CMA/CFM REVIEW

PART 3 - CHAPTER 1

STRATEGIC PLANNING

Magic Memory OutlineTM

. STRATEG
A. Strategic Pl
1. Mission and Strategic Goals ...............................................................................................................
2
. Strategic Planning Horizon .................................................................................................................
3. Analysis of Strengths, Weaknesses, Opportunities, and Threats (SWOT Analysis) ........................
a. Strengths ......................................................................................................................................
b. Weaknesses ..................................................................................................................................
c. Opportunities ...............................................................................................................................
d. Threats .........................................................................................................................................
4. Role of Capital Budgeting and Capacity Planning ................................................................................
B. Short-Term/Tactical Planning .............................................................................................................................
C. Contingency Planning .........................................................................................................................................
D. Characteristics of Successful Strategic/Tactical Planning ..................................................................................

II. MANUFACTURING PARADIGMS 3-1-2

A. Just-in-Time (JIT) Systems ...........................................................................................................................
1. Quality Control ...............................................................................................................................
2. Kanban .........................................................................................................................................
3. Characteristics and Objectives .....................................................................................................
a. Smooth Production Flow .......................................................................................................
b. Pull Method of Production ....................................................................................................
c. Small Lot Sizes .......................................................................................................................
d. Reduced Setup Time ................................................................................................................
e. High Quality Standards .............................................................................................................
f. Preventive Routine Equipment Maintenance ...........................................................................
g. Effective Employee Teamwork ..............................................................................................
h. Versatile Workers and Equipment ...........................................................................................
4. Work/Manufacturing Cells .............................................................................................................
5. Advantages of JIT ........................................................................................................................
6. Disadvantages of JIT .................................................................................................................
B. Materials Requirements Planning (MRP) ...........................................................................................
C. Outsourcing .............................................................................................................................................
D. Theory of Constraints (TOC) ................................................................................................................
1. Steps in TOC Analysis .................................................................................................................
a. Identify ...................................................................................................................................
b. Exploit ....................................................................................................................................
c. Subordinate ..............................................................................................................................
d. Elevate ....................................................................................................................................
e. Go Back to Step 1 ..................................................................................................................
2. Throughput ...................................................................................................................................
a. Benefits of Focus on Throughput ...........................................................................................
b. Throughput Costing ...................................................................................................................
3. Dram-Buffer-Rope System ...............................................................................................................
a. Drum ....
b.
c.
4. Relationship With ABC ....................................................................................................................
E. Other Contemporary Productivity Concepts ................................................................................................
1. Automation and Use of Robots/Computer-Aided Manufacturing (CAM) ........................................
2. Computer-Aided Design (CAD) ......................................................................................................

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3. Computer-Integrated Manufacturing (CIM) ...............................................................................................
4. Flexible Manufacturing Systems .................................................................................................................
III. BUSINESS PROCESS PERFORMANCE 3-1-5
A. Value-Added Concepts .......................................................................................................................................
1. Quality or Usefulness ...................................................................................................................................
2. Contextual Approach ...................................................................................................................................
B. Value Chain Analysis ..........................................................................................................................................
1. Value Chain Activities .................................................................................................................................
a. Primary Activities .................................................................................................................................
b. Support Activities .................................................................................................................................
2. Competitive Advantage and Customer Value .............................................................................................
a. Offering or Differentiation Advantage ................................................................................................
b. Low-Cost Advantage ...........................................................................................................................
3. Steps in Value Chain Analysis ....................................................................................................................
a. Internal Cost Analysis ..........................................................................................................................
b
. Internal Differentiation Analysis ..........................................................................................................
c
. Vertical Linkage Analysis ....................................................................................................................
4. Limitations of Value Chain Analysis ..........................................................................................................
a. Periodicity of Financial Data ...............................................................................................................
b. Accessibility of Data ............................................................................................................................
c. Isolation of Information .......................................................................................................................
C. Value
D. Benc
1. Fou
a. Internal Benchmarking .........................................................................................................................
b. Competitive Benchmarking .................................................................................................................
c. Functional Benchmarking ....................................................................................................................
d. Generic Benchmarking ........................................................................................................................
2. Best Practices Analysis ................................................................................................................................
E. Reengineering/Business Process Reengineering ................................................................................................
1. Definition .....................................................................................................................................................

