About This Chapter
In this final chapter, we consider a number of techniques that have emerged over recent years. This moves us from the concentration on analysis to the broader view of management, although it would be difficult to draw the dividing line.
As we moved through the 20th century, the costing of manufacturing processes and the tangible assets associated with them shifted to knowledge-based assets and strategies to manage those intangible assets. Managerial thinking changed, and the practice of imposing systems and decisions from the top down without question developed into more participative styles.
These developments, and other changes, led to the rethinking of strategic formulation and the cost information required. The new business environment of organizational empowerment, competitive capabilities, and core competencies required the collection and reporting of cost and other data that are future oriented and that recognize the external environment and the importance of nonfinancial as well as financial inputs. As well as updating this chapter to reflect these developments, we have included Big data and algorithms in our discussions. Although not a cost analysis technique, Big data is now increasing its importance in corporate strategy.
In the following sections, we review the main strategic cost management and their importance to you as a manager. Remember that the methods and techniques discussed in this and previous chapters are not substitutes for good management. They are there to inform, illuminate, and support management planning, control, and decision making.
Strategic cost management is the application of cost management techniques to simultaneously improve the strategic position of a firm and reduce costs.1
Both academic thinking and practitioners’ experiences have developed and modified the methods and techniques we discuss in this chapter. One major line of thinking has been the work of Prahalad and Hamel2 and we commence the chapter with a brief review of their contribution. This is followed by an examination of two techniques that most managers will have heard of: value chain analysis and the balanced scorecard. This is followed by considering cost reduction, and, in that section, we provide some very practical advice for the reduction of overhead costs. The latter half of the chapter examines different approaches to performance evaluation and improvement processes.
None of the topics discussed in this chapter are replacements or alternatives to the various methods and techniques we explained in earlier chapters. As you read through our explanations, you will appreciate that all the topics require reliable cost data for strategic purposes. Without this information, you could not implement them successfully in any organization.
Core Competencies
If we look for a conceptual framework that underpins many of the techniques explained in this chapter, then it is to be found in the works of Prahalad and Hamel2 on core competencies. They contended that, where companies have areas of significant competitive advantage, these can be used as the structure of the organization’s overall strategy. If it is difficult for competitors to replicate these core competencies, they can be exploited to increase customer-perceived value.
Core competencies are the skills and technologies that have been developed throughout an organization. It is the aggregate of the learning processes by individuals and groups across the learning organization. In the next section where we consider the balanced scorecard, we can see how it embraces the acquisition, cultivation, and exploitation of core competencies in which an organization excels and gains a competitive advantage.
Hamel and Prahalad coined the term “strategic architecture” to explain the process by which an organization manages its core competencies to enjoy future competitive success. Strategic architecture can be considered as a roadmap or a plan that charts the way to the organization’s future success. The plan is not concerned with improvements in present performance but with the nurturing of core competencies to provide strengths for enjoying future successes in emerging opportunities. It sets out not only where the organization is going but also the steps it must take to get there.
Although conceptually appealing, there are difficulties in how strategic architecture is to be applied at the specific organizational level, a criticism that the authors acknowledged. The core competencies must be capable of being recognized and articulated in such a way that they can be managed. Their presence needs to be communicated throughout the organization to contribute toward strategy development.
Strategic Positioning
Research conducted by Al-Hazmi3 led him to conclude that: “market instability stimulates strategic movement and cost information is being used in management thinking to support strategic development in meeting competitive pressures and in restructuring and reconfiguration of business strategy.” In this section, we discuss two techniques that adopt a holistic view of the organization and look toward the future but with the benefit of knowledge from the past.
Value Chain Analysis
An organization may be very proficient at developing strategy, but it must also be able to implement it at every stage in the organization’s operations. Value chain analysis is a technique that enables an organization to focus on each separate operation and to ensure that it adds value to the product or service. The value chain was developed by Porter,4 but there have been additions, modifications, and other claimed improvements by consultants and academics over the years.
The foundation of the technique is the identification of the process of value added that is performed in the industry of which the organization is a part. For example, an organization may have a value chain that looks like the diagram shown in Table 6.1.
This is only a simple layout, and in practice the value chain analysis would require much more detail, depending on the industry and the nature of the organization. The emphasis of the analysis is the examination of the entire chain of operations and the contribution made by the particular company.
When the diagram is complete, an analysis can be conducted of the entire value chain to determine the organization’s current and potential competitive advantages. In conducting this analysis, the organization will be weighing up its core competencies and determining whether its strategic competitive advantage is cost leadership or differentiation.
