Strategic Cost Management

Strategic Cost Management

IntroductionStrategic managementinvolves the formulation and implementation of the major goals and initiatives taken by a company's top management on behalf of owners, based on consideration ofresourcesand an assessment of the internal and external environments in which the organization competes.Strategic management provides overall direction to the enterprise and involves specifying the organization's objectives, developing policies and plans designed to achieve these objectives, and then allocating resources to implement the plans. Academics and practicing managers have developed numerous models and frameworks to assist in strategic decision making in the context of complex environments and competitive dynamics.[2]Strategic management is not static in nature; the models often include a feedback loop to monitor execution and inform the next round of planning.Harvard ProfessorMichael Porteridentifies three principles underlying strategy: creating a "unique and valuable [market] position", making trade-offs by choosing "what not to do", and creating "fit" by aligning company activities with one another to support the chosen strategyDr.Vladimir Kvintdefines strategy as "a system of finding, formulating, and developing a doctrine that will ensure long-term success if followed faithfully.Corporate strategy involves answering a key question from a portfolio perspective: "What business should we be in?" Business strategy involves answering the question: "How shall we compete in this business?"In management theory and practice, a further distinction is often made between strategic management and operational management. Operational management is concerned primarily with improving efficiency and controlling costs within the boundaries set by the organization's strategy.Strategic Cost Management (SCM) is understood in different ways in literature as a matter of fact that there is no universally agreed definition. In fact, different costs are for different purposes. However, SCM can be defined as the use of cost information to do the following: help formulate and communicate strategies, carry out tactics that implement those strategies objectives. [Govindarajan and Shank]. In other words this means that SCM is not only cost management but also a tool use to increase revenues, improve productivity and customer satisfaction, and at the same time improve the strategic position of the company. The key is that costs must be viewed by looking simultaneously at the value they provide to achieve company's strategic/long-term objectives.Three types of cost management are:1. Those that strengthen the organizations competitive position.An example of a cost management technique that strengthens an organizations position is illustrated as follows. A hospital redesigns its patient admission procedure so it becomes more efficient and easier for patients. The hospital will become known for its easy admission procedure so more people will come to that hospital if the patient has a choice. The strategic position of the hospital has just been increased over its competitors.2. Those that that have no impact on the organizations position.An example of a cost management technique that has no impact on the organizations competitive position is illustrated as follows. An insurance company decides to reevaluate its accounts payable system to make it more efficient. The evaluation has no positive benefits to the insurance company in the external market. The objective of the change is to make the organization more profitable.

3. Those that weaken the organizations position.An example of a cost management technique that will weaken the organizations competitive position is illustrated as follows. A large airline company only has two desks for administering and selling tickets. This set-up induces long lines for the airline customer who can ultimately result in high dissatisfaction and a bad reputation for the airline. This may reduce the amount of ticket sales when compared with the airlines competitors. Even though having only two desks available for customers may initially be cost effective, in the long run, it harms the company. As a general rule, an organization should never undertake any practices that are predicted to weaken the position of the organization.Cost estimating can be done in a variety of ways. Accurate cost estimating is one of the main elements involved in cost management. The following is a list of estimating techniques that may be used for an organization: Analogous Estimating (Top-Down Estimating)- Using the cost of a previous, similar project as a reference for predicting the cost of the current project. This is a form of expert judgment and is used when there is a limited amount of information about the project. Parametric Modeling- Using mathematical parameters to predict project costs. Models can be simple or complex. They are most reliable when (1) the historical information is correct, (2) the parameters are quantifiable, and (3) The model can be applied to both large and small scale projects. Bottom-Up Estimating- This involves estimating the cost of work items and them summing the estimates to get a project total. Smaller work items increase the cost and accuracy. Computerized Tools- Project management software and spreadsheets aid in project estimation.

Report ObjectivesThis report is a summary of a research done on the area of Strategic Cost Management (SCM). This report includes a detailed discussion and application of Life Cycle Costing (LCC) which a company can use to achieve its strategic objects in today's dynamic business environment. Hence, the main focus of this report is on LCC as mentioned.Since textbooks normally covers the theoretical aspects of these areas in management accounting, journals are being used as the main source of information to cover the topic in-depth.

