Scpm Notes

STRATEGIC COST AND PERFORMANCE MANAGEMENT CA.
DINESH JAIN
STRATEGIC COST &

PERFORMANCE
MANAGEMENT
SUMMARY NOTES
FOR CA FINAL
BY CA. DINESH JAIN
DEDICATED TO MY LOVABLE
FATHER [RAMESH JAIN]
BHARADWAJ INSTITUTE (CHENNAI) 1

STRATEGIC COST AND PERFORMANCE MANAGEMENT CA. DINESH JAIN
TABLE OF CONTENTS
SCPM Summary Notes ............................................................................................................ 3

Chapter 1 – An Introduction to Strategic Cost Management ............................................ 5
Chapter 2 – Modern Business Environment ...................................................................... 14
Chapter 3 – Lean System and Innovation ........................................................................... 17
Chapter 4 – Specialist Cost Management Techniques ..................................................... 21
Chapter 5 – Management of Cost Strategically for Emerging Business Models ........ 27
Chapter 7 – Strategic Profit Management........................................................................... 35
Chapter 8 – An Introduction to Strategic Performance Management ........................... 40
Chapter 9 – Strategic Performance Measures in Private Sector...................................... 47
Chapter 10 – Strategic Performance Measures in the Not-For-Profit Organisations . 53
Chapter 11 – Preparation of Performance Reports ............................................................ 55
Chapter 12 – Transfer Pricing ............................................................................................... 57
Chapter 6 – Strategic Revenue Management ..................................................................... 59

SCPM Summary Notes
Paper Pattern:
• Fully MCQ Based [50 MCQ x 2 Marks = 100 Marks]
• Expected weightage = 50 Marks of Theory and 50 Marks of Practical
4 Case Scenario x 12 Marks 48 Marks
Total Marks 100 Marks
• However students have said that around 18 case studies have also come in exam. [Max marks of
12 and Min marks of 4 Marks]
Likely areas for Case Scenarios:
Chapter 1 • TCM versus SCM
• Value Chain Analysis
• Cost leadership and Product Differentiation
• STEEPLE
• Mendelow’s matrix
• Business model canvas
• Value Proposition Canvas
• Porter’s Five Forces Model
• IT/IS/IM Strategy
• Role of Management Accountant
Chapter 2 • Cost of Quality
• Service Level Agreement (See additional question given for this area)
• SCM – Push Model vs Pull Model
• Upstream vs Downstream supply chain
• Downsizing vs outsourcing vs offshoring
• Problem on customer account profitability or customer life-time value
Chapter 3 • Just in Time
• JIT – Takt Time, Cycle time, Process cycle efficiency
• Kaizen Costing
• 5S
• OEE
• Six Sigma – DMAIC vs DMADV
• Cellular manufacturing
Chapter 4 • Cost Control vs Cost Reduction
• Target Costing
• Stage of Product Life-Cycle
• Life Cycle Costing
• Theory of Constraints
• Environmental Management Accounting
Chapter 5 • Types of key technologies in digital transformation
• Cloud Computing
• Blockchain Methodology – Including encryption controls
• Meaning of disruptive innovation
• Meaning of incumbents
• Incubators
• Meaning of Disruptive Model
• Types of E-commerce Model
• Emerging markets and strategies in emerging markets
• Strategies to counter new business models
Chapter 6 • Optimal mix of Products ranking based on contribution
• Monopoly
• Pricing policy
• Skimming and Penetration Pricing
Chapter 7 • Distribution of costs on the basis of ABC method
• Value added and non-value-added activities
• Manufacturing cycle efficiency
• Pareto Analysis
Chapter 8 • Meaning of matrix organization
• Five ways to gain competitive advantage through value chain
• Mckinsey 7S – Hard S vs Soft S
• Complex Business Structures
• Behavioral aspects in performance measurement
• Altman Z score
• Argenti’s A Score
Chapter 9 • ROI versus RI
• EVA
• Types of non-financial performance measures
• Balanced Scorecard
• Building Block Model
• Four levels of Performance Pyramid Model
• Three-way classification under Triple Bottom Line
Chapter 10 • Value of Money Framework
• Adapted Balanced Scorecard
Chapter 11 • Disclosure in ESR Reporting
• Types of performance reports
Chapter 12 • Minimum and Maximum Transfer Price
• Domestic Transfer Pricing
• International Transfer Pricing
Chapter 13 • Planning and Operating variance
• Interpretation of sales volume variance
• Market size and share variance

Chapter 1 – An Introduction to Strategic Cost Management
Evolution of cost concepts over time horizon:

• Cost ascertainment (recording of cost) → Cost Control (containment of cost) → Traditional cost
Management (cost reduction) → Strategic cost management (aligning costs to strategies)
Limitations of TCM:
• Ignores competition, market and customer requirement + excessive focus on cost reduction +
limited focus on review and improvisation + Reactive approach + Short-term outlook + Ignores
dynamics of marketing and economics + uses cost data in quantitative manner and ignores
qualitative aspects of cost information
Necessity of SCM:
• Detailed cost analysis + In-depth understanding of cost structure + strategic use of cost data for
competitive advantage + links cost management into strategy + Analysis of cost relations among
different activities (using Activity based costing)
Strategic Cost Management:
• SCM is use of cost management technique to improve strategic position of business as well as
control costs
• Integrate cost information and Decision-making framework; SCM focuses on achieving
sustainable competitive advantage through product differentiation and cost leadership
Stages of Strategic Management:
• Stage one – Formulate strategies
• Stage two – Communicate strategies across organization
• Stage three - Develop action plans to implement strategies
• Stage four – Develop and implement control to monitor success of objectives
Pillars of Strategic Cost Management:
• Three Pillars: Strategic Positioning Analysis + Cost Driver Analysis + Value Chain Analysis
• Linkage: Understand value chain (highlights company’s strength) + Decide optimal strategic
position (cost leadership/product differentiation) + Identify relevant cost drivers (volume and
production cost drivers in cost leadership versus technology and quality control in product
differentiation)
Value Chain Analysis:
• Identification and analysis of various activities that adds value to final product + Identification
and elimination of non-value-added activities + includes activities performed to
design/produce/market/deliver and support product
• Activities = Primary Activities + Support Activities
• Purpose of Value Chain: Identifying opportunities for Product differentiation + Cost leadership
(Eliminate/reduce costs)
Primary Activities:
Inbound Logistics Receiving, Storing and handling RM
(Raw material
Handling and
warehousing)
Operations Transforming RM into FG/Services
(Machining,
Assembling and
Testing)
Outbound Logistics Storage, distribution and delivery of FG – Involves planning the timing and
(Warehousing and location of delivery
distribution of FG)
Marketing & Sales • Market research to determine marketing mix with focus on initial 4P
(Advertising and later expanded to 7P. Integrate 7P with 4C
promotion, Pricing • Product perspectives: Product (meets customer needs) + Price +
and Channel relations) Place (distribution channels) + Promotion (communication strategy
for customers) + People (training staff) + Process (Streamlined

process for service delivery) + Physical evidence (Physical elements
which provide positive experience such as high-quality packaging
• Customer Perspective: Consumer wants and needs + Cost to satisfy
(total cost of customer including price but other cost like
time/effort/convenience) + Convenience to Buy (making it easy for
customers to buy the product) + Communication (Two-way
communication listen to customer feedback and building
relationships)
Service (installation, • Installation, training and repair – Need for service is higher in
repairs, parts durable products (Example: Washing machine) as compared to
replacement) FMCG products (Example: Personal Care items, cleaning products)
Support Activities:
Firm Infrastructure General Management, Accounting, Finance, Strategic Planning
Human Resource Recruitment, training and development of Human Resources
Management
Technology Development R&D, Product and process improvement, IT Management
Procurement Purchase of Raw Material, Machines and Supplies, managing vendor
relationships
Value Chain Analysis and Competitive Advantage:
• Identifies critical success factors + Categorizes activities into value-added and non-value-added
+ Eliminate non-value-added for cost leadership and enhance value-added for product
differentiation + Identify improvement opportunities in each activity
Strategic Framework for Value Chain Analysis:
• Industry Structure Analysis [STEEPLE Analysis, Porter’s Five Forces Model]
• Core competencies Analysis [Unique Strength]
• Segmentation Analysis [Division of large number of customers into smaller groups]
Value Shop Model or Service Value Chain:
• Serve companies from service sector – Telecom companies, insurance companies, banks
• Focuses on solving problems of customers and not creating value by producing product
• Primary Activities: Problem finding and acquisition + Problem solving + Choosing among
solutions + Monitoring and evaluation + Implementation
• Same support activities as value chain approach
Strategic Positioning Analysis:
• Analyses company’s relative position within a strategic industry segment [Example: MSIL in
Auto Industry]
• Focus is on achieving competitive advantage by developing strategies/plans and achieve
superior performance in relation to true peer group – SPA study can translate into premium
price (differentiation) or lower cost (cost leadership)
Tools for SPA:

• SWOT Analysis is primary tool for both external and internal environment analysis
• External Environment Analysis [PESTEL Analysis (Political, Economic, Social, Technological,
Environmental and Legal) + Porter’s Five Forces Model +Porter’s Diamond Model [Factor
conditions + Demand conditions + Related and Supporting industries + Firm Strategy and
Structure]
• Internal Environment Analysis [Porter’s value chain + Critical Success Factors and Core
Competencies + Product Life-cycle Analysis + Mckinsey 7S Framework]
Components of SPA:
Culture Beliefs and • Guiding principles for strategic decisions
Assumptions – • Culture can be measured on four critical cultural trait areas:
Vision and Values Adaptability, Mission, Involvement and Consistency
• Good culture = Improved ROE/growth/customer satisfaction

Stakeholders’ • Identify stakeholders and their needs – influences mission statement
influences and and objectives – focus is to meet all needs by having KPI for every
expectations need/objective
Mendelow’s matrix for identification of stakeholders:

Low interest Influential Keep Satisfied Government
and High Regulators,
Power Independent
Directors
Low interest Marginal Monitor/marginal Local
and low power Players (minimum effort) community,
General
Public
High interest Key Players Manage closely Major client,
and high strategic
power investors,
Board of
Directors
High interest Affected Keep informed NGO,
and Low Suppliers,
Power Employees
Micro Environment Strengths (exploit aggressively) + weaknesses (Address at root-cause level)
Macro Environment Utilize opportunities and create defence mechanism against threats
Cost Driver Analysis:
• Cost driver = Trigger of change in cost – Increase in cost driver will lead to more cost
• Traditional costing distributes costs based on single cost driver while strategic costing (ABC)
uses multiple cost drivers
Different types:
• Resource Drivers – Cost related to resources consumed – Material usage/machine usage
• Activities Drivers – Cost associated with specific activities – Number of setups/inspections
o Organizational Activities and Drivers – Costs arising from organizational structure and
Processes – Includes Structural and executional drivers
o Operational activities and drivers – Cost related to day-to-day operations of the business
– Includes unit-level, batch-level, product-level and facility-level)
Structural vs Executional Drivers:

• Structural: Strategic decisions about economic structure – Scale (large-scale vs small-scale),
Scope (backward/forward integration), technology (more/less), complexity
• Executional: Efficiency and effectiveness of business activities – Employee involvement, Quality
of service, Product design, linkage with suppliers
Key tools for Strategic Management:
• Activity based costing + Benchmarking + Competitive advantage analysis (what an organization
should adopt to excel over others) + Just-in-time + Kaizen Costing + Target Costing + Theory of
constraints + Total Quality Management + Value Chain Analysis
Traditional cost management vs Strategic cost Management:
• Allocation of cost – TCM (Single driver) and SCM (ABC)
• Nature – TCM (Reactive) and SCM (Proactive and dynamic)
• Objective – TCM (Cost reduction) and SCM (Improve strategic position)
• Risk appetite – TCM (risk-averse approach) and SCM (risk-taking ability)
• Scope – TCM (Internal business environment) and SCM (both internal and external)
• Term – TCM (short-term focus) and SCM (long-term focus)
Gaining Competitive Advantage:

• Helps develop superior strategies for gaining competitive advantage through cost leadership or
differentiation
• Focus on finding white space – area of unmet demand leading to opportunity
• Kiss of death (strategic mistake): Sometimes company can compete both on cost and
differentiation – however this can lead to company stuck
• Broad vs focus strategy: Broad targets wider market and focus target specific niche market –
Leads to Broad cost leadership + Focus cost leadership + Broad Differentiation + Focus
Differentiation
Differentiation Advantage (Product Differentiation) – DRIVING UP PRICES (QUALITY):

• Distinctive value to customers – customer ready to pay premium price
• Source: Quality (design, know-how, performance), Innovation, customer relation/response,
wide-product range
• Benefits: Earn high margin with premium price (OR) build market share by charging normal
price
Low-Cost Advantage (Cost Leadership) – DRIVING DOWN COSTS:

• Lowest cost producer – balance price with quality
• Source: Cost effective inputs, PI/BPR, Low-cost distribution, learning curve
• Benefits: Charge normal price and improve profits (OR) charge lower price and build market
share
Relationship between strategies and cost management emphasis:

Aspects Strategic Emphasis
Product Cost Leadership
Differentiation
Role of standard costs in assessing performance Not very important Very important
Importance of concepts such as flexible Moderate to Low High to very high
budgeting for manufacturing cost control
Perceived importance of meeting budgets Moderate to Low High to very high
Importance of marketing cost analysis Critical to Success Relatively less important
Importance of product cost as an input to Low High
pricing decision
Importance of competitor cost analysis Low High
How to conduct value chain Analysis?
• Reconfiguration of value chain or reduction of cost of each individual activity can give
competitive advantage
• Step 1: Identify value chain activities – Primary and secondary
• Step 2: Determine cost and value of activities – Measure how they increase user satisfaction and
customer value + identify associated cost
• Step 3: Assessing and identifying opportunities for competitive advantage – Focus on process
and activities to identify cost leadership/differentiation opportunities
Value Chain Analysis for assessing competitive advantage:
• Approach 1 – Internal Cost Analysis: Identify value creating processes + determine proportion
of total cost + identify cost driver + links between processes + opportunity for cost advantage
• Approach 2 – Internal differentiation Analysis: Identify value creating processes + sustainable
differentiation strategies for enhancing customer value
• Approach 3 – Vertical linkage Analysis: Linkage of value chain with supplier/customer
Business Model:
• Explains how an organization creates value and delivers products/services
• Margretta: Two key components – Producing and Selling
• Johnson, Christensen, and Kaggerman: Three components – Customer value Proposition
(value that customer gets) + Profit formula (company’s approach to generate revenue and
profits) + Key resources and processes (essential assets, capabilities and activities)

