STRATEGIC COST MANAGEMENT BOOK PDF
The text, Strategic Cost Management, presents a comprehensive coverage of This book provides a new framework to the vital issue of cost management, use. Strategic Cost Management - Free download as Powerpoint Download as PPT, PDF, TXT or read online from Scribd Reference Books. From this perspective, strategic cost management (SCM) can be thought of as .. these three objectives still come through frequently in today's textbooks—as.
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Interest in strategic cost management derives from the rise to promi- nence of " strategy" in recent years. Several influential books have contrib- uted to the current. PDF | Despite recent developments in the stream of research devoted to strategic cost management (SCM), there are limitations found with this research, notably. Strategic Management and. Strategic Cost Management, Accumulating to Postgraduate Diploma, Progressing to MA, MBA, MSc . Click to Book this Course.
However, to date there has been little attention to this topic in the major research journals in accounting.
The New Tool for Competitive Advantage
Except for two papers in the Accounting Review Kaplan, b; Patell, there are no references to strategic analysis in the Accounting Review, Journal of Accounting Research, or Journal of Accounting and Economics.
One journal, Accounting Organization and Society, has published articles on strategy and control but not on strategic cost issues. The dearth of attention to strategic analysis in the traditional research journals in accounting carries through to the managerial accounting textbooks as well. Only a few of the topics of strategic cost management receive some attention in only a few of the best-selling management accounting texts.
Further evidence of the lack of concern among management accountants with strategic topics is found in a survey by Robinson and Barrett of management accounting curricula. Their study measured the extent to which the topics prescribed by the American Assembly of Collegiate Schools of Business for managerial accounting were being covered in accredited and nonaccredited programs. Strategic topics were not mentioned anywhere in the report. The reader must look outside the major accounting journals and the accounting curricula in most AACSB schools to find the literature about strategic cost management.
In summary, two observations emerge. First, there is an extensive and rapidly growing literature on the concept of strategic cost management. Second, the ideas reflected in the concept have to date received scant attention in the leading accounting research journals, the leading textbooks, or graduate and undergraduate curricula. Which of these two observations is more reflective of the attention the concept deserves involves a value judgment that the reader is encouraged to consider very carefully.
Tektronix is an example of one firm in which the new concepts have essentially replaced traditional managerial accounting, as described by Turney and Anderson To help frame the reader's consideration of the concept, this chapter presents a definition of strategic cost management. Chapter 2 summarizes the development of the field in terms of the three principal themes deemed to underlie it. Chapters 3 through 14 explain our perspective on each of these three themes in more depth.
They represent a summary of the state of the art as of How is strategic cost management different? It is cost analysis in a broader context, where the strategic elements become more conscious, explicit, and formal. Here, cost data is used to develop superior strategies en route to gaining sustainable competitive advantage.
Strategic Cost Management
No doubt cost accounting systems can help in other areas as well inventory valuation, short-term operating decision, etc. However, the use of cost data in strategic planning has not received the attention it deserved, either in cost accounting textbooks or in management practice.
Yet, the Amos Tuck School of Business Administration at Dartmouth College is one of only a few business schools in the country that teach a course built around the specific techniques used by these firms in this business niche. A sophisticated understanding of a firm's cost structure can go a long way in the search for sustainable competitive advantage.
This is what we refer to as "strategic cost management. Under this view, business management is a continuously cycling process of: 1 formulating strategies, 2 communicating those strategies throughout the organization, 3 developing and carrying out tactics to implement the strategies, and 4 developing and implementing controls to monitor the success of the implementation steps and hence the success in meeting the strategic objectives.
Accounting information plays a role at each of the four stages of this cycle. At stage one, accounting information is the basis for financial analysis, which is one aspect of the process of evaluating strategic alternatives. Strategies that are not financially feasible or that do not yield adequate financial returns cannot be appropriate strategies. At stage two, accounting reports constitute one of the important ways that strategy gets communicated throughout an organization.
The things we report are the things people pay attention to. Good accounting reports are thus reports that focus attention on those factors that are critical to the success of the strategy adopted. At stage three, specific tactics must be developed in support of the overall strategy and then carried through to completion. Financial analysis, based on accounting information, is one of the key elements in deciding which tactical programs are most likely to be effective in helping a firm to meet its strategic objectives.
