Strategic Cost Management - A Bird's Eye View

By

Ms. Shweta Desai

Mr. Bhargav Pandya
Lecturers
Shree Leuva Patel Trust MBA Mahila College
Shreemati. Shantaben H Gajera Shaikshanik Sankul
Chakkargadh Road, Amreli-365 601
 

Abstract:

Strategic cost management has become an essential area now days. While formulating the strategy for the
accomplishment of organizational overall objectives, different cost driver should be clearly identified.
Identification of key cost drivers help companies to focus on key activities that will constitute almost 90%
of the total costs. In view of this, the importance of strategic cost management should not be
underestimated. This implies that organization should be installing appropriate framework of strategic cost
management to reduce its costs in key areas on which the success of organization is heavily dependent.

To give spotlight to the companies in this complex business model we have covered some important
aspects of strategic cost management. Which can be very much help full to the business world. In this
paper we have tried to give some general explanation of strategic cost management. We have first defined
the meaning and applications of strategic cost management and then we w3ent on to describe the
framework and steps involved in strategic cost management programme. And lastly we have tried to
identify some key enablers that will facilitate effective implementation of strategic cost management
programme along with the questions that are to be answered while implementing strategic cost
management programme in an organization successfully.

Introduction:

Many of the terms are not new: cost reduction, target costing, total cost management, or cost avoidance.
These efforts have been targeted in several organizations. But how many purchasing and supply
organizations have adopted these tactics for the short-term gain and how many have taken a strategic
approach that spans several links in the supply chain? More and more will be taking the strategic
approach, focusing on strategic cost management. It has now a days become abuzz word in the street of
corporate houses. Corporate houses are now searching out for ways to manage their huge conglomerates.

The downsizing and reengineering initiatives so prevalent in the early '90s have largely proved financially
short-sighted. With hindsight, we now know that almost half of downsizing companies reported lower
profits the year following their cutbacks. Cost-cutters' stock prices grew more slowly than those of
companies which successfully grew both their top and bottom lines. Less than one in five cost-cutters were
subsequently able to put their companies back on a profitable growth track. Pressures on costs come from
many external quarters, including shifting customer priorities, the emergence of new competitors and
channels, and increasingly inquisitive financial mark.

Concept of Strategic Cost Management:

Trying to define strategic cost management requires looking at today's leading organizations who are
venturing in this area. Some of the processes are new and uncharted territory, so there's no textbook to
spell it out.
Cost Management Defined:

The Purchasing Handbook defines cost management as, "the establishment of programs that
regularly analyze purchase requirements and suppliers to identify lowest total cost and
maximize total value to the company. The development of a savings forecast by commodity is
necessary to define budget parameters for building cost-of-goods structures."

Strategic Cost Management:

Strategic cost management can be defined as" scrutinizing every process within your organization,
knocking down departmental barriers, understanding your suppliers' business, and helping improve their
processes"

Applications of Strategic Cost Management:

There are three basic business areas where strategic cost management can be applied.

Strategy:

A strategy in general terms refers to a plan of action that will shape the direction of organization's success.
Companies of late have realized the importance of clear articulation of strategy and its effective
implementation. Before formulating any strategy, the management should think about the business model
whether it is still relevant or need to be changed? Or whether the objectives of the business are going to
be accomplished through laid out strategy.

Operations:

By setting the priorities according to its significance we can operate the tasks effectively and efficiently.

Organization:

Company should time and again check whether it is allocating its limited resources in the businesses which
generate more value for the entire organization. Resources as such are the liming factors for any
organization and that's why the company should be  focus on the structure of the business and it should
decide well in advance whether it should own all resources or not?

Strategic Cost management framework:

The Strategic cost management framework provides a clear plan of attack for addressing costs and
decisions that affect them. Following are the three core components of this framework.
Core Functions:

Core functions elaborate on the nature of the business. It answers the very obvious question what type of
business are we in? At this stage the company has to clearly identify its courses of actions with respect to
strategy planning, research and development, and product development.

Customer Delivery Function:

This step emphasizes more on value addition with various activities such as marketing, sales,
manufacturing, quality assurance and control, sourcing, procurement and logistics, engineering and
maintenance, customer service and technical support etc. Excellence in those activities can create a sort of
competitive advantage for the company if it could harness its resources intelligently than its competitors.

Support Functions:

As the name suggests, to support the core activities of business some secondary activities are to be
carried out which includes IT, Finance and Accounting, HR management General administration. These
activities will facilitate the performance of the core activities in a way that goals of the business can be
accomplished successfully without wasting limited resources. They will also help in synchronizing the
different tasks which are to be carried out simultaneously.

Strategic Management Programme Steps:

SCM Programme includes following five steps. These steps can be detailed out as follows:

1. Focus:

 Focus state starts with reviewing the different strategies of the company. Reviewing the strategies will
lead to clear identification of performance gaps and this will help to bridge the gap by improving targets
already set beforehand. Modifying the targets will lead to developed plan of attack which will foster better
internal communication within the organization.