Osterwalder’s Business Model Canvas:
• Contains nine elements [Four cost elements + Four revenue elements + Value Proposition]
Cost Elements
Key Resources Most important resources – Helps in planning volume of activity – can also be
called as key factor/limiting factor
Key Partners Suppliers/channel partners – can lead to strategic alliances
Key activities Most important things to keep business running/working – helps in absorbing
cost of support activities
Cost Structure Cost of operating the business and performing activities
Revenue Elements
Customer segment Who are company customers and why they buy from us
Channels Distribution channels to deliver products/render the service – Physical and
virtual/digital channels
Customer Interaction with customer – how we get them, keep them and grow them
Relationship
Revenue Streams How money is made - Direct sale/transaction based/freemium/subscription
model
Value Proposition
Value Proposition Focus on solving customer’s needs and problems and not the capabilities of
business
Value Proposition Canvas:
• Helps in designing, testing, building and managing customer value proposition – It is a plugin
to business model canvas
• Focus on mapping customer segments and value propositions
Customer Segments (Items which business cannot control)
Customer Jobs Issues customers are trying to solve
Customer Pains Negative aspects which customers dislike/avoid
Customer Gains Outcomes/benefits which customers desire
Strategy: Understand customer pain severity and design pain relievers + Differentiate between jobs,
pains and gains + Identify which jobs are important, which pains are extreme and which gains are
essential for success
Value Proposition Map (Items which business can control)
Products and services To address customer jobs
Pain relievers To address pains
Gain creators To create gains
External Environment:
• Survival + Sustainability = Crucial for business success; Agile strategy = To adapt to change
• External environment (Beyond control) analysis is critical and it includes Industry analysis +
Understanding customers and markets + Basis of competition + Industry key success factors +
Core competencies Analysis
Industry Analysis:
• Industry = Collection of companies engaged in similar business activities producing comparable
products/services + No universally accepted definition + It can vary based on competitive
landscape and strategic focus of organization
• External Environment analysis is critical for analysing industry; External environment = Remote
environment + Industry operating environment
• Remote Environment (Factors affecting all industries) – STEEPLE factors (Social, Technological,
Economic, Environmental, Political, Legal and Ethical) – These factors have affected industry in
past and are likely to affect future growth
• Industry Operating Environment – Factors specifically affect the industry in question – Can be
analysed through Porter’s Five Forces Model – Includes customers/competitors/life
cycle/regulations
Industry Profitability Analysis [Porter’s Five Forces Model]

• Porter’s five forces model is dynamic model which includes five forces which collectively
determine the intensity of competition and profitability
Bargaining Power of • Power of customers to drive prices down
Buyers • High power (few customers/buy in large volumes/switching to
different supplier is easy)
Bargaining Power of • Power of suppliers to drive prices up
Suppliers • High Power (Few suppliers/Supplied input is crucial/Substitute
for input not available)
Threat of Substitute • Likelihood of customers switching to alternative products
products/services • High if close substitutes are available
Threat of New entrants • Evaluates how easy it is for new competitors to enter the industry
• Difficult to enter if there are barriers to entry (Significant capital
investment/Technology requirement/Regulatory hurdles)
Intensity of competitive • Level of competition among existing firms
rivalry • High when there are many competitors/undifferentiated
products/exit barriers
Impact of entry and exit barriers on industry profitability:

• Low entry barriers and Low exit barriers = Low and stable returns
• Low entry barriers and high exit barriers = Low and Risky returns
• High entry barriers and low exit barriers = High and stable returns
• High entry barriers and high exit barriers = High and Risky returns
Understanding customers and markets:
• Post industry analysis, next step is analysing customers, markets and segments
• Segmentation divides a broad market into smaller and more manageable segments based on
criteria such as demographics/behaviour/needs
• STP Strategy (Segmentation/Targeting and Positioning) + Through understanding of customer
needs = Design appropriate strategy and develop capabilities to meet those needs
Market Includes varying number of buyers/potential buyers and sellers
Market segment • Identification of group of customers with specific characteristics + Specific
marketing strategies
• Homogenous internally + Heterogenous externally (distinct) + clearly
identifiable (measurable) + reasonable and profitable size + responsive to
market offerings (accessible)
• Automobile industry = Luxury segment (Rolls-Royce) + Economy segment
(Toyota Corolla)
Market Product segmentation (commercial/passenger vehicles) + Demographic
Segmentation segmentation (Age, Gender, Family situation, Education Example: Apparels) +
Analysis Psychographic segmentation (Personality traits/values/attitudes/lifestyle
Example: Business and First class in Airline) + Behavioural segmentation
(Purchasing habits/spending habits Example: Plus/prime members of Flipkart) +
Geographic Segmentation (city/country/climate/rural/urban)
Basis of Competition:
• Basis – Why customers choose one business over another – Product quality, Features,
Functionality, Style and Availability
• Business should identify demand drivers + Assess risks + Work towards sustainable competitive
advantage by identifying CSF and exploit them
• Natural competition (Emerges from evolutionary pressures and entities must adapt to survive
– Telecom Industry) and Strategic Competition (deliberate deployment of resources and
strategies to gain competitive advantage – E-commerce industry)
Industry Key Success Factors:
• Essential factors for achieving competitive advantage – Agility, reliability, diversity – Develop
KPI for every CSF

• CSF may change over time and hence periodic assessment of CSF needed – Example (Reliability
and Efficient distribution was CSF in telecom and Nokia was successful – CSF changed to R&D,
screen size and camera wherein Nokia Struggled)
Core Competencies Analysis:
• Unique advantage – Helps company to stand out in industry – Can be cost leader or product
differentiator
• Sources: Resources (Tangible and intangible) + Capabilities (Ability to effectively utilize
resources)
• Test of core competency: Relevance (significantly influence customer decision) + Difficult to
imitate + Breadth of application (compete in multiple markets)
• Linkage with value chain: Identify core competencies of current businesses + Leverage core
competencies across value chain of other existing businesses + reconfigure value chain of
existing business + create new value chain
Information Technology – The Strategic Context:
• Technology has impact on various industries – Digital mode of delivery – traditional stores being
replaced with e-commerce stores
• Just like oil was critical in industrial economy, data is critical in digital economy – useful for
informed decision making
• Information technology, Information system and information management = Three
interconnected concepts = Alignment critical to maintain overall organizational strategy
Information System (IS), Information Management (IM) and Information Technology (IT):
• Essential to harness the full potential of technology + manage information effectively +
maintain/gain competitive advantage
• IT = Use of computer and software for data creation, processing, storage, retrieval and exchange
• IT Strategy = Comprehensive plan aimed at meeting both IT and business goals
• IS = Resources used for gathering, processing and disseminating information – Includes
hardware, software, processes and data management
• IS Strategy = Align development with business needs + Plan for IT layout implementation +
seek strategic advantage from IT
• IM = Involves the entire lifecycle of organizational activities related to information (acquisition
+ distribution + disposal)
• IM Strategy = Information activities are managed effectively and data access/usage is controlled
to authorized users
Basis IS Strategy IT Strategy IM Strategy
Resolve (Scope) What needs to be achieved How to accomplish Where to apply in
it organization
Driven Force Business Driven Technology Focused Management Driven
(business needs and goals) (Technological (Management priorities and
advancements) objectives)
Directional Top-Down Bottom-Up Multi-Directional
(Upper management to (Lower levels (IT [Can be both]
other levels) Teams) to upwards)
Orientation Demand Oriented Supply Oriented Relationship Oriented
[Meet demand of users] [Supply of [Develop strong
technology and relationship between Data,
resources] Technology and
Management]
Organizational Division/SBU/Function Activity Based Organization wide
Level Based (Developed for key
business activities)
IT/IS strategy:
• Benefits: Creates competitive advantage + Counters industry forces + Tapping new
opportunities + Seamless integration of value chain and supply chains + Help in change
management

• Issues: High costs and risks
IT/IS and Porter’s Five Forces:
• Threat of new entrants: Existing players can use IT to create barriers (expensive, time-
consuming and technically challenging IT applications) + New entrants can use IT to break these
barriers
• Supplier’s bargaining power: IT helps in identifying new suppliers + e-procurement to prevent
cartel + Price comparison + Automatic order rotation
• Buyer’s bargaining power: IT can be used to reduce/counter buyer bargaining power +
Improved customer service through IT + Customer data mining (customized suggestions based
on order/search history) + lock customers through rewards/loyalty bonus
• Threat of Substitutes: Threat can be countered by developing advanced products + Develop
products before competitors and protect with patent + Use of CAD/CAM for rapid design and
manufacturing
• Competitive rivalry: Use IT to maintain market share + use tools such as JIT/ERP + Can help in
developing collaborative venture (Makemytrip and OYO coming together through IT)
IT/IS and the Value Chain:
• Inbound Logistics: Bar coding systems (automate warehousing) + Virtual warehouses + RFID
(Radio-frequency Identification) systems to track items throughout supply chain
• Operations: CAD/CAM/Robotics/CIM for manufacturing + IT is also used by service entities
(Example: Zomato)
• Outbound Logistics: Bar-coding system/RFID for vehicle scheduling
• Marketing and Sales: Customer database maintenance through IT + Makes CRM easy + Digital
marketing + social marketing + internet marketing
• After-sales service: Computer software and IOT enabled remote service software
• Firm infrastructure: Collaboration among various departments through ERP + Office
automation systems
• Technology Development: Usage of IT/IS strategies
• Human Resource Management: Artificial intelligence and automation to streamline
payroll/talent management/learning and development
• Procurement: Using technology for e-procurement and appraising expression of interest + IT
can enhance cost efficiency
Role of Management Accountant as leader:
• Role evolved due to changing business environment and organization structure
• Organization success depends on ability to handle complex challenges + They now assume role
of business leader + Identify opportunities + make strategic decision + maintain ethical
Behaviour
Evolving role of Management Accountant:
• Traditional role: Accounting + Long-term planning + Developing MIS + Maintaining optimal
capital structure + Ease in control systems + Participation in decision making process
• Modern roles: Analyze data + Plan + innovate and lead + budgeting + Forecasting +
Performance management + Internal process control + Integrate technology, financial analysis,
strategy and leadership
• Expanded role: Analysis (To offer new insights and vision) + Planning (building informed
strategies) + Innovation (Advocates Technological advancement and breakthroughs) +
leadership (from planning to execution)
Management Accountant - In Role of a Leader, Who Drive the Strategy:
• Leader vs Manager: Being leader is different + Includes creating vision + change agents + take
risks + long-term focus + building relationships
• Importance of Leadership: Making or assisting in decision making + communicating strategies
+ plans + Vision and values + Ethical conduct
Communication:
• Types: Vertical (upward and downward) + Horizontal (communication at same level) +
Diagonal (crosses different levels and departments)

• Change Agents: Communicate organization vision and strategy to reduce resistance to change
• Includes both formal and informal exchanges + listening is crucial for reducing communication
barriers
• MBWA (surprise checks): Management by walking/wandering around refers to managers
moving around in unstructured manner to check employees/equipment/status of work
• Technological advancements have changed communication methods
Decision Making:
• Involves identification + Gathering information + Assessing alternatives
• Smooth decision making = Strong leader + Transformational leadership + Make rational
decision (objective/fully informed/consistent/logical) + Strong rapport and communication
with other departments
• Irrational decisions = Enthusiasm + lack of listening + forecasting errors + pre-notions
Business Ethics:
• Examines ethical principles and moral problems in business environment
• Changed orientation from shareholders to all stakeholders + Socio-economic approach of
balancing economic and social costs for sustainability
• Management accountants should follow ethics in decision making. Example: TBL approach

Chapter 2 – Modern Business Environment
Modern Business Environment:

• Rapid Changes + Technological impact + Transition from seller’s market to buyer’s market
• Impact on Price + Response Time + Quality + Performance
• Price will decline due to increased competition
Cost of quality:
• Cost of good quality – Cost of conformance
o Prevention cost – To ensure defect does not happen (Examples: Quality review, Training
cost, Re-engineering of production process, Supplier screening, Preventive Maintenance
o Appraisal cost – To check whether defect is there (Examples: Equipment testing cost,
Quality control consultant, Inspect raw material)
• Cost of Bad quality – Cost of non-conformance – Cost of defective units
o Internal failure cost – Defect identified within the company (Examples: Downtime cost,
Manufacturing rework, Faulty goods, Material scrapped, Rejected units)
o External failure cost – Defect identified outside by the customer (Examples: Warranty
repair, customer support, Replacements, Lost profits from lost customers due to bad
quality, Sales return processing)
• Cost of good and bad quality have inverse relationship
• Cost of quality is best expressed as a percentage of total cost
Optimal COQ:
• Optimal COQ = Level at which the overall COQ is lowest – it won’t happen at zero defect and
hence companies have to agree on acceptable level of defect
PAF Model
• Helps in measuring and classifying quality costs
Iceberg Model:
• Many of the costs of quality are hidden and thus making it difficult to identify by formal
measurement systems
Total Quality Management:
• All departments of the company to focus on meeting customer needs [Customer is the King]
• Eradicate waste + increase efficiency + continuous improvement + focus on quality at all stages
Six C’s of TQM:
• Commitment + Culture + Continuous improvement + co-operation + Customer focus + Control
Deming’s contribution:
• 14 points are added
• Mostly logical points
• Unique points are single supplier for any item + Cease dependence on inspection + Drive out
fear + Eliminate management by objectives
Note:
• Management by Fear is an autocratic style of management
• Management by objectives is setting clear, measurable objectives and tracking performance
against those objectives. Example: Standard costing
Deming wheel or PDCA Cycle:
• Plan work – Do (execute plan) – Check performance – Act (take corrective action
• Deming wheel is continuous process and has to be repeated on ongoing basis
TQM Implementation:
• Do proper pre-implementation work and collect data on current issues
• Then work on implementation and do post-implementation check
Criticisms:
• Focus on documentation + Internal focus (can contradict sometimes with external focus) + not
appropriate for service industry
• One approach of managing this is total employee involvement
TQM vs Six Sigma:

• Both are similar – TQM focuses on process improvements and Six sigma looks to reduce defects
Supply Chain Management:
• Supplier + Manufacturer + Distributor + Wholesaler + Retailer + Consumer
Processes of Supply Chain management:
• Customer Relationship Management + Supplier Relationship Management + Customer service
Management + Demand Management + Order fulfillment + Manufacturing Flow Management
+ Product Development and Commercialization + Returns Management
Push Model vs Pull Model:
• Push Model – Manufacture based on forecast + Stock item + has working capital requirement
and incurs carrying cost – followed if demand is predictable
• Pull Model – Manufacture based on orders + No stock item + No working capital + No carrying
cost – used if demand is highly unpredictable
• Bullwhip effect - small fluctuations in demand at the retail level can cause progressively larger
fluctuations in demand at the wholesale, distributor, manufacturer, and raw material supplier
levels – This can become a problem in Push Model
Upstream Supply Chain vs Downstream Supply Chain:
• Upstream – Relationship with suppliers
• Downstream – Relationship with customers
• Money normally has upstream flow + Material normally has downstream flow + Information
can follow both ways
Upstream Supply Chain Management:
• Supplier relationship management tool can be used + IT can be used for e-sourcing, e-
purchasing and e-payment
Downstream Supply Chain Management:
• Use concept of six markets model to keep existing customer happy and find new customers
[Internal markets + Referral Markets + Influence Markets + Recruitment Markets + Supplier
Markets + Customer Markets]
• Customer relationship management tool can be used to record all information about customer
+ based on information we can analyze the customer and their behaviour
• Types of CRM [Operative CRM (Captures all interactions of the company with customer for
operational decisions) + Analytical CRM (Analysis of operational data that helps in predicting
customer behavior + Collaborative CRM (ensuring information about customer flows to all
associated departments)]
• Analysis can also be done at profitability level which can help in classifying
o Platinum customers – Most profitable
o Gold customers -Profitable
o Iron customers – Low profit but desirable
o Lead customers – Unprofitable and undesirable
• Customer lifetime value = PV of lifetime income – initial cost to acquire customer
• Customer Selection (Type of customer to be targeted) + Customer acquisition (Developing
relationship with new customers) + Customer retention (keeping existing customers happy and
retaining them) + Customer extension (doing cross-selling/up-selling of related items)
Service Level Agreement:
• Contract between customer and supplier provider + Rewards and penalties are defined based
on performance + Useful to ensure quality while outsourcing the work
Resilient and sustainable supply chain:
• Developing supply chain which is not impacted during adverse events such as COVID-19, wars
etc – Diversify sourcing to multiple geographies and multiple entities
Gain-Sharing Arrangement:
• Gain-sharing arrangement = Agreement between supplier and company in which gains are
shared
• Simple form of gain-sharing arrangement is supplier performing his part of the contract without
guaranteed payment
Downsizing, Outsourcing and off-shoring:

• Downsizing – Reduction in workforce due to economic slowdowns
• Outsourcing – Transferring non-core activities to outside vendor
• Off-shoring – Setting up branch in another entity and doing the work from there – could be
because of cheap labour

Chapter 3 – Lean System and Innovation
Lean System:
• Lean System = System without seven types of waste
• Seven types of waste = Over-production, inventory, waiting, motion, transportation, rework
from defects, over-processing
• Core principle - Perfect first-time quality
• Core characteristics – zero waste
• Benefits – Improve quality, reduce costs and enhance flexibility
• Stakeholders – Customers, Employees and Organization (Director, CEO and owner)
Just-in-Time:
• JIT Purchasing; Purchase coincides with consumption = Zero Raw material inventory = Supplier
reliability is critical
• JIT Production; Production coincides with sales = Zero FG inventory = Accurate Prediction of
sales is critical
• Benefits = very less inventory = less carrying cost
• Issues = stockouts + overtime + Supply chain can fully fail
• Other points: Shorten set-up time + Make employees to use multiple machines
• Kanban System – System for giving signal to other machines to start manufacturing
• Impact of JIT: Reduction of material handling cost + Reduction in labour idle time + Elimination
of defects as urgently as possible + Elimination of RM inspection + Reduction in waste and
overhead costs + Increase in FG Prices
Available Production Time
Takt Time =
Total Time Required
Cycle Time:
• Time taken to produce one unit including inspection, movement, storage and processing
Value Added Time
Process Cycle Efficiency =
Total Time
• Value added time = Processing time
Backflush costing:
• Material consumption entry is not recorded till we complete the manufacturing of the
production + Post production completion consumption is recorded as per BOM
• Accurate production reporting + Abnormal scrap reporting can impact inventory accuracy
Kaizen Costing:
• Kaizen = continuous improvement = Small but continuous changes = Doing steps of value
engineering for existing product
• Steps: Establish cost reduction target + Ascertain gap + Implement plan
• Principles: Know your customer + Let it flow (zero waste) + Go to Gemba (Go to place where
action lies) + Empower People + Be Transparent
• Cost reduction target can be fixed through top-down approach (non-participative) or bottom-
up approach (participative)
5S:
• Sort: Removal of unnecessary items + identifying what is required, how much is required, when
it will be required and where it will be required
• Set-in-order: There shall be place for everything and everything shall be in its place
• Shine: Cleanliness in all aspects
• Standardize: Document best practice and follow them throughout organization
• Sustain: Continuation of other 5S by providing training, having surprise checks, conducting
audits
• Sixth S being focused on called as Safety
Benefits of 5S:
• High quality + Productivity + Low cost with enhanced safety
• 5S is foundation for TPM, Value engineering, Preventive maintenance, Lean systems, JIT, TQM
5S and PDCA:

• 5S forms part of Do step of PDCA and is an enabler of continuous improvement
• Plan + DO are enablers; Check + Act are results
TPM:
• TPM helps to keep equipment in top working condition + no breakdown/delay
• Four Stages: Preparation + Introduction + Implementation + Institutionalization (becoming
perfect and getting awards)
• Foundation: 5S
• Eight pillars: Autonomous maintenance (Operators to take care of routine maintenance tasks)
+ Focused improvement (Kaizen) + Planned Maintenance (Scheduled maintenance based on
predictive and preventive maintenance) + Early Management (Shortening the time for product
development and integrating maintenance needs at the design phase) + Quality Maintenance
(Proper functioning of equipment to get adequate quality) + Education and Training (Ongoing
training and development of employees) + Office TPM (Extend TPM to admin and support
functions) + Safety, Health and Environment (No accidents, injuries and environmental
incidents)
OEE:
• Performance measure of TPM
• Need to avoid time related losses (equipment failure and set-ups adjustments) + performance
related losses (idling and reduced speed) + quality related losses (reduced yield + quality defects
and rework)
• OEE = Availability x Performance x Quality
• Ideal values: Availability (>90%), Performance (>95%) and Quality (>99%). Overall OEE > 85%
Operating Time
Availability Ratio = x 100
Planned Production Time
Standard Time
Performance Time = x 100
Operating Time
Good units
Quality Ratio = x 100
Total Units
𝐒𝐭𝐚𝐧𝐝𝐚𝐫𝐝 𝐓𝐢𝐦𝐞 𝐟𝐨𝐫 𝐆𝐨𝐨𝐝 𝐮𝐧𝐢𝐭𝐬
𝐒𝐢𝐧𝐠𝐥𝐞 𝐟𝐨𝐫𝐦𝐮𝐥𝐚 𝐟𝐨𝐫 𝐎𝐄𝐄 =
𝐏𝐥𝐚𝐧𝐧𝐞𝐝 𝐏𝐫𝐨𝐝𝐮𝐜𝐭𝐢𝐨𝐧 𝐓𝐢𝐦𝐞
Cellular Manufacturing/One-Piece Flow Production System [One-piece flow would mean moving
products one at a time through each step and not doing production of multiple units like batch
processing]
• Multiple cells + Each cell has one or more machines + U-shaped design is used so that supervisor
moves less and able to watch entire process
• Goals: Move quickly + Little waste
• Benefits: Flexibility in operations (to meet peak demand) + Quick identification of problems +
Improved employee communication + Massive gain in productivity and is considered as
ultimate in lean production
• Implementation: Group parts into families (based on design/machinery) + Systematic analysis
of each family + Production flow analysis (sequence of operations) + use mathematical models
and algorithms + Optimize operations to reduce inter-cell material handling , total cost of
holding
Clustering methods:
• Part family mapping (based on design/machinery requirement)
• Machine grouping into cells based on similarities in routing of parts
• Mapping part family to machine cells – can be done through rank order clustering algorithm
• If interested to learn more – then watch this video for rank order clustering algorithm -
https://youtu.be/zq0OmfuIwak?si=tnpIzIPIhPdXCVUj
Difficulties in forming cells:
• Exceptional elements + machine distances + Bottlenecks in machines + Location of machine
(non-U Structure) + Part routing + Variation in load of cells
Benefits and costs:
• Benefits – Reduced flow time + Reduced flow distance + reduced floor space + Reduced
inventory + Reduced handling + Reducing scrap and rework + Improved production and
quality control + Benefits for employees (Teamwork + Good culture + Problem identification
and motivation)
• Costs – Decreased production flexibility (Realignment of cells/design is difficult and hence can
create rigidity)
Six Sigma:
• ata driven quality improvement technique – Objective is to eliminate defects – Six sigma wants
us to measure existing defects and work on zero defect goals
• Focus: Develop customer centric process + Decision based on data driven facts + Process
improvement + Proactive management + Teamwork + Perfectionism + Improve cycle time +
Comprehensive business enhancement
Numerical concept of Six Sigma:
Sigma Defects per million Defective Percentage Quality/profitability
Level opportunities (DPMO) percentage (%) yield (%)
One 6,91,462 69% 31% Loss
Two 3,08,538 31% 69% Non-competitive
Three 66,807 6.7 93.3 Average industries
Four 6,210 0.62 99.38 Above average
Five 233 0.023 99.977 Below maximum
productivity
Six 3.4 0.0034 99.99966 Near perfection
DMAIC (Define, Measure, Analyze, Improve, Control) [Reactive Process and increases capability)
• Used for improving existing business process – used when there is stability
(technology/customer demand/competitor actions) and we are changing one process
Steps:
• Define: Identify the problem or improvement opportunity.
• Measure: Collect data and determine current performance.
• Analyze: Identify root causes of defects.
• Improve: Develop and implement solutions to eliminate defects.
• Control: Monitor the improvements to ensure they are sustained.
DMADV (Define, Measure, Analyze, Design and Verify) [Proactive process and increase capacity]
• Used for designing new processes or products that meet Six Sigma quality levels from the
beginning
• DMADV is used in case of high uncertainty or we have to change multiple processes
Tools used in Six Sigma:
Project Charter Define Establishes project scope, goals, resources, and timeline
Effort/Impact Define Assesses the effort required versus the potential impact of
Analysis proposed improvements to prioritize opportunities.
Process Mapping Define Visualizes current processes, inputs, outputs, and
interactions to understand the workflow and identify
improvement areas
Tree Diagram Define or Organizes and hierarchically structures potential causes of a
Analyze problem to identify root causes
Quality Function Define or Translates customer requirements into specific product or
Deployment Measure process design characteristics to ensure alignment with
customer needs.
Measurement Measure Evaluates the reliability and consistency of measurement
Systems Analysis systems used to collect data
Check Sheet Measure A tool used to systematically collect and organize data in
real-time
Process Capabilty Measure or Measures the ability of a process to produce output within
Analyze specification limits.

Histogram Measure or Displays data distribution to understand variation within a
Analyze process.
Pareto Diagram Analyze Prioritizes problems or causes based on their frequency or
impact
Run Chart Analyze Displays data over time to identify trends or patterns
Scatter Graph Analyze Shows the relationship between two variables to identify
correlations.
Statistical Analysis Analyze Applies statistical methods (e.g., hypothesis testing,
of Data regression analysis) to analyze data and understand root
causes.
Limitations:
• Narrow focus (focus on quality only) + Intangible results (difficult to measure performance) +
high investment (Training/software/recruitment cost) +Complex + Real-time barriers
(resistance to change/lack of real time data) + Not all products meet six-sigma standards
Lean Six Sigma:
• Lean Six Sigma = Lean System + Six Sigma. Both can complement each other
• Benefits: Greater results + Process improvement + Elimination of waste + Quality improvement
+ Maximize profits + Minimize costs + Build better teams
Process Innovation:
• Implementation of new or significantly improved method of production/delivery
• Routine changes + Minor improvements + Simple adjustments + Cyclic changes are not
considered as innovation
• Areas of innovation: Production/Delivery/Support services
• Comparison with BPR: PI develops entirely new methods or significantly enhance existing
process – BPR redesigns and optimizes existing process
• PI is more radical and can bring structural changes (new technologies/novel ways of organizing
tasks)

Chapter 4 – Specialist Cost Management Techniques
Cost Control:
• Standard Costing and Budgetary control: Setting standard/budget + Measuring actual cost +
Continuous comparison of actual performance with target
• Targets fixation: Can be internal/external targets – External targets derived from external
sources such as competitors/industry data
Prerequisites:
• Delegation of Authority + Assignment of Responsibility + Clear Targets + Motivated Employees
+ Timely reporting + Review and control
Cost Reduction:
• Real and Permanent reduction without quality compromise + Continuous effort to reduce cost
• Areas of cost reduction: Product Design (maximum scope – Example: Tata Nano) + organisation
(proper structure to avoid duplication of work) + Factory layout (Cellular Manufacturing) +
Production Plan programme and method (Proper Plan and Efficient execution)
Tools and Techniques for Cost Control and Cost Reduction:
• Value Analysis (Improving the value of product/service by assessing the functions and
removing the functions which do not add value)
• Inventory Management (JIT and Backflush)
• BPR
• Target costing and Kaizen Costing
• Standardization of Product, Components
Cost reduction vs cost control:
• Cost reduction (realistic savings in cost) vs Cost control (temporary savings in cost)
• Cost reduction (No compromise on quality) vs quality compromise may happen (cost control)
• Cost reduction (Emphasis largely on future) vs cost control (emphasis on present and past)
• Cost reduction (corrective function) vs cost control (preventive function)
Target Costing:
• Target Cost = Target selling price (determined by customer/market) – Target Profit (determined
by company)
• Exact opposite of cost-plus pricing approach (Cost plus pricing approach ignores competitor
prices, customer willingness to pay and cost control)
Steps of Target costing:

• Re-orient culture of thinking and attitude (market driven prices) + Identify market requirements
+ establish market driven target price (determine price, volume and profit margin) + Determine
target cost + Establish target costing process + Brainstorm and analyze alternatives (Establish
cost models for each design) + use tools to close gap (value engineering/value analysis) +
Measure results and monitor continuously
Additive approach of finding target cost:

• Put cost for every feature of the product and find out the target cost as sum of cost of every
feature
Principles of Target Costing:

• Leadership of Target Selling Price + Focus on customer + Teamwork (Cross-functional teams) +
Reduce lifecycle cost + Focus at product design stage + Attention to all stages of value chain
Pros of Target Costing:

• Proactive management + Commitment from all + Customer focus + Use of management control
systems + Enhanced planning and awareness + Employee awareness and empowerment +
Collaboration with suppliers + Minimize non-value added activities + Reduce time to market
Cons of Target Costing:

• Lengthening of development process + Finger-pointing within company + Difficult to reach
consensus in cross functional teams + May reduce quality of product if cheap components are
used
• Solution: Strong control over design teams + Good team leader
Impact of Target Costing on Profitability – Improves profitability in two ways

• Continuous emphasis on product costs
• Precise targeting of correct selling price
• Target costing should be a central part of the strategy if company introduces steam of new
products or existing products face severe pricing issues
Most useful situations of Target Costing [Optimizing costs in product development, manage
diversified product lines, leverage automation and technology and navigate short product life cycles]
• Useful if majority of product costs are locked in at design phase – Useful for most manufactured
products – only for few services
• Characteristics of company getting benefitted from TC: Assembly oriented industries
(repetitive process industries) + Involved in diversity of product lines + Use advanced
manufacturing techniques such as CAD, CAM + Shorter product life cycles + Implementing
management systems such as JIT and value engineering + Developing systems for reducing costs
in all stages of product life-cycle
Components of Target Costing System:
• Components = Value Analysis + Value Engineering
• Value Analysis = Planned approach of cost reduction + Review material composition and
production design + make changes which do not affect customer but reduce cost
• Value engineering = Application of value analysis to new products; Value engineering relates
closely to Target costing as the same focuses on cost reduction before production
• Ways to reduce cost: Eliminate functions + Reduce durability or reliability without losing value
+ Minimize design complexity + Improved design + substitute or combine steps + seek supplier
assistance
Kaizen Costin vs Value Engineering:
• Initial value engineering cannot find all cost reduction opportunities + Kaizen costing keep
repeating these steps to further reduce cost
Type of Cost Reduction Program:
Approach 1 – Component based cost Reduction:
• Design team sets specific cost reduction targets for major components + Incremental cost
reduction + Applied for redesign of existing products in market + Moderate cost savings as focus
is on small and incremental changes
Approach 2 – Feature based cost reduction:

• Design team sets specific cost reduction targets based on product features + Encourages new
design + leads to significant cost savings due to substantial changes in design + Longer
development times and carries high risk
Learning Curve:
• Learning curve shows that as you repeat a task, the time or cost to complete it decreases at a
decreasing rate.
• This means the more you do something, the more efficient you become, but each improvement
gets smaller.
• The slope of the curve represents the rate of improvement, usually expressed as a percentage.
• Other names for the learning curve include the experience curve, improvement curve, and
progress curve

Learning Curve
Doubling of Non-doubling of
Production production
Average time of desired units = Time

Average Time for 2X units = Average
taken for first unit x (No of
time of X units x LCR
units^Learning coefficient)
Example:
Doubling of Production:
Average time of 1 unit = 10 hours; LCR = 80% Average time of 2 unis = 10 x 80% = 8 hours
Average time of 5 units = 15 hours; LCR = 90% Average time of 10 units = 15 x 90% = 13.5 hours
Average time of 40 units = 4 hours; LCR = 75% Average time of 80 units = 4 x 75% = 3 hours
Non-doubling of Production:
Example 1:
Average time of 1 unit = 100 hours; LCR = 80%; Learning co-efficient = -0.322
100 100
Average time of 40 units = 100 x (40−0.322 ) = = = 30.48 hours
400.322 3.28111005644
How to get 400.322 :
• Press 40 in calculator and press square root button 12 times = 1.00090101099
• Deduct 1 from the number. Multiple this with 0.322 (number which we wanted to power) =
0.00029012553
• Add 1 to this number and press x&= 12 times = 3.28111005644
• Resultant number is 400.322
Example 2:
Average time of 1 unit = 30 hours; LCR = 80%; Learning co-efficient = -0.3219
30 30
Average time of 250 units = 30 x (250−0.3219 ) = 0.3219
= = 5.068
250 5.91901867151
How to get 2500.3219 :
• Press 250 in calculator and press square root button 12 times = 1.00134892188
• Deduct 1 from the number. Multiple this with 0.3219 (number which we wanted to power) =
0.00043421795
• Add 1 to this number and press x&= 12 times = 5.91901867151
• Resultant number is 2500.3219
Life-Cycle Costing:
• Costing for entire life-cycle and determination of life-cycle profit
• Life-cycle Profit = Life-cycle Revenues – Life-Cycle Costs
Stages of marketing:
• Introduction – Stage 1 – New Product – Minimal customer awareness and acceptance – no
competition and no profits
• Growth – Stage 2 – Rapid growth – Customer awareness – Competition entry – Profit starts
declining at end of growth phase
• Maturity – Stage 3 – Sales increases but at decreasing rate – Intense price competition – New
models can be introduced to extent product line
• Decline – Stage 4 – Decline in sales – Availability of better substitutes
Note:
• One additional phase exists before introduction of Product – Product Development Phase (R&D)
– This however is merged with introduction phase
• Another version of PLC – Introduction – Growth – Maturity – Saturation – Abandonment
Characteristics and Strategies of PLC:
Introduction Growth Maturity Decline
Characteristics
Objectives Create product Maximize market Maximize profits Reduce
awareness and trial share while defending expenditures &
market share milk the brand
Sales Low sales Rapidly rising Peak sales Declining sales
Costs per High cost per Average cost per Low cost per Low cost per
customer customer customer customer customer
Profits Negative Rising profits High profits Declining profits
Customers Innovators Early adopters Middle majority Laggards
Competitors Few Growing number Steady number Declining number
beginning to
decline
Strategies
Product Offer basic product Offer product Diversify brands Phase out weak
extensions, service and models items
and 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 encourage brand minimal level
trial heavy consumer switching
demand
Link between BCG Matrix and PLC:
• Introduction = Question Marks (High growth and low market share); Growth = Star (High
growth and high market share); Maturity = Cash Cow (Low growth and high market share);
Decline = Dog (Low growth and Low market share)
Characteristics of PLC:
• Finite life + Product goes through predictable cycles + Variation in average profit and cost per
unit in each stage + Different risks as different stages and hence strategic actions must adapt to
this + Functional emphasis changes as per stage (R&D at development + Marketing at
introduction and growth + cost control at maturity and cost reduction at decline) + New uses
(product extension)/new markets (market extension) can increase life

Benefits of Product Life Cycle Costing:
• Early action for revenue generation or cost reduction + More accurate assessment of revenues
and costs + Long-term focus vs short-term profits + Improved cost effectiveness over entire
lifecycle + Long-term picture of product line profitability + Tracing all costs (including R&D and
marketing) over entire life cycle
Maximizing Product Life Cycle Return:
• Value engineering at design phase + Reduce time to market + maximize life by extending
especially the growth phase
Uses of PLC:
• Planning tool – helps in identifying challenges and take appropriate strategic action at each stage
• Control tool – measuring product performance against past products
• Forecasting tool – less useful as product have diverse sales patterns and varying stage durations
Theory of Constraints – Optimized Production Technology
• Identify Bottlenecks (Limits production as availability is limited)
• Focus on Bottleneck resources (Use 100% + Don’t use 100% of non-bottleneck resources as same
would lead to increase in WIP inventory)
Focus of TOC:
• Increase Throughput (Selling Price – Direct Material cost) – Rate of earning money
• Minimize Investment – Assets such as fixed assets and current assets (stock of Raw material) –
Also includes R&D expense (treated as Asset)
• Decrease Operating expenses – All expenses other than Direct material cost
Goldratt’s Five Steps for improving performance:
• Identify constraints – Exploit constraints (ensuring full utilization) – Subordinate non-bottleneck
resource as per constraint – Elevate performance of constraint (Do debottlenecking) – repeat
process (new bottleneck would have been created)
Throughput Accounting:
Throughput contribution per bottleneck minute
TA Ratio for Product =
Factory cost per bottleneck minute
Demand of bottleneck resource
TA Ratio for Factor =
Supply of bottleneck resource
Note: Only raw material cost is considered as variable cost while calculating contribution and all other
costs like labour cost is considered as fixed cost under this approach
Pros and Cons of TOC:
• Advantages: Reduction in inventory (Less WIP) + More productive machines + Ability to meet
shorter lead times + More flexible (adapt more quickly to demand) + better customer service +
better product mix
• Disadvantages: Focus on short-term goals + No quality focus + focus on push approach + Need
application in entire supply chain process (management commitment + production + allocation
of resources + allocation of support functions (maintenance, procurement, logistics)
• TOC Approach focuses only on variable costs – useful for short-term product mix decisions –
can be used for product prioritization and resource allocation – However it should be used along
with other strategies like TQM to have better performance
Environmental Management Accounting:
• Identify + Collect + Analyze environmental cost information for decision making
• Focus is to consider Planet bottom-line of TBL Framework (Environmental Dimension)
• Applications – Product Pricing + Budgeting + Investment Appraisal + Cost calculation
Growing importance of EMA:
• Environmental cost (significant part of total cost) + Increasing regulatory requirements +
Preference for socially and environmentally responsible companies
Environmental information:
• Physical information – Quantitative tracking of resources used (Energy usage + water usage +
material usage) and waste generation and emission
• Monetary information – Cost associated with controlling waste and emission + Consider both
savings and earnings

Environmental Cost Classification:
Generic Classification
•Internal Environmental Cost - Direct impact on income statement
•External Environmental Cost - Impact on society
•US Environmental Protection Agency Classification
•Conventional Cost - Raw material, utilities, energy costs
•Hidden costs - cost which get hidden as overhead but are environmental cost
•Contingent costs - Cost to be incurred on future date (Penalties, clean-up cost)
•Relationship and corporate image cost - Intangible costs (cost to prepare environmental reports)
•Hansen and Mendoza
•Environmental Prevention costs - Preventing environmental impact
•Environmental Appraisal costs - Determining if products are in compliance with env standards
•Environmental Internal Failure costs - Damage but not released into environment
•Environmental External Failure costs - Cost incurred due to damage to environment
•UN Division for Sustainable Development
•Costs to protect environment - Example (Measures taken to control pollution)
•Cost of wasted material, capital and labour - Example (Inefficiencies in production process)
• There is an inverse relationship between internal and external costs of Generic classifications.
Governments are trying to convert most of the external costs into internal costs through penalties
EMA Methodology:
• Stage 1 – Identification of Environmental costs (expressed and hidden)
• Stage 2 – Allocation of environmental costs to cost Centre and cost units
• Stage 3 – Controlling environmental cost
Techniques for identification and allocation of environmental costs:
• Input-output analysis – Difference between input and output is waste
• Flow cost accounting – Records material losses at various stages – Tracks material costs + System
costs (in-house handling costs cush as personnel costs) + Delivery and disposal costs
(transportation costs for good product and disposal costs for waste)
• Life-cycle costing – Consider environmental cost for entire lifecycle
• Activity Based Costing – For allocation of internal environmental costs to cost centre – Focus is
to remove hidden cost from overheads and allocate to products
Controlling Environmental costs – First step is to identify and then we should control/reduce it
• Waste cost – Mass balance approach (determines how much waste is created)
• Water cost – Incurred twice – Buying cost and disposal cost – identify water saving opportunities
• Energy cost – Identify inefficient practices and save costs
• Transport and travel – Saving in travel and transport costs
• Consumables and raw material – Discuss with management – identify and control it
Role of EMA in Product/Process related decision making:
• Correct costing of products is critical for correct decision making – EMA improves cost accuracy
and hence pricing accuracy
Advantages and Disadvantages of EMA:
• Advantages: Improving revenue (premium pricing for environment friendly products) + cost
reduction + improved brand image
• Disadvantages: Increase in costs to comply with legal and regulatory requirements + Additional
burden for top management + Cost of failure (huge cost in case of failure)

Chapter 5 – Management of Cost Strategically for Emerging Business Models
Introduction:
• External environment provides opportunities and threats – we need to use internal strengths
and weaknesses to exploit opportunities and threats
• Business environment is dynamic – Adaptation to change is critical – timely response to be
provided – Adapt to new business models
Major change Drivers [Technology is the major factor]

