Scmpe Summary

Last Day Revision - Theory SCMPE
Last Day Revision - Theory

Chapter 1: Introduction to Strategic Cost Management
What is Traditional Cost Management (TCM):
• TCM involves allocation of cost and overhead and focus is on cost control and cost reduction
• TCM focuses on variance analysis
Limitations of TCM:
• Cost reduction at the expense of quality reduction
• Ignores external factors (competition, market growth, customer requirement)
• Short-term outlook
• Reactive approach
• Limited focus on reviewing existing process and improving them
Example: Preventive maintenance vs Breakdown maintenance, Decision on closure of service centre
What is Strategic Cost Management (SCM):
• SCM focuses on improving the strategic position of business as well as improve costs
• Aim is to have sustainable competitive advantage through cost leadership/product
differentiation
Stages of Strategic Management:
• Stage 1 – Formulation of policies
• Stage 2 – Communication of strategy
• Stage 3 – Implementation
• Stage 4 – Control
Necessity of SCM:
• Sustainable competitive advantage through cost leadership/product differentiation
• Can also help in implementing four stages of strategic management
TCM vs SCM:
• TCM has short-term focus whereas SCM has long-term focus
• TCM focuses on internal whereas SCM focuses both on internal and external
• TCM has single cost driver (volume of product) whereas SCM has separate cost driver for every
activity
• TCM objective is attention directing and problem solving whereas SCM objective is cost
leadership or product differentiation
• TCM objective is cost reduction whereas SCM focus on cost containment (cost reduction and
value improvement) at same time
• TCM focuses on being risk-averse whereas SCM involves risk taking and ability to adapt to
changing environment
Components of strategic cost management:
• Strategic Positioning Analysis
• Cost Driver Analysis
• Value Chain Analysis
Strategic Positioning Analysis:
• Analysing the company’s relative position within an industry for its performance
• It reflects the kind of value a company will create and how it will be different from rivals
Example: Cost leadership/Product differentiation
• It also considers the impact of internal and external environment on company’s overall strategy
Example: Starbucks (High-end café) vs Dunkin Donuts (economical price)
Cost Driver Analysis:
• Cost driver basically are those factors which influence cost
• Two types: Structural cost driver and Executional cost driver
• Structural cost driver: Related to strategic decision making and has long-term effect. Example:
Scale, Experience, Technology and Complexity
• Executional cost driver: Related to operational decision making and has short-term effect.
Example: Workforce involvement, Design of production process, Efficiency of plant layout,
importance of TQM, Supplier relationships
Value Chain Analysis:
• Identifies various activities that add value to the end product
BHARADWAJ INSTITUTE (CHENNAI) 14

• Objective is to eliminate non-value-added activities
• It helps in designing, producing, marketing, delivering and supporting a product
Types of Primary Activities:
• Primary Activities: Inbound logistics, Operations, Outbound Logistics, Marketing & sales,
Service
• Support Activities: Firm Infrastructure, Human Resource management, Technology
Development and Procurement
Strategic Framework for Value Chain Analysis:
• Industry Structure Analysis
• Core Competencies Analysis
• Segmentation Analysis
Industry Structure Analysis [Porter’s Five Forces Model]
• Bargaining Power of buyers: Single buyer vs large number of buyers, high cost vs low cost of
switching suppliers
• Bargaining Power of Suppliers: Few suppliers vs large number of suppliers, importance of raw
material, availability of alternate input
• Threat of Substitute products/services: Few substitutes vs multiple substitutes – focus on
building brand and customer loyalty to restrict the threat of substitutes
• Threat of new entrants: Barriers to entry, perceived profitability
• Intensity of competition among existing firms: High number of firms vs few firms
Core Competencies Analysis:
• Core competence is unique skill that adds customer value – it is difficult for others to replicate
• It is the primary source of competitive advantage for firms. It is a function of collective skillset
of people, organization structure, resources and technological knowhow
• Core competence is critical and loss of the same can prove disaster to firm. Example: Nokia,
Kodak
• Core competence comes from resources (can be tangible (land, building, inventory, machinery,
money) or intangible (brand/patent/technology) and capabilities (refers to company’s ability to
put resources to productive use)
• VCA and core competencies: Value chain approach can be used to validate core competencies
in current businesses, leverage competencies in other existing businesses, reconfigure value
chain of existing businesses and use core competencies to create new chains
Segmentation Analysis:
• Single industry is basically a collection of different segments. Example: Motor vehicle industry
• Segmentation analysis focuses on analysing structural characteristics of different segments
• It can help in entering a segment/exiting a segment/reconfiguring a segment
• Segmentation can be on the basis of demographics, Geography etc. Example: ITC Limited
Steps in Segmentation Analysis:
• Identify segmentation variables and categories
• Construct a segmentation matrix
• Analyze segment attractiveness
• Identify key success factors of each segment
• Analyze attractiveness of broad versus narrow segment scope
Superior Performance and Competitive Advantage:
• Profitability improves with superior performance which leads to wealth maximization
• A company can survive and prosper if it supplies what customers want and is also able to
survive competition
• Competitive advantage can come from Product differentiation/Cost leadership
Differentiation advantage (Product Differentiation):
• Customers perceive that the product offered is of higher quality and outperforms competitor
products
• Differentiation can come from quality product, timely delivery, wide variety of goods
• Superior quality, innovation and customer responsiveness can give differentiation advantage
• Can help in charging higher price while retaining market share or charging a lower price to build
market share

Cost Leadership (Low-Cost Advantage):
• Cost leadership is achieved if the total costs are lower than that of competitors
• Charging same price as that of competitor and improve profitability or charge lower price while
maintaining profitability and improve market share
• Arises due to access to low-cost raw materials, innovative process/technology, low-cost
distribution
• Problem with this is if competitors replicate ways to reduce cost
Value Chain Analysis for Competitive Advantage:
• Internal cost analysis
• Internal differentiation analysis
• Vertical linkage analysis
Internal Cost Analysis:
• Identify the firm’s value creating processes
• Determine the proportion of total cost of the product or service attributable to each value
creating processes
• Identify the cost drivers of each process
• Identify the links between processes – Cost reduction in one process can have
favorable/negative cost impact on other process and hence linkage analysis is critical. Example:
Compromise in quality of raw material can increase service costs.
• Evaluate the opportunities for achieving relative cost advantage
Internal Differentiation Analysis:
• Identify the firm’s value creating processes
• Evaluate differentiation strategies for enhancing customer value – Superior product features,
effective marketing and distribution, excellent customer service, superior brand image and
better-quality product at competitive prices
• Determine the best sustainable differentiation strategies
Vertical Linkage Analysis:
• Competitive advantage not only comes from internal activities but also through linkages of a
firm’s value chain with that of suppliers or users
• It includes all upstream and downstream activities
• We need to have understanding of cost or revenues of each process of entire value chain and
this can be achieved by performing vertical linkage analysis
Vision, Mission and Objectives:
• Mission– Why does the company exist – Statement of organization value/major goals
• Vision– What the company would like to achieve – must be challenging
• Objective/goal – Precise and measurable future state that the company wants to achieve – helps
in attaining mission and vision
Value Shop Model (or) Service Value Chain:
• Serve companies from service sector – best applies to telecommunication companies – can also
be applied to insurance companies and banks
• Value chain approach can be used for manufacturing companies. However, no value addition
takes place in service companies and hence we need a different model
• Focus is to solve customer problems rather than creating value by producing product form an
input of raw materials
• Has same support activities as that of value chain approach but has different primary activities
• Primary activities: Problem finding and acquisition, Problem solving, Choosing among
solutions and execution and control/evaluation
Chapter 2 – Modern Business Environment

Modern Business Environment:
• Business environment has changed drastically and transitioned from a seller’s market to a
buyer’s market
• Companies need to satisfy the customer with exceptional performance of the processes

• Characteristics: Globalization, Intense competition, Global excess capacity in production &
services, new managerial methods, ease of Global travel & transportation, Timely availability of
material and service, availability & accessibility of data and knowledge
Cost Of Quality (COQ):
• Quality = Conformance to specifications + Ability to satisfy customer expectations/value for
money
• COQ = Cost of Conformance + Cost of Non-Conformance
• Cost of Conformance: Cost of Good quality – Prevention and Appraisal Costs
• Cost of Non-conformance: Cost of Poor Quality – Internal Failure and External Failure costs
Types of Costs:
• Prevention Costs: Cost incurred for preventing poor quality products/services – planned and
incurred before actual operation
• Appraisal Costs: Cost incurred for measuring and monitoring activities related to quality
• Internal Failure Costs: Cost incurred due to identification of defect before the product reaches
the customer
• External Failure Costs: Cost incurred to rectify the defects discovered by the customers
Optimal COQ:
There is an inverse relationship between conformance and non-conformance costs. Increased
expenditure on conformance costs will lead to reduction in non-conformance costs. Optimal COQ is
one where the combined cost is at minimum. It is not necessary to have zero defect as the combined
cost may not be minimum
Prevention, Appraisal and Failure (PAF) Model:
• PAF model is used for measuring and classifying quality costs. It includes 1) Gather data on
number of failures 2) Apply some assumptions to data and quantify them 3) Chart the data
based on four elements 4) Allocate resources to combat weak-spots 5) Do this study on regular
basis – PAF model is basically establishing relationship between conformance and non-
conformance costs
Total Quality Management:
• Integrate all organizational functions to focus on meeting customer needs + organizational
objectives
• Improve quality of output through continual improvement of internal practices – focus on
eradicating waste and improve efficiency
• Products/services produced should meet/exceed customer expectations – Follows principles
such as total employee involvement, continuous improvement, customer focus, full
documentation of activities, clear goal-setting, performance measurement from customer
perspective
Six C’s of TQM:
• Commitment: Quality improvement is part of all employees’ job + clear commitment from top
towards quality
• Culture: Training to make the change + encourage all to contribute and make quality a part of
everyone’s job
• Continuous improvement: Long-term focus on quality
• Co-operation: Total Employee Involvement in development of improvement strategies
• Customer focus: Perfect service + zero defect for both internal and external customer
• Control: Procedure to monitor the extent of improvement + correcting the deficiencies +
Documentation
Deming’s 14 points Methodology:
• Long-term commitment towards improvement
• Adopt the new philosophy – entire management to adopt this and not only the workforce
• Cease dependence on inspection
• Move towards single supplier for one item
• Improve constantly and forever
• Institute training on the job
• Institute leadership – Focus on leadership and not supervision
• Drive out fear – Management by fear is counter-productive