2. Planning and Training:

  Planning plays a crucial role in implementing strategic cost management programme. To implement the
planning, a manager should gather very efficient team members and train them accordingly. Setting up of
project management structure will facilitate the implementation of strategic cost management by clearly
identifying the day to day activities, steering guidance and offering ad hoc assistance.
3. Fact Finding:

 This stage includes the tasks such as data gathering, conducting interview, developing benchmarks,
conducting and customer surveys.

4. Analysis and Recommendations for changes:

 Analysis of activities plays a crucial role in ascertaining the cost of the company.  It can be done by
various strategic cost management analytical tools viz. cost driver analysis, activity-based costing,
selective business process reengineering etc. An action plan for proposed change should address the
following questions what, who, when how aspects of the activities.

5. Implementation:

 In implementation stage the first task to be done is to define responsibilities and accountability of each
individual and controlling i.e. monitoring and corrective action should be the taken at each stage of
programme. And this is how the continuous improvement can be achieved. The third, fourth and fifth sate
in the above process indicates continuous improvement.

Key Enablers That Facilitate Strategic Cost Management.

Each individual organization needs to review their various supply needs and supply chains and determine
what enablers are of prime importance to their situations. We will discuss an approach to that problem
later in the paper. In this section we will discuss a number of generally applicable enablers, some of which
are likely to be present in many supply situations. The enablers are grouped by the three phases present
in most cost management approaches: analysis and planning, implementation, and ongoing management
and control. Some apply to more than one phase and are so listed but discussed only at the first listing.

Analysis and Planning Enablers:

 Top management support and sponsorship - Without this forget the whole idea of cost
management. However, to get this support, top management must understand the value of supply
chain management to the bottom line. If management seems reluctant to recognize this from
internal efforts alone, cooperative efforts with suppliers and/or customers may help to convince
them.
 Information systems - To capture spending by commodity or service, supplier, and geographical
area. Information can be used to: identify opportunities for synergy with other supply chain
members in areas such as leveraging spend, pooling knowledge, acquiring/providing/sharing
technology, identify areas where transfer of best practices will reduce costs, optimize location and
use of resources, such as inventories, in the supply chain, and help to identify total cost drivers.
 Identity of total cost drivers - What are all of the elements that make up the total cost in a
given supply chain? Total cost drivers may vary by geographical areas and may include items such
as logistics, transportation, inventory, lead time, lack of infrastructure, lack of qualified or trained
personnel, lack of qualified suppliers, and production impact of particular products or services.
Additional drivers that may be present in a global analysis could include tariffs and duties, currency
exchange rates, hostile political or geographical environments.
 Cost models - If models of major costs in the supply chain are not available, they may need to be
developed. Cost models may have to be adjusted by country or region in global supply chain
situations. Some techniques for modeling costs include learning curve analysis, experience effect
analysis, price productivity analysis, implied set-up cost analysis, should-cost analysis, comparative
process analysis, and cost breakdown analysis. Some approaches to cost and price modeling and
analysis are presented in Chapter 19 of the current edition of The Purchasing Handbook.
 A strategic cost management plan - There must be known cost management objectives and a
plan as to how you are going to achieve them. One approach to prepare such a plan is to use a
 three-step approach that includes: classifying purchases, matching cost analysis tools with the
purchase classifications, and focusing on strategic cost management techniques to achieve cost
management results.
 Effective cross-functional teams - Vital to the success of any cost management effort because
of the varied departments and functions that are affected and need to be involved to implement
cost management initiatives. All parties either affected by the costs in question or involved in
generating those costs need to be involved in the applicable cost management teams.
 Known Business strategies - To develop purchasing cost management strategies, overall
business strategies must be known. The maximum effect of strategic cost management in the
supply chain can only be achieved when supply chain strategies are aligned with overall business
strategies. Obviously, to achieve alignment, overall business strategies must be known to the
supply chain team.
 Alignment of supply strategies with business strategies - To be most effective, purchasing
cost management strategies must be aligned with overall business strategies. This enabler is key to
successful strategic cost management and also to obtaining full support of top management. Do not
make the mistake of concentrating cost management efforts in an area that management considers
unimportant, or in an area of the business that is not strategically important to the company and/or
may be up for divestiture.
 Total cost approach to procurement - Frequently the most significant cost reductions in a
supply chain do not result from lower prices. Price is important but it is not the only cost. Costs
other than price may have more reduction potential or may be easier to reduce than price itself. Do
not overlook any cost element. Sometimes costs that are indirectly linked to the use of products or
services may contain large reduction potential as a result of changes in the purchased products or
services.
 Balanced approach to sourcing - It is inefficient to either purchase everything through alliances
or purchase everything on a transactional basis. All purchases must be analyzed and categorized
according to criteria such as total spend, long-term vs. short-term need, strategic importance, and
supply base capabilities. From such an analysis individual purchase categories can be identified as
candidates for strategic alliances, small-value purchase techniques, and transactional approaches.
 Performance measurements - Without measurements you don't know where you are, where you
came from, or where you are going. Performance measurements should be established for all
aspects of a strategic cost management plan that are critical to its success. Therefore the first step
in establishing measurements is to identify critical success factors and then develop indicators to
measure how well they are being achieved. The results of measurement can be used to report
success, to identify problem areas, and as the basis for taking corrective action.
 Redefinition of procurement business processes - Necessary to accommodate balanced
sourcing and efficient methods for handling transactional purchasing activities. Adoption of a
continuous process improvement approach to supply chain operations will cause continual
redefinition of business processes in the supply chain.
 Maximize the leverage effect of purchasing - Use the information available from data systems
to determine global spend by product, supplier, and geographical area to identify leverage
opportunities. Leverage benefits can include price, quality, service, availability, knowledge, and
other factors

