Strategic Cost Management (SCM)

Definition: Strategic Cost Management or otherwise called as

SCM is the cost management technique that aims at reducing
costs while strengthening the position of the business. It is a
process of combining the decision-making structure with the
cost information, in order to reinforce the business strategy as
a whole. It measures and manages costs to align the same with
the company’s business strategy.

Stages of Strategic Cost Management

 Formulating Strategies
 Communication of Strategies in the entire organization.
 Planning and Carrying out tactics, to execute those
strategies.
 Developing and implementing controls to track the
success.
In Strategic Cost Management (SCM), primary importance is
given to constant improvement in the product to provide
better quality to its target customers. It is an essential part of
the value chain that covers every facet such as purchase,
design, production, sales and service.
 Need for SCM

1. It is an updated form of cost analysis, in which the

strategic elements are more clear and formal and improves the
overall position of the company.
2. It is used to analyse cost information, and use it to
develop various measures to achieve a sustainable competitive
advantage.
3. It provides a better understanding of the overall cost
structure in the quest of gaining a sustainable competitive
advantage.
4. It uses cost information specifically to govern the
strategic management process – formulation, communication,
implementation and control.
5. It helps in identifying the cost relationship between value
chain activities and its process of management to gain
competitive advantage.
The strategic cost management must be implemented at the
initial stages of production, so as to reduce heavy cost failure.

Objectives
The main objective of this standard is to provide a basic
guideline to those companies who plan to undergo cost
analysis as a part of strategic analysis. It tries to facilitate the
practitioners to apply SCM as a driver to ensure sustainable
competitive advantage. The standard presents relevant
analysis covering three core components of SCM which are,
a) Strategic positioning
b) ; b) Cost driver analysis;
c) and c) Value chain analysis.
Importance of Strategic Cost Management:
Strategic cost management has become an essential area now
a day. While formulating the strategy for the accomplishment
of organisational overall objectives, different cost drivers
should be clearly identified. Identification of key cost drivers
helps 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 an
organisation should be installing appropriate framework of
strategic cost management to reduce its costs in key areas on
which the success of organisation is mainly dependent.
Strategic cost management is understood in different ways in
literature.
Strategic cost management can be defined as “scrutinizing
every process within your organisation, knocking down
departmental barriers, understanding your suppliers’
business, and helping improve their processes” Cooper
and Slagmulder argued that strategic cost management is
“the application of cost management techniques so that
they simultaneously improve the strategic position of a
firm and reduce costs”.

Strategic Cost Management: Top 12 Techniques:

The following points highlight the top twelve techniques

involved in strategic cost management. The techniques
are: 1. Activity Based Costing (ABC) 2. Target Costing
(TC) 3. Total Quality Management
(TQM) 4. Benchmarking 5. Business Process
Reengineering (BPR) 6. JIT Inventory Control
System 7. Balanced Score Card 8. Kaizan Costing 9. Six
Sigma 10. Life Cycle Costing (LCC) 11. Theory of
Constraints (TOC) and Others.