2. Radical Rath
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. Competitive Advantage ...............................................................................................................................
F. Pareto Principle ...................................................................................................................................................
G. Kaizen/Continuous Improvement .......................................................................................................................
H. Activity Based Management (ABM) ..................................................................................................................
1
. ABC/ABM Cross .........................................................................................................................................
a
. ABC - A Cost Accounting Tool ..........................................................................................................
b
. ABM - A Management Tool ...............................................................................................................
2. Steps in ABM ...............................................................................................................................................
3. Combination of improvement Methods ......................................................................................................
4
. Common ABM Applications .......................................................................................................................

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 CMA/CFM REVIEW

PART 3 - CHAPTER 1

STRATEGIC PLANNING

The material in this chapter is tested on the CMA exam at Level B, which means that the candidate is
responsible for demonstrating knowledge, comprehension, application, and analysis.

I. STRATEGIC AND TACTICAL PLANNING

Planning is a continuum from long-term and strategic to short-term and detailed. All parts of an organization's
planning must fit together for long-term success.

A. Strategic Planning

Strategic planning determines the path an organization chooses for attaining its mission and long-term goals.
Goals, objectives, plans, etc., are related terms that may vary from organization to organization.

1. Mission and Strategic Goals: The mission of an organization is its central purpose, the reason for its
existence. It answers the questions "What business are we in?" or "What business do we want to be in?" This may seem
like an obvious question, but it isn't always easy to answer. A company can meander from one focus to another on its
way to failure if it doesn't know what business it is really in. Strategic goals are the major goals that relate to the
company's mission. The mission defines the broad goals that are compatible with the company's mission. The mission is
translated into strategic goals that an organization worked toward over the long term. There are generally goals related
to profitability, market share, service and product quality, employee development, community service, and so on.

2. Strategic Planning Horizon: Strategic plans are company-wide plans with a long planning horizon,
sometimes as much as ten to thirty years. Many companies have a "5-Year Plan" which is revised annually with a new
year added each time. In for-profit companies, a major part of strategic planning would be profit related. Capital
budgeting has a strategic component in that the decision whether or not to build a new factory will affect the company's
profits for many years.

3. Analysis of Strengths, Weaknesses, Opportunities, and Threats (SWOT Analysis): Strategic plan
formation involves an analysis of the enterprise SWOT qualities: internal strengths and weaknesses (resources), and
external opportunities and threats (environment). SWOT analysis helps managers clarify the organization's mission,
which in turn leads to long-term objectives such as business diversification, addition or deletion of product lines, or
penetration of new markets.

a. Strengths: These internal factors focus on areas where we have a comparative advantage because
of internally created resources. Examples are patents, copyrights, or highly trained people.

b. Weaknesses: These internal factors are the opposite; they represent areas where we are weak or
our competitors have comparative advantages over our internally created resources.

c. Opportunities: These are external factors that involve matching the environment to the
organization. The focus and attention is on critical issues and choices facing the enterprise. Opportunities can, and
should, be prioritized.
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 d. Threats: External in nature, these factors can arise from a competitor or from changes in market
demographics. Threats may also be the consequence of an adverse change in one of our necessary inputs.

4. Role of Capital Budgeting and Capacity Planning: All aspects of an organization's strategic planning
process must fit together. Therefore, capital budgeting (see the later section in this chapter) and capacity planning must
be made in concert with other strategic plans.