The analysis will also seek to identify opportunities for adding value. This may be the introduction of computerized procedures, expanded services to customers, or use of just-in-time delivery of raw materials. The scrutiny of the value chain should also highlight potential areas of cost reduction, which may lead to decisions about outsourcing certain activities where the organization is not competitive.
Table 6.1 Value chain
An organization should be able to calculate the makeup of costs all the way from the raw materials phase to the end price paid by the ultimate customer on a value chain. Strategic cost analysis can be restricted not only to one’s own internal costs but also to suppliers, distribution channels, and competitors. By including the impact of costs both inside and outside the company, the value chain helps the managers understand the total sum of the shifting costs throughout the chain. Strategies are then developed to address the ramifications of the costs.
The value chain is revealing but not simple to construct. Despite the complications of the task, the value chain gives benefits by exposing the cost competitiveness of your position and the potential strategic alternatives.
The Balanced Scorecard
The balanced scorecard provides a framework for managers to use by linking different performance measurements together. This tool assists managers to clarify their vision for the organization and translate their vision into measurable actions that employees can understand and enables managers to balance the concerns of various stakeholders. “The indicators should measure performance against the critical success factors of the business, and the ‘balance’ is the balancing tension between the traditional finan-cial and nonfinancial operational, leading and lagging, and action-oriented and monitoring measures.”5
The balance scorecard allows managers to focus on both financial and nonfinancial measures to assess performance. It translates an organization’s vision, mission, and strategy into an integrated set of performance measures that can be evaluated in the form of a report card: the scorecard.
The concept is based on the proposition that there are four critical success factors (CSFs) or perspectives that encapsulate the strategy of the organization. For each of these factors, the organization needs to develop three to five measures.
•Financial perspective. This uses traditional financial measures such as return on investment to assess whether the organization is meeting its financial objectives.
•Customer perspective. By using measures such as growth in market share, number of new customers, and customer satisfaction surveys, the organization seeks to ascertain whether the customers’ expectations are being met.
•Internal business process perspective. This evaluates the effectiveness and efficiency of managing the internal operations or value chain: the organization’s success in improving critical business processes. There are three areas of attention: innovation, operations, and post sales service.
•Learning and growth perspective. This assesses the organization’s abilities in adapting, innovating, and growing. There are four factors that are measured: goal congruence (measured by satisfaction ratings), skill and process development (measured by the percentage of employees trained), workforce empowerment (measured by the percentage of line workers making management decisions), and enhanced information system capabilities (measured by the percentage of processes with real-time feedback).
It is essential that there is a balance among the four dimensions, and one critical success factor should not predominate. There should also be a balance between quantitative and nonquantitative measures. They should be forward looking, as well as backward looking, and both short term and long term. The relationships among the four dimensions can be shown in the form of a diagram or strategy map. Some companies in the oil and chemical industries, such as Mobil Corporation, have come up with a fifth CSF for the balance scorecard: the environmental perspective.
Implementing a balance scorecard requires a substantial amount of work and is best carried out by a team of managers from different areas of the organization. The stages they would go through are as follows:
•Stage 1: Preliminary evaluation. This would involve evaluating the external environment and the organization and its strategy. It would also evaluate the financial position, human and capital resources, and the procedures and processes being used.
•Stage 2: Implementation plan. This would consist of meetings with managers to explain the project, discuss its objectives, and gain support.
•Stage 3: Development of objectives, measures, and buy-in. The goal is to achieve consensus on objectives and to establish a cause-and-effect linkage across objectives at both senior and midlevel management.
•Stage 4: Measures and targets. There should be a clear, unambiguous measure for each target so that managers know what they are expected to achieve.
•Stage 5: Agreement. Middle and senior managers should agree on the responsibilities for each area and on the objective and understand the method for measuring performance.
•Stage 6: Top management support. Top management should be involved throughout the process, but it is essential that they understand, agree, and sign off on the system.
There are difficulties in implementing and maintaining a balanced scorecard. By its implementation, we are contemplating significant organizational change, and there can often be strong resistance. Implementation can be time consuming and expensive. The measures and targets may be difficult to set and open to criticism at the time they are established or later when they are in operation. It is also a long process and it is frequently found that there is what may be termed “system innovation syndrome.” This is where the team, as well as other managers, responsible for implementing the balanced scorecard becomes exhausted by the exercise. Shortcuts are taken, inappropriate and ambiguous measures and targets are set, and some managers retain the old methods.