And finally, at stage four, monitoring the performance of managers or of business units usually hinges partly on accounting information. The role of standard costs, expense budgets, and annual profit plans in providing one basis for performance evaluation is well accepted in businesses around the world.
These tools must be explicitly adapted to the strategic context of the firm if they are to be maximally useful. Three important generalizations emerge from this way of viewing management accounting: 1. Accounting is not an end in itself, but only a means to help achieve business success.
There is thus no such thing as good accounting practice or bad accounting practice as such. Accounting techniques or systems must be judged in light of their impact on business success.
Specific accounting techniques or systems must be considered in terms of the role they are intended to play. A concept such as return on investment analysis may have little relevance for assessing the performance of middle-level managers in situations where investment decisions are made centrally.
However, this concept may at the same time be critically important in assessing the attractiveness of different strategic investment options. Accounting analysis that is not useful for some purposes may be extremely useful for others. A working knowledge of management accounting thus involves knowledge of the multiplicity of roles accounting information can play. Shank 51 In contrast, management accounting today often adopts a focus which is largely internal to the firm — its purchases, its processes, its functions, its products and its customers.
Another way of saying this is that manage- ment accounting takes a "value added" perspective, starting with payments to suppliers purchases , and stopping with charges to customers sales. The key theme is to maximize the difference the value added between purchases and sales.
But the "value chain" concept is fundamentally different from the "value added" concept. From a strategic perspective, the value added concept has two big problems; it starts too late and It stops too soon. Starting cost analysis with purchases misses all the opportunities for exploiting link- ages with the firm's suppliers. Such opportunities can be dramatically Important to a firm. Consider the following example. One of the major American automobile companies began a few years ago to implement "Just In Time" management concepts In its assembly plants Houlihan, ].
Manufacturing costs represented 30 percent of sales for the auto firm. It was believed that applying JIT concepts could eliminate 20 percent of these costs because assembly costs in Japanese auto plants were known to be more than 20 percent below those In American plants.
As the firm began to manage its factories differently to eliminate waste and the need for inventory buffers, its assembly costs did begin to drop noticeably. They began to demand price Increases which more than offset the assembly plant cost savings. The auto firm's first response was to chide its suppliers that they, too, needed to embrace JIT concepts for their own opera- tions. A value chain perspective revealed a much different picture of the overall situation.
Of the auto company's sales, 50 percent was pur- chases from parts suppliers; of this amount, 37 percent was purchases by the parts suppliers and 63 percent was suppliers' value added. As the auto company reduced its own need for buffer stocks. It placed major new strains on the manufacturing responsive- ness of Its suppliers.
The suppliers' manufacturing costs went up more than the assembly plants' costs went down.
The reason, once identified, was very simple. The assembly plants experienced huge and uncertain variability in their production sched- ules. One week ahead of actual production, the master schedule was more than 25 percent wrong 95 percent of the time.
When the Inven- tory buffers are stripped away from a highly unpredictable production process, the manufacturing activities of the suppliers become a night- mare. For every dollar of manufacturing cost the assembly plants saved by moving toward JIT management concepts, the suppliers' plants spent much more than one dollar extra because of schedule instability.
Because of its narrow value added perspective, the auto company had ignored the impact of its changes on its suppliers' costs. Management did not realize that a major element in the success of JIT for a Japanese auto assembly plant is schedule stability for its supplier firms. In fact, whereas the American plants regularly missed schedules only one week ahead by 25 percent or more, the Japanese plants varied 1 percent or less from schedules planned four weeks in advance [Jones and Udvare, ].
The lack of awareness of supply chain cost analysis concepts on the part of this company's management accountants proved to be a very costly oversight. Should those management accountants have been exposed to value chain concepts somewhere in their accounting edu- cation? In addition to starting too late, value added analysis has another ma- jor flaw; it stops too soon. Stopping cost analysis at sales misses all the op- portunities for exploiting linkages with the firm's customers.
Customer link- ages can be just as important as supplier linkages. Exploiting customer linkages is the key idea behind the concept of "life cycle costing. Forbis and Mehta  describe how a life cycle costing perspective on the cus- tomer linkage in the value chain can lead to enhanced profitability. Explicit attention to post-purchase costs by the customer can lead to more effective market segmentation and product positioning.