B. Short-Term/Tactical Planning

Tactics are used to support and achieve organizational and strategic goals. Such plans and policies translate
long-term strategies into shorter-term specifics for each division, department, etc. The time period is normally not
longer than one year. They contain more detail and are more action oriented. Short term planning includes:

· Short-term objectives
· Tactics for achieving short-term objectives
· Operational planning (including a master budget)

C. Contingency Planning

Plans are always subject to uncertainties. Regardless of the care with which a plan is developed, its
assumptions, forecasts, and goals may not be achieved. Contingency planning is the identification of alternatives that
may be adopted depending on future circumstances. This type of planning allows managers to quickly detect when an
original plan has become inadequate, and it minimizes potential losses.

Contingency planning is particularly important in cases where the original plan is subject to considerable risk
from external factors that can reduce opportunities or create threats.

D. Characteristics of Successful Strategic/Tactical Planning

Organizations that successfully integrate and implement their strategic and tactical plans are more focused,
flexible, and successful than other organizations. They are more focused on the organization's strategies as they make
day-to-day decisions. Coordination is improved among the various subunits in the organization, and short-term
decisions are more consistent with long-term goals. These organizations are also more flexible in adapting to changing
circumstances and shifting competition. SWOT and other strategic analyses help managers identify major limitations
and threats, which enables them to develop appropriate contingency plans. In addition, successful strategic/tactical
planning includes the measurement and monitoring of specific targets to be achieved. These targets may be short-term
or long-term, and they may be called goals, objectives, or something else.

II. MANUFACTURING PARADIGMS

The strategic management part of the CMA exam requires knowledge of several commonly-used
manufacturing paradigms that reduce costs and improve manufacturing efficiency.

A. Just-in-Time (JIT) Systems

Just-in-time (JIT) refers to systems in which items are delivered where and when needed.

In a JIT production system, each component in a production sequence is produced as it is needed by the next
processing step. It is described as "demand-pull" or just "demand" production. JIT requires a detailed system for
integrating the sequential operations of the process. Accurate sales forecasts are needed for effective finished goods
planning and production scheduling. If possible, products should be designed to use standardized parts to reduce
manufacturing time and per unit input costs.

A JIT inventory system is one in which the company develops a group of reliable local vendors who can
supply the inventory with minimum lead time just before the item is required in the manufacturing process.

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 1. Quality Control: Little or no inventory is kept on hand, so production is interrupted if parts do not
arrive as needed or are defective. Quality control is critical, as is a good relationship with vendors to obtain high quality
materials with frequent deliveries. If quality control procedures are not in place, the entire process breaks down.

2. Kanban: The basic principle of just-in-time production is not to produce anything until the next stage in
the production process is ready to work on it. The procedure originated in Japan and is based on the "kanban" concept.
A kanban is a communication device, which may be a card, sign, or production bin. When work is completed in one
area, the card, sign, or empty bin is returned to the preceding work area to signal that additional materials/products are
demanded. This demand triggers production at the previous station - hence the name "demand-pull". The ultimate
demand is the customer's order or anticipated orders.

3. Characteristics and Objectives: Just-in-time production has the following characteristics and
objectives:

a. Smooth Production Flow: Smooth, uninterrupted flow of material is needed from suppliers
through the production process and finally to customers as completed goods without fluctuations that can lead to excess
inventories and/or delays. Raw material must arrive when needed for each subassembly so that the production process
functions smoothly.

b. Pull Method of Production: The pull production method is utilized, whereby goods are produced
at each step of the manufacturing process only when required by the subsequent step.

c. Small Lot Sizes: Purchasing materials and producing subassemblies in small lot sizes reduces
inventory buildup and associated costs.

. Reduced Se

e. High Quality Standards: High quality standards for direct materials and finished products are
required to avoid production line shut-downs and waiting time costs.

f. Preventive Routine Equipment Maintenance: Routine preventive maintenance avoids downtime

from malfunctions and associated waiting time costs from resultant delays in the production process.

g. Effective Employee Teamwork: Employee teamwork generates ideas to improve product quality
and production efficiency, and to reduce costs.

h. Versatile Workers and Equipment: In order to produce a variety of products as needed to avoid
bottlenecks and resultant higher costs, both workers and equipment must be versatile.