• Break down barriers between departments
• Eliminate slogans – Harassing workforce without improving the processes is counter-
productive
• Eliminate management by objectives
• Remove barriers to pride of workmanship – Reduce worker dis-satisfaction
• Institute education and self-improvement
• Transformation is everyone’s job
Plan-Do-Check-Act Cycle (PDCA):
• Activities to incorporate continuous improvement
• Plan (Establish objectives and action plan) – Do (Implement the action plan) – Check (measure
the effectiveness) – Act (Take corrective action)
Criticisms of TQM:
• Extensive focus on documentation
• Emphasizes on quality assurance rather than improvement
• Emphasizes on internal focus
• May not be appropriate for service-based industries – standardized approach ignores the culture
of the organization
Business Excellence Models:
• Philosophy for developing and strengthening the management systems and processes –
improve performance and create value for stakeholders
• Develop quality management principles that increases efficiency, minimizes waste, increase
employee loyalty and achieve excellence in everything an organization does
• Common business excellence models: European Foundation for Quality Management (EFQM),
Balridge criteria for performance excellence, Singapore business excellence framework, Japan
Quality Award Model and Australian business excellence framework
EFQM Excellence Model:
• Provides an all-round view of organization + how different methods can fit together and
complement each other
• EFQM components: Fundamental concept of excellence, Conceptual framework (criteria),
Logical assessment framework (RADAR)
• Fundamental Concepts: Essential foundation for any organization to achieve sustainable
excellence - Sustaining outstanding results, adding value for customers, creating a sustainable
future, developing organizational capability, harnessing creativity and innovation, leading with
vision, inspiration and creativity, managing with agility, succeeding through talent of people
• Criteria: Criteria focuses on what an organization does (enablers) and what it achieves (results)
– Enablers (Leadership, people, strategy, Partnership & resources, processes, products and
services) – Results (People results, customer results, society results, business results) – Enablers
should focus on innovation, learning and creativity
• RADAR (results – approaches – deploy – assess – refine): Identify the required result – Plan
and develop the approach – deploy the approach – assess and refine and the approach if
required
Balridge Criteria of Performance Excellence:
• Forms the foundation for various other business excellence models
• Seven categories: Leadership, strategic planning, customer and market focus, measurement,
analysis and knowledge management, workforce, process management, business results
Business Excellence Model and Organization Culture:
• Focuses on strengthening the internal function and communication + Strong ties with customers
+ Incorporating these in culture
• Strong and empathetic leader, employee empowerment, motivation, innovative and creative
culture – these can make employee connected to the management philosophy of the organization
Theory of Constraints:
• TOC focuses on increasing output, minimizing investment and decreasing operating expenses
• Throughput Contribution: Measures rate of generating money – Throughput contribution =
Sales – Direct material cost
• Investment: Include assets such as facilities, equipment, fixtures, computers and R&D expense

• Operating expense: Includes direct labour and all operating and maintenance expense
Goldratt’s five step method for improving performance:
TOC describes the process of identifying and taking steps to remove the bottlenecks that restrict output
• Identify the constraints
• Exploit the constraints
• Subordinate and synchronize the constraint
• Elevate the performance of the constraint
• Repeat the process
TOC – Advantages and Disadvantages:
• Advantages: Reduction in inventory, more productive machines, ability to meet shorter lead
times, more flexible, better customer service, better product mix and better customer
relationship
• Disadvantages: Short-term focus, focus on increasing sales and volume whereas no emphasis
on quality, Focus on push approach
Supply Chain Management:
• RM Supplier + Producers who convert RM into output + Warehouses that store + Distribution
centres that deliver to retail stores + Retailers who sell the product
• Entire network of organizations that design, produce, deliver and service products
• It includes production planning, purchasing, material management, distribution, customer
service and forecasting
• Integration of key business processes from end user through original suppliers that provides
products/services and information that add value to customers and other stakeholders
• Eight key processes: Customer relationship management, Supplier relationship management,
Customer service management, Demand management, Order fulfilment, Manufacturing flow
management, Product development and commercialization, Returns management
• Push Model vs Pull Model: Under Push model stocks are produced based on anticipated
demand whereas under Pull model stocks are produced on the basis of actual demand
• Role of e-commerce: Benefits both customer and manufacturer – Helps in fulfilling customer
needs + carry fewer inventories + send products to market very quickly
• Upstream and downstream supply chain: Information / material /capital/finance flow related
to supplier is called upstream and the same related to customer is called downstream supply
chain.
• Upstream flow: Material (Returns, repairs and after-sale service), Information (orders, POS
data), capital/finance (Payments)
• Downstream flow: Material (Product and parts), Information (capacity, delivery schedules),
capital/finance (Invoices, pricing, credit terms)
Management of Upstream Supply Chain:
• Relationship with suppliers: Factors influencing a supplier selection are innovation, quality,
reliability, cost/price reduction – Supplier relationship management can help in managing the
entire upstream supply chain – Company should have a suitable supplier strategy considering
sources, number of suppliers, cost, quality and speed
• Use of information technology: Main activities in upstream are procurement and logistics – IT
can be used for E-sourcing (invitation to tenders), E-purchasing (electronic catalogues, recurring
requisitions, electronic purchase orders) and E-payment (e-invoicing and fund transfer)
Downstream Supply Chain Management:
• Relationship Marketing
o Six Markets Model
• Customer Relationship Management
o Analysis of customers and their behaviour
o Customers Account Profitability (CAP)
o Customers Lifetime Value (CLV)
o Customer’s selection, acquisition, retention and extension
• Use of Information Technology
• Brand Strategy
Relationship Marketing:

RM helps the organization to keep existing customer and to attract new customers – Marketing is critical
to successfully handle downstream supply chain
Six Markets Model:
• Internal Markets – Include internal departments and staff – staff are critical to have customer
oriented corporate culture
• Referral Markets – Existing customers who refer new customers + Referral sources such as
consultancy firm
• Influence Markets – Entities and individuals which have the ability to influence marketing
environment of a firm
• Recruitment Markets – Commercial recruitment agencies, Universities and Agencies having
access to potential employees
• Supplier’s Markets – Traditional Suppliers + Organizations with which the firm has some form
of strategic alliance – helping in better quality and faster reach
• Customer’s Markets – Existing + Prospective customers + Intermediaries
Customer Relationship Management: Focus on knowing the needs of the customers and providing
them with the best solution – Detailed information about customer’s personal information, purchase
history, buying preference and concerns are stored
Analysis of customers and their behaviour:
• Analysis based on geographical location or purchasing characteristics
Customers Account Profitability (CAP):
• Calculation of profitability at customer level – It involves analysis of customer base into
segments + computation of annual revenues + computation of annual costs + Identification and
retention of quality customers + Re-engineer/eliminate unprofitable segments
• Activity based costing is used in CAP – Customer can be categorized into Platinum (Most
profitable), Gold (Profitable), Iron (Low profit but desirable) and Lead (Unprofitable and
undesirable)
• Major challenge in CAP Analysis is computation of right cost
Customers Lifetime Value:
• Present value of net profit that we derive over the entire life + ABC technique will have to be
used + This will help in focusing on more profitable customers and stop servicing non-profitable
customers
Customer selection, acquisition, retention and extension:
• Decide on type of customer to be targeted + Develop relationships with new customers and
acquire them + Company should retain the customers by meeting customer needs and ensuring
service quality + Increase sales by selling more products, cross-sell and up-sell expensive
products
• Use of Information Technology in Downstream Supply Chain Management: Linking of sales
system of the company with the purchase system through Electronic Data Interchange (EDI).
Use of IT results in quick action, reduction in associated time and cost
• Brand Strategy: Branding makes a huge difference in its appeal to customers – It can be usage
of logo or specific color or any other means by which product/service is distinguished from
others
Service Level Agreements (SLA):
• Agreement between the customer and service provider
• Agreement can be with an external organization or within different teams of same organization
• Service providers’ rewards and penalties are specified in Service Level Agreement – SLA’s can
be periodically revised if needed
Benefits of Supply Chain:
• Inventory reduction
• Personnel reduction
• Productivity improvement
• Order Management improvement
• Information visibility
• New/improved processes
• Customer responsiveness

• Standardization
• Flexibility and globalization of performance
Gain Sharing Arrangements:
• Review and adjustment of an existing contract to provide benefits to both parties
• Example: Supplier agrees to perform services with no guarantee of payment – he will receive
payment only when we receive money from original customer
• Gain sharing arrangements are, on the face of it, a win-win situation for suppliers and their
customers
Outsourcing:
• Outsourcing is normally done to reduce costs or improve efficiency by shifting some tasks to an
outside vendor
• Outsourcing is not only limited to manufacturing. Even services can also be outsourced.
Example: Call center service
• Outsourcing is integral part of downsizing/re-engineering
• Advantages: Cost savings – Reduction in investments in technology, infrastructure and people
– flexibility in staffing
• Disadvantages: Losing sensitive data – Loss of control on operations outsourced – Quality
problems
Chapter 3: Lean System and Innovation

What is Lean System?
• Organized method for waste minimization without productivity loss
• Seven types of waste (non-value adding activities): Over-production, Holding more inventory,
Waiting time, motion time (movement of people/equipment), transportation (movement of
goods), rework and over-processing
• Techniques of Lean System: Just-in-Time, Kaizen Costing, 5S, Total Productive Maintenance,
Cellular Manufacturing/one-piece flow production systems, Six-sigma
• Principles: Perfect quality, waste minimization, continuous improvement and flexibility
• Characteristics: Zero waiting time, Zero inventory, Pull processing, Continuous flow of
production and continuous ways of reducing processing time.
Just-in Time:
• Produce/procure products only when needed – Pull system wherein company doesn’t maintain
stock
• Just-in-time production: FG is produced based on demand and not for stocking
• Just-in-time purchase: Raw material is purchased in such a manner that purchase and
consumption coincide
Steps in JIT System:
• Suppliers to supply material on exact date and time
• Straight delivery to production floor
• Visit of engineering staff at supplier sites to examine supplier
• Installation of EDI system to tell supplier about requirement
• Dropping off products at the specified machines
• Shorten the setup times
• Eliminate the need for long production runs
• Training to employees to operate multiple machines
• Accounting systems changes to support JIT – Backflush costing
Features of JIT System:
• Reduction in material handling cost – materials are moved in sequence as products are grouped
in manufacturing cells
• Workers are multi-skilled – can work on multiple machines – leads to reduction in labour idle
time
• Apply TQM – eliminate defects as quickly as possible
• Place emphasis on reducing set-up time – production in small batches – lower inventory –
improves ability to respond to customer demand