There is also a tendency for the balanced scorecard to be regarded as a “macho management trophy.” At executive meetings, figures may be traded as if they are blood pressure measures. The true value of the balanced scorecard will only be appreciated if the implementation is robust and rigorous, and the same meticulous thought is given to keeping it updated. Lewy and Du Mee (1998) have come up with the “10 commandments” of dos and don’ts when developing an effective balance scorecard.6
Cost Reduction
According to Brierly, Cowton, and Drury, “A cost can be a vague and indeterminate concept, and as a consequence a variety of costs can be identified for reduction.”7 To assist you in identifying what the costs are and how and why you should reduce them, we explain various methods such as target costing, life-cycle costing, and activity-based management in this section.
Before we look at these, we look at some very practical general advice on cost reduction given in the Harvard Business Review.8 The advice proposed ways to reduce overheads by 10 percent, 20 percent, and 30 percent. We briefly comment on a few of these suggestions for the 10-percent level:
•Although discretionary perks and activities can be cut out, if too savage it may reduce employee morale. However, such activities may be consolidated for cost savings. For example, some events may be turned into multidepartmental, thus allowing some of the costs to be shared.
•Assess the amount of supervisory management required. If the work is repetitive and has little change-over time, reduced supervision may be possible.
•Analyze expenditures on miscellaneous items such as telephone calls, stationery, technology add-ons, and travel and entertaining expenses.
As the authors of the article point out, many of the cost reductions they suggest at the 10 percent level can be made without disrupting the interactions with other departments. These are not strategic applications to cost reduction but are offered as an encouragement for you to consider all activities for which you are responsible. Having looked at the practical advice, we will now consider more complex techniques. It may be that you are not in a management position to implement these, but a knowledge of the concepts will enhance your knowledge of the issues and also explain some of the actions taken by senior management or midlevel managers in other departments.
Target Costing
Traditionally, companies price their products or services using the cost-plus model, and some still do. Essentially, this uses the average costs (variable and fixed) to which a markup is added in the form of a percentage to give the market price. This approach is only feasible if the market is noncompetitive or only slightly competitive.
The danger of the cost-plus model is that changes may have occurred in the market environment where the organization has traditionally operated. Prospective customers now have access to the Internet to trace alternative sources of supply, which may be cheaper or of better quality. Products often have a shorter life than previously, so the pricing must be right to gain the maximum advantage in the shortest time. There is also the problem of competition from companies choosing cost leadership as a strategy.
To remedy the deficiencies of the cost-plus model, organizations turn to target costing, which is often referred to as price-led costing. The market decides the price, and cost containment is essential. Target costing was developed by Toyota in Japan during the 1960s.9 This technique ensures that the product is introduced to the market with a specific functionality, quality, and selling price. It is also planned that the product can be produced at a life-cycle cost that generates an acceptable level of profitability.10
Key Definition
Target costing involves the establishment of target costs for each product and each product-related activity, starting with the design of the product and culminating with the sale of the product.11 Thus this process requires information relating to the organization’s competitive product and supply chain strategies. Target costing is a reversal of the cost-plus model, and we start with the market price. The organization uses market research information to determine the price customers are willing to pay given the product’s functionality and quality and the alternatives provided by competitors. We then deduct the profit we wish to make, and the balance is the target cost we must achieve to be successful. The target cost is the maximum cost that is allowable in the production, distribution, and disposal of the product:
target cost = target selling price – target profit.
It is essential that an organization examines all the product costs in the product cycle and not focus on a narrow range. A balance must also be maintained, and an organization must be careful that the cost reductions achieved in one area are outweighed by the cost increases suffered by another area as a consequence. Integration of effort can be enhanced by using a team approach.
One area that is frequently not investigated is that of design. Comparatively small changes in design can lead to considerable reductions in production costs. Value engineering is performed to redesign the product and kaizen costing (also known as continuous improvement) is performed to streamline its manufacturing and distribution processes. It is essential that designers and production managers share their expertise in order to achieve the target cost.
In implementing target costing, it is important that you have a good grasp of the relationship of the components of fixed and variable costs and of how they behave both long term and short term. It may be that by increasing fixed costs, such as by greater mechanization, variable costs in the form of labor can be reduced. Variable or fixed costs may also be reduced by outsourcing, but this is a decision that should not be taken lightly.
Target costing is not a complex technique, but it is essential that the entire process is analyzed as follows:
•Calculate the target cost that satisfies the market price and the organization’s target profit.
•Evaluate the types of actions that may be implemented in different departments or areas to bring actual costs in line with the target.
•Assess whether the reduction in costs in one area may lead to a consequential increase in costs in other areas.
•Set targets for each area in discussion with managers.
•Monitor the cost reductions to ensure that the actions implemented produce the required results.