Sharing of Risks and Rewards - Necessary to the successful integration of activities in a supply chain to
achieve strategic cost management in the chain. Provides all chain members with incentives to cooperate
and participate in cost management initiatives

Implementation Enablers:

 Supply chain visioning - Brainstorm cost improvement possibilities with affected business units
and others in your organization and supply chain members/partners. Do this through working
sessions with the active leadership of business units or internal customer groups to develop a
common understanding of internal customer requirements and to develop a value proposition, i.e. a
distinctive competence that can be used to better serve internal customer needs and how
operations must be changed to implement the envisioned improvements.
  Diffusion of best practices in the organization - Without organization-wide application of best
practices, cost management objectives cannot be fully achieved. Frequently a best practice in one
part of the supply chain is a good model for application elsewhere in the chain to achieve the most
effective cost management.
 Strategic alliances - Necessary in key supply chains to achieve the close cooperation required for
effective cost management. The set-up and maintenance costs of strategic alliances rule them out
in many purchase situations but they are necessary in high-spend, critically important areas.
 Planned change management - Changes in processes and procedures must be well-planned and
executed. Use techniques such as pilot implementation of changes (make mistakes on a small
scale). Also, adequate training in new or changed processes must be provided for all affected
groups and individuals.
 Supply base rationalization - To effectively manage costs, the number of suppliers must be
reduced to a minimum. Qualification and maintenance of large supplier bases is expensive.
Leverage potential for price, quality, service, delivery, and technology cannot be maximized without
reducing the number of suppliers.
 Existence of shared supplier-customer strategies - Shared strategies are best and most easily
obtained by use of cross-functional teams. Such teams must include supplier, critical third party,
and customer representation in addition to key functions of the buying organization.
 Minimization of transactional activities of purchasing - Eliminate, automate, or shift non-
value-added activities, e.g. processing of low-value purchase transactions out of purchasing.
 Shifting of supply chain costs - Find the member of the chain that can perform the activity most
efficiently and move the activity there. Be sure that actual cost reduction (and not merely cost
shifting) is achieved in the total cost of the supply chain.
 Outsourcing - If an activity can be performed more efficiently by someone who is not a member of
the supply chain, shift the activity outside the supply chain, effectively enlarging the chain but
making it more efficient. Guard against potential loss of technological advantage when outsourcing
state of the art processes.

Ask yourself the following questions to determine if you're on a course for strategic cost
management:

Organization and Personnel

 Have tactical purchasing duties been organized to require a minimum of purchasing and supply
management's time?
 Have personnel been trained in team approaches to management?
 Is there a plan for continuity of relationships and knowledge as organizations change?
 Have you identified all significant supply chains of which you are a member?

Cost Improvement

 Is there a plan for strategic cost management?

 Have the controlling functions or supply chain members for each significant cost in your
organization been identified?
 Are there resources devoted to finding or obtaining new approaches to breaking cost barriers?
 Is cost modeling being used or is there an active effort to develop or buy cost modeling capability?

Flexibility

 Do you have contingency plans in the event key suppliers are unavailable?
 Are you ahead of expected changes in technology and products that could impact effective cost
management?
 Are your partnership and alliance agreements flexible?
 Do your partners and alliance members offer a variety of capabilities that you may need over a
period of time? Do your agreements with them include all of these capabilities?
Endpoint:

In today's era organizations are trying their hard to reduce their costs. Ascertaining cost and finding out
the ways to reduce it has become the main issue for the organizations stepping into the uncertain
environment of 21st century. By following certain steps and framework of cost management, an
organization can effectively and efficiently implement some good strategies related to reduction of costs
and that in turn will decide the future competitive advantage of the companies trying to maintain their
market share and brand image in the tough competitive markets.

References:

* www.uakron.edu/uba/scm/issues.html
* www.vancechan.com/strategic-cost_management.html
* htto://www.ism.ws/pubs/ISMMag/099933.htm