4. Work/Manufacturing Cells: In a JIT production system, work is often broken down into sets of tasks
that are performed in different work or manufacturing cells. Each cell is a work area that performs a particular set of
tasks.

5. Advantages of JIT: Reducing inventory under just-in-time produces immediate savings in the form of
lower financing carrying costs. Included are the working capital which would otherwise be necessary to carry and
support the inventory, storage, inventory taxes, insurance and security costs. Most of these expenses are shifted to the
supplier under a JIT system. It also frees space on the production floor which had been used to store work-in-process. A
less visible advantage is that a JIT system requires better overall inventory and production management which may
promote total quality control. Inventory hides problems such as quality problems, bottlenecks, coordination problems,
obsolescence, shrinkage, and supplier unreliability. In order to implement just-in-time, these problems have to be solved
rather than worked around with inventory buffers. Solving these problems permits ~eat improvements in productivity.

6. Disadvantages of JIT: Because it is necessary to receive inputs with minimum lead time, the vendor's
reliability becomes very important. This is especially important if there are no alternative supply sources. The material
and freight costs of multiple small orders may go up on a per unit basis. The supplier networks must be continually
monitored because their variables are usually less controllable than a system involving only the personnel of the
company. Out-of-stock situations may increase, resulting in customer dissatisfaction and possible downtime. Brand
loyalty may deteriorate, and the ultimate effect on a firm's downstream users and distributors may not be fully
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measurable.

B. Material Resource Planning (MRP)

The acronym MRP refers to "material resource planning" or to "material requisition planning." MRP refers to
the use of a computerized information system to schedule and order inventories of raw materials and other components
used in manufacturing. A sales forecast or specific customer's order for completed product units specifies a given
requirement date. The system then uses a bill of material and master production schedule to identify the type and
quantity of components needed and determines the amount and timing of orders to be placed for the needed
components. Orders may be placed through electronic data interchange (EDI) or a more traditional ordering system. In
recent years, MRP has evolved to include both materials and financing--the planning of cash requirements to pay for
inventory purchases.

The MRP system increases profitability by improving inventory management and reducing the investment in
unneeded and potentially obsolete inventory. It also helps managers identify situations where it is appropriate to incur
additional shipping costs to receive materials needed for a valuable order.

C. Outsourcing

Manufacturers are increasingly using outsourcing to reduce costs and improve their flexibility to modify
strategies and operating plans with changing circumstances. Outsourcing decisions, along with their benefits and
limitations, and discussed in detail later in CMA Part 3, Chapter 4.

D. Theory of Constraints (TOC)

The Theory of Constraints (TOC) was developed by E. M. Goldratt during the 1980s. TOC is based on the idea
that an organization has a single goal, which is achieved through a complex system of linked activities. Improvement in
individual activities often has little effect on achievement of the overall goal. Therefore, TOC focuses on identifying
and addressing variables--called constraints--that have a significant effect on global performance.

1. Steps in TOC Analysis: Goldratt proposed the following 5 steps for implementing the Theory of
Constraints as a continuous improvement process.

a. Identify: The 1st step is to identify the system's constraints; it asks the question: What to change?
In TOC, a constraint is a limitation on a system's performance. Goldratt argued that there are very few (perhaps only
one) true constraints in most systems, although there may be many bottlenecks. Fixing a bottleneck (such as a limited
physical resource) improves performance in only one subpart of the entire system, whereas fixing a constraint improves
total system performance.

b. Exploit: The 2nd step is to decide how to exploit the system's constraints; it asks the question:
What to change to? This step involves assumptions underlying the current system and identifying methods for relieving
the constraint, leading to improved system performance. The focus in this step is on identifying simple, practical
solutions rather than complex fixes. Attention is given to breaking through conflicts, avoiding unintended negative
consequences, and ensuring success.