Life-Cycle Costing
On a personal basis, you will most likely be familiar with the concept of life-cycle costing. If you are considering buying a new car, you will not only consider the cost of the car but also look into other aspects. If you are financing the purchase, then you will have to pay interest over several years. There is also the question of insurance and maintenance and repairs. Some models of cars are renowned for being expensive for parts! Finally, you will want to know how the car holds its value and what it may be worth when you come to exchange it.
Companies are increasingly concerned with the life-cycle cost when they either purchase an item or manufacture it. For example, if a company is implementing a new computerized system, there is not only the initial cost of purchasing it. There will be the training costs of staff to operate the system and the possible costs of the supplier for maintenance, breakdowns, and upgrades. There is also likely to be the less quantifiable costs of the disruption caused during the implementation period. There may even be costs associated with running the old system and the new system until there is confidence in its efficiency.
There have been four categories of life-cycle costs proposed. These are research and development cost, production and construction cost, operation and maintenance support cost, and retirement and disposal cost. The importance of each component will vary from company to company and over time.
Retirement and disposal costs have become increasingly important as environmental legislation compels companies to remedy damage that is caused by their operations. Product design costs at one time were not carefully controlled, but it is now apparent that the nature of design will to a large extent determine the production costs. Careful design with an understanding of the production processes can reduce costs substantially.
There is an added complication with some of these costs, as they will be incurred at some future date. This introduces the concept of the time value of money. If asked whether you would prefer to spend $10,000 now or in 20 years’ time, you would pick the former. This is not only because of inflation, but also if you have $10,000 now and invest it, even at a low interest rate, it will become substantially more than $10,000. Working backward, the $10,000 in 20 years’ time is worth less now. This means that future cash flows need to be discounted to their present value.
Life-cycle costing has several advantages. It is future oriented, and it compels managers to examine the long-term financial implications of the strategic decisions they are making. It also encourages managers to examine and question the costs incurred at every significant stage in the life of the product. The purposes for which organizations could choose to use life-cycle costing are the acquisition of a system or project on long-term budgets and operating results and the comparison among competing suppliers of products and services. Repair costs, maintenance, and warranties are all other concerns that encourage management to look at the life-cycle costing.12
Unfortunately, there is a tendency for deep analysis when the decision is being made but for very little monitoring and control afterward. Although managers carefully predict the costs to be incurred over the life of the asset, few ensure that actual costs are compatible with predictions. This lack of control and monitoring may be because the accounting records, once the decision is made, consolidate the costs of maintenance and similar expenditures under one heading for the entire department or organization.
Activity-Based Management (ABM)
This term has become increasingly used, at least in textbooks, and some managers would argue that they have always practiced ABM but merely regarded it as good management. Having said that, the technique formalizes practices, is a logical extension of activity-based costing (ABC), and reflects the concepts of value chain analysis but give them a narrower focus.
Unlike the traditional cost approach, ABM regards the organization as a set of interlinked processes that create and deliver value to customers. The most basic concept in ABM is that of an “activity,” hence its relationship with ABC. As explained in an earlier chapter, ABC identifies the relationship between overhead costs and activities. It uses the concepts of cost pools that capture the overhead costs of specific activities and that specify cost drivers. These drivers cause the costs of those activities that we analyze to determine an allocation rate. ABM extends this by taking the information computed by ABC and analyzing the activities to reduce costs.
There are two main aspects to the application of ABM. One is ascertaining those activities that do not add value and eliminating or reducing them. Activities are non-value-adding if their elimination would not affect the customer’s perceived value of the product or service or impair the functioning and operation of the organization.13,14,15 You will appreciate the relationship between this aspect and value chain analysis. The second aspect is to ascertain which activities add value so that we can enhance them. ABM will also seek to improve the efficiency and effectiveness of all major activities and identify new value-added activities.
If we consider typical non-value-added activities in a manufacturing environment, the following are the obvious ones:
•Storage and internal transport of raw materials, work in process, and finished goods. These can be significant and may be reduced by using systems such as just-in-time deliveries of supplies and configuring the production lines to reduce movements of work in process and finished goods.
•Idle time and down time. It may be more financially beneficial to conduct regular maintenance and employ progress chasers to ensure that capacity is functioning at its most efficient.
These examples are from a manufacturing environment, but you can apply the principles to any type of activity. A key factor to concentrate on is the wastage of time. This is costly, and often means that the customer is also waiting. In some service industries, customers may regard waiting as a normal part of the activity, but speedy service is usually expected.
If you are a manager in a company where ABC is successfully implemented, you should have no difficulties in adopting ABM. Even if your company has a poor costing system, the concepts of eliminating or reducing non-value-added activities and enhancing value-added activities can still be applied.