Cause Effect
Digital Technologies Advanced Manufacturing
Business Ecosystems Lean start-ups
Hypercompetition Agile Organisations
Transformation and disruption Start-ups vs incumbents
Supply chain partnerships Intrapreneurship
Innovation hubs and incubators
Digital Technologies:
• Revolutionized the way information is processed, accessed and utilized
• Includes electronic tools, Systems and Devices that utilize data + Advancements supported by
network or internet connectivity
• Examples: Smartphones, Cloud computing, Internet of Things, blockchain
• Impact: Enhanced connectivity + Financial inclusion + E-commerce + Healthcare + Public
services
• Key Digital Technologies are explained below:
Internet of Things:
• Makes lives more convenient, efficient and connected
• How does IOT work: Devices are connected with sensors + They collect data + They send
data back to other device or computer systems + Based on data actions are taken
automatically. Example: A smart lock which unlocks when we are nearby to the lock
• Applications: Smart-homes (Smart lights) + Healthcare (wearable devices) + Manufacturing
(sensors to monitor maintenance need) + Transportation (smart vehicles) + Agriculture
(Monitor soil moisture)
• Benefits: Efficiency + Innovation + Market responsiveness + Global operations
Robotics:
• Meaning: Machines that can sense their surroundings + Make decisions based on rules +
Perform physical actions
• Role: Efficiency (speed and accuracy) + 24/7 operations without fatigue
• Applications: Healthcare (surgical robots) + Agriculture (Robots for plantation) + Food
preparation (restaurants) + Military (Bomb disposal) + Manufacturing (Industrial robots)
Artificial Intelligence:
• Meaning: Systems that can mimic human thought process
• Impact: Data analytics and problem solving
• Example: Generative Design (quick generation and adjustment of design based on user input)
Automation:
• Technology to perform tasks without human intervention
• Business process automation (automation of business tasks) + IT automation (Automating IT
processes and workflows)
Types:
• Basic Automation – Automation of simple and straightforward tasks – Includes business
process management and robotic process automation – Example: Automated invoice
reminder
• Process Automation – Use of software and applications to carry out business processes
consistently and transparently – Includes workflow automation and process mining –
Example: Automating the approval process for leave requests

• Integration Automation – Replication of human actions based on pre-defined rule – Example:
E-commerce platform which places an automated order based on inventory level rule defined
by purchase manager
• AI Automation – Most advanced method – Uses machines which follow rules and also learns
from past experiences – Example: Customer service chatbots
Cloud:
• Providing computing services such as storage, processing and software over internet
• Benefits: Cost-effective, Scalable, Accessible, Efficient and secure
• Examples: Amazon web service and Google Cloud
• Forms – Xaas + Saas (Microsoft 365) + Paas (Google App engine) + Iaas (AWS cloud) + Baas
(backend service)
Autonomous vehicles:
• Operating of vehicles without human operator. Example: Tesla
3D Printing [Additive Manufacturing]
• Creation of complex and custom objects from digital design + Layer by layer creation where
next layer is added to earlier layer
• Techniques: Filament is heated which deposits molten material and the same solidifies to
form object – Fused Deposition Modeling (OR) Fused Filament Fabrication
• Cost of 3D printing can sometimes even cost more than a 3D printer
Digital Twin:
• Virtual model that replicates physical products, processes or systems
• Example: Patient-specific digital twin in healthcare – can be used for simulation and modeling
– digital twin of patient heart can be created based on past data and then simulation can be
performed on various treatments
Augmented Reality:
• Adds images/videos/3D models onto what we see in real world through devices like smart
glass, smartphones or tablets – Useful for improving understanding (education), productivity,
entertainment
• Utility: Real time instruction to workers when working on complex product (OR) virtual try-
on in retail industry
Mobile Internet:
• Base for various other applications such as Augment reality, improved connectivity for
robotics and automation, real-time data and analytics
Blockchain:
• Digital ledger where transactions (like buying or selling) is recorded – ledger shared among
multiple systems – transactions are entered by multiple systems and the same forms a chain
– hence cannot be tampered
• Multiple transactions form part of a block – when one block is full a new block is created
Automation vs Extension vs Transformation:
• Automation – Replacing human tasks with technology Example: Self-checkout machines in
supermarkets
• Extension – using technology to add new capabilities or improve existing ones. Example: Smart
home devices
• Transformation – Changes how an organization operates, what it offers and how it interacts with
customers or users. Examples: EV is a transformation in the automotive industry
Business Ecosystem:
• Network of different business and organizations + Include suppliers + Distributors + Customers
+ Competitors + Government Agencies
• Companies in business ecosystem are like animals in community – They have to adapt to survive
• Impact: Companies should do collaboration and form partnerships and alliances – This strategy
is better than trying to be best on their own
• Companies need to decide whether they want to part of ecosystem – determine their role and
see what benefit they can get
Types of Business Ecosystems:

• Innovation Ecosystems: Focus on collaborative innovation (e.g., COVID-19 vaccine
development, Silicon Valley Tech Ecosystem, Automotive industry and Autonomous vehicles).
• Platform Ecosystems: Revolve around a core product or service with complementary offerings
(e.g., Apple’s App Store, Amazon Web services).
• Service Ecosystems: Emphasize value exchange through integrated services (e.g., Uber’s ride-
sharing network, Airbnb (connects Airbnb, hosts, guests, local experiences provider, payment
processors and cleaning services)).
Three Flywheels – Fuel Business Eco-system Success:
• Flywheels are mechanisms that keep spinning once they gain momentum
• Data Flywheel (collecting more and richer data leading to better insights and decisions Example:
Netflix) + Growth Flywheel (attracting more customers and partners to make it more valuable
Example: Facebook) + Cost Flywheel (reducing costs by spreading costs over large number of
units Example: Amazon)
Hyper-competition:
• Intense and unstable market competition requiring constant adaptation + Companies are
constantly trying to outperform each other + Customers have higher bargaining power
• Characteristics: High rivalry, rapid change, low entry barriers, and temporary advantages.
• Innovation is the key mitigant: Essential for success, involving constant market disruption +
Continuous innovation is needed. Example: Apple’s iphone
• Strategy: Use D'Aveni's 7S Framework to stay competitive by focusing on stakeholder
satisfaction, strategic soothsaying (predicting future trends), speed, surprise, signals, Shifting
the rules of a market and Simultaneous and sequential thrust (implementing multiple
strategies).
Transformation and Disruption:
• Industries evolve through continuous improvement and innovation. Example: Television
• Transformation – Occurs when innovation changes how competition works in an industry –
Organization needs to align to new changes - Example: UPI payments have transformed small
merchant payments
• Disruption - Happens when competitor offers significantly better value than existing firms –
Example: Uber and Ola
• Entry of Reliance Jio was both disruption (Business model disruption, technology disruption
and market share disruption) + Transformation (Industry dynamics, customer expectations,
Policy and regulatory impact)
Types of Disruption:
• Low-End Disruption – New entrant focuses on customers who prioritize cost over features –
existing players move to high-end customers. Example: Online bookstores
• New-market disruption – New entrant targets customers who were under-served or not served.
Example: Personal computers
• Main difference between the two is that low-end disruption focuses on overserved customers,
and new-market disruption focuses on underserved customers.
Components of Disruptive Innovation:

• Technology is the enabler + Disruptive/Innovative business model focus on serving new or low-
end customers + Coherent value network (business ecosystem to ensure success)
Advanced Manufacturing:
• Using innovative technologies and methods to improve production process
• Objectives: Enhance output + Increase value + Market responsiveness + Flexibility + Reduce
time to market + Reduce inventory + Utilize capital efficiently + Control costs + Enhance overall
value
Classification
• Level 1 – Stand-alone (unitary) – Individual machines
• Level 2 – Cells – Group of machines

• Level 3 – Linked islands – Group of level 2 cells connected into larger production systems
• Level 4 – Full integration – entire process linked through computer integrated manufacturing
Techniques:
• Cellular manufacturing
• Numerically controlled machines (machines controlled through magnetic
tape/microcomputers)
• Flexible manufacturing systems – Connects various machines and automate material handling
• Computer-aided design
• Computer-aided manufacturing
• Computer-integrated manufacturing – integrates all aspects of manufacturing
Lean-startup:
• Focus on rapid iteration (agile engineering), experimentation and learning to get a perfect
product/service
• Focus on continuous feedback and adjustments and not on extensive planning and assumptions
in a new product introduction
• Principles: Minimize upfront investment + Continuous improvement + Discovery-driven
planning + Minimal viable product (simplest version of a product that enables innovators to
collected maximum feedback from customers with least effort)
• Benefits: Risk mitigation + Efficiency + innovation
Traditional vs Lean Start-up:

• Traditional – Business Plan and Implementation driven+ Product development through
waterfall or agile manufacturing + Failure is exception + Operates on complete data
• Lean-startup – Business model and Hypothesis driven + Product development through agile
development + Failure is expected + operates on good enough data and takes rapid decision
Lean Start-up Methodology:

• Build-measure-learn loop: Problem identification + Build Minimum viable product + Measure
performance and gather data from users + Learning (analyze what is working and what is not)
+ Iteration
• Objective is to spin the feedback loop at maximum speed
• Investigative development (continuous asking why till we get to root-cause (five whys method)
+ Align with business model drivers + Pivoting (if current approach is not successful, then we
need to pivot (change strategy)
• Impact: Cost savings as basic product is developed + Need for experimentation budget
Agile Organization:
• Features: Quick Adaptation + Empowered Teams + Continuous improvement
• Traditional vs Agile: Traditional (Hierarchy structure + Centralized decision making + limited
flexibility) and Agile (Flatter structure + Decentralized decision making + Highly flexible)
• Organization is machine in Traditional organization (every one has specific function and role)
vs Organization is living organism in Agile
• Characteristics: Customer centric approach + Open communication + Strong growth mindset +
Quick decision making
• Design thinking + Lean Start-up + Agile Methodologies = Powerful framework for innovation
Design thinking vs Lean-startup vs Agile vs Six sigma:
• Design thinking – User-centered problem solving – Understand customer needs + Define
problem + Generate range of ideas + Prototype and then test
• Correct sequence = Design thinking – Lean-startup – Agile – Six Sigma
Start-ups vs Incumbents:
• Fight is who gets it first: Startup needs distribution vs Incumbent needs innovation
• Start-up (temporary organization) + incumbent (permanent organization)
• Start-up (Flexibility, Speed, Agility and Innovation) + Incumbent (Customers, brand value,
supporters and investors)

• Start-up (small and cross functional teams) + incumbent (Hierarchical structure)
• Start-up (Risk-taking culture) + incumbent (Consensus driven culture)
• Start-up (Mostly online sales + limited advertising spend) + incumbent (Primarily offline +
extensive advertising)
• Start-up (loss making and struggle with financial needs) + incumbent (Strong financial position)
Stage of development of Start-up:

• Pre-startup stage – problem-solution fit stage – mapping of solution to the problem
• Startup stage – Product-market fit stage – Making product marketable
• Scale-up stage – Scale fit stage – Growing in size and becoming unicorn
Intrapreneurship:
• Aimed at accelerating innovation within large organization + Developing entrepreneurial
mindset among employees + Proactive response to combat stagnation
• Implement new ideas within established businesses
• Intrapreneur does not have ownership/independence as compared to entrepreneur
• Intrapreneur can create value through improved processes/new products
Innovation hubs and incubators:
• Innovation Hub – Physical or virtual space that serves as collaborative environment bringing
researchers, creators and innovators – Objective is to develop innovative ideas into products
• Incubators – Structured programs to support early-stage startup in developing ideas into viable
businesses – Provide mentoring, resources and support services on fee/equity
• Incubators typically have a higher direct impact on startups due to their focused support
structure. They provide tailored guidance and resources that directly contribute to the startup’s
success and growth trajectory
• Incubator vs accelerator: Accelerators focus on rapid growth and scaling through intensive,
short-term programs
Supply Chain Partnership:
• Co-ordination and cooperation between internal departments and external partners (supplier/
distributors/logistics providers) – Objective is to meet customer demand while optimizing flow
of goods
• Benefits: Enhanced agility + Less Bullwhip effect (real-time data sharing) + Improves supply
chain collaboration + Cost reduction
• Successful collaboration: Collaborate in strong areas + Long-term collaboration + Joint
performance management
• Essentials: Real-time data sharing + Advanced AI and Machine learning + In-context messaging
(interface that facilitate real-time communication)
• Supply chain partnership software can be used to improve forecasting accuracy and to
strengthen collaboration
Approaches to supply chain innovation:

• Rapid supply chains – speed and efficiency
• Agile supply chains – Flexibility to adapt to changes in demand
• Lean supply chains – prioritize waste elimination
Business Model:
• Explains how organization create value and deliver product/service – Includes producing and
selling
• Customer value Proposition (value that customer gets) + Profit formula (company’s approach
to generate revenue and profits) + Key resources and processes (essential assets, capabilities and
activities)
Emerging business Models
• Hyper Disruptive Business Models
• Models related to sustainability [People + Planet + Profit]
• Models relevant to emerging national markets
Hyper Disruptive Business Models

• Fundamentally alter the way products, services or industries operate – Create new
markets/redefine existing ones/leverage technology
• Types of disruption: Creation (create new product) + Disintermediation (remove intermediaries)
+ refinement (improve existing products) + reengineering (rethink traditional processes) +
Optimization (Streamlining operations)
• Impact: Competitive advantage + market leadership + Adaptability
• Free Model: Offering basic services for free while monetizing through advertising or premium
features (e.g., Google's search engine, Facebook)
• Subscription Model: Charging recurring fees for access to products or services (e.g., Netflix for
streaming content, Spotify for music)
• Freemium Model: Providing basic services for free and charging for premium features or
upgrades (e.g., Dropbox, LinkedIn) – Model is useful in lowering customer acquisition costs
• Digital Platform Model: Creating online platforms that connect users or facilitate transactions
(e.g., Airbnb, Uber).
• Hypermarket Model: Offering a wide range of products under one roof at competitive prices
(e.g., Walmart, IKEA) – Objective is to crush competition and dominate market
• Access-over-Ownership Model: Providing access to goods or services without the need for
ownership (e.g., car-sharing services, bike-sharing services).
• Service Ecosystem Model: Building interconnected services that create value through mutual
collaboration (e.g., Apple ecosystem with devices, apps, and services).
• Experience Model: Focusing on creating unique and memorable customer experiences (e.g.,
Disney theme parks, luxury resorts).
• On-Demand Model: Fulfilling customer needs immediately or at short notice through efficient
delivery or service provision. Example: Uber, Blinkit Grocery
Free Model – Sub-categorization:
• Advertising model (hidden revenue model) – Earn through advertising income
• Cross-subsidisation (Razorblade business model) – Selling core product (printer/razor) at low
margin or at loss and stimulate demand for allied products (cartridges/blades)
• Open source (Free access or Gift Model) – The product or service is free for anyone to use,
allowing for easy creation of a community for technology improvement. Example: Wikipedia
• Promotion – Low-cost product/service is provided with purchase of another product. Example:
Supermarkets offer free gift when customers spend a specified amount
Digital Model – Sub-categorization:
• Business to Business – India Mart
• Business to consumer – Amazon
• Customer to customer – OLX
• Customer to Business – Youtube
Free model to Freemium Model to Subscription Based Model:
• Free Model can transition into freemium model and then the same can transition into
subscription model
• Free model can be used for any type of product/service whereas freemium and subscription is
majorly for services
Models related to Sustainability:
• Sustainable business model = Social consideration (People) + Economic consideration (Profit) +
Environmental Consideration (Planet)
Bearable vs Equitable vs Viable vs Sustainable decision in the context of TBL:
Environmental Social Economic Performance of Sub-set
Acceptable Acceptable Not acceptable Bearable
Not acceptable Acceptable Acceptable Equitable
Acceptable Not acceptable Acceptable Viable
Acceptable Acceptable Acceptable Sustainable
Elements of Sustainable Business Model:

• Diverse resources + Modular structure (different units which can work independently as well
as they are integrated) + Open to ideas from outside + surplus capacity + aligning business
operations to market trends
Approaches for developing sustainable business model:

• Product service systems – Customers pay for product services rather than purchasing the
product itself
• Open innovation – Collaboration with external partners to co-create and commercialize new
ideas – sharing of risk and rewards
• Peer-to-peer innovation – Collaborative process where individuals/groups share resources,
knowledge and capabilities – leverages open source principles. Example: Mozilla Firefox
• Closed-loop production (Cradle to Cradle): Design products that enable recycling or reuse
throughout lifecycle. Example: Carpet manufacture reclaims and recycles old carpets to produce
new ones
• Crowdfunding: Raising funds from large number of individuals
• Sharing economy: Individuals/organization share access to goods/services + Collaborative
consumption Example: Uber enables individuals to share their asset with others for a fee
• Social enterprises and benefit corporations: Prioritizes social and environmental objectives
alongside financial goals. Focus is on Positive social impact. Example: Grameen Bank
• Gift Economy: Promotes social sustainability through voluntary donations – extreme form of
sharing economy. Example: Pay what you want
• New manufacturing Paradigm: Utilization of latest manufacturing capabilities like 3-D printing
to make production efficient
Caution against sustainable business models:

• Long-term vision on sustainability vs short-term profit goals
• Traditional performance benchmarks focus on financial metrics such as profitability, revenue
growth
• Focus of businesses is on challenging competition and have shareholder wealth maximization
Emerging Markets/Emerging Economies:
• Emerging market/Economies = Society moving from authoritarian regimes to open, free-market
economies
• Increasing economic freedom + Economic Integration (getting more integrated towards global
economy) + Middle class expansion + Improving living standards + Social stability + Increase
funding/cooperation from multilateral institutions (World Bank/IMF/WTO)
• Adopting information and communication technologies + Low per-capita incomes (10 to 75% of
average income of EU) + Catching up growth + Institutional transformation
Importance of Emerging Market:
• Represent significant part of global consumption + Marketing opportunities (market extension)
• Price sensitive market + need for cost reduction
• Strategy: Accept small profits + Find new ways to capture value (developing unique products
+ Implementing unique distribution channels)
Characteristic of Emerging National Markets relevant to Business Model:
• Sociopolitical Governance (Volatility and Uncertainty – Frequent changes in Govt regulations)
• Market Heterogeneity (Diverse range of consumer preferences – Hence product offerings need
to be varied)
• Inadequate infrastructure (Poor infra – companies may need to invest in their own logistics)
• Chronic resource shortage
• Unbranded competition (Competition from local and unbranded products)
• Clientelistic exchange prevalence (personal connection and relationships)
• Informal institutional flux (informal practices shape business operations)
• Distribution challenges
Action by Companies:

• Focus on cost reduction + Emphasize local leadership and decision making + innovation and
flexibility
Strategic Responses to New Business Models:
• Cause Drivers – Digital Technologies + Business Ecosystems (including supply chain
partnerships) + Hyper competition + Transformation and Disruption
• Effect Drivers – Reactive elements that respond to change drivers – have circular effects,
influencing and being influenced by the changes
Cause Drivers:
Driver Strategy
Digital Start-ups focus on innovation and disruption (Razorpay software became
Technologies Unicorn in 2020 through innovation + Incumbents focus on existing products and
markets (Reliance Jio by Reliance Industries Limited)
Business Strategies to capture value:
Ecosystems • Meeting changing customer needs (Record feature in Airtel DTH)
• Be the reason for which customer buy the product (Processor
manufacturer (AMD or Intel Inside) in laptop
• Being indispensable integrator (Google Play Store which is an essential
part of Android Ecosystem and is indispensable for both app developers
and users)
Strategic Aspects:
• Flexibility + Cooperation + Regional harmony (ensuring alignment with
regional policies) + Focus on all stakeholders + Transparency + Free flow
of information (effective communication + Confidentiality) + Shared
economy and resource clustering (Resource sharing as well as
maintaining core capabilities for themselves) + Economics of scope
(Horizontal (integration with competition) /vertical integration
(backward (supplier) and forward (customer)/diversification
Hyper- • Focus on series of short-term advantages – Get benefit of one disruption
competition and immediately move to the next one
• Culture of constant innovation + R&D budget + Lean Start-up Culture +
D’Aveni 7S Framework
Transformation • Companies can become non-existent if this is not handled properly.
and Disruption Example: Nokia
Strategies:
• Milk as cash cow (Generate steady income from existing product without
additional investments). Example: HUL
• Invest or counter invest. Example: Reliance Jio
• Blocking the path or creating hurdle on the road. Example: Ola and Uber
vs Local taxi unions
• Counter disruption and make original inventor non-existent
• Restrict presence and shift focus on the core. Example: Tata Steel
• Withdraw Example: Jet Airways
Points to consider in strategy: Customer expectations (no compromise on

existing customer needs) + Resource availability + Response based on market
segment priority + Commercial benefits

Chapter 7 – Strategic Profit Management
Profitability Analysis:
• Profitability Analysis = Measure the performance of the firm against acceptable standards –
Analysis as per management requirement – Identify CSF and take appropriate decisions – this
also involves taking corrective action in case of deviations
Strategic Profitability Analysis:
Change in operating income can be because of the following components:
• Growth = Increase/decrease in profit due to change in units sold
• Price recovery = Increase/decrease in profit due to change in prices of output and input
• Productivity = Increase/decrease in profit due to efficient/inefficient usage of inputs
• Growth/Price recovery is applicable for both sales and cost – productivity only for cost
• Alternative classification:
o Growth component can be split into market size and market share factor
o Product differentiation component = Market share factor + Price recovery component
o Productivity component = Productivity component
Particulars Growth Component Price Recovery Component Productivity Component
Sales Not Applicable
Difference between Difference between standard
Variable Difference between standard
budget and data and standard data based
Costs data based on actual price
standard on actual price
Fixed Costs and actuals
Table for calculation:

Particulars Budget (last Standard (Revised Actual price x Actual (current
year data) for Actual output) Standard Volume year data)
[A] [B] Driver [D]
[C]
Sales
Less: Variable
costs
Less: Fixed
costs
Profit
Activity Based Costing:
• More accurate method of costing – Assigns overhead costs to products on the basis of multiple
cost driver
Step 1: Compute Cost Driver Rate under ABC:
Activity Total Cost CD Name CD Quantity CD Rate
𝐓𝐨𝐭𝐚𝐥 𝐂𝐨𝐬𝐭
𝐂𝐃 𝐑𝐚𝐭𝐞 =
𝐂𝐃 𝐐𝐮𝐚𝐧𝐭𝐢𝐭𝐲
Step 2: Apportionment of Overheads:

Particulars Product A Product B
CDQ Amount CDQ Amount
Step 3: Computation of cost per unit under ABC:

Particulars Product A Product B
Material cost XXX XXX
Labour cost XXX XXX

Overhead cost (Step 2) XXX XXX
Cost per unit XXX XXX
Profitability Analysis through ABC:
• Service sectors: Low direct cost + Overheads cannot be easily attributed to product/service
• ABC accurately measures resource consumption + Leads to accurate costing + Provides useful
data for profitability analysis of products/customers/business segments
Direct Product Profitability (DPP) Analysis:

• DPP Method helps in assessing the profitability of individual products/market segments
• Primarily used in retail sector – Assigns both purchase costs and indirect costs (based on
resource consumption) to products – helps in computing net profit of each product
• Benefits: Better cost analysis + Better pricing decision + Better stores and warehouse
management + Rationalization of product range
• DPP Statement:
o Sales – COGS = Gross Profit;
o Gross Profit – Indirect costs [Overhead cost – volume related cost – product batch cost
– inventory financing cost] = Net profit
Customer Profitability Analysis:

• Profitability analysis of different customers/groups of customers – similar to DPP (which is for
product) – cost allocation based on usage of activities
• Useful for service organizations such as bank/hotel
• Benefits: Identifies customers are eroding overall profitability + constructive dialogue between
buyer and seller to improve margins
ABC in Advanced Manufacturing Environment (Contributing factor = Global Competitiveness +
Workplace Automation)
Global Competitiveness:
• Intense competition led to new technologies such as Just in Time Manufacturing and Advanced
Manufacturing + Improve customer value while increasing profits
• ABC Supports continuous improvement (Insights about activity performance + demand
sources) + Increased product cost accuracy = Critical for success
Workplace Automation:
• New technologies = Computer Aided Design + Robotics + Advanced Manufacturing
• Shift in cost structure – Labour cost replaced with indirect equipment cost and overheads
• ABC can help in allocating these costs and improve product cost accuracy – However no impact
on accuracy in case of single product situation
Activity Based Cost Management (ABM)
• ABC helps in cost management (reducing and controlling cost) – ABM is basically cost
management application of ABC
• ABM = Cost Driver Analysis + Activity Analysis + Performance Analysis
• ABC vs ABM: ABC captures information and the same is used by ABM for continuous
improvement
Types of ABM:
• Operational ABM – Focus on efficiency and lower cost – improving value-added activities and
eliminating non-value-added activities
• Strategic ABM – Deciding which products to be manufactured and which activities to be used –
taking strategic decision based on ABC data
Designing and implementing ABM (Cost Driver Analysis + Activity Analysis + Performance
Analysis)
Cost Driver • Cost Driver = Factor that causes change in cost
Analysis • Analyzing cost driver is first step in improving cost effectiveness of
activities and Cost management

Activity • Categorize into value-added and non-value-added activities
Analysis • Eliminate non-value-added activities and reduce number of activities
• Identify activities and group into activity centres - Example (Production –
Machine setup, operation and assembly + Quality control (Inspection,
Testing) + Maintenance (Routine maintenance, Emergency repairs,
Equipment inspection)
Performance • Identify significant activities that has most potential for improvement
Analysis • Approach 1: Compare cost driver rates of key activities with benchmarks to
identify which activities cost more and work on improving them
• Approach 2: Compare based on quality, cycle time, productivity and
customer service to judge activity performance
• Measuring activity performance can help in continuous improvement
Value-added Activities/Non-value-added Activities:
• Business = Linked activities that adds value to customer; Managing activities to enhance
customer value/manage cost; Activities = Value-added and non-value-added activities
• Value-added Activities = Customers are willing to pay for the services
• Non-value-added activities = Not valued by customers causing waste, delay; Examples: Moving
time, machine setup; Non-value-added Activity costs has to be separately disclosed in activity
cost center reports
How to determine the Activity nature:

• Necessary Activity = Value Added
• Activity efficiently performed = Value added; Inefficient usage = Non-value-added; Standards
can be established to check efficiency of activities
• Sometimes Value Added and Sometimes Non value Added – Needless movement of RM (Non
Value Added) & Necessary movement of WIP (Value Added)
Five Major Non-Value-Added Activities – wastage of cost/time/resources on

Storing Cost for holding inventory
Moving Movement of material (RM/WIP/FG) from one department to another
Waiting Time and resources are spent in waiting for next process
Inspecting To check if products meet specifications
Scheduling To plan manufacturing of different products
Elimination of above wastage:

Inspection Time Total Quality Control and Zero-Defect Manufacturing
Moving Time Cellular Manufacturing
Waiting Time and Storage Time Just in Time Systems
Scheduling Time Producing exactly based on demand
Ways in which time is spent in manufacturing process:

Receipt time Time taken by marketing department in communicating order to
manufacturing
Manufacturing cycle time Total amount of production time required per unit
Delivery time Time taken to deliver product to customer post manufacturing
Delivery cycle Gap between receipt of order and delivery of goods = Receipt Time +
time/Customer response Manufacturing Cycle Time + Delivery Time
time
Retail Cycle Time Length of time from ordering to selling an item in a retail environment
Service company cycle Time between service order and service completion
time
Velocity Number of units produced in given time

Manufacturing cycle Value added time (Processing Time)
efficiency/Process cycle Processing time + Inspection time + Waiting time + move time
efficiency
Business Applications of ABM:
Cost Reduction Identify costs + opportunities for cost reduction + quantify process waste +
facilitate continuous improvement
Activity Based Resource input for each activity + Prepare budget for every activity + compare
Budgeting actual + identify discrepancies + continuous improvement + cost-effective
budget + contains three key elements (type of work + Quantity of work + Cost of
work to be done)
BPR Substantial changes + Assess business performance + Identify process efficiency
opportunities
Benchmarking Compare ABC derived activity costs of one segment with other segments
Performance Focus on activity performance to manage costs + Focus on cost, time, quality and
Measurement innovation
Implementing ABM:
• Identify most important issues and address those issues by getting correct information
• Top Management support
• Incorporate ABC into cost/financial reporting process
• If integrating not possible, then implement separate ABC system
• Information system should provide needed information
• Implementation team = Should contain the actual users of ABM
• Start with high-level implementation (pilot projects/initial rollouts)
Benefits of Activity Based Cost Management:
• Cost Reduction + Helps in implementing Activity Based Budgeting + Helps in understanding
underlying causes of business processing costs (process improvement) + Helps in decision
making effectiveness + Key resource management (Identify key process waste elements and
leverage of key resources)
ABC and ABM:
• ABC = Enables correct distribution of overheads and improves product costing accuracy
• ABM = Broader concept = Helps in cost management = Focus on planning, execution and
measurement of competitive advantage
Activity Based Budgeting:
• Planning and controlling the expected activities + Derives cost-effective budget + identifies
financial and non-financial requirements to meet strategic goals
• ABB = Type of work to be performed + Quantity of work to be performed + Cost of work to be
performed
• Enhances financial forecast accuracy + Rapid financial plans and models based on volume
assumptions
• ABB = Products/services to be produced → Activities needed to produce → Resources needed
to perform activities
ABB vs Traditional Budgeting:
• ABB is more powerful planning and control tool as compared to traditional budgeting
• Emphasize Cost reduction through elimination of wasteful activities
• ABB builds budget for each activity based on resources needed and forecast various costs
Activity Flexible Budgeting:
• Activity flexible budgeting = Prediction of what will be activity costs as activity output changes
• This is different from traditional flexible budget – Traditional flexible budget is based on output
alone – Activity flexible budgeting is based on multiple activity driver of respective activities
ABC – Decision Making Tool:
• Analyzing profitability of customer/products
• Complement to TQM – Tracks financial impact of improvements suggested by TQM
• Significant advantage for wholesale distributors – Helps in deciding expansion/rationalization
of product range