c. Subordinate: The 3rd step is to subordinate everything else; it asks the question: How to change?
This step involves gaining commitment and developing a successful action plan. Sometimes organizations must change
long-standing patterns of behavior in parts of the system that are not constrained, and there can be emotional resistance
to change. It is essential to actively involve employees in developing the action plan and to subordinate other activities
to relieve the constraint.

d. Elevate: The 4th step is to determine whether desired results have been achieved--i.e., whether
output meets market demand--and, if not, to elevate the process by obtaining more capacity. Elevation might occur by
further modifying capacity use, outsourcing, or expanding capacity.

e. Go Back to Step 1: The 5th step is to engage in continuous improvement by repeating the TOC
analysis. Once the system's constraint has been relieved, the attention turns to the next constraint (theoretically, there is
always a constraint).
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 2. Throughput: Generically, throughput is the output relative to input of a system. In TOC, throughput is
defined as the rate at which the system generates money based on sales. Thus, the focus is on producing goods that are
sold, rather than simply producing goods.

a. Benefits of Focus on Throughput: A focus on throughput encourages managers to evaluate

product profitability measured as a rate based on time, rather than measured as profitability per unit. This focus
maximizes profit for constrained capacity. Also, managers are not encouraged to produce excess inventory, because
products are measured as throughput only when they are sold.

b. Throughput Costing: To encourage a focus on maximizing money based on sales, some

organizations adopt throughput costing to measure the throughput rate. Throughput contribution is measured as
revenues minus only direct material costs (purchases from outside suppliers). In most cases, costs such as direct labor
are not truly variable, so they are treated as period costs. Compared to other costing methods, throughput costing

discourages managers from producing excess inventories. (See CMA Part 2, Chapter 2 for discussions of absorption
costing and variable costing.)

3. Drum-Buffer-Rope System: A dram-buffer-rope system is a tool for managing product flow, inspired
by the Theory of Constraints. The system focuses on maximizing throughput around the constraint as follows:

a. Drum: The constraint in the system sets the pace (i.e., the "drum") for production. Production
cannot exceed the slowest path through the system.

b. Buffer: Protective inventory is built into the system to provide slack around the constraint. Unlike
JIT, in which desirable inventory is zero, TOC builds an allowance for problems into the system. Such problems might
include last-minute customer orders, delays in vendor shipments, employee absenteeism, equipment failure, etc. An
inventory buffer is needed to reduce risks to throughput.

. Rope: A "p

4. Relationship With ABC: TOC and ABC are complementary, rather than competing, analytical tools.
ABC (see CMA Part 2, Chapter 2) focuses on cost measurement for long-term decision making. TOC focuses on
throughput rather than cost measurement, and it addresses primarily short-term decision making.

E. Other Contemporarv Productivity Concepts

CMA candidates are expected to recognize other types of contemporary productivity concepts, such as the
following. Many of these concepts involve technology that is currently evolving and tends to be costly; increased
acceptance and adoption will likely occur as costs fall and system quality improves.

1. Automation and Use of Robots/Computer-Aided Manufacturing (CAM): The use of electronic or

mechanical machines to perform functions with little human intervention. Currently works best for functions that are
repetitive. Potential benefits include fewer safety and health problems, increased reliability, higher throughput, and
lower cost.

2. Computer-Aided Design (CAD): The use of software by architects, engineers, or others to design
products such as buildings, bridges, cars, clothing, etc. The drawing may be two- or three-dimensional, allowing the
user to view the object from different angles. May also be used to conduct a computerized test to determine whether
engineer-designed parts will fit together.

3. Computer-Integrated Manufacturing (CI1VO: Complete computerized manufacturing system that

designs products, schedules and optimizes production, integrates with ERP and other systems, and monitors
performance. Every machine in the assembly process communicates with others machines using job ticket information
that includes material requirements, machine set-up specifications, and production tolerances.

