOCUMENT
• -CUSTOMER REQUIREMENTS ON THE PRODUCT
• - CHARACTERISTIC FEATURES OF COMPETITORS
  PRODUCTS TO FACILITATE COMPARISONS
• This ensures that all relevant market factors
  product characteristics are considered

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TARGET COSTING-CUSTOMER REQUIREMENTS

• APPLY REVERSE ENGINEERING INVOLVING A CROSS
  FUNCTIONAL TEAM OF PEOPLE FROM PRODUCT AND
  PROCESS ENGINEERING, MANUFACTURING,INDUSTRIAL
  ENGINEERING,PROCUREMENT, ESTIMATING.
• REVERSE ENGINEERING CAN PROVIDE SOLID DATA ABOUT
  THE MATERIALS AND THE VALUE ADDING PROCESSES USED
  IN MANUFACTURING COMPONENTS.

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TARGET COSTING-CUSTOMER REQUIREMENTS

• NON VALUE ADDING COSTS SUCH AS INSPECTION ,
  MATEREIAL HANDLING , SETUP, MAINTENANCE,SUPERVISIO
  N,, ADMINISTRATIVE COSTS,ALL MUST BE ESTIMATED
  OR INFERED FROM PLANT TOURS, COMPANY PUBLICATIONS
  OR OTHER EXTERNAL DATA SOURCES eg
  CONSULTANTS,SUPPLIERS,CUSTOMERS,GOVT SURVEY,NEWS
  PAPER MAGACINES OR SUBSCRIBER DATA BASES.

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TARGET COSTING-FUTURE COST STRUCTURES

• A MANUFACTURER SHOULD THEREFORE DEVELOP ESTIMATES
  OF COMPETITORS COST STRUCTURES
• -BY ANALYSING THE INTERNAL COSTS OF EXISTING
  PRODUCTS,
• -CATEGORISE THEM BY COST DRIVER
• -DEVELOP COMPARATIVE RATIOS BY COST DRIVER TO
  TRANSLATE INTERNAL COSTS INTO ESTIMATED
  COMPETITOR COSTS

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TARGET COSTING-FUTURE COST STRUCTURES

• COST DRIVERS USED FOR COMPARISON RELATE TO
• THE ORGANISATION COSTS INCLUDE ALL LABOUR AND
  BENEFITS FOR HOURLY AND SLARIED WORKERS
• SOURCING OR LOGISTICS COST INCLUDE ALL RAW
  MATERIALS, SUPPLIER DEVELOPMENT COSTS AND
  TRANSPORTATION COSTS

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TARGET COSTING-FUTURE COST STRUCTURES

• MANUFACTURING
• PROCESSESMANUFACTURING PROCESS COSTS INCLUDE
  ALL NON LABOUR BURDEN COSTS (MAINTENANCE
  SUPPLIES, DEPRECIATION, PROCESS SCRAP AND
  UTILITIES)

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TARGET COSTING-FUTURE COST STRUCTURES

• DESIGN
• PRODUCT DESIGN COSTS INCLUDE DESIGN
  SCRAP,MATERIAL DESIGN PREMIUMS RELATED TO
  DIFFERENCE IN SPECIFICATIONS,THE NUMBER OF
  COMPONENTS,OR THE TYPE OF MATERIAL SELECTED

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TARGET COSTING-FUTURE COST STRUCTURES

• STEPS INVOLVED
• THE STRUCTURE ANALYSIS-TO GATHER COST INFORMATION
  ABOUT ONE OF THE MANUFACTURERS CURRENT PRODUCTS
  THAT HAS DESIGN AND PERFORMANCE CHARACTERISTICS
  SIMILAR TOTHOSE OF THE NEW PRODUCT UNDER
  DEVELOPMENT AND ALSO SIMILAR TO THOSE OF THE
  COMPETITORS

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TARGET COSTING-FUTURE COST STRUCTURES