Performance Evaluation and Improvement
We made the point in an earlier chapter that you get what you measure. Evaluation of performance will depend on the measure you are using for the performance. If it is not well-crafted, the performance measure may have been achieved but not the underlying strategic objective.
The desirable characteristics of performance measures, whether for groups or individuals, are that they
•are credible and understandable
•measure the performance desired
•do not conflict with other measures in the organization
•are aligned to the organizational strategic objectives
•reflect the responsibilities of the employee or group
•are capable of change where necessary
Even with great care, performance measures may not reflect all these characteristics. In attempting to capture the essence of activities, it is possible to derive a measure that is too complex to be understood by the employee. It may also be that the measure does not take account of events outside the employee’s control. Sometimes decisions that affect your own performance will be made at a higher level or outside of the organization, such as a change in regulations.
Strategic Business Units
A strategic business unit (SBU) consists of clearly defined operating activities that are controllable by the SBU manager. In essence, the concept of an SBU mirrors some of the arguments of “beyond budgeting” that we discussed in Chapter 5. The manager of an SBU normally has autonomy for decision making and monitoring and controlling all aspects of the resources of the SBU. It is the notion of “controllability” of costs that makes the SBU system fair and that acts as an incentive for managers.
Usually there will be an agreement or contract with the manager setting out the responsibilities, the measurable performance required, and the incentive for doing so. The incentive should be set at such a level that the manager is highly motivated to achieve the performance measures. In establishing SBUs, an organization chooses to be decentralized, where local mangers of SBUs have considerable responsibility in planning, control, and decision making, as opposed to a centralized organization, where top-level management controls the various subunits.
The types of SBUs are similar to the responsibility centers we discussed earlier, except the degree of managerial autonomy is much higher in SBUs. The following are the main types you will encounter:
•Cost SBUs. These do not generate revenues or profits but provide a product or service at an agreed cost. Examples are maintenance SBUs, dispatching SBUs, and information technology SBUs.
•Revenue SBUs. These are concerned solely with generating revenue and do not have responsibility for costs.
•Profit SBUs. They have the responsibility for both revenues and costs. They are expected to generate a predetermined level of profit.
•Investment SBUs. They have responsibility for the investment in assets that generate the profit.
A variety of measures can be used to evaluate the performance of the SBUs. These may be simple financial measures, such as achievement of budgeted costs or profits, or can be more sophisticated and use financial ratios such as profit margins and return on investment. Sometimes nonfinancial measures may be used in addition to give comprehensive measures of performance, and these may be incorporated in a balanced scorecard for the SBU.
Even with well-established and agreed performance measures and a robust incentive scheme, it is possible that managers will find ways to manage the performance measures to achieve the reward. In particular, they may have a short-term focus or attempt to shift costs.
Managers will usually receive their incentive in the form of a bonus based on annual measures. They are, therefore, motivated to concentrate on performance in the short term rather than to plan for the long term. Costs that should be spent on maintenance, employee training, new products, or process initiatives and similar long-term investments are ignored. This becomes an even greater issue when an SBU manager anticipates rapid promotion if the performance measures are met. It will be left to the successor to address the problems.
Cost shifting can take different forms and may be due to managers purposely shifting some costs outside of their responsibility, or where there is ambiguity in the range of their responsibilities, ignoring some of the consequences of their actions.
We have already discussed the issue of managers and uncontrollable costs, and this is an area where a manager may shift costs. If we consider a cost SBU, it would seem only fair that a manager should be responsible for only those costs that can be controlled. In the majority of instances, these will be variable costs, and the manager will not be responsible for fixed costs. A manager may therefore take action to shift costs from the variable definition to the fixed definition.
There are also situations where, for the benefit of their own SBU, managers may make a decision that has an adverse effect on SBUs elsewhere in the organization or even outside the organization. It could be argued that the just-in-time system shifts the costs of holding raw materials partly to the supplier and partly to society in the form of pollution and crowded roads at inconvenient times.
Cost Allocation
The measures used to evaluate the performance of managers in discharging their responsibilities will include an element of indirect costs or overheads that may be significant. As we saw in our explanation of full costing, the allocation of central overheads is arbitrary. Managers may find that they have the responsibility of overheads that they are unable to control. Unfortunately, they may take actions that enhance their performance measures but are detrimental to the monitoring and control of the entire organization.
Several of the indirect costs such as electricity, rent, cleaning, and refurbishments may be allocated on the space occupied by a department. A devious manager may attempt to reduce the space that his or her department occupies, thus reducing the amount of overhead allocated to the department. The manager may feel virtuous because the amount of overhead has been reduced, which reflects more favorable performance measures. However, the organization still has that space and the overheads. Organizationally, there are no benefits.