Review of literatureBefore striking very straight on the prices such as spot and future prices, it is quite imperative that there should be a good understanding of the market as a whole. Dodd & Jones (2007) in their article Analysis of effectiveness of Derivative Market in Brazil: Hedging and Central Bank Interventions & Regulations pointed that financial institutions in Brazil use modern risk exposure models to assess and minimize their risk. Even the Central Bank gives a support in this regard. They found that if derivatives can provide a reliable ways to minimize risk, particularly interest rate risk, then there will be smooth international capital flows. They emphasized that the central bank needs to be proactive to avoid creation of greater speculative opportunities. Li Xidan and Zhang Bing (2008) in their research article Price linkages between Chinese and World Copper Future Market emphasized that there existed a time varying relationships between the Chinese Copper market & its London counterparts. There is a long run relationship between Shanghai Future Market (SHFE) and London Metals exchanges (LME) copper futures prices. The influence of LME on SHFE is greater than that of SHFE on LME. Coming further to another research report extracted from the web site of CFTC (2008) by none other than the Division of Market Oversight of Central Future Trading Commission of US (CFTC), which reports on Large Trader Activity in the Silver Future Market because of allegations by the commentators and analysts that the price of silver future on NYMEX has been manipulated downward on the short side of the market. The report of the Division of Market Oversight comes out with the finding that there is no evidence of manipulation in the silver future market. Silver cash and future prices have been risen dramatically between 2005 and 2007, with silver outperforming gold, platinum suggesting that silver prices are not depressed relative to other metal prices. Long Ruyin and Wang Lei (2008) have talked about dynamic relationship among Chinas metal futures, spot price and Londons future prices. Their study shows that the aforesaid three have the long equilibrium relationship, the copper future price of Shanghai have internalities to the futures of London, the aluminum future price have externalities, the three have different price discovery functions.

Gravelle John, Global Mining Leader, PwC, in its report titled Metal mired in global uncertainty (Gold, Silver and Copper Price Report 2014) said that few commodities in the mining sector have escaped the downturn caused by global economic uncertainty and volatile markets. Gold, silver and copper are among the closely watched metals. They have also been some of the hardest hit in 2013.In India, there has been very few studies on the similar front such as Bose Sushmita (2008) in her study of trends in commodity prices of commodity market in India, found that multi-commodity indices having higher exposure to metals and energy products and with efficient and clear price dissemination in national and international markets behave like the equity indices in terms of efficiency and flow of information. She found that future markets can provide information for current spot prices and can help to reduce volatility in spot prices of relevant commodities and can also provide for effective hedging of price risk. Agricultural indices on the other hand do not reflect such features properly. Her study has suggested that relationship between spot and future markets in price discovery has been an important area of research. While most studies talk about that there is information flow between spot and futures markets, the degree of flow and direction vary significantly depending on the commodity selected, market infrastructure and operation of arbitrageurs in the future market. Kumar Brajesh and Pandey Ajay (2008) investigated the cross market linkages of Indian commodity futures with futures markets outside India. They found that world markets have bigger (unidirectional) impact on Indian markets. However, effect of Londoan Metal Exchange (LME) on Indias Multi Commodity Exchange (MCX) is stronger than the effect of MCX on LME. Results of return and volatility spillovers indicate that the Indian commodity futures markets function as a satellite market and assimilate information from the world market. Further after going through one working paper of Ghosh (2009), on Issues & concerns of commodity derivative market in India: An agenda for research available in the website of Takshashila Academia of Economic Research (TAER) Limited (earlier known