Strategic Cost Management: Technique # 1. Activity Based

Costing (ABC):
ABC is a natural outgrowth of today’s competitive and
complex environment. ABC provides a closer approximation
of the cost of a product than that provided by the traditional
volume based costing method. The main principle of ABC
states that activities cause costs and to control costs, the
activities must be controlled.
Under ABC system, the activities are identified, the expenses
related to each activity are clubbed together to get activity-
wise expenses, a cost driver for each activity is selected and
finally the cost of the product is worked out.
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Traditional cost accounting measures what it costs to do a task
whereas ABC records the cost of not doing also. The system
monitors activities more closely, relates costs to activities and
bring in cost effectiveness. This system of costing makes a
great impact in the service sector also.
ABC is a primary source of information for Activity Based
Management (ABM). ABM is basically a top down approach
wherein the top management exploits information derived
from ABC and passes the decision to the operational level
towards continuous improvement and excellence.
Strategic Cost Management: Technique # 2. Target Costing
(TC):
As customers become more demanding and seek great value,
importance of effective cost management becomes even more.
Much of the Indian manufacturing in the past was occurring in
a cost plus environment, aided by extensive government
regulations. The operating practice was to fix a price as: Price
= Cost + Profit. But in the global market the customer will
dictate the price and features that he will be looking for.
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Target costing is a new attempt in which cost is the difference
between the price expectation of the customers and margin
expectations of the corporation entities. Cost = Price – Target
Profit. Management Accountant will have to work closely
with design and engineering personnel to achieve this target.
Strategic Cost Management: Technique # 3. Total Quality
Management (TQM):
Total Quality Management is a term first coined by the U.S.
Naval Air Systems Command to describe its Japanese-style
management approach to quality improvement.
TQM is a set of management practices throughout the
organisation, geared to ensure that the organisation
consistently meets or exceeds customer requirements. TQM
places strong focus on process measurement and controls as
means of continuous improvement.
Total Quality is a people-focused management system that
aims at continual increase in customer satisfaction at
continually lower real cost. In a TQM effort, all members of
an organisation participate in improving processes, products,
services and the culture in which they work.
Strategic Cost Management: Technique #
4. Benchmarking:
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Benchmarking is the process of determining who is the very
best, who sets the standard, and what that standard is. In other
words, Benchmarking refers to the search for the best
practices that yields the benchmark performance, with
emphasis on how you can apply the process to achieve
superior results.
Often Benchmarking is used to evaluate performance.
Benchmarking represents “best practice” available inside or
outside the organisation.
Strategic Cost Management: Technique # 5. Business
Process Reengineering (BPR):
Business Process Reengineering, when fully implemented,
will reduce a lot of clerical work and maintenance of records.
Thus Purchasing, Material Receipts, Accounts Payable
procedures and documentation will be virtually eliminated.
Instead annual contracts with a few reliable suppliers to whom
payments for quantities consumed in production will be made.
These improvements are made possible by the rapid strides
made in Information Technology. Government support and
the attitude of Business Executives at the top level will
determine the pace of acceptance of these recent
developments.
It can be noted that the above system and practices would lead
in overall improvement in the performance of the
organisation, reduction in cost of production and improvement
in productivity. As such the above singularly and collectively
play a very vital role in the financial control of an
organisation.
Strategic Cost Management: Technique # 6. JIT Inventory
Control System:

Originally developed in Japan and successfully implemented.

Under this system, a company should maintain a very minimal
level of inventory and rely mostly on suppliers to provide
parts and components “Just in Time” to meet assembly
requirements.
JIT philosophy is dedicated to the elimination of waste
because stocks of raw materials and finished goods are
reduced leading to minimum holding cost of inventory.
However, this system may not be applicable in the present
Indian situation because of unreliable transport arrangement,
not so excellent relations with suppliers and distance of
supply sources from the factory. Over emphasis on safety
stock will come in the way of its implementation.

Strategic Cost Management: Technique # 7. Balanced

Score Card:
The balanced score card is a strategic cost management
technique for communicating and evaluating the achievement
of the strategy of the organisation. It has been developed by
Kaplan and Norton. This technique has been adopted by
rapidly growing organisations as a mechanism to help
effectively manage their performance and strategy.
Traditional financial measures such as ROI, RI, value added,
EPS, variance analysis etc. deal with past performance and are
inadequate for evaluating current information needs of large
growing companies.
Strategic Cost Management: Technique # 8. Kaizan
Costing:
Kaizan refers to continual and gradual improvement through
small betterment activities, rather than large or radical
improvement made through innovation or large investment in
technology. It is the process of cost reduction during the
manufacturing phase of an existing product. Kaizen costing is
most consistent with the saying “slow and steady wins the
race.”
It is a Japanese term for making improvements to a process
through small, incremental amounts rather than through large
innovations. It is a planning method used during the
manufacturing cycle with an emphasis on reducing variable
costs in one period below the costs in a base period.
Strategic Cost Management: Technique # 9. Six Sigma:
Six Sigma originated at Motorola in the early 1980s in
response to a CEO-driven challenge to achieve tenfold
reduction in product-failure levels in five years. It is a
multifaceted approach to process improvement, reduced costs,
and increased profits. With a fundamental principle to
improve customer satisfaction by reducing defects, its
ultimate performance target is virtually defect-free processes
and products.
The Six Sigma methodology, consisting of the steps:
Identifying the Process—Define- Measure-Analyse-Improve-
Control,” is the roadmap to achieving this goal. Within this
improvement framework, it is the responsibility of the
improvement team to identify the process, the definition of
defect, and the corresponding measurements, improvement
and control.
The primary objective of Six Sigma is to improve customer
satisfaction, and thereby profitability by reducing and
eliminating defects. Defects may be related to any aspect of
customer satisfaction high product quality, schedule
adherence, cost minimisation etc.
Strategic Cost Management: Technique # 10. Life Cycle
Costing (LCC):
A life cycle cost analysis calculates the cost of a system or
product over its entire life span. This also involves the process
of Product Life Cycle Management so that the life cycle
profits are maximised.
The analysis of this system includes cost for planning,
research & development, production, operation, maintenance,
cost of replacement and disposal or salvage. This concept
provides important information for pricing and also helps in
managing cost incurred throughout lifecycle of a system or
product.
Short notes :
1) Activity Based Costing :
Activity-Based Costing (ABC) How Activity-Based Costing
(ABC) Works
Activity-based costing (ABC) is mostly used in the
manufacturing industry since it enhances the reliability of cost
data, hence producing nearly true costs and better classifying
the costs incurred by the company during its production
process
 