Cost allocation is also a major issue with SBUs. Where there are central costs such as IT, maintenance, and human resources being provided centrally and the costs allocated, there may be an incentive for the manager to use outside sources if they are less expensive or offer other benefits. The use and charge for central services is frequently a controversial area where there are no immediate solutions.
Total Quality Management (TQM)
Strategic cost analysis is used to improve organizational performance, whether this is in a hospital, bank, manufacturer, restaurant, or any other type of organization. The size and nature of the organization will determine the cost data it requires. But the purpose of the analysis is to seek improvements in performance. In this last section, we discuss total quality management (TQM).
You will find that parts of our explanation repeat and build upon the advice we gave in earlier chapters on measuring and monitoring performance; some parts echo the principles and practices of value chain analysis and balanced scorecards. Other parts capture the notions of cost cutting and cost reduction.
The philosophy and practice of TQM encapsulate all aspects of an organization so that every business discipline and profession can call it their own. Whether you are in accounting, marketing, production, or any other functions, you will be involved in TQM if your organization decides to implement it.
But be careful: Quality has multiple meanings. Customers can perceive quality as
•luxury compared to other products or services, even if you have to wait for it
•delivery at the time promised and the price agreed
•consistency, in that the product or service is exactly the same no matter at which outlet you purchase it or at what time
•the availability of spare parts or quick service time
The first stage in implementing TQM is to analyze your customer expectations and to develop measures to capture them. These can be both quantitative, such as the time taken for a repair to be conducted, or nonquantitative, such as the enhancement to personal image that the customer hopes to achieve by buying the product or service.
Fortunately, there is considerable agreement on the principles and practices of TQM. Although different sources emphasize various components, a list of the 12 factors that most agree on has been constructed16:
1.Committed leadership. A near-evangelical, unwavering, long-term commitment by top managers to the philosophy, usually under a name something like TQM, Continuous Improvement (CI), or Quality Improvement (QI).
2.Adoption and communication of TQM. Using tools like the mission statement and themes or slogans.
3.Closer customer relationships. Determining customers’ (both inside and outside the firm) requirements, then meeting those requirements no matter what it takes.
4.Closer supplier relationships. Working closely and cooperatively with suppliers and ensuring they provide inputs that conform to customers’ end-use requirements.
5.Benchmarking. Researching and observing the best competitive practices.
6.Increased training. Usually includes TQM principles, team skills, and problem-solving.
7.Open organization. Lean staff, empowered work teams, open horizontal communications, and a relaxation of traditional hierarchy.
8.Employee empowerment. Increased employee involvement in design and planning, and greater autonomy in decision making.
9.Zero-defects mentality. A system in place to spot defects as they occur, rather than through inspection and rework.
10.Flexible manufacturing. Applicable only to manufacturers. Can include just-in-time inventory, cellular manufacturing, design for manufacturability (DFM), statistical process control (SPC), and design of experiments (DQE).
11.Process improvement. Reduced waste and cycle times in all areas through cross-departmental process analysis.
12.Measurement. Goal orientation and zeal for data, with constant performance measurement, often using statistical methods.
We are able, therefore, to describe TQM in general terms and also to indicate the particular role of strategic cost accounting. The main cornerstones of TQM are customer satisfaction and continuous QI in all processes and functional areas of the organization, including research and design, production, marketing, finance, and information systems.
You need to consider who the customers are. The immediate buyer may not be the final user of the product or service. Suppliers, insofar as they have business relationships with the organization, can be considered as having the same needs as customers insofar as ethical trading and clarity on the organization’s needs when purchasing. Some would argue that there are even internal customers, such as employees who are frequently completing their work to satisfy the next stage in the production process.
CI assumes that all processes, procedures, and practices can be improved. Frequently, the best suggestions for improvements are generated by the employees doing the specific job. TQM encourages employee empowerment, but at the same time, the essential integration of processes and procedures must be obtained. The use of multidepartmental teams can minimize possibilities of disruptions through partial implementation of improvements.
There are many claimed benefits of TQM. Companies that implemented it not only speak of the time and cost in doing so but also express pleasure with the visible improvements that are introduced. The gains that organizations have made include:
•a reputation as a quality organization;
•reduction in costs without lowering of quality and often with quality being improved;
•increases in financial measures such as profit margins and return on investment;
•the ability to charge higher prices for products and services than previously;
•better customer-retention levels and a decrease in returned goods and repairs under guarantees;
•an increase in presence in new markets both nationally and internationally;
•better working relationships with suppliers, sometimes leading to reduced purchasing costs and better delivery times;
•speedier response times to changes in the market and customer preferences.
