Cornerstones of cost
management, 4e
Chapter 11
Strategic cost management
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Learning objectives
1. Explain what strategic cost management is and how it
can be used to help a firm create a competitive
advantage
2. Discuss value-chain analysis and the strategic role of
activity-based customer and supplier costing
3. Tell what life-cycle cost management is and how it can
be used to maximize profits over a product’s life cycle
4. Identify the basic features of JIT purchasing and
manufacturing
5. Describe the effect JIT has on cost traceability and
product costing
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Introduction
Cost management
Strategic Decision Making and Cost
Management
•
Strategic decision making
– Choosing among alternative strategies

•
Goal - Selecting a strategy that provides a company with
reasonable assurance of long-term growth and survival
Strategic cost management
– Use of cost data to develop and identify superior
strategies that will produce a sustainable competitive
advantage
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Introduction
Cost management
Competitive Advantage, Total Product, and
Post-Purchase Costs
•
Competitive advantage: Creating better customer
value for the same or lower cost than offered by
competitors
– Customer value: Difference between customer
realization and customer sacrifice
•
•
Total product: Complete range of tangible and
intangible benefits that a customer receives from a
purchased product
Post-purchase costs: Costs of using, maintaining,
and disposing of the product
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Introduction
Cost management
Strategies For Increasing Customer Value
To Achieve Competitive Advantage
•
Cost leadership
– Looks to provide the same or better value to customers
at a lower cost than offered by competitors
•
Differentiation
– Strives to increase customer value by increasing what
the customer receives
•
Focusing
– Places emphasis on a market or customer segment
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Introduction
Cost management
Strategic Positioning
•
•
Process of selecting the optimal mix of three general
strategic approaches
Role of cost management
– Reduce costs
– Strengthen the chosen strategic position
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Introduction
Cost management
Value-Chain Framework
•
Industrial value chain: Linked set of value-creating
activities
– Firm must understand the entire value chain in order to
create and sustain a competitive advantage
•
Compelling approach to understanding a firm’s
strategically important activities
– Recognition of complex linkages and interrelationships
among activities within and beyond the firm is vital
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Introduction
Cost management
Types of Linkages
•
•
Internal linkages: Relationships among activities that
are performed within a firm’s portion of the value chain
External linkages: Relationship of a firm’s value-chain
activities that are performed with its suppliers and
customers
– Types - Supplier linkages and customer linkages
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Introduction
Cost management
Identification and Selection of Firm’s
Activities
•
•
•
Firm’s activities can be used to produce or sustain a
competitive advantage
Help exploit a firm’s internal and external linkages
Classification of activities
– Organizational activities
– Operational activities
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Introduction
Cost management
Organizational Activities and Cost Drivers
•
Types of organizational activities
– Structural activities: Determine the underlying
economic structure of the organization
– Executional activities: Define the processes and
capabilities of an organization
•
Organizational cost drivers: Structural and
executional factors that determine the long-term cost
structure
– Types - Structural and executional cost drivers
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Introduction
Cost management
Exhibit 11.2 - Organizational Activities
and Drivers (1 of 2)
Structural Activities
Structural Cost Drivers
Building plants
Number of plants, scale, degree of
centralization
Management structuring
Management style and philosophy
Grouping employees
Number and type of work units
Complexity
Number of product lines, number of
unique processes, number of unique
parts, degree of Complexity
Vertically integrating
Scope, buying power, selling power
Selecting and using process
technologies
Types of process technologies,
experience
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Exhibit 11.2 - Organizational Activities
and Drivers (2 of 2)
Executional Activities
Executional Cost Drivers
Using employees
Degree of involvement
Providing quality
Quality management approach
Providing plant layout
Plant layout efficiency
Designing and producing
products
Product configuration
Providing capacity
Capacity utilization
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Operational Activities and Drivers
•
•
Operational activities: Day-to-day activities performed
as a result of the structure and processes selected by
the organization
Operational cost drivers: Factors that drive the cost
of operational activities
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Introduction
Cost management
Exhibit 11.3 - Operational Activities
and Drivers (1 of 2)
Unit-Level Activities
Unit-Level Drivers
Grinding parts
Grinding machine hours
Assembling parts
Assembly labor hours
Drilling holes
Drilling machine hours
Using materials
Pounds of material
Using power
Number of kilowatt-hours
Batch-Level Activities
Batch-Level Drivers
Setting up equipment
Number of setups
Moving batches
Number of moves
Inspecting batches
Inspection hours
Reworking products
Number of defective units
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Exhibit 11.3 - Operational Activities
and Drivers (2 of 2)
Product-Level Activities
Product-Level Drivers
Redesigning products
Number of change orders
Expediting
Number of late orders
Scheduling
Number of different
products
Testing products
Number of procedures
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Exhibit 11.4 - Organizational and
Operational Activity Relationships
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Value-Chain Analysis
•
Identifying and exploiting internal and external linkages
to strengthen a firm’s strategic position
– Exploitation of linkages relies on analyzing how costs and
other nonfinancial factors vary
•
Objective - To control cost drivers better than
competitors
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Introduction
Cost management
Exploiting Internal Linkages
•
•
Relationships between activities are assessed and
used to reduce costs and increase value
Knowing the cost drivers of activities is crucial for
understanding and exploiting linkages
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Introduction
Cost management
Exhibit 11.5 - Internal value chain
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Exploiting Supplier Linkages
•
•
Managing linkages in order for the company and the
external parties to receive increased benefits
Suppliers provide inputs and can have a significant
effect on a user’s strategic positioning
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Introduction
Cost management
Managing procurement costs using activitybased costing (1 of 2)
•
Purchasing managers should choose suppliers whose
quality, reliability, and delivery performance are
acceptable
– Requirements