Life Cycle Costing - As a SCM ToolImplementationThe second major process of strategic management isimplementation, which involves decisions regarding how the organization's resources (i.e., people, process and IT systems) will be aligned and mobilized towards the objectives. Implementation results in how the organization's resources are structured (such as by product or service or geography), leadership arrangements, communication, incentives, and monitoring mechanisms to track progress towards objectives, among others.Running the day-to-day operations of the business is often referred to as "operations management" or specific terms for key departments or functions, such as "logistics management" or "marketing management," which take over once strategic management decisions are implemented.The LCC concept was developed by United States' (US) Department of Defense in the early 1960s to increase the effectiveness of government procurement (Shields and Young 1991). After that, the concept came into the business, and is used there in product development studies and project evaluation. Then the concept was taken by the management accounting. However, the application of LCC is limited until 1980s when there were criticisms of the traditional management accounting practices, which is focused primarily on the manufacturing stage of a Product's Life Cycle (PLC).PLC progresses through a sequence of stages from introduction to growth, maturity, and decline. Thus, accountants might not be able to analyze cost behavior and computation of all associate costs would be challenging. The planning and design stage incur the most cost so cost management has to be done in this stage.LCC refer to the process of estimating and accumulating the total costs that the producer or manufacturer will incur over the product's entire life; from the beginning to diminish the particular product. In other words, "cradle-to-grave costing". The main focus of LCC is not only to reduce the costs that the producer will incur over the PLC including design, manufacturing, marketing, logistics, and service, but also the costs that customer will incur such as the costs of acquisition, operation, maintenance, shutdowns, and disposal. This means that, LCC explicitly takes the longitudinal cost structure of the product's quality and time-related features into the account in two different angles. Therefore, a LCC perspective is useful not only when costs are considered from the customer's view but also considering the producer's view throughout PLC (Artto 1994).Hence, user of the product plays a major role as the cost driver in LCC.Although, the traditional cost management approach primary focus on the manufacturing stage of the product the PLC costs do not end when the product has been manufactured. As many authors commonly cited, 80-90 percentage of the costs are committed or locked-in by the decisions made in the early stage of PLC. As mentioned, cost management should be done at this stage. Thus, the key to managing or reducing cost is to focus attention and effort on those decisions (Shields and Young 1991). But it is important to note that there are some arguments against committed or locked-in costs. For example, in there study, Cooper and Slagmulder (2004) "...our research suggest otherwise. Specifically we found that Olympus Optical (product they studied) is able to manage costs throughout its life..."In the management accounting perspective, the main purpose of LCC is to adopt a SCM technique which will maximize the return over the cost objects total life by focusing on the operational and terminal cash flows. LCC builds a conceptual framework that facilities management's ability to exploit internal and external linkages of the product. Thus, it helps the management accountants to understand the cost consequences of developing and making a product and to identify areas in which cost reduction efforts are likely to be most effective in a way that promotes the strategic competitive advantage of the company.Nevertheless, many authors argued that there are four broad purposes for LCC in SCM context. Below mentioned are: [consider refernce]1. to assess whether the operating profits earned during the manufacturing, phase will cover the costs incurred in the planning and decline phases;2. to identify associated costs during the planning period with a given product design and to take necessary actions;3. to support cost comparisons among different product designs to make more informed decisions among alternatives; and4. to identify the nature and timing of costs to plan and manage effectively.LCC-The PerspectivesProducer's PerspectiveThis perspective of LCC is based on the identifying, analyzing, and managing of each individual product's costs throughout its life cycle to take competitive advantage. According to Artto (1994) this refers to the costs that are included in product conception, design, product and process development, production, logistics, marketing, services and guarantees. Perhaps, this suggests that most of the costs are committed or incurred in the earlier stage especially in planning and designing stage of the product or service in the producer's perspective. Therefore, producers are able to analyze and manage costs before any final manufacturing and investment decisions are made.Customer's PerspectiveFrom the customer's perspective the focus is on costs incurred through purchase, operation, maintenance, support and disposal of product. Artto (1994) argued that a company's long-term success with customers requires products to have a lower expected associated costs when compare with substitute products.Also, Artto (1994) mentioned that organizations must do analysis to learn the market and customers on a three dimensional way; product quality, time-related factors and purchase price. In fact, to be competitive in the market, these factors are vital. So, product design and development criteria should derive from the customer's product selection criteria. This analysis should be done based on market and customers in the initial stage of product design and planning. Thus, with help of LCC analysis, management is able to make strategic cost decisions based on the mentioned two perspectives.

Success - LCC in ActionLCC is particularly important in environments in which there is large planning and development cost for example, the NASA's Advanced Air Transportation Technology (AATT) project have achieved there strategic goals and have been able to manage there cost through LCC on NASA's Decisions Support Tools (DST) (Wang and Datta).Integrated Business Machines (IBM) applies LCC and estimates and accumulates costs against profit over a PLC to determine profits which could generate. Plus, world's leading electronic and electric giants such as Sony (Japan) and Philips (Holland) have proven successful by applying the concepts of LCC.Also, many of the US construction firms have adopted LCC in order to reduce costs as projects that undergo; LCC analysis gives the total cost of the Net Present Value (NPV), therefore alternatives could be considered.BMW has proven so successful in using LCC analysis that helps the management for comparing costs of different designs in order to make decisions on most appropriate product mix (recyclable plastic parts). Also the Japan's car manufacturing giant Toyota uses LCC to make decisions on its Packing Design decisions in sales units. These, cases clearly show that LCC is a reasonably widespread SCM technique use globally.AdvantagesAs mentioned earlier, LCC is a SCM tool that manages costs form "cradle-to-grave", therefore with LCC, management is able to analyze the behaviour of all costs including indirect cost to estimates and monitor during PLC, perhaps starting from the initial stage. LCC reporting involves tracing costs and revenues on a product by product basis (all possible data) throughout their entire life. Hence, a company can take actions that lower costs in the subsequent stages of the PLC as well as lower consumer's costs such as operating and maintenance costs. LCC integrates all viewpoints (the customer and producer) and thus it leads to avoid partial optimization of the PLC costs and exploits both internal and external linkage (Lindholm and Suomala 2005a). Moreover, a successful implementation of LCC provides competitive advantage for the company (shields and Young 1991)

