Strategic Cost Management

Strategic Cost Management

Strategic Cost Management
 Strategic Cost Management
 

 
Title: Strategic Cost Management  Authors: John K. Shank And Vijay Govindarajan 
This book is organized around three key themes for managing cost effectively. 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
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Value chain analysis  

Traditional cost analysis has focused on the notion of value added (selling price less cost of purchased raw materials) under the mistaken impression that this is the only area in which a firm can influence costs. But value chain –not value added- is the more meaningful way to explore competitive advantage. Value added can be quite misleading, for at least three reasons: 
  1. It arbitrarily distinguishes between raw materials and many other purchase inputs. Purchased services such as maintenance or professional consulting service are treated differently than raw material purchase.     
  2. Value added does not point out the potential to exploit the linkages between a firm and its suppliers or between a firm and its customers with a view to reducing costs enhancing differentiation.     
  3. Competitive advantage can’t be fully explored without considering the interaction between purchased raw materials and other cost elements (e.g. purchasing higher quality, higher priced raw material could reduce scrap significantly and thus lower total cost). 
The focus of the value chain analysis, in contrast, is external to the firm and sees each firm in the context of the overall chain of value creating activities of which it is very probably only a part. We are aware of no firm that spans the entire value chain in which it operates. Value chain analysis is relevant for all firms. The methodology for constructing and using a value chain involves the following steps:
  1. Define the industries value chain and assign costs, revenues, and assets to each activity.
  2. Investigate the cost drivers regulating each value activity.
  3. Examine possibilities to build sustainable competitive advantage either through controlling cost drivers better than competitors or reconfiguring the value chain.
Efforts at simultaneously reducing costs and enhancing differentiation are possible by carefully considering costs, revenues, and assets at each value activity vis-à-vis competitors. Virtually no two companies compete in exactly the same set of value activities, value chain analysis is a critical first step in understanding how the firm is positioned in its industry. Building sustainable competitive advantage requires knowledge of the full linked set of value activities of which the firm and its competitors are a part. 
Once the value chain is fully articulated, critical strategic decisions regarding make/buy and forward/backward integration become clear. Investment decisions can be viewed from the perspective of their impact on the overall chain and the firm’s position within it. Once the chain is explicated, the next steps involve understanding what factors drive competitive success at the key value chain stages. The value chain analysis helps to quantify supplier power by calculating percentage of total profits that can be attributed to suppliers. This knowledge could help the firm identify ways to exploit linkages with suppliers. 
 
The value chain framework highlights how a firm’s product fits into the buyer’s value chain: under this framework, it is readily apparent what percentage the firm’s product costs are in the buyer’s total costs. This information could be very useful in encouraging the firm and the buyer to work together in cost reduction activities. In the final analysis, simultaneous pursuit of a low cost and differentiation depends upon a sophisticated understanding of the drivers costs, revenues, and assets at each value activity and the interlinkages across value activities.
 

Strategic positioning analysis  

The role of effective cost management systems is differentiated, depending on strategy. A firm following a cost leadership strategy in a mature, commodity oriented business; carefully engineered product target costs are likely to be a very important on-going management control tool. But, for a firm following a product differentiation strategy in a market-driven, rapidly growing, fast-changing business, carefully engineered manufacturing costs are less important. Monitoring of R&D productivity is more important in a pharmaceutical company than manufacturing cost control. 
Designers of management control systems should take explicit notice of the strategic context in which the controls are being applied. Companies/ business units can have missions that can be classified as build, hold, or harvest, and their managers can also decide to build competitive advantage based on low cost or differentiation. The appropriate management control process is influenced by which of these strategies a given company/business unit selects. 
 
Linking controls to strategies should not be used in a mechanistic manner, the suggestions made here are tendencies, not universal truths. Control systems should be designed in the context of each organisation’s unique external environment, technology, strategy, organisation structure, culture and top management style.

Cost driver analysis  

The basic concept of strategic cost drivers is to get away from the notion that volume drives cost. Cost is caused, or driven, by many factors that are interrelated in complex ways. Understanding cost behaviour means understanding the complex interplay of the set of cost drivers at work in any given situation. The basic outline of this strategic perspective is as follows:
  • For strategic analysis, volume usually is not the most useful way to explain cost behaviour.     
  • What is more useful in strategic sense is to explain cost position in terms of the structural choices and executional skills that shape the firm’s competitive position.     Not all the strategic drivers are equally important all the time, but some (more than one) of them are very probably very important in every case.     
  • For each cost driver there is a particular cost analysis framework that is critical to understanding the positioning of the firm. Effective general management today requires awareness of these issues. 
Strategic cost management framework provides a more useful way to apply the power of cost analysis concepts to for example technology investment opportunities within a fully articulated strategic analysis context. One essential step in effective management of technology change clearly is effective analysis of the investment opportunities. We believe that strategic cost management is a useful way to structure the analysis of such opportunities and thus represents an important component of technology management.
 
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                                           Albert Gagliardi
 
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Finance Leadership & Development. Chairman of the Dutch Controllers Institute (Vereniging van Register Controllers) 

De  senior Finance professional die ook kan boekhouden!   Ervaren senior Finance professional die ervoor zorgt dat de financiën orde zijn en blijven. Als Finance meedenkt in het structureren van de (administratieve)organisatie en zorgdraagt voor adequate management informatie. De Kleermaker, voor uw financieel maatpak!  De rode draad is werken en studeren. Ik ben begonnen als boekhouder en zo de hele carriere ladder opgeklommen tot CFO. 
Daarna in een internationale setting de Finance ervaring uitgebouwd. Als zelfstandig senior Finance professional mijn Finance ervaring in verschillende bedrijfstakken uitgebreid en daarnaast betrokken geweest bij andere organisatie vraagstukken. Tijdens mijn carriere in de avond gestudeerd via HBO, universiteit tot en met postdoctorale controllers opleiding.  Mijn kerncompetenties zijn: finance, controlling, administratieve organisatie, management accounting  Mijn ambitie is het financieel en bedrijfseconomisch geweten te zijn in het bedrijf

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