4. Flexible Manufacturing Systems: Manufacturing systems that allow products to be customized; not all
products go through the production process in the same way. Highly related to CIM; the process must adapt to each job
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ticket. Allows manufacturers to adapt to changing customer demand and quickly take advantage of new product
opportunities.

III. BUSINESS PROCESS PERFORMANCE

A business process is defined in the IMA publication, An ABC Manager's Primer, as "a sequence of two or
more activities with a common purpose." This section of the chapter introduces several methods used to improve the
performance of business processes.

. Value-Add

1. Quality or Usefulness: Value is added to a product or service by enhancing its quality or usefulness in
the eyes of the customer. To compete in today's global marketplaces and obtain (or maintain) a competitive advantage, a
company must examine the ways it can add customer value as part of its strategic planning process.

2. Contextual Approach: Adding value is contextual. It is different for each industry, for each fn-m, for
each product or service, and for each process and function within a firm. For example, adding value to a product that
has only just been introduced to the market requires a different approach (i.e. strategy) than for a mature product.
Furthermore, activities and processes that are initially determined to be value-adding may become obsolete and non-
value-adding.

B. Value Chain Analysis

In value chain analysis, business processes are viewed as a sequence of activities--a chain of events. The chain
includes both internal and external processes.

1. Value Chain Activities: Michael Porter, the originator of the idea of the value chain, groups the
activities into two categories: primary and support activities.

a. Primary Activities: These transform inputs into outputs and usually include

· inbound logistics - material handling and warehousing

· operations - manufacture of final product
· outbound logistics - processing orders and distribution
· marketing and sales - communication, pricing, and channel management · service - installation, repair, and parts

b. Support Activities: These are handled by staff functions and include

· procurement- purchase of raw materials, supplies, etc.

· technology development - acquisition of know-how and technological inputs
· human resource management - selection, placement, promotion, development, etc. · firm infrastructure - general
management, planning, finance, accounting, etc.

2. Competitive Advantage and Customer Value: The difference between the value a company offers its
customers and the cost to create that value is a firm's competitive advantage. With respect to products and services,
there are two categories of advantage.

a
. Offering or Differentiation Advantage: This exists when a customer perceives that a firm's product or service
offering is of higher quality, incurs fewer risks, and/or outperforms competing products or services. Examples include
on-time delivery, superior quality, wider range of goods and services, superior support, etc. Once differentiation
advantage has been established, a firm can increase its price, but not beyond the point at which the customers'
perception of cost versus benefit compromises maintenance of market share. Alternatively, the firm can decrease its
price to build market share.

b. Low-Cost Advantage: When a firm's total costs are lower than the market norm, it can price its

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product or services lower than its competitors' prices. Alternatively, it could charge the same price as its competitors
and increase its profitability accordingly. Sources of cost advantage include access to low-cost resources, innovative
technological processes, low-cost distribution channels, and excellent management.

3. Steps in Value Chain Analysis: The value chain approach is a vital part of the strategic planning
process. It is a continuous process of gathering, evaluating, and communicating information for business decision-
making. It allows a firm to understand its segments, distribution channels, price points, product differentiation, selling
options, and the value chain configurations that will maximize competitive advantage. Three types of analyses are
conducted: internal cost analysis, internal differentiation analysis, and vertical linkage analysis.

a
. Internal Cost Analysis: An examination of the internal processes (activities) of the firm is the starting point of value
chain analysis. Its purpose is to identify the sources of profitability and to determine the relative costs of internal
activities and processes. The principal steps include the following: (note the ABC linkage here)

· Identify value-creating processes and activities

· Determine portion of total cost of the product or service attributable to each value-creating process.
· Identify cost drivers for each process.
· Identify links among processes (i.e., could a change in one process cause a change in a related process; e.g.,
change the design of a product to increase its manufacturability, reduce costs, and improve quality).
· Evaluate opportunities for achieving relative cost advantage (e.g., consideration of outsourcing a function or
activity, development of special relationships with suppliers, etc.).