Or, de- signing a product to reduce post-purchase costs of the customer can be a major weapon in capturing competitive advantage. In many ways, the lower life cycle cost of imported Japanese autos helps to explain their success in the American market. Just as many cost management problems are misunderstood because of failure to see the impact on the overall value chain, many cost manage- ment opportunities are missed in the same way.
Consider one further example. In , the American suppliers of paper to envelope converters are suffering a loss in profit because they are being caught unaware in a significant shift in the value chain of the envelope converter [Shank, ].
Strategic Cost Management
The shift from "sheet fed" to "roll fed" envelope finishing ma- chines dramatically changes the raw material specifications for enve- lope paper. With "sheet fed" machines, the envelope company buys large rolls of paper 40 to 60 inches wide which are first cut into sheets, then cut into blanks in die-cutting machines, and finally fed by hand into the folding and glueing machines.
With "roll fed" machines, the envelope company buys very narrow rolls of paper 5 to 11 inches wide which are converted directly into envelopes in one combined operation. For large orders, they represent substantial over- 5 The Japanese firms achieve much higher schedule stability because of dramatically lower levels of complexity in their product lines. Shank 53 all savings for the envelope converter. The paper manufacturers do not want to complicate their pri- mary manufacturing process by producing rolls that are only 5 to 11 inches wide directly on the paper machines.
Instead, they use secon- dary machines called "rewinder-slitters" to convert the large rolls of paper from the paper machines into the narrower rolls the converters now want. Thus, the transition from selling wide rolls to selling narrow rolls has added an additional processing step for the paper manufac- turers.
The business issue here is how the change in the customers' value chain should be reflected in paper prices. Now that manufactur- ing costs along the value chain have changed in response to changed customer requirements how should prices change?
In the paper industry, where management accounting does not include value chain analysis or life style costing, rewinder-slitter costs are seen as just a small part of mill overhead which is assigned to all paper production on a per ton basis. For a large, modern paper mill, rewinder-slitter cost is no more than one or two percent of total cost. Also, very little of this cost is variable with incremental production since the mill always keeps excess capacity in such a small department.
The savings to the envelope converter from "roll fed" machines far ex- ceed this extra charge. Unfortunately, the full cost to the paper mill of providing the incremental rewinding-slitter service also far exceeds this extra charge. An external value chain perspective would look at the savings from narrow rolls for the cus- tomer and the extra costs to the paper mill and set a price differential somewhere in between. An internal mill costing perspective, however, sees no cost issue at all.
The lack of a value chain perspective contrib- utes to the lack of concern about product costing issues. The result is an uneconomic price, the impact of which is buried in a mill management accounting system that ignores value chain issues. Should the man- agement accountants in the paper companies have been exposed to value chain concepts somewhere in their management accounting education?
The "Strategic Positioning" Concept' The second major theme underlying the work in strategic cost manage- ment concerns the perceived uses of management accounting information. Stated, again, in question form: What role does cost management play in the firm?
Again, the theme of SCM here can be stated very succinctly. Following Porter's  delineation of basic strategic choices, a business can compete either by having lower costs cost leadership or by offering superior products product differentiation. That these two ap- proaches demand very different conceptual frameworks has been widely accepted in the strategy literature. Since differentiation and cost leadership involve different mana- gerial mindsets, they also involve different cost analysis perspectives.
As one example of how strategic positioning can significantly influence the role of cost analysis, consider the decision to invest in more carefully engi- neered product standard costs. For a firm following a cost leadership strat- egy in a mature, commodity business, carefully engineered product stan- dard costs are likely to be a very important on-going management control tool. But, for a firm following a product differentiation strategy in a mar- ket-driven, rapidly growing, fast changing business, carefully engineered standard manufacturing costs may well be much less important.
Shank, Govindarajan, and Spiegel cite an example in which a large chemical company uses cost variances extensively for some products and not at all for others depending on the strategic context. Although cost information is important in all companies in one form or another, different strategies demand different cost perspec- tives.
Expanding upon the work by Gupta and Govindarajan  and Govindarajan ], Table 1 summarizes some illustrative differences in control system or cost management emphases depending on the primary strategic thrust of the firm. Govindarajan's widely cited work provides empirical evidence of major differences in cost management and control system design depending on the strategy being followed.