• Carefully selected suppliers – high quality materials in timely manner – reducing the material
receipt time
Prerequisites of JIT:
Low variety, vendor reliability, Good communication, demand stability, TQM, defect free materials and
preventive maintenance
Impact of JIT:
• Waste costs: Continuous focus on reducing all type of waste
• Overhead costs: Material handling, quality inspection, space requirement for warehouse etc is
significantly reduced
• Product prices: Company can increase prices because it delivers high quality product with
timely delivery – if customers are price conscious then no premium will be paid
Backflushing in JIT:
• No data entry to be made unless production is completed – no entry to be recorded for
consumption of raw material/transfer of wages and overheads to WIP
• Automatic entry based on BOM would be passed once production is completed and raw
material will be reduced
Considerations before implementing back-flush costing:
• Production reporting – accurate reporting of production and training for same to employees
• Scrap reporting – track scrap and record them in books
• Lot tracing – Lot tracing is not possible – can be a problem if a manufacturer wants to track units
produced in a lot
• Inventory accuracy – Inventory will show very high balance till production is recorded. Hence
inventory in books won’t be accurate till production is recorded
Kaizen Costing:
• Kaizen means continuous improvement. It involves continuous examination and improvement
of existing processes
• Focuses on small incremental changes which are routinely applied for a long period resulting in
significant improvements
• Some of the steps of kaizen costing is also performed in value engineering. However initial value
engineering may not uncover all possible cost savings
• Cost savings in Kaizen are much smaller than value engineering. However they are critical as
competitive pressures will lead to price reduction and kaizen can help in maintaining target
profit
Kaizen Costing Principles:
• Seeks gradual improvements
• Encourages collective decision making
• No limitation on level of improvements
• Focuses on setting standards and continually improving the standards – leading to long-term
sustainable improvements
• Eliminate waste, improve systems and improve productivity
5S:
• Explains how a workplace should be organized
• Objective is to ensure efficiency and effectiveness
• Approach includes Sort, Set in order, Shine, Standardize and Sustain
• Sort: Keep necessary items and remove accumulation of unnecessary items
• Set in order: Arranging items in most efficient and accessible arrangement – ensuring FIFO –
placing items according to frequency of usage
• Shine: Cleaning your workplace frequently – keeping workplace safe, easy to work and clean
• Standardize: Standardizing the best practices and following them in the entire organization
• Sustain: Ensuring above 4-steps are maintained regularly – Training employees – Establishing
a culture of doing without being told
• 6th S – Safety: This is a developing one and is not part of original 5S
Total Productive Maintenance:
• System to maintain and improve the integrity of production and quality systems

• TPM ensures all equipment are in top working condition – Avoids breakdowns and delays in
manufacturing process
• Four stages: Preparation (establishing environment for setting up TPM), Introduction
(Initialization and information to stakeholders), Implementation (eight activities) and
Institutionalization (Getting TPM rewards)
TPM – Foundation and Pillars:
• Goal = Zero defect, Zero breakdown and Zero Accident
• Foundation of TPM = 5S
• P-1: Autonomous Maintenance (Operating equipment without breakdown and elimination of
defects)
• P-2: Focussed improvement – Kaizen (Minor improvements on continuous basis)
• P-3: Planned Maintenance (Proper maintenance system for improving reliability and
maintainability of equipment)
• P-4: Early management (Shortening time for product and equipment development)
• P-5: Quality maintenance (Customer satisfaction through delivery of highest quality product)
• P-6: Education and training (Improve knowledge/skills and enhance morale of employees)
• P-7: Office TPM (Application of TPM techniques in administration to improve productivity and
efficiency)
• P-8: Safety, Health and Environment (Safety is of utmost importance – aim to have zero accident
and zero health damages)
TPM – Performance Measures:
• OEE is used to measure success of TPM. It considers six types of losses (equipment failure, set-
up adjustments, idling/minor stoppages, reduced speed, reduced yield and quality
defects/rework)
• First two losses (time related), next two (performance related) and last two (quality related)
• OEE = Availability ratio x Performance ratio x Quality ratio
• Idle OEE: Availability (>90%), Performance (>95%), Quality (>99%). Hence overall OEE has to
be greater than 85%
Connection between TQM and TPM:
• Both make company more competitive by reducing cost, improved customer satisfaction and
reduced lead times
• Total employee involvement is needed in both
• Need for fundamental training and education
• Long time to notice sustained tangible benefits
• Commitment from top management is necessary for implementation
Cellular Manufacturing (CM):
• CM comprise of multiple cells – Each cell will have one or more machines – Product moves from
one cell to another cell after completing a part of process – Objective is to have U-shaped design
so that it is easy to supervise and manage
• Goal: Move quickly, wide variety of similar products, little waste
• Benefits: Flexibility in operations, quick identification of problems, improved co-ordination and
communication among employees, massive gain in productivity/quality, lower inventory, lead
time and space – It is also known as ultimate in lean production
Implementation:
• Grouping of parts by similarity in design/manufacturing into families
• Systematic analysis of each family using mathematical models/algorithms
• Optimization is performed to reduce total cost of holding, inter-cell movement, material
handling, external transportation etc
Difficulties in creating flow:
• Exceptional elements, machine distance, part routing, cell load variation, cell reconfiguring,
bottleneck machine and parts
Benefits and Limitations of CM:
Benefits:
• Merging of scattered processes to form short focused paths in concentrated places – Reduces
flow time/distance, floor space, rework

• Facilitation of production and quality controls
• Benefits to workers: Improvement of group cohesiveness/ workers are more easily able to see
problems/suggest improvements
Limitations:
• Can lead to decrease in production flexibility – cells need to maintain a specific flow – any
change in demand will need realignment of cells
Six Sigma:
• Quality improvement technique – to eliminate defect that affect customer satisfaction
• Focus: Customer satisfaction, decision based on data driven facts, proactive management team,
goal for perfection, collaboration with in the business
• Sigma basically tells how far a process deviates from perfection – higher the sigma number,
closer the process is to perfection
• One sigma(69% defects – loss), Two sigma (31% - Non competitive), Three sigma (6.7% -
Average), Four sigma (0.62% - Above average), Five sigma (0.023%- Below maximum
productivity), Six sigma (0.00034 – Near perfection)
Six Sigma Implementation – DMAIC:
• Used to improve existing business process; Can be used for on-going continuous improvement
process/alteration of single process/stable competitor actions/technology – basically can be
used when there is stability in business environment
• Define = Define the problem, project goals and customer requirements
• Measure = Measure the current performance
• Analyze = Analyze root-cause of variation and poor performance
• Improve = Improve by eliminating root causes
• Control = Maintaining improved process and future process performance
Six Sigma Implementation – DMADV:
• Used to create new product/process; Can be used for projects with strategic
importance/alteration of multiple process/changing competitor actions /technology –
basically can be used when there is uncertainty in business environment
• Define = Define the problem, project goals and customer requirements
• Measure = Measure the customer needs
• Analyze = Analyze the process options to meet customer needs
• Design = Design the detailed process to meet customer needs
• Verify = Verify the design performance and ability to meet customer needs
DMAIC vs DMADV:
Similarities:
• Based on defects per million opportunities (DPMO), use same kind of six sigma quality
management tools, basic parameter is customer needs
Differences:
• DMAIC is for existing processes and DMADV is for new processes
• DMAIC is reactive whereas DMADV is proactive
• DMAIC increases the capability whereas DMADV increases the capacity
• Benefits can be quantified easily in DMAIC – benefits are more difficult to quantify and tend to
be much for long-term in DMADV
Six Sigma:
• Quality management tools: Control chart, Histogram, Pareto diagram, process mapping, root
cause analysis, statistical process control, tree diagram, cause and effect diagram
• Limitations: Focuses only on quality, substantial infrastructure investment is needed +
Complicated for some tasks, all products cannot meet six sigma standards, focuses on specific
type of processes only
• Lean Six Sigma: Lean six sigma = Lean system + six sigma – Increases speed and effectiveness
– maximize profits, minimize costs, satisfy customers
Process Innovation:
• Involves implementation of new or significantly improved production or delivery method
• Regular changes to improve product/service/process performance is not innovation
Areas of innovation:

• Production: Enhancing manufacturing process by equipment/ technology
• Delivery: Tools, techniques, software solutions to help in supply chain/delivery systems
• Support services: Purchasing, maintenance and accounting
BPR:
• Fundamental rethinking (Challenging basic assumption on why we are doing things) + Radical
redesign (fresh start & clean-slate approach) + Dramatic improvements (major improvement in
cost, quality, delivery and speed) + End to end business process (focus on re-engineering entire
process and not few activities of processes)
Principles of BPR:
• Organize around outcomes and not tasks: Single person should perform all tasks of the process
• Have those who need the results of a process perform the process: BPR can lead to timely
service as co-ordination of activities is not needed
• Integrate the processing of information into the work process that produces the information
– this can lead to relaxation of segregation of duties and management should consider this risk
• Treat geographically dispersed resources as though they were centralized: Operations can be
decentralized, however they should act as centralized unit while dealing with other benefits to
get economies of scale benefits
• Link parallel activities instead of integrating their results: Use communication networks,
shared databases and teleconferencing to link parallel activities
• Put the decision point where work is performed and build controls into the process: Normally
there is a team who does the work and another team which monitors and make decisions –
however companies can eliminate the non-value added activity and use Information technology
to capture and store data which enables people to make decision on their own
• Capture information once and at the source: Collect information once and share in database so
that all who need can access
Stages of BPR:
• Process identification + rationalization + redesign + reassembly
Chapter 4: Cost Management Techniques

Cost Control vs Cost Reduction:
• Cost control is regulation of cost by executive action – it involves continuous comparison of
actual with standards/budgets to control cost – this will lead to temporary savings in cost –
there can be issues with product quality and is less dynamic approach
• Cost reduction is achievement of real and permanent reduction in cost – continuous attempt to
achieve genuine savings in cost – it does not accept a standard/budget but rather challenges the
budget to make improvements – dynamic approach and ensures maintenance of quality
• Focus areas for cost reduction: Product design, Factory layout equipment, Production plan
programme and method
• Tools and techniques for cost reduction: Value analysis, inventory management (JIT/EOQ),
BPR, Target costing, Kaizen Costing
Target Costing:
• Structured approach to determine the cost at which a new product of specified functionality and
quality must be produced, to generate a desired level of profitability at its anticipated selling
price
Steps in Target Costing:
• Step 1: Re-orient culture of thinking and attitude – Importance to be given to customer and
market driven prices
• Step 2: Identify the market requirements as regards design, utility
• Step 3: Establish the market-driven target price
• Step 3A: Determine the volume of product
• Step 3B: Establish the target profit margin
• Step 4: Determine the target cost
• Step 4A: Establish a balance between target cost and customer requirements
• Step 5: Establish the target costing process
• Step 6: Brainstorm and analyze the alternatives

• Step 6A: Establish product cost model and compute cost for the design
• Step 7: Use value engineering/value analysis to close the gap between target cost as per Step 4
and estimated cost as per Step 6A
• Step 7A: Reduce the indirect cost applications – Re-engineer process and remove non-value
added activities
• Step 8: Measure results and maintain management focus on further possibilities of cost reduction
Advantages of Target Costing:
• Proactive approach to cost management
• Reinforces commitment from all for process and product innovation
• Focus on customer study and deciding the price which customer would pay – can contribute to
market success
• Control systems to support and reinforce manufacturing strategies
• Planning well ahead of actual production and marketing
• Enhances employee awareness and empowerment
• Minimize non-value added activities
Principles of Target Costing:
• Leadership of target selling price
• Focusing on customer
• Using and developing teamwork
• Reduce the cost of product life cycle
• Focus on the stage of product design
• Attention to all stages of the value chain
Components of Target Costing:
• Value analysis – Planned and scientific approach of cost reduction – reviews the material
composition and production design – modification and improvement which do not reduce value
to customer
• Value engineering – Application of value analysis to new products
• Value engineering is cost avoidance/reduction for a new product whereas value analysis is for
a product already in production – both adopt the same approach of complete audit of the
product
• Questions in value engineering/value analysis: Can we eliminate some functions/ reduce
durability or reliability/minimize design/ substitute steps/ combine steps?
Kaizen Costing versus Value Engineering:
• Initial value engineering may not uncover all possible cost savings – kaizen costing is repeating
all value engineering steps till product is produced
• Value engineering identifies large savings – however Kaizen costing identifies small savings –
however these savings are critical to maintain target profit margins with continuous pressure
on realizations
Problems with target Costing:
• Elongation of development process – Multiple design iterations are done till target cost is
achieved
• Large cost savings can result in finger-pointing in various parts of the company
• Multiple opinions about design can make it difficult to reach consensus about design
• Need for detailed cost data for effective implementation
• May reduce the quality due to usage of cheap components
• Solution: Strong control over design teams with a good team leader can solve above problems
Impact of Target Costing on Profitability:
Large positive impact on profitability due to following
• Detailed continuing emphasis on product costs throughout the life-cycle
• Improves profitability through precise targeting of correct prices at which the company can sell
a profitable product in a robust manner
Target Costing vs Traditional Costing:
• Target Costing = Product specification – Target price and volume – Target profit – Target Cost
– Product design