 Updated Aug 23, 2019
What Is Activity-Based Costing (ABC)?
Activity-based costing (ABC) is a costing method that
assigns overhead and indirect costs to related products and
services. This accounting method of costing recognizes the
relationship between costs, overhead activities, and
manufactured products, assigning indirect costs to products
less arbitrarily than traditional costing methods. However,
some indirect costs, such as management and office staff
salaries, are difficult to assign to a product.
This costing system is used in target costing, product
costing, product line profitability analysis, customer
profitability analysis, and service pricing. Activity-based
costing is used to get a better grasp on costs, allowing
companies to form a more appropriate pricing strategy. 
The formula for activity-based costing is the cost pool total
divided by cost driver, which yields the cost driver rate. The
cost driver rate is used in activity-based costing to calculate
the amount of overhead and indirect costs related to a
particular activity. 
The ABC calculation is as follows:  
 1. Identify all the activities required to create the product. 
2. Divide the activities into cost pools, which includes all
the individual costs related to an activity—such as
manufacturing. Calculate the total overhead of each cost
pool.
3. Assign each cost pool activity cost drivers, such as hours
or units. 
4. Calculate the cost driver rate by dividing the total
overhead in each cost pool by the total cost drivers. 
5. Divide the total overhead of each cost pool by the total
cost drivers to get the cost driver rate. 
6. Multiply the cost driver rate by the number of cost
drivers. 
Benefits of Activity-Based Costing (ABC)
Activity-based costing (ABC) enhances the costing process in
three ways. First, it expands the number of cost pools that can
be used to assemble overhead costs. Instead of accumulating
all costs in one company-wide pool, it pools costs by activity. 
Second, it creates new bases for assigning overhead costs to
items such that costs are allocated based on the activities that
generate costs instead of on volume measures, such as
machine hours or direct labor costs. 
Finally, ABC alters the nature of several indirect costs,
making costs previously considered indirect—such
as depreciation, utilities, or salaries—traceable to certain
activities. Alternatively, ABC transfers overhead costs from
high-volume products to low-volume products, raising
the unit cost of low-volume products
2) Lean Management :
 Definition: Lean management refers to a technique
developed with the aim of minimising the process waste
and maximising the value of the product or service to the
customer, without compromising the quality. It is coined
by Toyota Production System, which is a part of lean
thinking. Lean is possible through distinct techniques such
as flow charts, just in time, total quality management,
workplace redesigning, and total productive maintenance.
It focuses on delivering value to customers. A number of
tools are deployed by the lean management system to link
customer value to the process and people. Principles of Lean

Principles of Lean Management

1. Identify value: The value must be ascertained from the

point of view of the ultimate customer by product family.
2. Map the value stream: Ascertain all the steps involved
in the value stream for each product family and then
eliminating those steps that are not productive.
3. Create the flow: Ensure that the steps which create
value take place in a perfect sequence, so the product reaches
the customer smoothly.
4. Establish Pull: Once the flow is initiated, customers pull
value from the next level activity.
5. Seek Perfection: When the value is specified, value
streams are ascertained, non-productive steps are eliminated
and flow and pull are instigated. The process is started again
and continue, till the perfection state is arrived, in which the
perfect value is created with no waste.
Single Piece Flow is an ideal state of operation that replaces
the batch sizes and lost production with working on one
product at a time. Lean Manufacturing System aims at
implementing one piece flow in every operation possible. It
can be achieved by eliminating the wastes such as
overproduction, space, defects, unnecessary human motion,
inventory, labour and so on.