It is interesting to compare the SCM perspective on the role of cost information with the perspective that is more prevalent in management accounting today. Often, the theme in management accounting texts today is the same that it has been for 30 years. That theme was first articulated by Simon et al ] who coined three phrases to capture the essence of management accounting: Gilbert and Strebel , Hall , Hambrick Wright ] or Shank and Govindarajan Shank 55 Table 1 Primary Strategic Emphasis Role of standard costs in assessing performance Importance of such concepts as flexible budgeting for manufacturing cost control Perceived Importance of meeting budgets Importance of marketing cost analysis Importance of product cost as an input to pricing decisions Importance of competitor cost analysis Product Differentiation Not very important Moderate to low Moderate to low Critical to success Low Low Cost Leadership Very important High to very high High to very high Often not done at all on a formal basis High High cial Executives Institute commissioned a team of faculty from Carnegie Tech which now is Carnegie Mellon University to study the elements of effective controllership.
The point is not to deprecate per se this long standing common start- ing point, but rather to emphasize how much our conception of what we do starts with our consensus about why we do it. Each of the three well known roles involves a set of concepts and techniques that are implicitly assumed to apply to all firms, albeit, perhaps in varying degrees.
For ex- ample, standard cost variances are a key tool for "attention-directing" and contribution margin analysis is a key tool for "problem solving. If agreement could be reached that why we do management accounting differs in important ways depending on the basic strategic thrust of the firm, it would be a much easier transition to see that how we do management accounting should also reflect the basic strategic thrust. Even if management accounting in most companies today is still heav- ily involved with conventional tasks, it is important to realize that this need not be true in the future.
Management accounting can adapt to the real business needs of the firm, if those needs are articulated.
The "Cost Driver" Concept What causes cost? In SCM it is acknowledged that cost is caused, or driven, by many factors that are interrelated in complex ways. Understand- ing cost behavior means understanding the complex interplay of the set of "cost drivers" at work in any given situation.
At this level of generality, the idea is almost tautological. It is hardly contentious or counter-intuitive See, for example. In management accounting today, cost is a function, primarily, of only one cost driver, output volume. Cost concepts related to output volume permeate the thinking and the writing about cost: In SCM, output volume per se is seen to capture very little of the richness of cost "behavior.
SCM, on the other hand, tends to draw upon the richer models of the economics of industrial organization [Scherer, One other strategic cost driver, cumulative experience, has also received some attention among management accountants over the years as a deter- minant of unit costs. That is , even in the "learning curve" literature in accounting, output volume is still the pre-eminent cost driver.
Experi- ence is seen as a phenomenon which can help explain the changing rela- tionship between output volume and cost over time.
Strategic Cost Management: An Overview
If output volume is a poor way to explain cost behavior, what is a better way? Porter  presents one attempt to create a comprehensive list of cost drivers, but his attempt is more important than his particular list.
In the strategic management literature better lists exist [Riley, ]. Follow- ing Riley, the following list of cost drivers is broken into two categories. The first category is what are called "Structural" cost drivers, drawing upon the industrial organization literature Scherer, ]. From this perspective there are at least five strategic choices by the firm regarding its underlying economic structure that drive cost position for any given product group: Horizontal integra- tion is more related to scale.
Each structural driver involves choices by the firm that drive product cost. Given certain assumptions the cost calculus of each structural driver can be specified. Shank 57 have received a large amount of attention from economists and strategists over the years. Of these three, only experience has drawn much interest from management accountants, as noted above. Technology choice is a sufficiently thorny topic area that it is not really surprising that manage- ment accountants have pretty much ignored it.
At the level of explicit analy- sis, so have most other people as well. Perhaps the most explicit work that deals with cost analysis for technology choices is in industrial economics. Under this view, business management is a continuously cycling process of: 1 formulating strategies, 2 communicating those strategies throughout the organization, 3 developing and carrying out tactics to implement the strategies, and 4 developing and implementing controls to monitor the success of the implementation steps and hence the success in meeting the strategic objectives.
Accounting information plays a role at each of the four stages of this cycle. At stage one, accounting information is the basis for financial analysis, which is one aspect of the process of evaluating strategic alternatives. Strategies that are not financially feasible or that do not yield adequate financial returns cannot be appropriate strategies.