• Traditional Costing = Product specification – Product design – Estimated cost – Target Profit –
Target Price
Most useful situations for Target Costing:
• Useful when majority of product costs are locked in during product design phase – mostly
useful for manufacturing industries and few service industries
Characteristics of companies benefitting from target costing:
• Assembly-oriented industries
• Uses technologies such as factory automation/computer-aided design
• Shorter product life cycles
• Implementing management methods such as JIT/Value engineering
Life-cycle Costing:
• Identifying cost and revenues over a product’s life – objective is to maximize profits generated
over the entire life cycle
Stages:
• Introduction: First stage – new product is launched – minimal awareness and acceptance –
negligible competition and non-existent profits
• Growth: Second stage – Expansion of sales with customer awareness – entry of competition
leading to decline in profits around end of stage
• Maturity: Sales continue to increase but at a decreasing rate – intense price competition will lead
to decline in profit – players start planning for a new product
• Decline: Decline in sales volume – Demand for the product disappears – availability of better
and less costly substitutes in the market
Life Cycle Characteristics:
Particulars Introduction Growth Maturity Decline
Objectives Create product Maximise Maximise profits Reduce
awareness & trial market share while defending expenditures & milk
market share the brand
Sales Low sales Rapidly rising Peak sales Declining sales
Costs per High cost per Average costs Low cost per Low cost per
Customer customer per customer customer customer
Profits Negative Rising profits High Profits Declining Profits
Customers Innovators Early adopters Middle Majority Laggards
Competitors Few Growing Steady number Declining Number
Number beginning to decline
Life Cycle Strategies:
Particulars Introduction Growth Maturity Decline
Product Offer basic product Offer product Diversify brands Phase out weak
extensions, service and models items
& warranty
Price Cost plus profit Price to penetrate Price to match or Price cutting
market beat competitors
Advertising Build product Build awareness & Stress on brand Reduce level to
awareness amongst interest in mass differences and keep hard core
early adopters & market benefits loyalty
dealers
Distribution Build selective Build Intensive Build more Go selective:
distribution distribution intensive Phase out
distribution unprofitable
outlets
Sales Use heavy sales Reduce to take Increase to Reduce to
Promotion promotion to entice advantage of heavy encourage brand minimal level
trial consumer demand switching
Characteristics of PLC:
• Products pass through 4 stages – Product cost, revenue and profit follow predictable course
throughout PLC

• Profit per unit varies as product passes through these stages
• Strategies under each stage has to be different as product gets exposed to different opportunities
and threats
• Functional emphasis is different in each stage – focus is on R&D during development stage and
on cost control during decline stage
• Finding new uses/new users can increase life of product
Benefits of PLC:
• Earlier action to generate revenues or lower costs
• Better decision at each stage with accurate and realistic assessment of revenues and costs
• Promotes long-term rewarding
• Considers cost over entire life cycle – helps in improving cost effectiveness
• Long-term picture of product line profitability
• Traces R&D costs incurred to individual products over their entire life cycles – so all costs can
be considered and compared with revenues
Uses of PLC:
• Planning Tool – Characterizes the marketing challenges in each stage and poses major
alternative strategies (application of kaizen)
• Control Tool – Measure product performance against similar products launched in the past
• Forecasting Tool – This is not much useful as sales histories exhibit diverse patterns and the
stages vary in duration
Pareto Analysis:
• Tool to focus on most important aspects of decision making
• Based on 80:20 rule (or) 70:30 rule – helps in directing management attention to key control or
planning aspects
Uses of Pareto Analysis:
• Prioritize problems, goals and objectives to identify root causes
• Selection of key quality improvement programs + key customer relations and service programs
+ key employee relations improvement programs + key performance improvement programs
Application of Pareto Analysis:
• Pricing of product + Customer profitability analysis + ABC analysis (stock control) + Quality
Control + Activity based costing
Pros and Cons of Pareto Analysis:
Pros:
• Breaks big problem into smaller pieces by looking at root causes + Identification of significance
of each cause + Prioritize focus areas + ensure optimal use of scarce resources + control
mechanism
Cons:
• Possibility of exclusion of important problems + effectiveness is dependent on correct
data/information + Wrong identification of priority areas
Environmental Management Accounting:
• EMA is process of collection and analysis of information relating to environmental cost for
internal decision making
• Integrates best management accounting practice with best EMA
• Identifies environmental related costs and seeks to control these costs
• Objective is to get information which helps in evaluating sustainability and/or environmental
efficiency of a company
• Areas of application: Product pricing, Budgeting, Investment appraisal, Calculating costs,
measuring savings of environmental related projects
Environmental Costs – Classification:
US Environmental Protection Agency Classification:
• Convention costs = Raw material and energy costs
• Hidden costs = Costs which are accounted for but hidden as overheads
• Contingent costs = Cost to be incurred at a future date
• Relationship cost = Intangible costs – Example: cost of preparing environmental reports

United Nations Division for Sustainable Development classification:
• Costs incurred to protect environment
• Costs of wasted material, capital and labour
Hanson and Mendoza Classification:

• Environmental Prevention costs = Cost for preventing adverse environmental impact
• Environmental Appraisal costs = Costs incurred to determine whether products, process and
activities are in compliance with environmental standards
• Environmental Internal Failure costs = Costs incurred from activities that have been produced
but not discharged into environment
• Environmental External Failure costs = Cost incurred on activities after discharging waste into
environment
Generic Classification:
• Internal costs: Costs which have a direct impact on income statement of a company
• External costs: Costs which are imposed on society at large
• There is an inverse relationship between internal and external costs
EMA Methodology related to management of Environmental Costs:
• Phase 1 – Identification of Environmental Costs (expressed and hidden)
• Phase 2 – Allocation of environmental costs to cost centre and cost units
• Phase 3 – Controlling environmental cost
Identification of Environmental Costs:
• EMA requires an intense review of general ledger – some expenses can be hidden as overheads
• Allocation of environment costs to products using appropriate basis and the same can help in
making
• Decision with help of EMA: Different pricing of products + Re-evaluation of profit margins +
Phasing out certain products + re-designing process/products to reduce environmental costs +
Improving house-keeping and monitoring of environmental performance + Calculation of
NPV/IRR for investment decisions
Techniques to identify environmental costs:
• Input-output analysis: Traces inflows of raw material and outflow of finished products – helps
in measuring wasted material
• Flow cost accounting: Records material flows as well as material losses incurred at various
stages – Material flows are broadly categorized as material, systems and delivery and disposal
– Material cost is RM cost – Systems is in-house handling cost for RM (personnel cost) – Delivery
and disposal cost is cost of material leaving the company (Transportation/disposing waste)
• Life-cycle costing: Measuring life-cycle environmental cost – TQM approach can be used to
reduce costs
• Activity Based Costing: Allocation of environmental costs to products on the basis of
appropriate cost drivers – Objective is to remove environmental costs from general overheads
and allocate on the basis of suitable allocation base [Volume of emission/waste (or) Toxicity of
emission and waste treated (or) relative costs of treating different types of emission]
Controlling Environmental Costs:
• Waste: Mass balance approach can be used to find how much material is wasted in production
– we compare amount of material purchased with product yield – Waste has environmental
costs due to generation of greenhouse gases and loss of land resources
• Water: Identify where water is used and reduce consumption
• Energy: EMA identifies inefficiencies and wasteful practices – helps in energy cost reduction
• Transport and Travel: EMA can help in identification of savings in transport and travel cost
• Consumables and raw material: Directly attributable and discussion with management can
help in reducing them
Other points in relation to EMA:
• Reasons for controlling environmental costs: Reducing carbon footprint + Scope for cost
reduction + Regulatory requirement

• Role of EMA in decision making: Correct costing of products helps in making sound business
decision + different pricing of products + re-evaluation of profit margins + phasing out certain
products
• Advantages: Improving revenues (products can be sold at premium) + Cost reductions +
Improving brand image
• Disadvantages: Increase in costs (cost to comply with legal and regulatory requirements) + Cost
of failure (cost of clean-up and fines due to poor environmental management + Additional
burden on top management to implement EMA
Chapter 5: Decision Making

Important Formulae/Concepts to be revised:
• Format of marginal cost statement
• Profit volume ratio
• Break-even point
• Margin of Safety
• Sales to achieve desired profit
• Profit at desired sales level
• Break-even point for multiple products
• Indifference Point
• Shut-down point
• Limiting factor – Statement of ranking and statement of allocation
Relevant Cost:
• Relevant cost: Relevant costs are those expected future costs but differ for alternative courses of
action. All variable costs are relevant unless provided otherwise and all fixed costs are irrelevant
unless provided otherwise
• Committed costs vs discretionary cost: Committed fixed costs are unavoidable cost (irrelevant)
and discretionary fixed costs are avoidable fixed cost (relevant)
• Opportunity cost: Opportunity cost is value of next best alternative. It is measure of the benefit
of opportunity foregone and is a relevant cost
Non-financial Considerations:
• Non-financial factor is long-term focused and ensures profitability and sustainability in long-
term for an organization
• Following are the non-financial factors: Quality, Employee satisfaction, Customer satisfaction,
Corporate social responsibility, Environmental factors, Intellectual property, Intangible assets,
Competitor’s movements and Brand Name
Ethics:
• Ethics are moral principles that guide the conduct of individuals.
Following are the guidelines:
• Make an ethical decision by honesty and fairness
• Consequence of decision and effect on others to be analyzed
• Consider obligations and responsibilities to those who are affected by the decision
• Make decision which is ethical and fair to people who are affected by it
Qualitative factors:
• Outsourcing decision: Quality of goods, reliability of suppliers, impact on the customers and
suppliers
• Sell or further process decision: Readiness of employees to work extra hours to further process
product, availability of material
• Keep or drop decision/ Shut-down decision: Termination of employees if the product is
dropped, effect on employees who are not terminated, effect on suppliers from which raw
material for the product was purchased, effect on customer who previously purchased the
product being dropped
Chapter 6: Pricing Decision

Pricing Decision:
• Most crucial and difficult decision – Affects long-term survival