Suppliers should be evaluated based on total cost and not
just purchase price
Supplier costs are assigned to products using causal
relationships
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Introduction
Cost management
Managing procurement costs using activitybased costing (2 of 2)
•
Activity-based costing
– Defines suppliers as cost objects and traces costs
related to purchase, quality, reliability, and delivery
performance to suppliers
– Defines products as cost objects and traces supplier
costs to specific products
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Introduction
Cost management
Managing customer costs
•
Failure to assign customer-servicing costs accurately
will prevent sales representatives from managing the
customer mix effectively
– Customer-related costs allow the firm to classify
customers as profitable or unprofitable
– Once identified, actions can be taken to strengthen the
strategic position of the firm
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Introduction
Cost management
Product Life-Cycle Viewpoints
•
Product life-cycle: Can refer to a product class as a
whole, to specific forms, and to specific brands or
models
– Revenue-producing life: Time a product generates
revenue for a company
– Consumable life: Length of time that a product serves
the needs of a customer
•
Viewpoints are marketing-oriented and productionoriented
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Introduction
Cost management
Exhibit 11.7 - General Pattern of Product
Life Cycle: Marketing Viewpoint
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Production Viewpoint
•
•
Defines stages of the life cycle by changes in the type
of activities performed
Emphasizes life-cycle costs
– Life-cycle costs: All costs associated with the product
for its entire life cycle
– Costs include:


Research and development
Production and logistics support
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Introduction
Cost management
Exhibit 11.8 - Product Life Cycle:
Production Viewpoint
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Consumable Life-Cycle Viewpoint
•
•
Related to activities that define the stages of
purchasing, operating, maintaining, and disposal
Emphasizes product performance for a given price
– Price is the costs of ownership that includes purchase,
operating, maintenance, and disposal costs
•
Total customer satisfaction is affected by purchase
price and post-purchase costs
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Introduction
Cost management
Life-cycle management
•
Consists of actions taken that cause a product to be:
– Designed and developed
– Produced, marketed, distributed, and operated
– Maintained, serviced, and disposed
•
Helps maximize life-cycle profits by taking advantage
of revenue enhancement and cost reduction
opportunities
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Introduction
Cost management
Relationships among life-cycle viewpoints
•
•
•
Marketing viewpoint is revenue-oriented
Production viewpoint is cost-oriented
Consumable life-cycle viewpoint is customer value–
oriented
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Introduction
Cost management
Exhibit 11.9 - Typical Relationships of
Product Life-Cycle Viewpoints (1 of 2)
Marketing Product Life Cycle:
Attributes
Sales
Introduction
Low
Growth
Maturity
Rapid growth
Slow growth,
peak sales
Decline
Declining
Production Life Cycle:
Attributes
Introduction
Growth
Maturity
Decline
Expenses:
Product R&D
High
Moderate
Moderate
Low
Product R&D
Moderate
High
Moderate
Low
Plant & equipment
Low to moderate
High
Moderate
Low
Advertising
Moderate to high
High
Moderate
Low
Service
Low
Moderate
High
Low
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Exhibit 11.9 - Typical Relationships of
Product Life-Cycle Viewpoints (2 of 2)
Consumable Life Cycle:
Attributes
Introduction
Growth
Maturity
Decline
Customer value:
Customer type
Innovators
Mass market
Mass market,
differentiated
Laggards
Performance
sensitivity
High
High
High
Moderate
Price sensitivity
Low
Moderate
High
Moderate
Competition
None
Growing
High
Low
Attributes
Profits
Introduction
Negligible
to loss
Growth
Peak levels
Maturity
Moderate
to high
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Decline
Low
Revenue Generation and Cost reduction
strategies (1 of 2)
•
Revenue-generating strategies depend on marketing
life-cycle stages and customer value effect
– For viable revenue enhancement, customers must be
willing to pay a premium for any improvement in product
performance
•
Cost reduction strategies
– Actions taken in early stages of the production life-cycle
can lower costs for later production and consumption
stages
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Introduction
Cost management
Revenue Generation and Cost reduction
strategies (2 of 2)
– Careful product design and process design can help
reduce:



Manufacturing costs
Logistical support costs
Post-purchase costs
– Activity-based costing information is critical for life-cycle
cost reduction decisions