At stage two, accounting reports constitute one of the important ways that strategy gets communicated throughout an organization. The things we report are the things people pay attention to. Good accounting reports are thus reports that focus attention on those factors that are critical to the success of the strategy adopted.
At stage three, specific tactics must be developed in support of the overall strategy and then carried through to completion. Financial analysis, based on accounting information, is one of the key elements in deciding which tactical programs are most likely to be effective in helping a firm to meet its strategic objectives. And finally, at stage four, monitoring the performance of managers or of business units usually hinges partly on accounting information.
The role of standard costs, expense budgets, and annual profit plans in providing one basis for performance evaluation is well accepted in businesses around the world. These tools must be explicitly adapted to the strategic context of the firm if they are to be maximally useful.
Three important generalizations emerge from this way of viewing management accounting: 1. Accounting is not an end in itself, but only a means to help achieve business success. There is thus no such thing as good accounting practice or bad accounting practice as such. Accounting techniques or systems must be judged in light of their impact on business success. Specific accounting techniques or systems must be considered in terms of the role they are intended to play.
A concept such as return on investment analysis may have little relevance for assessing the performance of middle-level managers in situations where investment decisions are made centrally.
However, this concept may at the same time be critically important in assessing the attractiveness of different strategic investment options.
Accounting analysis that is not useful for some purposes may be extremely useful for others. A working knowledge of management accounting thus involves knowledge of the multiplicity of roles accounting information can play.
In evaluating the overall accounting system for a business, mutual consistency among the various elements is critical. The key question is whether the overall fit with strategy is appropriate. For example, a target cost system with tight, engineered cost allowances may be an excellent tool for assessing manufacturing performance in a business following a strategy of being the low-cost producer.
However, developing such an accounting tool might be dysfunctional in a business pursuing a strategy of differentiation via product innovations. Summarizing these three generalizations, the key managment questions to ask about any accounting idea are: 1. Does it serve an identifiable business objective? For example, facilitate strategy formulation, assess managerial performance, etc. For the objective it is designed to serve, does the accounting idea enhance the chances of attaining the objective?
Does the objective whose attainment is facilitated by the accounting idea fit strategically with the overall thrust of the business? For an accounting idea to be useful for a particular purpose in a particular business at a particular time, all three of these questions must yield an affirmative answer.
This book is about accounting as a tool for strategic management. The ideas presented here yield affirmative answers to these three questions, with explicit attention to the strategic issues involved. In short, strategic cost management SCM is the managerial use of cost information explicitly directed at one or more of the four stages of strategic management. The emergence of strategic cost management SCM results from a blending of the following three themes, each taken from the strategic management literature: 1.
Value chain analysis 2. Strategic positioning analysis 3. Cost driver analysis Cost management issues underlying each of these three themes are developed and illustrated in this book. Synopsis of Chapters In chapter 2, we present the overall framework for this book, which is that the emerging concept of SCM is a blending of the financial analysis elements of three themes from the strategic management literature -- value chain analysis, strategic positioning analysis, and cost driver analysis. In chapter 3, we present a short case dealing with a private label opportunity for a bicycle manufacturer that supports a strategic analysis as well as a relevant cost analysis.
The chapter demonstrates that strategic cost analysis is often just a different application of the same sorts of financial tools we normally use today. But, even when the analysis is different only in its focus and not in its underlying structure such as a value chain analysis , the insights can differ dramatically. What we emphasize is a need for managers to be aware that cost analysis must explicitly consider strategic issues and concerns.
Chapters 4 and 5 deal with value chain analysis -- the first key to effective cost management. In chapter 4, we define the value chain concept, contrast it with the value-added notion, and highlight the strategic power of value chain analysis. We then discuss the methodology for constructing and using a value chain. Finally, we discuss two real world examples to illustrate the power of the value chain perspective.These activities will facilitate the performance of the core activities in a way that goals of the firm can be accomplished successfully without wasting limited resources.
With persuasive evidence, Shank and Govindarajan demonstrate the strategic power of value chain analysis, i. BPI For each cost driver there is a particular cost analysis framework which is critical to understanding the positioning of a firm.
Because of its narrow value added perspective, the auto company had ignored the impact of its changes on its suppliers' costs. But, a careful reading of exactly what changes were made at Tektronix should be chilling to anyone still committed to the AACSB's recommended management accounting curriculum.
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