b. Internal Differentiation Analysis: The purpose of this analysis is to identify the sources of
differentiation within the internal activities which can provide opportunities for creating or maintaining superior
differentiation advantage. The focus here is on the customer's perceived value of the products/services. It includes the
following:

· Identify customer's value-creating processes (i.e., how can the firm enhance a customer's
product so that it will, in turn, add value to something the customer does? e.g., how can
Boeing enhance an airplane so United Airlines can itself provide more valuable service to
its customers?).
· Evaluate differentiation strategies for enhancing customer value (e.g., product features that are aesthetically
pleasing or functionally superior; marketing channels that provide superior responsiveness, convenience, variety,
and information; service and support appropriate to the customer's specific needs; brand or image positioning
indicative of quality; and price issues relative to customer's use of the product or service).
· Determine best sustainable differentiation strategies (i.e., use the best selection of
resources available to create value for the customer).

c. Vertical Linkage Analysis: This has an external focus. It examines all potential value-adding
opportunities in upstream and downstream processes throughout the industry. It considers the competitive advantage
that can come from strategic links with value-adding processes of suppliers, distribution channels, or users. The analysis
includes the following steps:

· Identify industry value chain and assignment of costs, revenues, and assets to value-
creating processes. An industry's value chain includes the value-creating activities of (1)
suppliers of materials and components, (2) varied buyers (end-users), and ends with the
disposal and recycling of materials. Included in this analysis are competitive benchmarking
activities and strategic decisions about what processes of the industry value chain a firm will
engage in (i.e., where does the firm want to participate within the industry value chain?).
· Determine cost drivers of each value-creating process throughout the industry value chain.
· Evaluate opportunities for creating or maintaining competitive advantage. This requires
an examination of how each company within the industry competes so as to determine
where competitive niches are available.
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4. Limitations of Value Chain Analysis: The following three limitations need to be taken into account:

a. Periodicity of Financial Data: The figures used for value chain analysis are generally derived
from one period's financial data. Long-term, strategic decision-making requires information about changes in cost
structures, market prices, and capital investments from one period to another. Where figures are not valid from one
period to another, the analysis needs to be redone under the new conditions.

. Accessibilit

c. Isolation of Information: The determination of cost drivers for each value-creating activity, the
identification of value-chain linkages, and the computation of supplier and customer profit margins are all difficult.
However, the information obtained from value chain analysis is crucial to the development of an understanding of a
firm's competitive situation, cost structure, and linkages with suppliers and customers.

C. Value Engineering

This is the system of examining the cost of each component relative to its function to determine if the cost is
equal to the value added by the function. Where the function is not justified by the cost expended, the component should
be eliminated or modified. On a narrow scale, the components of a product or service are examined. A broader
application of value engineering is the examination of all components (or processes) within a firm's value chain.

D. Benchmarking Process Performance

A benchmark is a point of reference from which measurements can be made. It serves as a standard of
comparison. Benchmarking, therefore, is the process of identifying products and services, organizational activities,
functions and processes that represent "best practice" (i.e., the benchmark) to be strived for and attained. It is a
continuous evaluation process and is an essential element of quality audits and gap analysis.

. Four Types

a. Internal Benchmarking: Evaluation of business units within the organization which have similar
business processes to identify the best practices. It results in quality improvement targets that are internally based and
does not necessarily identify the one best practice. However, it is easy to do and inexpensive.

b. Competitive Benchmarking: This is the process of measuring an organization's products, services,

and processes against those of its toughest competitors. It is both more difficult and more expensive than internal
benchmarking, but it may identify practices unknown to the firm and releases an organization from self-imposed limits.
It is both more difficult and more expensive than internal benchmarking. To make competitive benchmarking easier,
several best practices databases are being developed. SMA 4R states that competitive benchmarking "helps facilitate a
culture that values continuous improvement, increases sensitivity to changes in the external environment, and prioritizes
the areas to be worked on first."

c. Functional Benchmarking: This examines business functions in organizations outside the firm's
industry. The purpose is to find innovative processes not used in the industry. Business functions include marketing,
distribution, finance, etc.

d. Generic Benchmarking: This examines specific activities such as invoicing, payroll, purchasing,
order entry, etc.