Produces information about activities and cost drivers
Encourages good life-cycle planning
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Introduction
Cost management
Target Costing
•
Useful tool for establishing cost reduction goals during
the design stage
– Target cost: Difference between the sales price needed
to capture a predetermined market share and the
desired per-unit profit
– Requires close interaction between the firm and its
suppliers
•
Cost reduction methods
– Reverse engineering
– Value analysis
– Process improvement
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Introduction
Cost management
Exhibit 11.10 - Target-Costing Model
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JUST-IN-TIME (JIT) MANUFACTURING (1 of 2)
•
•
•
•
Demand-pull system
Objective is to eliminate waste by producing a product
only when it is needed
Assumes that all costs other than direct materials are
driven by time and space drivers
Improves quality, increases productivity, reduces lead
times, inventories, and setup times, and lowers
manufacturing costs
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Introduction
Cost management
JUST-IN-TIME (JIT) MANUFACTURING (2 of 2)
•
JIT manufacturers emphasize long-term contracts
– Help reduce the uncertainty in demand for the supplier
and establishes the mutual confidence and trust
– Reduce the number of orders placed

Helps drive down ordering and receiving costs
– Reduce the cost of parts and materials
– Ensure reasonably stable demand for a supplier’s
products
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Introduction
Cost management
JIT Purchasing
•
•
Requires suppliers to deliver parts and materials just in
time to be used in production
Utilizes supplier linkages by:
– Negotiating long-term contracts with a few suppliers
located close to the production facility
– Establishing more extensive supplier involvement
•
Vital considerations
– Performance
– Commitment
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Introduction
Cost management
JIT - Plant Layout
•
Follows a pattern of manufacturing cells
– Manufacturing cells: Contain machines that are
grouped in families, usually in a semi-circle
– Each cell is viewed as a mini-factory
•
Executional cost driver for a JIT setting is cell structure
– Cell structure increases the ability of an organization to
execute successfully and affects structural activity
– Labor is multiskilled and not specialized
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Introduction
Cost management
Exhibit 11.11 - Plant Layout Pattern:
Traditional versus JIT
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JIT - Grouping of Employees and Employee
Empowerment
•
Each cell requires easy and quick access to support
services
– Centralized service departments are scaled down, and
employees are reassigned to work directly with
manufacturing cells
•
Employee empowerment increases productivity and
overall cost efficiency
– Fewer managers are required when workers assume
greater responsibilities, and the organizational structure
becomes flatter
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Introduction
Cost management
JIT - Total Quality Control
•
JIT cannot be implemented without a commitment to
total quality control (TQC)
– Acceptable quality level (AQL): Approach to managing
quality that is diametrically opposed to the traditional
doctrine

Permits or allows defects to occur provided they do not
exceed a predetermined level
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Introduction
Cost management
Exhibit 11.12 - Comparison of JIT Approaches
with Traditional Manufacturing and Purchasing
JIT
Traditional
1. Pull-through system
1. Push-through system
2. Insignificant inventories
2. Significant inventories
3. Small supplier base
3. Large supplier base
4. Long-term supplier contracts
4. Short-term supplier contracts
5. Cellular structure
5. Departmental structure
6. Multiskilled labor
6. Specialized labor
7. Decentralized services
7. Centralized services
8. High employee involvement
8. Low employee involvement
9. Facilitating management style
9. Supervisory management style
10. Total quality control
10. Acceptable quality level
11. Buyers’ market
11. Sellers’ market
12. Value-chain focus
12. Value-added focus
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Exhibit 11.13 - Product Cost Assignment:
Traditional versus JIT Manufacturing
Manufacturing Cost
Traditional Environment
JIT Environment
Direct labor
Direct tracing
Direct tracing
Direct materials
Direct tracing
Direct tracing
Materials handling
Direct tracing
Direct tracing
Repairs and maintenance
Direct tracing
Direct tracing
Energy
Direct tracing
Direct tracing
Operating supplies
Direct tracing
Direct tracing
Supervision (department)
Allocation
Direct tracing
Insurance and taxes
Allocation
Allocation
Plant depreciation
Allocation
Allocation
Equipment depreciation
Direct tracing
Direct tracing
Custodial services
Allocation
Direct tracing
Cafeteria services
Direct tracing
Direct tracing
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Effect of JIT on Product Costing
•
JIT manufacturing converts many common costs to
directly attributable costs
– Increase in directly attributable costs increases the
accuracy of product costing
•
All batch-level activities are converted into unit-level
activities
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Introduction
Cost management
JIT's Effect on Job-Order and ProcessCosting Systems
•
In implementing JIT in a job-order setting, the firm
should first separate its repetitive business from its
unique orders
– Costs are accumulated at the cellular level
•
Process costing is simplified
– Need to compute equivalent units vanishes
– Calculating product costs involves collecting costs for a
cell for a period of time and dividing the costs by the
units produced for that period
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Introduction
Cost management
Backflush Costing
•
•
Uses trigger points to determine when manufacturing
costs are assigned to key inventory and temporary
accounts
Varying the number and location of trigger points
creates different types of backflush costing
– Trigger points - Events that prompt the accounting
recognition of certain manufacturing costs
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Introduction
Cost management
Backflush Costing - Variations of trigger
points
•
•
•
•
Purchase of raw materials and the completion of goods
Purchase of raw materials and the sale of goods
Completion of goods
Sale of goods
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Introduction
Cost management