• Price can be based on cost/competitor’s pricing
• Pricing decision helps in meeting organization objective of maximizing profits/sales/
output/utilization of resources
• Pricing policy should provide incentive for using improved technology, ensure better balance
between demand and supply, encourage optimum resource utilization, encourage exports
Theory of Price:
• Primary objective of any organization would be to maximize profits. Optimum price is one
which helps an organization in maximizing profits
• Optimum price is one wherein the marginal revenue is equal to marginal cost. Company can
identify optimum price with price maximization model
Pricing under different market structures:
• Perfect competition: Large number of sellers selling homogenous product – Free entry and exit
of firms – No specific pricing policy and the firms are price takers
• Monopoly: Single producer – Firm is price setter – Firm should consider elasticity of demand
and fix price which can lead to maximum profits
• Monopolistic Competition: Firms producing similar but no identical products – Consumers
may buy more at lower price than at higher price – Optimum price can be computed by equating
marginal revenue with marginal cost
• Oligopoly: Few sellers selling identical product – Price is based on demand and reactions of
other firms in the industry – Predatory pricing (Keeping price artificially low below full cost),
Limit-pricing strategy (to discourage entrants), Cost-plus pricing, players can collude and raise
price together
Price Customization:
• Customizing the price based on taste, preference, perceived value
• Based on Product Line – 16GB vs 32GB Pen drive
• Based on customer past behaviour – Discounts for customer with good payment track record
• Based on demographics – Railway concession for senior citizens
• Based on time differential – different prices for different time period
Price Sensitivity:
• Measures customer’s behaviour to change in price of a product. Products are offered at multiple
prices – Price at which demand of the product starts declining is the level where price sensitivity
begins.
• 9 Factors impacting price sensitivity: Unique value effect (more unique product will have lower
sensitivity), Substitute awareness effect (high sensitivity if buyer is aware of close substitutes),
Difficult comparison effect (Low sensitivity if buyer has difficult in comparing two alternatives),
Total expenditure effect (Low sensitivity if the expenditure is a low proportion of consumer
income), End-benefit effect (Low sensitivity if expenditure is low compared to total cost of end
product), Shared cost effect (Less sensitivity for buyer if cost is borne by another party), Sunk
investment effect (Low if product is used along with assets already bought), Price quality effect
(Low if the quality is perceived to be high) and Inventory effect (Less if the product cannot be
stored)
Pricing Methods:
• Competition based
o Going Rate Pricing
o Sealed Bid Pricing
• Cost-based
• Value-based
o True Economic Value
o Perceived Value
Cost-based pricing methods:
• Most commonly used method – Price is equal to cost plus profit margin
• Cost would mean full cost and include all fixed costs as well
• Limitations: Allocation of inter-department overheads is on arbitrary basis + allocation of
overheads will require estimation of normal output which cannot be done precisely

• Company can also add a suitable mark-up percentage to variable cost to avoid above limitations
(or) Also sometimes the mark-up can be identified on the basis of required rate of return on
investment
Competition based pricing methods:
• Charging a price on the basis of what the competitors are likely to charge – Pricing is not based
on company’s own cost/demand but is based on competitor’s actions
• Going Rate Pricing: Price = Average price level of the industry – This is useful where it is
difficult to measure costs – Provides fair return and is least disruptive to entire industry – Used
in highly competitive conditions in homogenous product market and also used in Oligopolistic
market conditions
• Sealed-Bid Pricing: Competing on the basis of bids such as original equipment
manufacturers/defence contract work – Companies will bid for the contract and the offer price
would primarily be based on what the competitors are likely to charge
Value-based strategies:
• Pricing based on customer’s perception of value offered by a product
• Objective value or True Economic Value: Value of benefit a product is likely to offer as relative
to other products – True Economic Value = Cost of the next best alternative + Value of
performance differential
• Perceived Value: Value which customer understands the product to deliver – Product should
be priced below perceived value and above cost of production – Benefit to seller = Price – cost
of production – Benefit to buyer = Perceived value – price
• Creation of value for customers: Develop a product that satisfy the needs + Promotion strategy
to convey the value to customers + Right distribution channel so that product reaches the end
customer + Pricing strategy which incentivizes buyers to buy and sellers to sell the product
Other pricing scenarios:
• Pricing in periods of recession: Price should be less than total cost but above marginal cost –
This will ensure that firms continue to use their skilled employees (will be difficult to re-employ
if discharged), Plant and machinery can be prevented from deterioration, avoids competition
and business would be ready to take advantage of improved business conditions
Pricing below marginal cost:
• Materials are or perishable nature
• Large stocks have been accumulated and prices have fallen
• Popularize a new product
• Enables sales boost of other products having larger profit margin
Strategic Pricing of new products:
• Pricing of a new product poses a big problem due to demand uncertainty – Pricing can be done
only after thorough market study and consumer behaviour analysis
Categories of product:
• Revolutionary product: New for the market and has the potential to create its own value -
Enjoys premium price as reward for its innovation and taking first initiative
• Evolutionary Product: Upgraded version with few additional characteristics – Priced based on
cost-benefit, competitor and demand for the product
• Me-too product: A product is said to be a me-too product when a product emerges as a result
of success of revolutionary product – Price taker policy
Market entry strategies:
Skimming Pricing:
• Policy of high prices during initial period
• Scenario when this is followed: Inelastic demand, High initial prices serves the cream of the
market who are relatively insensitive to price, Demand is not known and hence this can help in
covering high initial cost of production, High initial capital outlays and high promotional
advertising expenditure
Penetration pricing:
• Using low price for entering into mass markets – Penetration pricing is to be differentiated from
predatory pricing (predatory pricing is charging very low price to drive competitors from
market)

• Scenarios when this is followed: Elastic demand, substantial savings due to large scale
production, entry barrier of keeping low price due to threat of competition
Pricing and Product Life-Cycle:
Skimming Pricing:
• Introduction = High prices but low profit margin due to high fixed costs
• Growth = Reduce price to penetrate market further
• Maturity = Price to match or beat competitor
• Decline = Cut price if not repositioning
Penetration pricing:
• Introduction = Low price to gain higher share quickly/prevent competition
• Growth = Increase price
• Maturity = Retain higher price in some segments
• Decline = Some increase may happen in late decline stage
Price Adjustment Policies:
• Tools to change price for various customer differences and changing situations
• Distributor discounts = Discounts can vary based on wholesaler, retailer, dealer – these are also
called as functional discounts
• Quantity discounts = Price reductions based on quantum of purchases
• Cash discounts = Priced reductions based on promptness of payment
• Price discrimination = Charging different prices based on customer, product, place or time – It
is possible if the customer can be segmented (or) customer not able to re-sell to segment paying
higher price (or) competitor should not be under-selling in segment of high prices
• Geographic pricing = Price can vary based on geography due to freight costs
Structured approach to pricing decisions:
• Company and marketing objectives
• Set pricing objectives and policy
• Assess target markets
• Assess cost structure
• Assess customer demand
• Assess competitors
• Select pricing method
• Select specific pricing
Sensitivity Analysis in Pricing Decisions:
• Significant in making right decision – helps in striking the right balance in which price is good-
looking to generate enough sales and is also profitable
• It can also help in determining how much to spent on R&D and marketing
• It can help in finding how sales and costs will respond to changes in market conditions
• It can be based on market demand, changes in market price, exchange rate fluctuation, initial
outlay, R&D, production cost, marketing cost, introduction dates and product prices
Pricing of Services:
• Customized services can be provided to customer – pricing decision is not easy and is likely to
have distinct pricing pressure
• Customer participation is needed in few services – hence he may incur some intangible cost –
we should consider customer’s intangible costs while fixing the price of the service
• Prices are controlled in few services such as Education, healthcare and transport
• Prices can also be determined in collective manner through trade association or professional
bodies
Chapter 7: Performance Management and Evaluation

Responsibility Accounting:
• Collection, summarization and reporting of financial information – Individual manager is
accountable for costs (or) revenues (or) assets
• Suitable when top management has delegated authority to make decisions – RA is used to
measure each manager’s performance
Types of Organization Structure:

• Entrepreneurial Organizational Structure: In this entrepreneur (owner) is expected to have
knowledge of everything. Control/decision making revolves around owner
• Functional organizational structure: Business is departmentalized on basis of functions such as
production, sales, marketing and finance – Useful for small organizations – Less independence
to managers to make decisions
• Divisional Organizational structure: Multiple divisions operating under broad corporate
framework – Each division will have various functions – Decentralization of decision making
• Matrix organizational structure: Under this cross-functional teams are set-up to reap benefits of
decentralization, speedy decision and early resolution of problem, as representation is from
multiple teams
Recognized levels of decentralization:
• Cost centre: Manager is responsible for cost incurred – major focus is cost minimization –
suitable for functional organizational structure
• Revenue centre: Concerned about raising revenues with no responsibility for costs –
Performance measures through sales variances
• Profit centres: Responsible for both revenues and costs – performance measured through profits
• Investment centres: Responsible for revenues and costs + Acquisition and disposal of assets
Performance Management System:
• Stage 1: Determine the organizational structure and ensure that the structure must be
appropriate and best fit
• Stage 2: Evaluate the degree of delegation of control and also identify the responsibility centres
• Stage 3: Establish the performance measures (both financial and non-financial) and target for
each measure
• Stage 4: Review the performance (with the help of KPI dashboard) and take corrective actions
(if required)
Characteristics of good performance measures:
• Provide incentive to make decision in the best interest of the company (Goal Congruence)
• Only Include factors for which manager can be held accountable
• Considers long-term as well as short-term objectives
Financial and non-financial measures:
• Financial Measures: ROI, RI and EVA
• Non-financial Measures: Balanced scorecard, Performance Pyramid, Building Block,
Performance Prism and Triple Bottom Line (TBL)
Pros and cons of performance measures:
• Pros: Develops agreed amount of activity + Clarifies objectives + Better process understanding
+ Facilitates comparison + Promotes accountability + Target setting
• Cons: Tunnel vision (undue focus on one area at expense of other) + Myopia (Too much focus
on short-term measures) + Misrepresentation (not presenting data correctly) + Misinterpretation
of data + Ossification (out-of-date measures) + Gaming (deliberate attempt to change data)
Common thread in all performance measures:
• Be allied to corporate strategy
• Include internal as well as external measures
• Include financial as well as non-financial measures
• Need to balance multiple dimensions of performance
• Include important (easy as well as difficult) measures
• Include measures for manager as well as employees’ motivation
Return on investment:
• Pre-tax ROI = EBIT/Investments; Post-tax ROI = [EBIT x (1-Tax)] /Investments
• EBIT/Operating profit should be controllable in nature – This would mean that EBIT should be
before head office expenses
• Investment = Capital employed = Long-term money = Debt + Equity + preference (or) Fixed
assets + Current assets – Current liabilities
• Capital employed can be opening (or) closing (or) average – compute all in exam if problem is
silent (or) write an assumption and compute one – preferable to compute based on closing
capital employed