Organizations have found problems in introducing TQM and have abandoned it or decided on partial implementations. The difficult issues have been the following:
•Agreeing which customers they are trying to satisfy and how those customers perceive quality. There may be a customer chain, and if the final customer is not satisfied, the displeasure may result in a lowering of sales or in other customers in the chain seeking alternative suppliers.
•Identifying appropriate measures of quality and being regularly able to collect, analyze, and feedback these data to employees.
•Attempting to achieve employee empowerment but at the same time ensuring integration of all the processes and functions.
•Not only seeking CIs but also attempting to benefit from the gains of consistency and from standardization of procedures and practices.
The final question is whether TQM is for you and your organization. In a very well-constructed study in the United States, the value of TQM was assessed. As with all academic studies, the researchers pointed out that there were limitations to their research but concluded, “The message for managers is that, although TQM programs can produce performance advantages, they do not address the needs of all organizations, and they are fraught with pitfalls for firms that lack the requisite complementary resources.”17 Although this article is dated 1995, we believe that the words of caution are as valid now as they were then.
Strategy and Performance
The techniques and methods we have discussed earlier in this chapter are concerned with cost strategy and performance. Some authors18 have identified two aspects to strategic cost management: executional cost management and structural cost management. With executional cost management, the strategy is already decided and the company’s cost management is concerned only with performance within that strategy. Structural cost management is concerned with tools, products, and processes that will develop a cost structure that fits with strategy.
This analysis of two aspects of strategic cost management was investigated by the tracking of environmental costs in Canadian firms. The authors note that it may not be possible to generalize the results because of the nature of the study. However, it does give a fuller picture of strategic cost management and its various aspects. It also complements the claims that we have made in this book, namely that companies will devise the methods and techniques that best meet their needs.
To demonstrate the development strategic cost management that took place in an unusual setting, we draw from a study by Knardal and Petterson.19 Their research examined the design and use of a budget for a large Norwegian festival known as the St Olav Festival which has been running for decades and has an international reputation. Festivals usually take place over a very short period of time and sometimes have the reputation of mismanagement and large budget deficits. The aim of the study was to identify how a budget, as a management control system (executional) could integrate creativity and strategic change (structural cost management).
A key factor in the success of the budgetary control system was the inclusive nature of the exercise. Discussions on budgets took place in weekly meetings with the whole staff. The composition of the program, artistic issues, and budget were discussed. The discussions involved cost–benefit analyses which included artistic values as well as financial. The findings showed that all the key employees became committed to the budget through interactive and diagnostic uses during the planning period. This approach also linked planning with decisions on the cultural projects and the festival managers were able to develop organizational learning among the employees.
Big Data and Analytics
Cost analysis techniques do not, by themselves, determine corporate strategy and the growing fascination with Big data is that it opens up another perspective. Big data is thousands or millions of observations from many sources. When you reply to an advertisement, conduct a search on your computer, use a money-off coupon to purchase a product, click the “accept” button when agreeing to terms of service without reading the agreement, someone somewhere is collecting that data.
Big data is continually being collected and its characteristics are:
Volume
There is masses of data collected from many different sources.
Depth
The data usually come from the original source and is not superficial. It is “raw” data and has not been manipulated or interpreted and can incorporate a wide range of data.
Velocity
The collection of the data is continuous.
Variety
The data can be of many types such as structured, unstructured, numerical, and so on.
Accessibility
It is usually easy to collect. It is difficult to analyze.
The problem with Big data is that it is an incredible volume of both structured and unstructured data. The consequence is that for several years it has been difficult to capture, manipulate, and analyze the data using traditional database and software techniques.
Big data analytics uses specialized software tools for analyzing large sets of data to identify patterns and to determine those that are most relevant for making business decisions. With the appropriate analysis of Big data, it is claimed that companies can boost sales, increase efficiency, and improve operations, customer service, and risk management. It appears that an increasing number of companies are using Big data, although there is little information in the public domain on how it is being used and the successes in business developments.
Although properly analyzed Big data is valuable, it can be abused and the general rules of statistical analysis should be applied. It is possible to analyze large compilations of data and find, without any prior hypothesis, a correlation between pairs of variables purely by chance and there is no direct causation. In other words, one variable is not influenced by another.
However, the information can then be used as a hypothesis but it should be tested with data not used in the original search. The general rules of analyzing any types of data are:
1.Consider the problem you are investigating
2.Formulate a question that addresses the problem
3.Consider the implications and possible answers to the question
4.Conduct the analysis
5.Ensure that the analysis does not show only correlation but there is causation.