Change in focus from production to marketingThe direction of strategic research also paralleled a major paradigm shift in how companies competed, specifically a shift from the production focus to market focus. The prevailing concept in strategy up to the 1950s was to create aproductof high technical quality. If you created a product that worked well and was durable, it was assumed you would have no difficulty profiting. This was called theproduction orientation.Henry Fordfamously said of the Model T car: "Any customer can have a car painted any color that he wants, so long as it is black."Management theoristPeter F Druckerwrote in 1954 that it was the customer who defined what business the organization was in.In 1960Theodore Levittargued that instead of producing products then trying to sell them to the customer, businesses should start with the customer, find out what they wanted, and then produce it for them. The fallacy of the production orientation was also referred to asmarketing myopiain an article of the same name by Levitt.Over time, the customer became the driving force behind all strategic business decisions. Thismarketingconcept, in the decades since its introduction, has been reformulated and repackaged under names including market orientation, customer orientation, customer intimacy, customer focus, customer-driven and market focus.It's more important than ever to define yourself in terms of what you stand for rather than what you make, because what you make is going to become outmoded faster than it has at any time in the past.Jim Collinswrote in 1997 that the strategic frame of reference is expanded by focusing onwhya company exists rather than whatit makes.In 2001, he recommended that organizations define themselves based on three key questions: What are we passionate about? What can we be best in the world at? What drives our economic engine?

Nature of strategyIn 1985, Professor Ellen Earle-Chaffee summarized what she thought were the main elements of strategic management theory where consensus generally existed as of the 1970s, writing that strategic management: Involves adapting the organization to its business environment; Is fluid and complex. Change creates novel combinations of circumstances requiring unstructured non-repetitive responses; Affects the entire organization by providing direction; Involves both strategy formulation processes and also implementation of the content of the strategy; May be planned (intended) and unplanned (emergent); Is done at several levels: overall corporate strategy, and individual business strategies; and Involves both conceptual and analytical thought processes.Chaffee further wrote that research up to that point covered three models of strategy, which were not mutually exclusive:1. Linear strategy: A planned determination of goals, initiatives, and allocation of resources, along the lines of the Chandler definition above. This is most consistent withstrategic planningapproaches and may have a long planning horizon. The strategist "deals with" the environment but it is not the central concern.2. Adaptive strategy: In this model, the organization's goals and activities are primarily concerned with adaptation to the environment, analogous to a biological organism. The need for continuous adaption reduces or eliminates the planning window. There is more focus on means (resource mobilization to address the environment) rather than ends (goals). Strategy is less centralized than in the linear model.3. Interpretive strategy: A more recent and less developed model than the linear and adaptive models, interpretive strategy is concerned with "orienting metaphors constructed for the purpose of conceptualizing and guiding individual attitudes or organizational participants.SWOT AnalysisBy the 1960s, the capstone business policy course at the Harvard Business School included the concept of matching the distinctive competence of a company (its strengths and weaknesses) with its environment (opportunities and threats) in the context of its objectives. This framework came to be known by the acronym SWOT and was "a major step forward in bringing explicitly competitive thinking to bear on questions of strategy."Kenneth R. Andrewshelped popularize the framework via a 1963 conference and it remains commonly used in practice.A SWOT analysis is an organized design method used to evaluate the strengths, weaknesses, opportunities and threats complex within the person or the group or the organization where the functional process takes place.SWOT analysis involves both internal and external factors in an organization. such that the first two elements indicate internal capability and limitations while the last two factors indicate chances in business and limitations.(SW =strength and weakness are internal factors while OT= Opportunities and threats are external issues to a business).