• Disadvantage: Goal congruence issues – Divisional ROI can improve however company ROI
can decline and vice versa
Residual income:
• Pre-tax RI = EBIT – (Cost of capital x capital employed); Post-tax RI = [EBIT x (1 – Tax Rate)]
– [Cost of capital x capital employed]
• EBIT and capital employed is computed in same manner as that of ROI
• Advantage: No Goal Congruence issues – Divisional managers will act in the best interest of the
company
• Disadvantage: Absolute measure so it becomes difficult to compare the performance of a
division with other division of companies of different size
Economic Value Added:
• EVA = NOPAT – (WACC x Opening Capital Employed)
• EVA versus RI: EVA and RI are similar measures. However EVA considers economic value of
assets and hence will need accounting adjustment – For instance R&D is considered as asset and
not an expense
• EVA is computed based on opening capital employed unless the question specified otherwise
• EVA Limitations: Focuses on historical data + Absolute measure and hence cannot be used to
compare divisions of different sizes
EVA Adjustments:
• Advertising, R&D expense, Staff Training, Non-cash items:
o Current year: Add back to NOPAT + Add back to closing capital employed
o Previous years: Add back to opening capital employed
• Depreciation:
o Current year: Add accounting depreciation and deduct economic deprecation -adjust
NOPAT and closing capital employed
o Previous years: Add back cumulative accounting depreciation and deduct cumulative
economic depreciation to opening capital employed
• Tax:
o Current year: Add back accrual based taxes and deduct cash taxes
Balanced Scorecard (BS):
• BS considers both short-term and long-term goals – meets expectations of shareholders,
customers and employees
Four Perspectives of BS:

• Financial Perspective – How do we look at shareholders: Provides financial targets and checks
whether strategy is contributing to revenues and earnings
• Customer Perspective – How do customers view us: Lead indicators which contribute to
customer satisfaction and impacts future success of company – Example: On-time delivery, On-
site service, after sales support, defects per order, cost of product, free delivery
• Internal Perspective – At what must we excel?: Objectives and processes which are necessary
to achieve financial and customer objectives
• Learning and growth perspective – How do we continue to improve and create value?:
Activities and infrastructure that must be created for long-term growth – Learning and growth
objectives stem from people (employee capabilities), systems (information system capabilities)
and Organizational procedures
Benefits and reasons for failure of BS:
• Benefits: Improved long-term performance as BS gives equal importance to both financial and
non-financial measures – Discourages short-term focus as company has to take care of non-
financial measures as well
• Reasons for failure of BS: Managers mistakenly think that they already have non-financial
measures and hence already have a balanced scorecard – Senior managers delegate
implementation responsibility – Copying strategies and measures used by best companies –
Notion that BS is to be used only for reporting purposes
Performance Pyramid:

Building Block Model:

• Standards: Equity (equally challenging for all), Achievable (Realistic targets) and Ownership
(acceptable to all)
• Dimensions:
o Results - Financial Performance (overall performance in monetary terms) and
Competitive Performance (Performance in relation to competitors)
o Determinants – Quality (Consistently good quality and it should be enough for price
paid), Flexibility (responsiveness to change), Innovation (new products and new ways
of doing things) and Resource Utilization (efficient usage of assets)
• Rewards: Motivation (rewards scheme should motivate), clear (clearly communicated in
advance) and controllability (reward/penalty based on those factors which are in employee’s
control)
Performance Prism (PP):
• PP aims to meet the needs and requirements of all stakeholders – It is in contrast to other
measures which primarily focus on shareholders
• Stakeholder management is critical and it recognizes the need to work with stakeholders to
ensure their needs are met
Key questions:
• Stakeholder satisfaction – Who are stakeholders and what do they need
• Strategies – What strategies can help in stakeholder satisfaction
• Processes – Processes required to implement above strategies
• Capabilities – Capabilities for operating and enhancing processes
• Stakeholders’ contribution – What does the company need from stakeholders
Triple Bottom Line:
• TBL is also known as 3P framework (People, Planet and Profit)
• Sustainable organization has to ensure social and environmental performance along with
financial performance
• Environmental Bottom Line (Planet) – Measures impact on air, water, ground, waste emission
• Social Bottom Line (People) – Measures corporate governance, health and safety, human rights,
ethical behaviour
• Economic Bottom Line (Profit) – Measures profitability
Bearable vs Equitable vs Viable vs Sustainable decision in the context of TBL:
Planet People Profit Performance of Sub-set

Acceptable Acceptable Not acceptable Bearable
Not acceptable Acceptable Acceptable Equitable
Acceptable Not acceptable Acceptable Viable
Acceptable Acceptable Acceptable Sustainable
Linking CSF and KPI:
• CSF represent objectives that businesses are trying to achieve – derived from strategic goals of
organization – company should consider industry structure, competitive strategy,
environmental factors and temporary influences while deciding CSF
• KPI are derived from CSF – they are measurable and helps in understanding whether
organization has achieved its CSF
• Each CSF can have one or more KPI – KPI targets should be SMART (specific, measurable,
achievable, relevant and time bound)
• Every organization should implement KPI but the benefit of KPI is realized only when they are
implemented in right way – we should understand CSF and KPI linked relationship for this
Benchmarking:
• Technique for continuous improvement in performance – Comparing firm’s
products/services/processes with best performing organizations
• Objective is to find how can we improve and ensure that improvements are implemented –
Driving force to establish high performance and means to accomplish these goals
Goals of Benchmarking:
• Significant improvements in performance, efficiency, cost savings and new revenues
• Targets cycle time, productivity, customer service, quality and production costs
Types of Benchmarking:
Classification 1: Based upon content and scope of Benchmarking:

• Process benchmarking: Comparison of critical business processes (order processing) with best
practice organizations from same or other sector
• Functional benchmarking: Comparison of functions with companies from different business
sectors to find ways of improving
• Strategic benchmarking: Similar to process benchmarking but differs in scope and depth – focus
is on improving long-term performance by comparing high level aspects such as new
products/services/core competencies
• Performance Benchmarking: Comparing outcomes (performance measures) with either an
internal or external firm
• Product benchmarking: Reverse engineering. Buying a rival product + Dismantle + compare
with own product
Classification 2: Based upon benchmarking partner:

• Competitive benchmarking: Comparison with competitor
• Collaborative benchmarking: Comparison with benchmarking partner with intent of
developing a learning atmosphere and sharing of knowledge
Classification 3: Based upon Boundary:

• Geographical Boundary - Global benchmarking: Comparison of business processes and trade
practices with companies from across the Globe
• Organization’s business boundary: Internal benchmarking (Comparison with partners from
within same organization. Example: ITC FMCG with ITC Hospitality. Benefit is of access to
confidential data and information) and External benchmarking (Comparison with partners from
outside organizations)
Categorization of External Benchmarking:

• Intra-group benchmarking: Group of companies within same industry share data about their
processes and benchmarking is done
• Inter-industry benchmarking: Non-competing businesses with similar process participate in
benchmarking exercise – Example: Publisher of school book with publisher of university books

Process of Benchmarking:
• Planning: Identify what to benchmark + Find benchmarking partners + Determine data
collection method and collect information
• Analysis: Determine current performance gap + Project future performance levels
• Integration: Communicate findings and gain acceptance + Establish functional goals
• Action: Develop action plans + Implement action plans and monitor progress + Recalibrate
benchmarks
• Maturity: Attain leadership position + Fully integrate practice into processes
Pre-requisites and Difficulties of Benchmarking:
• Pre-requisites: Top management support, clear definition of objectives, correct scope in relation
to objectives, availability of sufficient resources, communication to staff about reasons of
benchmarking
• Difficulties: Time-consuming, need direct involvement of senior manager, resistance from
employees, wastage of time in benchmarking non-critical functions, best practice may not tailor
to company’s needs and culture
Not for profit sector:
• Does not exist for earning profits but for achieving certain social or charitable cause
• Key characteristics: Performs non-economic activities + requires funds from members/external
contributors to arrange resources + Fiduciary (trust) relation towards contributors to ensure
proper application + No distribution of surplus
Not for profit sector – Challenges in measuring performance:
• Difficult to quantify costs/benefits: For example an organization providing free education to
poor students, the benefits derived by students cannot be quantified – However they should try
to balance costs and benefits based upon opportunity value and cost
• Performance and commitment of Government: Participates mostly in high public importance
(Food security, Education and health) activities – Primary role is of Government to provide this
– hence achievement of objective is dependent on Government
• Measuring the utility of funds: Some organization spend out of budget and don’t earn revenue
– assessing whether spending has been appropriate is a key challenge – VFM framework to be
used to assess utility of funds spent
• Multiple objectives: Multiple objectives – there can be conflict among them – We should
prioritize based upon importance and urgency
Not for profit sector – VFM Framework:
• Value for money framework can be used to measure performance of companies in not-for-profit
sector
• Effectiveness (Spend wisely): Whether organization has achieved the mission and objectives?
• Efficiency (Spend well): Whether maximum output has been achieved with minimum input?
• Economy (Spend less): Whether the desired output has been achieved using the lowest cost? –
Use of lowest cost approach should not compromise quality
• Additional two E’s have been added – Equity (Spend fairly) and Ethics (Spend properly)
Not for profit sector – Adapted Balance Scorecard:
• Customer perspective – Satisfaction of beneficiary and other stakeholder’s interest
• Financial perspective – Fund raising, fund growth and funds distribution
• Internal process perspective – Internal efficiency, volunteer development and quality
• Innovation and learning perspective – Organizational capability to adjust to changing
environment
Not for profit sector – Other performance measures:
• Quality of service
• Attainment of objectives
• Ability to raise funds to meet objectives efficiently
• Transparent and periodical reports to the stakeholders
• Long-term impact/benefits of activities of not-for profit organizations
Performance reports:
• Responsibility accounting can be implemented only by issuing performance reports at regular
intervals

• Performance reports compare budgeted results with actual results + Effect of activity changes
and how these changes have been controlled by management
• Reports should flow from bottom and top. Manager should receive detailed update on his
performance and summary of performance of other lower-level managers
• At bottom level, it helps in determining the required corrective measures and at top level these
reports help in knowing the performance of all segments
Chapter 9 – Divisional Transfer Pricing

Transfer Price:
• Refers to the price charged by one division to another division
• Utility: Performance evaluation, Employee engagement and compensation, Resource allocation,
taxation and profit remittance
• Transfer price is often associated with arms-length price – However this is more from taxation
perspective
• Transfer price is revenue for one division and cost for other division – Price should be fixed in
such a way that it is good-deal for both divisions
Transfer Pricing Methods:
• Market Based
• Cost Based
o Marginal cost based
o Standard cost based
o Full cost based
o Cost plus markup based
• Negotiation based
Transfer Pricing and Goal Congruence:
• Wrong transfer price may lead to individual managers working in the best interest of the
division. However this can impact overall company performance. This will lead to sub-optimal
utilization of resources
• Minimum transfer price = Additional outlay cost per unit + Opportunity cost per unit
• Maximum transfer price = Lower of net marginal revenue and external purchase price (adjusted
for saving/increase in costs)
Proposal for resolving TP Conflict:
• Dual rate transfer pricing system: Supplying division can record transfer price by including a
profit margin whereas purchasing division will record at cost – Promotes goal congruence –
however accounting records will be complicated and can lead to scenario of artificial profits
• Two part transfer pricing system: Transfer price = Marginal cost + lump-sum charge. Supplying
division can recover marginal cost and lump-sum charge will contribute towards recovery of
fixed cost. Purchasing division can buy goods at lower rate as compared to market price
Chapter 10 – Strategic Analysis of Operating Income