Stakeholders of Lean Management

 Stakeholders

 Customers: For a firm, nothing can give more

satisfaction than seeing your customers delighted, which
can be due to the satisfaction they derive from the product
or the customer service. To achieve this the issues and
concerns of the customers are addressed first.
 Employees: Employees are the rank and file of the
organisation, who are the most valuable asset of the
organisation. When the employee is happy, he/she will also
work for the organisation with great enthusiasm and
efficiency that will help in making the organisation the best
of its kind.
 Organisation: Organisation includes board members, the
Chief Executive Officer, and the business owners. Add to
that; it covers the policies, programmes and procedures and
other implementation. A well managed and balanced
organisation is capable of fulfilling customers requirements.
Lean management is philosophy, which intends to
continuously eliminate the waste, in all the processes, through
small and incremental improvement. It improves quality and
reduces defects, as well as enhances the overall manufacturing
flexibility. However, at times, it encounters certain limitations
such as low productivity, prolonged cycle time, costly
organisation, etc.

Kaizen Technique :
Kaizen (continuous improvement)

Kaizen is an approach to creating continuous improvement

based on the idea that small, ongoing positive changes can
reap major improvements. Typically, it is based on
cooperation and commitment and stands in contrast to
approaches that use radical changes or top-down edicts to
achieve transformation. Kaizen is core to lean manufacturing,
or The Toyota Way. It was developed in the manufacturing
sector to lower defects, eliminate waste, boost productivity,
encourage worker purpose and accountability, and promote
innovation.

As a broad concept that carries myriad interpretations, it has

been adopted in many other industries, including healthcare. It
can be applied to any area of business, and even to personal
life. Kaizen can use a number of approaches and tools, such
as value stream mapping, which documents, analyzes and
improves information or material flows required to produce a
product or service, and Total Quality Management (TQM), a
management framework that enlists workers at all levels to
focus on quality improvements. Regardless of methodology,
in an organizational setting, the successful use of Kaizen rests
on gaining support for the approach across the organization,
and from the CEO down.

Kaizen is a compound of two Japanese words that together

translate as "good change" or "improvement," but Kaizen has
come to mean "continuous improvement" through its
association with lean methodology. Kaizen has its origins in
post-World War II Japanese quality circles. These circles or
groups of workers focused on preventing defects at Toyota
and were developed partly in response to American
management and productivity consultants who visited the
country, especially W. Edwards Deming, who argued that
quality control should be put more directly in the hands of line
workers. Kaizen was brought to the West and popularized by
Masaaki Imai via his book Kaizen: The Key to Japan's
Competitive Success in 1986.

As with lean, Kaizen is complementary to Six Sigma.

Ten principles of Kaizen

Because executing Kaizen requires enabling the right mindset

throughout the company, 10 principles that address the Kaizen
mindset are commonly referenced as core to the philosophy.
They are:

1. Let go of assumptions.
2. Be proactive about solving problems.
3. Don't accept the status quo.
4. Let go of perfectionism and take an attitude of iterative,
adaptive change.
5. Look for solutions as you find mistakes.
6. Create an environment in which everyone feels
empowered to contribute.
7. Don't accept the obvious issue; instead, ask "why" five
times to get to the root cause.
8. Cull information and opinions from multiple people.
9. Use creativity to find low-cost, small improvements.
10. Never stop improving.
How Kaizen works

Kaizen is based on the belief that everything can be improved

and nothing is status quo. It also rests on a Respect for People
principle. Kaizen involves identifying issues and
opportunities, creating solutions and rolling them out -- and
then cycling through the process again for other issues or
problems that were inadequately addressed. These following
seven steps create a cycle for continuous improvement and
give a systematic method for executing this process.

Kaizen cycle for continuous improvement:

 Get employees involved. Seek the involvement of

employees, including gathering their help in identifying
issues and problems. Doing so creates buy-in for change.
Often, this is organized as specific groups of individuals
 charged with gathering and relaying information from a
wider group of employees.
 Find problems. Using widespread feedback from all
employees, gather a list of problems and potential
opportunities. Create a shortlist if there are many issues.
 Create a solution. Encourage employees to offer
creative solutions, with all manner of ideas encouraged.
Pick a winning solution or solutions from the ideas
presented.
 Test the solution. Implement the winning solution
chosen above, with everyone participating in the rollout.
Create pilot programs or take other small steps to test out
the solution.
 Analyze the results. At various intervals, check
progress, with specific plans for who will be the point of
contact and how best to keep ground-level workers
engaged. Determine how successful the change has been.
 Standardize. If results are positive, adopt the solution
throughout the organization.
 Repeat. These seven steps should be repeated on an
ongoing basis, with new solutions tested where appropriate
or new lists of problems tackled.