LimitationsLCC estimates too early in the life of a project when the degree of accuracy is questionable and assuming that the alternative has a finite life cycle. The cost of performing a LCC analysis may not be appropriate for all projects and a high sensitivity to changing the requirements. The LLC is influenced by many factors of which some simply cannot control as they arise without warning. Like the entry of new competitor. Beside, the managers and employees might find LCC as a not sound SCM technique and it is difficult to compute costs in the customer's perspective. Also, the disputes in evaluating future cost and dealing with uncertainties regarding factors affecting LCC may have restricted its use (Lindholm and Suomala 2005a). The application of LCC relies on the availability of cost information, thus the normal product costing practices affect companies' abilities to utilize the approach. If company fails to sufficiently track product costs, it is unlikely that the true total cost of the product can be measured consistently and accurately. Also the long PLC could make LCC difficult. Moreover, there is evidence from practice that the failure to recognize the uneven cash flows during the product life cycle can motivate undesired and inappropriate decision making (Lindholm and Suomala 2005a)

Data Analysis and Interpretation1) Type of organizationa) Public b) Private

2) Do you adopt Strategic Cost systema) Yesb) No

3) How would you characterize the management style of your organization?a) Dictatorialb) Autocraticc) Democraticd) Liaise Fare

4) How would you characterize your management commitment to Strategic Cost?a) Not a priorityb) Low priorityc) Some priorityd) High prioritye) Top priority

5) How would you rate your Strategic Cost implementation on communication of the objectives and rationale for the project?a) Fairb) Averagec) Goodd) Excellent

ConclusionSome authors criticize LCC as it only is applicable for the product which has a certain life period (e.g not products with short life). However, Cooper and Slagmulder (2004) argued that companies can achieve significant savings during product life cycle even in an environment of products with short life cycles and aggressive cost management focused on product design.According to Takala and Carlson (2001), the most respected criticism of the PLC, was made by Dhalla & Yuspeh (1976) that is "clearly, the PLC is a dependent variable which is determined by market actions; it is not an independent variable to which companies should adapt their marketing programs" and "Forget the product life cycle!" Perhaps, this was more related to the LCC use in marketing.In their study Lindholm and (Suomala 2005a) argued that the adoption of LCC depends on the organisational functions rather than different sectors, as there are some belief that LCC is only applicable for industries like military and construction sector. Perhaps, this is not the case as discussed earlier (see Success - LCC in action).ConclusionSCM is important to organizations because it is more than focusing on costs but also value and revenue in both internal and external angles, which is consider as a critical factor for the success of the companies in the 21st century's competitive business environment. Many studies (Shields and Young 1991, Arrto 1994 and Lindholm and Suomala 2005a) increasingly stress that rapid changes in the business environment especially technological changes and shortened life cycles have made LCC critical to organizations. LCC differs from other costing methods because it generally includes revenues as well as costs of the PLC (Artto 1994).Since, LCC is to support during the product planning stage and the analysis of the cost behaviour of a particular product helps managers and accountants to manage costs more effectively and minimize wrong decision-making as it focuses cost behavior of each unique phase of the PLC. Because different types of costs tend to predominate in different phases of the life cycle, by identifying the timing and nature of significant costs in advance, organizations can develop more effective means of budgeting and managing these costs. Beside, it is also very useful when making decisions regarding operation and maintenance (such as warranty) costs incurred during the life of the product. But the key issue is how far beyond the stage where action is taken should a company look for positive impacts reduce costs.Detailed analysis of LCC makes manufactures to arrive at make-or-buy decisions to be more completive or re-gain its competitiveness in the industry. Because LCC draws general conclusions in all relevant costs which the producers has to incur in making a product or service before the productions doesn't take place.Likewise, by applying LCC as a SCM technique, managements are able to apply may other techniques in to make economic decision viable such as cost-benefit analysis, discounted cash flow, sensitivity analysis and NPV analysis. Thus this would give an edge over competitors who do not use LCC as a SCM toolNonetheless, in practice LCC is often represent long-term costing, but the calculations do not cover the entire life cycle costs in many cases (Lindholm and Suomala 2005a). The reason for this is that historically colleted data (in early stages) might no longer applicable as some conditions change. Thus, appropriate use of historically collected data and dealing with the future uncertainties which affect the effectiveness of life cycle costs (in both perspectives), must be in the top priority of any organization to be competitive in the market and to achieve its strategic advantage by implementing LCC as a SCM tool.

Referencehttps://www.google.co.in/webhp?hl=en&tab=iw&gws_rd=ssl#hl=en&q=strategic+cost+management+wikihttp://en.wikipedia.org/wiki/Strategic_managementhttp://en.wikipedia.org/wiki/Strategic_managementhttp://www.fisglobal.com/ucmprdpub/groups/public/documents/document/c007601.pdfhttp://www.hrodc.com/COSTS.htm

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