Profitability Analysis:
• Profitability analysis basically measures the performance of the firm against acceptable
standards – it can be as per the requirement of the management to assist them in identification
of critical success factors and to take appropriate decisions
Strategic Profitability Analysis:
• Operating income is analysed through three main areas/components
• Growth component: Change in profit due to change in quantity sold
• Price recovery component: Change in profit due to changes in prices of outputs as well as inputs
• Productivity component: Change in profits due to change in product mix and/or yield of
inputs
Profitability Analysis through ABC:
• ABC system helps in tracing overheads to products/services with its emphasis on activities and
their cost drivers
• Cost is accurately measured and hence ABC is helpful in providing more useful information to
management

Direct Product Profitability:
• DPP is one of the methods to analyze the profitability for each product or segment of products
– DPP is primarily used in retail sector
• DPP can help in knowing the relative profitability of individual products so that management
can concentrate on profitable products and weed-out loss-making products
• Benefits of DPP: Better cost analysis + Better pricing decisions + Better management of stores
and warehouse space + rationalization of product range
Direct Product Profitability Statement:
• Profit = Selling price – Purchase cost – Indirect costs
• Indirect costs: Overhead cost (cost not directly linked to a particular product) + Volume related
cost (Cost related to space occupied by products ~ storage and transportation) + Product batch
cost (cost incurred on stocking items in shelves) + Inventory financing cost (interest cost on
inventory)
Customer Profitability Analysis:
• It is similar to DPP. However, in this case profitability is computed for different
customers/segments/groups – Service organizations such as bank or hotel need to cost
customers
• Benefits: Helps in identification of which customers are eroding profitability and which are
contributing to it + Basis for constructive dialogue between buyer and seller to improve margins
Activity based cost management (ABM):
• ABM basically utilizes cost information gathered through ABC – It focuses on managing
activities – it determines what drives the activities and how these activities can be improved to
increase profitability
• Objective is to manage costly activities with the goal of reducing costs and improving quality
• ABM involves cost driver analysis, activity analysis and performance analysis
Cost Driver Analysis, Activity Analysis and Performance Analysis:
• Cost Driver Analysis: Cost driver is basically the factor that cause activities to be performed –
Cost driver analysis can help in improving the cost-effectiveness of activities and cost
management through ABM – For example: Lack of training to employees could be the reason
for slow processing of customer invoices
• Activity Analysis: Activity analysis helps in identification of value-added and non-value added
activities
• Performance Analysis: Organization should focus on significant activities for performance
analysis – We should measure the performance of activities (comparison of actual versus
expected) – this can help in knowing how well the improvement efforts are working and is an
integral part of continuous improvement
Value-added and non-value-added activities:
• Value-added activities are those which are unavoidable in order to complete the process –
customers are willing to pay for these services
• Non-value-added activities are those which are not valued by internal or external customer –
this is a waste and should be avoided – customers are not willing to pay for these
Manufacturing cycle efficiency:
• Receipt time = Time taken by marketing department to specify to manufacturing department
exact requirement in customer’s order
• Process time = Time taken to convert input into output
• Inspection time = time spent on confirming if the product is of high quality
• Waiting time = Time that raw material/WIP waiting for the next operation
• Storage time = Amount of time inventory is in stock
• Delivery cycle time/Customer Response time = Gap between receipt of order and delivery of
goods
• Manufacturing cycle time = Production time required per unit
• MCE = (Processing time)/(Processing time + Inspection time + waiting time + Movement time
+ Storage time)
• Velocity = Number of units produced in a given time
Business applications of ABM:

• Goal of ABM = Satisfy customer needs with few resources
• Customer needs = Lower costs + Higher quality + Faster response time + Greater innovation
• Uses of ABM in business applications = Cost reduction + Activity based budgeting + Business
process re-engineering + Benchmarking + Performance measurement
• Cost reduction: ABM helps in identifying and quantifying process waste and help in continuous
improvement through continuous cost reduction
• Activity based budgeting: Framework for identifying amount of resources needed for budgeted
activity level – Actual results can be compared with budget to identify activities with major
discrepancies and then use this for continuous improvement
• BPR: Business process consists of set of linked activities – ABM can help in BPR by measuring
performance + determining cost of output + identify opportunity to improve process efficiency
and effectiveness
• Benchmarking: Comparing ABC derived activity cost of one segment with other segments
• Performance measurement: Focus on measuring the efficiency and effectiveness of activities
relating to cost, time, quality and innovation
Steps for implementing ABM:
• Identify important issues and what information is needed to address those issues
• Top management support for identifying critical needs
• Incorporate ABC method in financial reporting process
• Actual users of ABM should be part of implementation team
• Existing information system should support input requirements
• Integrate ABC into main costing system – if this is not feasible then we should develop a separate
system
• Implement ABM
Benefits of ABM:
• Excellent basis and focus on cost reduction
• Helps in implementation of Activity based budgeting
• Clear understanding of underlying causes of business processing costs
• Excellent basis for effectiveness of management decision making
• Identify key process waste elements, permit management prioritisation and leverage of key
resources
ABC versus ABM:
• ABC basically focus on finding accurate cost of product – ABM is a broader concept and it
focuses on using ABC data for better management of activities leading to continuous
improvement
Activity Based Budgeting:
• Planning and controlling the expected activities to derive a cost-effective budget that meets
required goals
• Key elements: Type of work/activity to be performed + Quantity of work/activity to be
performed + Cost of work/activity to be performed
• ABB works well with Activity based costing system – ABB improves the accuracy of forecasts
• It can also help in cost reduction through elimination of wasteful activities
Activity Flexible Budgeting:
• Prediction of required activity levels as output changes – making it flexible with change in
output
• This will help in doing variance analysis and also enhances ability to manage activities
• It is different from traditional flexible budgets. Under traditional flexible budgets, the cost varies
with a single cost driver (output) – however here we have different activities and each will have
a separate cost driver
ABC – Decision Making Tool:
• Complement to TQM: Provides data that can help in tracking the financial impact of
improvements implemented as part of TQM
• Significant advantage for wholesale distributors: Helps in decision addition/deletion of
product line

• Facility and resource expansion: ABC can help in knowing the need for expansion based on
activity demand – It will help in tracking whether the specified cost benefits are achieved as
expected post expansion
• Decision support for human resources: Ability to generate information about
employee/revenue ratios, productivity data through automation – this can help in deciding on
hr expansion/outsourcing
• Cost plus markup method: Fix accurate pricing if company follows cost plus mark-up method
Chapter 11 – Budgetary Control

Budgetary Control:
• Systematic control of operations through establishment of standards and targets (financial and
performance goals) + Continuous monitoring + adjustment of performance
• Budget is estimation of revenues and expenses over a specific future period of time
• Prerequisites: Serious attitude to system, clear demarcation between responsibility areas,
reasonable targets, established data collection, reports aimed at individual managers rather than
general, short reporting periods (monthly), timely variance reports, corrective action
Feedback control:
• Reaction after an action has taken place – tool for corrective action
• Measurement of differences between planned outputs and actual outputs achieved +
modification of subsequent action to achieve future required results
Types of Feedback:
• Primary: Reported to line management – control reports comparing actual and budgeted results
– Not reported to anyone higher if the variances are small (or) can be easily corrected
• Secondary: Feedback is sent to higher level in organization – used when there are large variances
– can also lead to variation in standards
• Negative: Feedback taken to reverse a deviation from standard – will lead to amendment of
process
• Positive: Taken to reinforce a deviation – no change in process – can lead to change in standards
Limitations:
• Depends on success of error detection systems + time lag between error detection, error
confirmation and error revision during which actual results may change again
Control Reports:
• Feedback devices – control reports cannot lead to change in performance but a change happens
if managers take action based on the report
Guidelines:
• Disclose both accomplishment and responsibility
• Extracted promptly
• Disclose trends and relationships
• Disclose variation from standards
• Standardized format
Feed-forward Control:
• Forecasting of differences between actual and planned outcomes and implementation of action
before the event to avoid such differences
Approaches on implementation:
• Indicator, both leading and early warning + Contingency Plans + Trend Analysis + Adaptive
mechanism + Congruent system designs + Policy directives
Guidelines on implementation:
• Through planning and analysis + System to be kept dynamic + Data on input variables must
be regularly collected + Requires action
Limitations:
• Concerned with estimation of uncertain future – problem of uncertainty will limit application
• Study of future is not well developed
Behavioural aspects:
• Contradictory goals of budgeting – Fair evaluation vs motivation
• Manager participation vs non-participation in budget setting – Manager participation can
improve motivation and performance – however risk of budgetary slack
• Unrealistic demanding targets can also adversely impact performance
• Hence budgetary control leads to a conflict between achieving financial control and
communicating organization goals
Effect of the budget difficulty on performance:
• Budget level that motivates the best level of performance may not be achievable – In contrast an
achievable budget may lead to lower level of performance as managers no longer aspire to meet
budget target
• Budget will have motivation effect if accepted by managers
• If budget is not accepted then demanding targets will lead to better results
• Generally demanding targets are seen as more relevant than less difficult targets, but negativity
gets in if targets are too challenging
Participation in budget setting:
Top-down Approach or imposed style approach:
• Budget is centrally prepared with little influence from sub-ordinates – Benefit (quick to prepare)
– Limitations (inaccurate budget and motivation issues)
• Suitability: Where personality characteristics of participation lead to no benefits + participation
will not lead to commitment from sub-ordinates + standard process with clear input-output
relationships + stable environment with large number of homogenous units
Bottom-up Approach or Participative Approach:

• Subordinates participate in the process of budget preparation – Benefits (accuracy and
motivation) – Limitations (budgetary slack and time consuming)
• Suitability: Suitable in all situations where top-down approach is not be followed
Styles of performance evaluation:
• Budget constrained style: Focus on manager’s ability to meet budget on short-term basis
• Profit conscious style: Focus on effectiveness of unit’s operations in relation to long-term goals
of the organization
• Non-accounting style: Evaluation of performance based on non-accounting data
A Summary of the Effects of Three Styles of Management
Particulars Budget- Profit- Non-
Constrained Conscious Accounting
Involvement with costs High High Low
Job-related tension High Medium Medium
Manipulation of Accounting Extensive Little Little
Information
Relations with Superiors Poor Good Good
Relations with Colleagues Poor Good Good
Limitations of Traditional Budgeting:
• Time-consuming and costly
• Constrains responsiveness and flexibility
• Barrier to change
• Adds little value
• Focus on cost reduction and not value creation
• Developed and updated infrequently, normally once a year
• Based on unsupported assumptions and guesswork
Beyond Budgeting:
• Focus is to move beyond budgets due to its inherent limitations – techniques such as rolling
forecasts and market related targets