• COMPETITOR COST MODELING THE MANUFACTURER SHOULD
  DEVELOP COST MODELS TO HELP ESTIMATE THE
  PRODUCTION COST OF COMPETITORS
  PRODUCTS.GENERALLY THE PROCESS INVOLVES
  DEVELOPING FACTORS THAT ADJUST CURRENT PRODUCT
  COSTS FOR COMPETITIVE DIFFERENCES IN

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TARGET COSTING-FUTURE COST STRUCTURES

• LABOUR RATES
• LABOUR HOURS
• PURCHASING
• PRODUCTION SCALE
• ECONOMIC DIFFERENCES AND
• COMPLEXITY

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TARGET COSTING-FUTURE COST STRUCTURES

• COMPETITOR INFORMATIONDEPENDING ON THE LEVEL OF
  ACCURACY REQUIRED FOR THE TARGET COST, COMPETITOR
  INFORMATION IS AVAILABLE FROM A VARIETY OF
  SOURCES.FOR DISCRETE PRODUCTS, THE BEST DATA
  SOURCES (IN TERMS OF COST AND EASE OF ACCESS) ARE
  PRODUCT TEAR-DOWNS AND EXTERNAL DATA SOURCES.
  THESE EXTERNAL DATA SOURCES INCLUDE

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TARGET COSTING-FUTURE COST STRUCTURES

• ANNUAL REPORTS
• MARKETING BROCHURES
• COMMERCIALLY AVAILABLE INFORMATION DATABASES
• GOVERNMENT REPORTS
• LOCAL NEWS SOURCES(NEWSPAPERS,NEWSMAGAZINES,
  INDUSTRY PUBLICATIONS)7

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TARGET COSTING-INTERNAL COST MODELS

• COST MODELS FOR INTERNAL COSTS RELATE TO SPECIFIC
  ELEMENTS IN THE STRUCTURE OF A PRODUCT.
• SIMILAR IN NATURE TO COMPETITOR COST MODELS,
  INTERNAL COST MODELS GENERALLY ARE DEVELOPED
  USING SPREADSHEET SOFTWARETO PROVIDE WHAT-IF
  COMPARISONS THAT IDENTIFY THE SENSITIVITY OF
  FINAL PRODUCT COSTS TO CERTAIN COST DRIVERS.

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TARGET COSTING-FUTURE COST STRUCTURES

• COST DRIVERS THAT HAVE IMPORTANT EFFECTS ON UNIT
  COST OBVIOUSLY PROVIDE THE GREATEST OPPORTUNITY
  FOR VALUE ANALYSIS AND COST REDUCTIONS

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TARGET COSTING-PRODUCT DESIGN

• CONSIDERING THE IMPACT OF VARIOUS COST DRIVERS
  DURING PRODUCT DESIGN CAN HELP A COMPANY TO
  CREATE A DIFFEREENT PERSPECTIVE.
• BY USING THE PRELIMINARY TARGET COST SET BY
  CONSIDERING THE BEST LEVELS OF COMPETITIVE
  PERFORMANCE ,ENGINEERS CAN DEVELOP A CONCEPTUAL
  DESIGN THAT FACTORS IN THE BEST DESIGNS FROM THE
  COMPANYS OWN EXISTING PRODUCTS AS WELL AS FROM
  COMPETITORS PRODUCTS

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TARGET COSTING-FUTURE COST STRUCTURES

• THE OTHER FEATURES MERIT ATTENTION INCLUDE THE
  FOLLOWING
• -SUPPLIER INVOLVEMENT
• -VALUE ENGINEERING
• -DEVELOPMENT CYCLE

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TARGET COSTING-CONTINUOUS IMPROVEMENT

• AS PART OF CONTINUOUS IMPROVEMENT EFFORTS, TARGET
  COSTING CONCEPTS CAN BE APPLIED TO EXISTING AS
  WELL AS NEW PRODUCTS.COST STRUCTURE ANALYSIS AND
  COST MODELS DEVELOPED FOR EXISTING PRODUCTS CAN
  SUPPORT CONTINUOUS IMPROVEMENT BY IDENTIFYING
  AND PRIORITISING CAUSES OF NON VALUE ADDING COSTS
  AND WASTE