As Big data and analytics become more widely used, it is highly likely that it will come under the responsibility of the accounting function in an organization. It is claimed that “Big data will, over the next 5 to 10 years, create new opportunities for accountants and finance professionals to take a more strategic, more future-facing, and more proactive role in organizations.”20
The Final View
In reading this book, you may have realized that, in the early chapters, we identify what we mean by cost, and in the final chapter, we expound on the strategic management of cost. The early chapters provide the foundations of strategic cost analysis, and the latter chapters explain more advanced techniques.
You are not able to apply the techniques in Chapters 5 and 6 unless you thoroughly understand the content of the preceding chapters. You must also remember that the techniques are mostly described in the form of theoretical models. What takes place in your own organization may have a more practical approach. You need to reread Chapter 1 so that you can identify the influences on your own strategic cost analysis.
In summary, the conceptual ordering of the chapters has been as follows.
Chapters 1 and 2
•How do we identify cost in different types of organization and how might they impact strategy?
◦Classification of cost
◦Absorption costing
◦ABC
◦Time-driven ABC
◦Job costing
◦Process costing
Chapters 3 and 4
•How do we plan our costs and analyze the difference between actual and planned performance?
◦Standard costing
◦Budgetary control
•What are the cost techniques that directly influence strategic decisions?
◦Break-even analysis
◦CVP analysis
◦Multiproduct analysis
◦Variable costing
◦Incremental analysis
•What is the cost information required to manage our strategy?
◦Value chain analysis
◦Balanced scorecard
◦Cost reduction
◦Performance evaluation and improvement
◦Strategy and performance
◦Big data and Analytics
Conclusions
This final chapter emphasizes the move away from “costing” past performance with only an internal landscape to techniques that are based on providing customer value, which is essential to success and even survival. This requires cost data that incorporate external forces and the future environment. And as our explanations demonstrate, the cost data and the formation and pursuit of strategy are intrinsically linked.
It is also evident that there is an overlap of some of the techniques we have discussed, or at least the sharing of common concepts. In a useful case study on lean accounting, the author notes that it is closely related to just-in-time and target costing and that it considers the entire life cycle of a product.21 The move is toward increasing value for the customer and thus increasing value for the organization and toward a strategic cost analysis of external and future events.
The topics in this chapter are those that you are likely to encounter in large organizations and, in various forms, in some smaller companies, regardless of whether you work in the service sector, the manufacturing sector, or the public sector. You may wish to refresh the contents of Chapter 1 to appreciate how certain characteristics influence the system that a company selects.
We commenced this chapter by explaining value chain analysis and the balanced scorecard. These are both comprehensive techniques that embrace the entire organization and that analyze it in its environmental setting. Such techniques are not for the faint-hearted. For companies to implement them takes substantial management effort and time, and requires organizational change. There are claimed benefits, but to achieve them 100 percent commitment is required at all levels in the organization.
The section on cost reduction offers a more practical and accessible array of techniques for companies, whatever their size. Although purists may argue that target costing, life-cycle costing, and ABM are not properly implemented by many companies, you need to ask yourself, “Does it work for me?” The whole purpose of strategic cost analysis is to assist you as a manager in planning, control, and decision making. If the methods you have implemented, however imperfectly, do this, you are to be congratulated.
The section on performance evaluation and improvements builds on the foundations we introduced in earlier chapters. A consistent theme is the identification of cost information and appropriate measures that will encourage the performance you require and are capable of monitoring. Those measures must be selected by you within the context of the company for which you work and of the strategy you are pursuing. You are the manager: The use of cost information and strategic cost analysis will improve your performance as a manager. The final section on Big data and analytics demonstrate how advances in technology will give opportunities for even better decision making.
As stated by Disraeli, a prime minister of England in the 19th century, “the most successful man in life is the man who has the best information.”22 Indeed, this is never truer than for today’s manager strategizing in an ever-increasing dynamic and competitive global business environment.
Notes
1.Cooper and Slagmulder (1998).
2.Prahalad and Hamel (1990).
3.Al-Hazmi (2010).
4.Porter (1985).
5.McCunn (1998).
6.Lewy and Du Mee (1998).
7.Brierly et al. (2007).
8.Coyne et al. (2010).
9.Tanaka (1993).
10.Cooper and Slagmulder (1997).
11.Woodcock (2000).
12.Korpi and Ala-Riska (2008).
13.Convey (1991).
14.Miller (1992).
15.Turney (1992).
16.Powell (1995).
17.Powell (1995, p.33).
18.For example, Henri (2006).
19.Knardal and Pettersen (2015).
20.Institute of Management Accountants & Association of Chartered Certified Accountants (2013).
21.Haskin (2010).
22.Disraeli (1880, p.156).