• Benefits: More adaptive process (ability to respond to change) + Decentralized process (more
authority to managers)
• Characteristics: Rolling budgets with KPIs + Benchmarking + focus on improving future results
+ allow managers to react to environment + encourage innovation + Timely resource allocation
• Suitability: Rapid change in environment + industries using management models such as TQM
(continuous improvement) + industries undergoing radical change such as BPR
• Benefits: Motivating managers + Eliminates behavioural issues + establishes customer oriented
teams + Managers do not focus on budget limits and work towards achieving key ratios + creates
information system for fast and open information
Principles of Beyond Budgeting:
• Management Processes: Rhythm (Dynamic process based on business rhythms and events ~
not around calendar year), Targets (set ambitious goals), Plan and forecasts (unbiased and not
political), Resource allocation (allocation as needed), performance evaluation (evaluate
performance with peer feedback for learning and development), Rewards (rewards based on
success against competition) – All above steps were done only at the time of budgeting in
traditional budgeting
• Leadership Principles: Purpose (Bold and noble targets – no short-term financial targets), values
(shared values and sound judgement), Transparency (make information open for innovation,
learning and control), Organization (avoid hierarchical controls and bureaucracy), Autonomy
(trust people with freedom to act) and customers (connect everyone with customer’s needs)
Implementation of Beyond Budgeting:
• Implementation: Define the case for change – Convince the board – Get started – design and
implement new process – train people – rethink role of finance – Change behaviour – evaluate
benefits – consolidate gains
Chapter 12 – Standard Costing

Planning and Operational Variances:
• When the current environment conditions are different from anticipated environment
conditions – then there is need to revised budgets and do variance analysis
• Planning variance = Revised standard compared with original standard
• Operating variance = Actual compared with revised standard
• The difference between the original and revised budget is called as PLANNING variances and
the difference between the revised and actual is called as OPERATING variances
Market size and share variances:
• Sales volume variance reports the difference between actual and budgeted sales quantity –
However in order to assess the performance of the sales team, market conditions during budget
setting and conditions actually existed should be considered
• Market size variance measures the impact on the quantity sold due to change in the market size.
It is similar to planning variance.
• Market share variance measures the impact on the quantity sold due to change in the company’s
share in the overall market. It is similar to operating variance
Variance Analysis in ABC:
• ABC approach is based on the assumption that the overheads are basically variable (but variable
with the delivery numbers and not the units output)
• Variance computation would be done in similar manner as that of VOH variances – however we
need to ensure usage of correct cost driver which can be customer deliveries / dispatches /
customer orders/production runs
Learning curve – impact on variances:
• Learning curve indicates that the amount of time taken to produce every successive unit will
reduce
• Understanding of learning curve will be critical while computing labour efficiency variances as
benefit of learning curve needs to be considered while calculating standard time
Relevant costing approach:

• Normally variances are computed by comparing standard cost with actual cost. However if
resources are limited then we should consider opportunity costs while computing efficiency
variances.
Variance Analysis and Throughput Accounting:
• An organization may run with limited resources – in this case it is critical to utilize resources
properly – we need to work around the limiting factor and stop utilization of other factors when
not needed – this will ensure limited WIP inventory
• Traditional variance analysis will not work under this set-up and it will lead to adverse
efficiency variances due to non-utilization of resources
• Under this system variance analysis will focus on tracking variations in the size of the inventory
buffer placed before the constrained resource, to confirm that the constraint in never halted due
to an inventory shortage
Variance analysis in advanced manufacturing environment/high technology firms:
• Variance analysis is applicable all types of companies – however advanced manufacturing
companies use more of automated operations and hence majority of costs which were once
variable have become fixed
• Only two variable costs are there – direct material and power cost to operate machines
• Focus is to compute direct material and variable OH variances – skilled labour is not a variable
cost but a committed cost and it is important to retain them even during slowdown and hence
no major focus is placed on labour variances
Standard costing in service sector:
• Variance analysis is tough to apply in service industries as major part of the cost is overhead
expenses rather than production expenses
• Traditional analysis will not work and hence company should use ABC costing along with
variance analysis for effective variance analysis
Standard Costing in public sector:
• Variance analysis is critical in public sector for cost control
• We should take details of actual cost incurred and compare the same with estimated cost to
know about the variation and investigate the reasons for the same
Factors to be considered when investigating variances:
• Size: Small variation should be ignored and any large variation beyond a set limit should be
investigated
• Type of variance: Adverse variance is given more importance while investigation as compared
to favorable variances
• Cost: Cost of investigation should be lower than likely benefit from the investigation
• Pattern in variance: Variances need to be monitored for a period and if there is a continuous
worsening in performance than the same should be investigated
• Budgetary process: If variation is due to unrealistic/uncontrollable standards then we should
re-evaluated the standards and not investigate the variance
Methods used for investigating variances:
• Simple Rule of Thumb Method: Arbitrary criteria – investigate if the variance is greater than a
certain amount or a certain percentage – based on managerial judgement
• Statistical decision model: Two types of system – In control system (system is operating fine
and variance is random fluctuation) & out of control system (system is not operating fine and
corrective action is to be taken) – Investigation is to be done for out of control system + In control
system if variation is beyond a set level based on probability
Possible interdependence between variances:
• Use of cheaper poor quality RM: Favorable material price variance and adverse material usage
variance
• Using more skilled labour to do work: Adverse labour rate variance and favorable labour
efficiency variance

• Changing the composition of a team: Cheaper labour mix (favorable mix variance) but adverse
yield variance
• Workers trying to improve productivity: Favorable labour efficiency variance, Adverse labour
rate variance, Adverse material usage variance (wastage of material due to fast working)
• Cutting sales price – Adverse sales price variance and favorable sales volume variance
Causes of variances:
• Material Price Variance: Use of different supplier + Change in order size + Unexpected increase
in buying cost due to higher delivery charges + efficiency/inefficiency of purchasing team + lack
of inventory control system leading to emergency purchases at higher price
• Material usage variance: Inferior quality material + Better quality control + Improved efficiency
leading to lower wastage + Change in material mix + Careless way of handling material +
Change in method of production + Material pilferage + Poor inspection
• Labour rate variance: Unexpected increase in labour rate + level of experience of labour can
impact labour cost + Payment of bonus + Change in composition of labour
• Labour efficiency variance: Improvement in efficiency + Workforce mix + Industrial action in
relation to workforce + Poor supervision + Learning curve effect + Resources shortage leading
to unexpected delay + Using inferior quality of RM + Introducing new machinery leading to
improved labour productivity
• Overhead variances: FOH expenditure variance due to spending in excess of budget + FOH
volume variance due to change in volume + VOH expenditure variance due to change in
running cost + VOH efficiency variance due to same reasons as that of labour efficiency variance
• Sales price variance: Higher discounts to encourage bulk purchases + Low price due to a
marketing campaign + Poor performance by sales personnel + Market or economic conditions
forcing changes in prices
• Sales volume variance: Success or failure of direct selling/marketing efforts + Unexpected
changes in customer preferences + failure to satisfy demand due to production issues + Higher
demand due to cut in selling price
Behavioural issues:
• Can lead to short-term focus due to inherent tendency towards short-term results
• Sub-optimal behaviour among employees like adding budgetary slacks
Standard costing in modern business environment:
• Non-standardized products + Variance reports may arrive late to solve problems + Outdated
standards + variance analysis may not give full detail + highly automated production + focus
on continuous improvement and hence standards are of no use + uses ideal standards than
current standards

Introduction to Strategic Cost Management SCMPE
Chapter 1 – Introduction to strategic cost management
Traditional cost management (TCM):

❖ Traditional cost management involved allocation of costs and overhead and focused largely on
cost control and cost reduction
❖ TCM focused on comparing actual results with standard expectations (typically budgets or
standard costs) and analyzing the difference. This process was also known as variance analysis
Limitations of TCM:
❖ Ignores competition, market growth and customer requirement
❖ Excessive focus on cost reduction
❖ Ignore dynamics of marketing and economics
❖ Limited focus on review and improvisation
❖ Reactive approach
❖ Short-term outlook
Strategic cost management (SCM):

❖ Strategic cost management (SCM) is the application of cost management techniques to improve
the strategic position of business as well as control costs
❖ SCM involves integrating cost information with decision –making framework to support the
overall organizational strategy
❖ SCM advocates that cost management techniques should be such that they improve strategic
position of a business apart from controlling costs
❖ SCM aims to help the organization to achieve sustainable competitive advantage through product
differentiation and cost leadership
Examples:
Preventive maintenance versus break-down maintenance:
A manufacturing company does not carry out preventive maintenance of its machineries on a
regular basis to save costs. Repairs of machinery is carried out as and when a machinery breaks down.
This is a traditional approach to cost management where the focus is on cost reduction and cost
saving. This is a short- term approach to manage costs. When machinery breaks down, the company
loses more in terms of loss of production time and idle labour time. Lack of regular preventive
maintenance and planned shutdown time also reduces the life of the machinery and has a longer-
term impact. If the loss of production is significant, the company might lose market share to its
competitors. Hence, it is important to look at cost management with a strategic focus.
Decision on closure of service Centre:
A telecom company closed down some of its customer service centres as a cost cutting measure.
This led to overcrowding of customers at other centres and longer waiting time for the customers. The
volume of work at other centres increased impacting the performance of employees. Both the
customers and employees, two of the key stakeholders, were not happy with the company’s
decision. This type of business decision can impact the reputation and brand image of the company
and impact the sales and profitability in the longer run.
Cost reduction can be good and bad:
➢ Good cost reduction is one wherein we can reduce costs as well as maintain or improve
quality
➢ Bad cost reduction is one wherein a company cut costs without considering the impact on
employees, customers and overall loyalty
➢ SCM focuses on only good cost reduction whereas TCM can involve both good and bad
cost reduction
Stages of strategic management (Formulation, Communication, Implementation and Control)

❖ Stage one: Formulating strategies
❖ Stage two: Communicating those strategies throughout the organization
❖ Stage three: Developing and carrying out tactics to implement the strategies
❖ Stage four: Developing and implementing controls to monitor the success of objectives

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Last Day Revision - Theory SCMPE

Last Day Revision - Theory

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Chapter 2 – Modern Business Environment

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Chapter 3: Lean System and Innovation

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Chapter 4: Cost Management Techniques

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Hanson and Mendoza Classification:

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Chapter 5: Decision Making

Chapter 6: Pricing Decision

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Chapter 7: Performance Management and Evaluation

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Four Perspectives of BS:

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Building Block Model:

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Classification 1: Based upon content and scope of Benchmarking:

Classification 2: Based upon benchmarking partner:

Classification 3: Based upon Boundary:

Categorization of External Benchmarking:

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Chapter 9 – Divisional Transfer Pricing

Chapter 10 – Strategic Analysis of Operating Income

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Chapter 11 – Budgetary Control

Bottom-up Approach or Participative Approach:

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Chapter 12 – Standard Costing

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Traditional cost management (TCM):

Strategic cost management (SCM):

Stages of strategic management (Formulation, Communication, Implementation and Control)

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