2. Best Practices Analysis: Best practices are defined as the processes, practices, or systems that have
performed exceptionally well and are widely recognized as superior. Generally refers to practices that are recognized as
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"best" both internally and externally, but may also refer to best practices only within an organization. Best practices
may be identified through benchmarking surveys or other methods. Best practices are then used as benchmarks against
which to measure performance and as ideal practices to strive for.

E. Reengineering/Business Process Reengineering

1. Definition: Reengineering is the redesign of business processes. It involves creative, break-through

thinking and results in the implementation of new ways of doing business that produce radical improvements in areas of
cost, quality, service, and speed. It requires a horizontal, cross-functional view of what needs to be done to serve the
customer's needs. However, the focus is on business processes rather than on the actual products and services.

2. Radical Rather Than Incremental Change: Reengineering is more than continuous quality
improvement, which calls for small, continuous, incremental steps forward, and which focuses on improving what
people are doing (see Kaizen, below). It involves more radical changes and attempts to change or realign activities so
that the customer is better served.

3. Competitive Advantage: Improvements in products can be copied by competitors (reverse engineered)

without their incurring the research and development costs. Improvements in business processes, on the other hand,
provide more leverage and are more difficult to copy.

F. Pareto Principle

Known as the 80/20 rule, the Pareto principle states that a small number of causes (20%) are responsible for a
large number of effects (80%). In business process performance, this principle suggests that correcting a small number
of design, implementation, or other types of problems can have a large positive effect on overall performance.

G. Kaizen/Continuous Improvement

Kaizen is a Japanese term meaning gradual, continuous improvement. In the context of business processes, the
Kaizen philosophy leads to small improvements and increasingly higher standards. Kaizen encourages identification
and elimination of non-value-added activities and improvements in quality.

H. Activity Based Management (ABM)

Activity based management (ABM) is a generic term used to describe the use of activity-based information to
improve business performance.

1. ABC/ABM Cross: Activity-based costing can be viewed from two perspectives, each of which has
activities as the central focus. The differing perspectives are depicted in the following ABC/ABM cross diagram:

a. ABC - A Cost Accounting Tool: Viewed vertically, the ABC cross depicts a cost accounting
allocation tool. Products result from activities; those activities consume resources. Resource costs are allocated to cost
objects on the basis of the relative amount of the particular activities consumed to produce the particular product. (For
more information about ABC, see CMA Part 2, Chapter 3.)

b. ABM - A Management Tool: Viewed horizontally, however, the cross shows a management
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process. This process is a series of activities measurable by their related drivers. Examination of the relationship
between these drivers and activities is useful to management for performance evaluation, planning and control, and
decision making. Thus, implementation of activity-based costing methods provides information that can lead to better
management decisions, i.e. activity-based management (ABM).

2. Steps in ABM: No consensus exists about the exact steps in ABM, but it typically involves first
applying activity based costing (ABC). Activities, costs, and drivers are identified, and costs are assigned to activities.
However, the focus of ABM is on the processes, not the costs. ABM uses cost information to understand, manage, and
improve processes.

3. Combination of Improvement Methods: ABM is used in conjunction with other improvement

methods, such as:

Just-in-time
Theory of constraints
· Benchmarking
· Business process reengineering
· Target costing
· Life cycle management
· Value chain analysis
· Total quality management

4. Common ABM Applications: The following are common uses for ABM:

· Customer profitability analysis

· Strategic planning
· Life cycle management
· Performance measurement
· Value analysis
· Budgeting
· Product costing
· Measure and monitor capacity utilization
· Analyze costs of quality

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