• Facility and Resource Expansion – Facility and resource expansion is based on cost
considerations and ABC can provide accurate cost
• Decision support for Human Resources – Helps in measuring cost associated with individual
employees/departments – can make informed decisions about optimal employee/revenue
ratios
• Cost plus mark-up method
Pareto Analysis:
• Strategy = Achieve objectives with limited resources; Prioritization of efforts towards significant
causes is critical
• Pareto’s rule = 80 percent of results can come from 20 percent of effort (vital few) + Remaining
20 percent of results can come from 80 percent of effort (trivial many)
• Uses law of diminishing returns (pick low-hanging fruit first) + Organization should focus on
vital few and ignore trivial many
• Pros: Prioritization + Optimal use of scarce resources + control mechanism + looks at root causes
• Cons: Possibility of exclusion of important problems + wrong identification of vital few
• Application: Pricing of product + Customer Profitability Analysis + ABC Analysis (Stock
control) + Activity based costing (80% of cost driven by 20% cost driver) + Quality control
How to do Pareto Analysis:
• Arrange the various causes in descending order of value and compute value as % of total value.
Also compute cumulative % of every item. Items forming part of top 80% would be part of vital
few

Chapter 8 – An Introduction to Strategic Performance Management
Strategy:
• Peter F Drucker Definition: Strategy = Pattern of Activities + Achieve organization objectives +
Adapt to environmental changes + Long-term Perspective
• Michael Porter Definition: Strategy = Competitive Positioning (differentiate from competition)
+ Deliberate Choices + Unique value Proposition
• To summarize focus is creating sustainable competitive advantage
• Effectiveness of Strategy = Efficient strategic Planning + Efficient Strategic Control
• Effectiveness = Doing the right things; Efficiency = Doing things in best possible manner
Performance Management:
• To assess performance against goals and objectives + Identify areas of improvement
Stages:
• Stage 1 – Decide appropriate organization structure
• Stage 2 – Degree of delegation and responsibility centre
• Stage 3 – Establish financial and non-financial performance measures and target
• Stage 4 – Review performance with KPI dashboard and take corrective actions
Interlinking of Performance Management and Strategy:
• Effective strategy – depends on efficient planning and control – depends on informed decision
making
• Performance Management system has CSF, KPI which allows alignment of individual goals with
that of organization – This will also provide information for decision making – This also helps
in achievement of strategic goals
Importance of Interlinking of Performance Management and Strategy Multifolds under Modern and
Dynamic Business Environment
• Performance Management – Traditionally focused on evaluating employee performance –
Modern focus is on aligning employee goals with that of organization and ensuring all work
towards same goal
• Modern focus will ensure that organization remain competitive and effectively achieve their
strategic objectives
Business Integration:
• Business = Group of departments; Effective integration of departments is critical as there is inter-
dependency among departments
• Business integration = Aligning all aspects of business + Achieving objectives + Avoiding sub-
optimization = Information technology will play key role in integration
• Business integration = Linking People + Operations (processes) + Strategy + Technology
Value chain and competitive advantage:
• Value Chain = Primary Activities + Support Activities
• Profit = Value which customer is ready to pay – cost incurred by the firm for the product
• Categorize activities into value added activities and non-value-added activities – Focus on
enhancing value added in differentiation – Focus on eliminating non-value added in cost
leadership
Approach 1 - Value-added and non-value-added activity:

Necessary + cannot be improved = No action to be taken Compliance with regulations
Necessary + can be improved = Modify the process to Supply chain logistics, customer service
improve value operations
Not required + can be eliminated eventually (later) = Obsolete machinery, excess inventory
Eliminate this eventually
Not required + can be eliminated immediately = Unproductive office meetings, unused
Eliminate it immediately storage space
Approach 2 – Decision on outsourcing:

• Non-value-added activities = Outsource it if they are non-core
• Value added activities = Depends on cost effectiveness and competency (can company perform
it better in-house)
Approach 3 – Value chain can make comparison easy:

• Compare our value chain with competitor to understand gaps and improve them
Approach 4 – Customers’ perspective:

• Consider internal users as customer – keep executing every stage to satisfaction – ultimate end
product would be to satisfaction of external customer
Approach 5 – To look at Big Picture ‘Value System’ (Wider integration):

• No organization can operate in isolation from customer and supplier = Hence we should
integrate our value chain with customers’ customer and suppliers’ suppliers and create an
extended organization (Value System)
Linkage of Value Chain Analysis and Performance Management:

• Value Chain Analysis Identify Value Driver Activities and Linkage among different activities
(How such linkage impact value?) + Business Integration Activities shall be integrated by
consolidating the linkage among the People, Operation, Strategy, and Technology, etc =
Performance Management – Better integration leads to more value preceived to consumer (at
same or lower cost), therefore increase in margin (performance)
McKinsey 7S:
• Useful in navigating change + Strategy implementation + Understanding interconnected
subsystems
Hard 3S – Easy to manage and change – Strategy, Soft 4S – Difficult to change - Style, Staff, Skills
Structure and Systems and Shared Values
• All areas are equally important but shared values is central to everything + All elements are
inter-related and hence change in one element will need tweaking in others
Strategy:
• Specific plan + Achieve goals + Scarce resources + Long-term objectives + Mission and vision
• Strategy should be aligned with other six elements + Not to implement short-term strategies
Structure:
• Formal framework + Coordination of tasks + Enables flow of work + Achieving goals
• Deciding responsibility centres + Role allocation + Authority allocation
• Provides role clarification + Decides hierarchy
Principles of defining Organizational Structure:

• Functional definition (Clarity on role + allocation of duties and responsibility)
• Span of control (Number of people a manger can supervise) – Wide span of control would mean
fewer layer of management (wide organization) – Narrow span of control means more layers
(tall organization)
• Delegation (Assigning tasks – Delegating authority is decentralization vs retaining authority is
centralization)
• Scalar chain (Clear chain of command + Minimizes confusion + Reduce wastage + Avoid
duplication of efforts)
• Unity of command (Each subordinate should report to one manager only
Calculation of Number of relations and Cross-relations:

• A is reporting manager to B and C. Here value of ‘n’ that superior along with subordinates is 3
i.e. A, B and C
• Number of relations = n(n-1)/2 = (3 x 2)/2 = 3 relations
• Number of cross-relations = n(n-1) = 3 x 2 = 6 Cross relations

Centralization vs Decentralization:
• Centralization = better control and standardization + better decision + improved management
control + Reduce job satisfaction
• Decentralization = Higher job satisfaction + Lower workload on top management + Loss of
control + Higher overhead costs + Alignment issue with organization objectives
Types of Organizational Structure:

Entrepreneurial Control revolves around proprietor (entrepreneur) + Plays dual role of manager
(Patanjali and owner
Ayurved)
Line Military (or) scalar-type organization – Supervisor directly controlling sub-
(Indian Army) ordinates – Authority flows from top to bottom
Functional Groups positions based on functional expertise, skills and work activities –
(Infosys) Expertise utilization + No duplication of efforts + In-depth specialization –
Communication challenges + Goal alignment issues
Divisional Organization segments on basis of divisions (products/service/geography) –
(Aditya Birla Flexibility + personal interest for managers – Duplication of efforts and barriers
Group) between divisions
Matrix • Employees report to both project and functional manager – Employee
(L&T) may get demotivated as confusion can get created due to two bosses
• Weak matrix structure – Project control in hand of functional manager
and not project manager
• Strong matrix structure – Project manager is on par with functional
manager and has separate project management team
Project Every project will have project manager – Full autonomy given to project
(Reliance Jio) manager – May handle multiple projects
Network/Virtual Major functions are outsourced + Highly centralized + Networking through
(Flipkart) technology + can compete with large companies + Reliability of partners may be
doubtful
Factors influence organizational structure:

• Organization needs to succeed in multinational, multi-language and multi-currency
environment
• Factors to be considered – Problem types (flexible structure for complex problems) + Diversity
+ Technology adoption (high reliance to technology would need decentralized decision making
for quick response) + Ownership type + Size + culture and values
Systems:
• Structure processes and daily activities to achieve organization goals – All activities revolve
around information system as core – Systems can help in seamless flow of information and
knowledge management
Style:
• Informal rules, culture and overall way of conducting business – significantly influenced by
leadership style
• Leadership style – Autocratic (centralized decision making) + Bureaucratic (adherence to rules
and regulations) + Democratic (Participative process
Staff:
• Most valuable and strategic resource + Drives strategy towards organizational success +
Integrating staff into strategy is critical + Satisfied workforce can reduce costs such as retraining,
recruiting and rehiring + Staff can become change agents + However if staff are not aligned with
other elements then it can impact performance
Skills:
• Identifying Core competence and working on it
• Identify skill gap and fill it + Think about outsourcing non-core skills
• Example: Hospital – Prescribing medicine + Nursing and performing surgery are key skills

Shared values:
• Guiding beliefs of people in the organization as to why it exists
• It is central to everything and was also called superordinate goals when it was introduced
Effective use of 7S Framework for business integration:
• Step 1 – Start with shared values – Check whether they are consistent with Hard 3S and if not
then what changes are needed
• Step 2 – Now check if Hard 3S is supporting each other and what changes are needed in that
• Step 3 – Now look at balance soft elements and see if it supports other elements (hard and soft)
– check if any changes are needed
• Step 4 – Iterative process of changes – Change in one element can impact changes in other
elements
Change Management and Gap Analysis with 7S Framework:
Change Management:
• Helps identify and implement changes + Moving from current to desired
• Preparing for change + implementing + embedding changes and reviewing progress
• Follow 3Cs – clear, compelling and credible
Gap Analysis:
• Understand current state + define desired state + Make action plan + Execute + review progress
7S Framework:
• Tools like 7S Framework can help in change management and gap analysis
7S Model and Performance Management:
• Mckinsey 7S - Identifying whether all the 7S elements are properly aligned and supporting each
other or not.
• Business Integration - 7S shall be integrated (through realignment) with help of gap analysis and
change management
• Performance Management – Better integration (alignment among 7S) leads to improved
performance
Influence of Structure, Culture and Strategy on Performance Measurement:
• Change in structure, culture or strategy will need new performance measurement techniques
and methods
Influence of Structure:
Functional Structure – Centralized control Divisional structure – Decentralized control
Performance data collected at functional level but Performance data collected and analyzed lower
analyzed at upper level + feedback sent down in hierarchy + more autonomy
• New structures such as project team and matrix organization have evolved for flexibility and
innovation + To conclude performance measures will vary based on structure
Influence of Culture:
Predictable and reliable culture Innovative and creative culture
Formal + uses tried and tested methods and Encourages risk-taking + Open to new methods and
techniques techniques
Influence of Strategy:
• Performance management should align with strategy – Consider customer satisfaction, quality,
time and innovation + Balance both financial and non-financial measures
Complex Business Structures:
• Why needed: Business processes can be performed better [OR] more cost effectively [OR]
without need for investment in expensive production capacity
Business structure with one or more of the following:
• Diluted control (Example: MNC with multiple subsidiaries and each subsidiary having own
management team)

• Shared objectives (Example: Joint venture with both venture partner have shared objectives)
• Pooled resources (Example: Group of companies investing in one asset and sharing it together)
• Connected virtually (Example: Global software company with teams connected virtually
through communication systems)
• Collaboration of different cultures, interests (Example: Merger of two companies from different
countries)
• Diverse business environment (Example: Conglomerate with operations in multiple industries.
Example; Tata Sons)
Prominent complex Business Structures: Strategic Alliances, Joint ventures, Franchising, Licensing,
Multinationals, Complex supply chains, Network Organizations and Virtual Organizations
Complex Business Structures – Problems and Solution:
• Establishing objectives: Strive towards goal congruence – Challenging due to different
values/vision/risk appetite of parties
• Approaches and Attitude: Common Minimum Program which covers quality, control and risk
• Accountability: Ambiguity can arise and hence Accountability should be clearly established and
communicated from the outset
• Lack of Trust: Mutually Decided control and reporting framework can lead to improved trust
• Cultural conflicts: Define shared values that are more liberal and inclusive
Common Problems in Prominent Business Structures:
Strategic Arrangement between two or Independence makes it challenging to
Alliance more enterprises undertake implement common performance measures
mutually beneficial project while (collecting data also is difficult due to
preserving independence confidentiality)
JV Combination of two or more • Above issues
parties • Accountability issue
MNC Subsidiaries in multiple countries Different cultures, language and legal
frameworks
Complex Network of enterprises • Trust and efficiency issues leading to
Supply Chain poor performance management
• Solution: Collaboration + Co-
ordination with free flow of
information
Virtual Little or no physical premises and Collecting reliable performance related data
Organizations employees connected through IT is difficult due to lack of control
Strategic Alliance vs Joint venture:
• JV is more complex and binding than a strategic alliance. Both help in sharing costs, risks and
expertise
Gamechanger for Complex Business Structures – Information Technology Breakthroughs:

• Accurate, Reliable and Timely information is answer to majority of issues – IT plays a crucial
role
• Core organization should invest in single system and used by all – easy to integrate and co-
ordinate and collect data
Behavioural Aspects in Performance Management:
• Organization performance = Aggregate of employee performance
• Behaviour dependent on Accountability + Performance Measures + Management styles &
culture
• Critical that employees exhibit ethical behavior – same also can lead to maximization of
shareholder wealth
Accountability:
• Accountability leads to better performance – Business managers (Agency theory) and other
employees (management control systems)

Accountability and Accounting Accountability and Control
• Hard Accountability – Focus on financial • Behavioural Control – Desired action
and quantitative data takes place
• Soft Accountability – Considers • Personnel control – Appropriate skills
qualitative aspects – subjective – can be • Cultural control – Conducive
measured employee surveys, 360-degree environment
feedback • Reporting control – Fair reporting of
performance evaluation
Performance Measures (CSF and KPI) acts as stimuli:
• What gets measured gets done – People will perform better if they know performance is being
measured
• Clearly communicated performance measures (CSF and KPI) can influence behavior and
performance
Management Styles & Culture Modifies Behaviour, therefore Influence Performance:
• Management style should match organization’s context – Budget constrained style during
maturity phase and profit conscious style during growth phase
• Culture should align with strategy – Cost leadership strategy align with financial control
cultures vs differentiation works with excellence/service culture
• Three Management Style:
o Budget Constrained Style emphasizes strict budget adherence and cost control, as seen
in Indian Railways – focus on short-term
o Profit Conscious Style focuses on long-term profitability and operational effectiveness,
exemplified by Reliance Industries Limited – focus on long-term
o Non-Accounting Style values leadership, innovation, and strategic contributions,
demonstrated by Infosys.
Corporate Failure:
• Why do companies fail: Lack of innovation (Nokia, BPL) + Hostile Business environment (UPI
payments impact on candy market) + Frequent changes + Financial misappropriations (Satyam)
+ Internal conflicts + Strategic failures
• Need for predicting corporate failure: Survival is important + Predicting failure can help in
corrective and preventive measures
• Models for prediction: Quantitative models (Use financial ratios) and Qualitative models (non-
financial information such as director report, regulatory filings)
Quantitative Models:
Altman Z score (1968) for Publicly held manufacturing firms [Most important and many students
have got questions in exam]
• Predicts probability of bankruptcy in next two years
• Considers five key ratios (liquidity, profitability, leverage, solvency and activity)
• Z Score = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5
Where:
Working capital Retained earnings EBIT Sales
X1 = X2 = X3 = X5 =
Total Assets Total Assets Total Assets Total Assets
Market value of equity
X4 =
Total Liabilities
Score interpretation:
Zone of distress (< 1.81) Grey Zone (1.81 to 2.99) Safe Zone (> 2.99)
Severe financial weakness Close monitoring Strong financial health
Beaver’s Univariate Model (1966):
• Predicts bankruptcy by evaluating only one ratio at a time – was considered as flawed and
replaced with Altman model
Taffler and Tishaw’s Model (1977):
• Z-score model using four ratios – used similar methodology as Altman model – was later refined
to Performance Analysis Score (PAS)
ZETA Model (1977)
• Upgraded bankruptcy prediction model by Altman, Haldeman and Narayana – used additional
data of bankrupt companies between 1969 and 1975
Altman Z Score for Private Firms, Non-manufacturers, and Emerging Markets (1983)
Private Firms 0.717X1 + 0.847X2 + 3.107X3 + < 1.23 Distress
0.420X4 + 0.998X5. 1.23 to Grey
Use book value of equity in place of 2.99
market value of equity in X4 > 2.99 Safe
Non-manufacturing firm in 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4 < 1.1 Distress
developed markets Uses only four ratios 1.1 to Grey
Non-manufacturing firm operating 3.25 + 6.56X1 + 3.26X2 + 6.72X3 + 2.6
in emerging markets 1.05X4 > 2.6 Safe
Performance Analysis Score (PAS or Tafflers’ PAS):
• Uses Z-score in percentile form (0 to 100) – any downward trend should be investigated further
• Z = 3.2 + 12.18X1 + 2.50X2 – 10.68X3 + 0.029X4
Where:
PBT Current Assets Current Liabilities X4 = No credit interval
X1 = X2 = X3 =
Current Assets Current Liabilities Total Assets (No of days of sustenance
without inflows)
Cash reserves
X4 =
Daily expenses
• Negative Z-score = potential bankruptcy.
H Score Model:
• Ranked percentile score between 0 to 100
• Companies with percentile of lower than 25 = Warning area
Shortcomings of using quantitative models to predict corporate failure:
• Heavy reliance on financial data – can be manipulated/window-dressing
• Uses historical data – can only predict for near future
• Root-causes or solutions is not revealed by the models
Qualitative Models - Argenti's A score
• Three dimensions – Defects lead to mistakes; mistakes (if not rectified) lead to symptoms of
failure
• Defects = Management weaknesses + Accounting Deficiencies
• Mistakes = Illustrative list - High gearing/overtrading/failure of big project
• Symptoms of Failure = Continuing mistakes = Deteriorating ratios (or) creative accounting
• Scores of three groups are also reviewed and evaluated – Helps in better analysis – High score
in mistakes may reveal poor management
Interpretation:
Group Maximum Score Healthy company
Defects 43 < 10
Mistakes 45 < 15
Symptoms of Failure 12 0
Total 100 < 25
If a company breaches any of the above threshold will be considered at risk
Short-comings of using Qualitative model:
• Subjectivity + Data Requirement (needs lot of non-financial information) + Input quality (quality
of input will impact assessment) + lack of solutions (identifies defects and mistakes but no
solution)
Preventing Corporate Failure:
Take performance improvement strategies on early warning signs
• Seeking external advice + Technical expert assistance
• Work towards solution rather than assigning blame
• Exiting a loss-making business to changes in operations management
• Effective management systems + Implementing controls to avoid further issues

Chapter 9 – Strategic Performance Measures in Private Sector
Performance Management System:

• To assess performance against goals and objectives + Identify areas of improvement
Stages:
• Stage 1 – Decide appropriate organization structure
• Stage 2 – Degree of delegation and responsibility centre
• Stage 3 – Establish financial and non-financial performance measures and target
• Stage 4 – Review performance with KPI dashboard and take corrective actions
Responsibility Accounting:
• Collection, Summarization and reporting of financial information – Manager is responsible for
costs/revenues/assets
• RA is beneficial when top management assigns decision-making powers to managers
Recognized levels of Decentralization:

• Cost/Expense Centres – Responsible for cost associated with that division – Main focus is on
cost minimization – useful in functional organizational structure
• Revenue centres – Manager is concerned about raising revenues with no responsibility for costs
• Profit centres – Responsible for both revenues and costs – performance measured through profits
• Investment centres – Responsible for Revenues + Costs + Also assets that generate revenues and
costs
Linking CSF and KPI:
• Performance matrix lists measures (sales revenue/new customer acquisition rate) and targets
(increase sales revenue by 20%) against each strategic objective (increase sales revenue by
expanding into new markets) + Also tracks actual performance and finds divergences
• Performance measure should cover areas such as profitability, market share and quality – these
are called CSF – essential to achieve targets
• Sources of CSF: Industry structure (innovation in technology industry) + Competitive strategy
and Position (operational efficiency for cost reduction strategy) + Environmental factors
(regulatory approval process in Pharma environment/industry) + Temporary influences
• KPI Dashboard (real-time) can be used to review performance and take corrective action
• CSF vs KPI: CSF helps in achieving objectives – KPI measures performance for CSF – KPI should
be SMART (Specific, Measurable, Achievable, Relevant and Time Bound) and one CSF can have
multiple KPI
• Goals vs Objectives: Objectives are quantifiable while goals are open-ended
• Measure vs Indicator: Indicator signals or points to condition but not quantify it + Measure
quantifies it. Example: Market Index indicates market sentiments, while the percentage rate of
return measures profitability or loss
Performance Measures:
• Performance measures can enhance strategic position by monitoring and evaluating
performance
• Ideal performance measure: Financial vs Non-Financial + Quantitative vs Qualitative + Long-
term vs Short-term + promote goal congruence + consider factors only for which you are
accountable
• Financial Performance Measures: Gross Profit + ROCE + ROI + RI + EPS + EVA + NPV
• Financial + Non-financial performance measures: Balanced Scorecard + Performance Pyramid
+ Building Block + Triple Bottom Line
Is considering pure financial performance measures/ indicators sufficient or not?:

• Financial measure promote short-term thinking + Hence balance between financial and non-
financial is needed for sustainable strategy
Pros and cons of performance measures:

• Benefits: Accountability + better performance + Divisional performance comparisons + agreed
targets
• Issues: Poor performance systems can lead to inappropriate actions and decisions (CSF: Enhance
the quality and speed of customer support; Wrong KPI: Reduce average call handling time to
less than 3 minutes Better KPI: Customer Satisfaction Score of 90% after a support call)
Financial Measures:
• Financial measures can help in measuring profitability, growth, liquidity and solvency
Gross Profit:
• Limitation: Weak correlation between Profit and shareholder value + Short-term measure
• Still Popular: Readily available + easy comparison from listed company financials + highlights
product profitability issues (action can be taken on cost increases or price pressures)
• Gross Profit = Sales – COGS; COGS = Opening inventory + Purchases + Wages + Direct expenses
– Closing inventory
• GP Margin = (GP/Sales) x 100
Return on Capital Employed (ROCE):
PBIT PBIT x (1 − Tax)
ROCE = (OR)
Average Capital Employed Average Capital Employed
• Capital employed = Equity share capital + Reserves + Preference + Long-term debt – Fictitious
assets (OR) Total Assets – Current Liabilities
• Limitation: Can lead to short-term focus – discourage capital investment
ROI (Relative measure can lead to sub-optimization – Higher the better)
• ROI is same as ROCE - calculated mostly for evaluation of divisional performance (investment
centres)
PBIT
ROI =
Average Investment
• Benefits: Ideal for comparison across divisions
• Limitations: Divisional ROI can be increased by actions which can reduce company ROI and
vice-versa – Goal congruence issues – Distorted by accounting policies
Residual income (Absolute measure and can lead to goal congruence – Higher the better)
• Residual income = EBIT – (Cost of capital x Capital Employed) [OR]
• Residual income = [EBIT x (1 – Tax)] – [Cost of capital x capital employed]
• Benefits: Promotes Goal Congruence
• Limitations: Cannot be used to compare divisions of different size – can be addressed by setting
target RI for every division based on size
ROI versus RI:
• Decision on ROI is done by comparing ROI of new project with existing ROI of division
• Decision on RI is done by comparing return of new project with cost of capital
• Hence both can give contradictory results
Earnings Per share (EPS):
PAT − Preference Dividend
EPS =
Weighted average number of equity shares
• Benefits: Understood by shareholders + Readily available + used in all sectors
• Limitations: Absolute number + accounting manipulation
• Issue of absolute number can be solved by using Price/Earning ratio which is a relative measure
Economic Value Added:
• Measure of economic profit – Measures companies’ overall performance and management
effectiveness
• Economic Value Added = {EBIT x (1-Tax rate)} – {Invested capital x WACC} [OR] NOPAT –
{Invested capital x WACC}
• Capital employed should be based on economic value (replacement cost basis) – hence we can
do revaluation of assets/liability
• Limitations: Absolute measure + based on historical data

• EVA improvement: Greater efficiency (Growth in operating profits without additional capital)
+ Profitable growth (Return on new project > Cost of capital) + Liquidate unproductive capital
(Eliminate assets where ROI < Cost of capital)
EVA Adjustments:
Item Impact on EBIT (Profit) Impact on Capital Employed
Advertising, Research and Increase current year profit and Increase capital employed for
Development expenses, Staff deduct economic depreciation the amount added back net of
Training on these items economic depreciation
Depreciation Add accounting depreciation Adjust capital employed by
and deduct economic adding back cumulative
depreciation accounting depreciation and
deduct cumulative economic
depreciation
Non-cash expenses Add back to Profit Add cumulative non-cash
expenses to capital employed
Tax Charge We need to add-back provision -
for tax debited in P&L and
deduct only cash taxes and
deduct tax lost on interest
Note:
• We should ideally use opening capital employed for EVA computation. This is because opening
CE is used to earn EBIT of current year.
• In case we use opening CE, then all current year adjustments are ignored in balance sheet (CE)
• If we start with PAT, then we should add back interest as interest is not to be subtracted in
NOPAT
Net Present Value:
• NPV helps in maximization of shareholder wealth; NPV = PV of inflow – PV of outflow
• Unlimited capital: Accept all projects with positive NPV
• Limited capital (capital rationing): Select projects based on Profitability index (PI)
• Benefits: Link between NPV and shareholder wealth + Superior to IRR + considers Risk + based
on cash flows and hence better than accounting profits (no manipulation risk)
• Limitations: Based on assumptions about cost of capital, cash flows + Complex calculations
Non-financial performance measures:
• Benefits: Long-term focus and sustainability + Balancing financial and non-financial
performance measures is critical for long-term visibility
• Financial are lagging indicators and non-financial are lagging indicators
• Difficulties: Qualitative information + Subjectivity + comparison difficulties + incomplete data
+ high collection and sorting costs
Importance of information (Intangible Asset):

• Information is crucial for gaining competitive advantage
• Utility: Develop customer relationships and loyalty + Introduce new products for target
customers + Produce high-quality products + Mobilize employee skills and motivation +
Effective MIS
Balanced Scorecard (Linkage between Performance Measures – Helps in linking vision and mission
to individual performance):
• Four dimensions – Financial + Customer + Internal business/operating efficiency + Innovation
(Learning and Growth)
• Major stakeholders – Shareholders + Customers + Employees; Focus on both short-term and
long-term
• Financial and non-financial measures + Internal and external aspects + Long-term and short-
term objectives
Financial Perspective – How do we look to shareholders?

• Checks if strategy is working by analyzing impact on revenues and earnings
• Provides expected performance benchmarks for strategies + helps in analyzing the impact of
other three perspectives
Customer Perspective – How do Customers view us?
• Target customers and segments – Identifies lead indicators of performance – Business can
enhance customer satisfaction, retention, acquisition and loyalty
• Examples: On-site service, after-sales support, defects per order, product cost, and free
shipment
Internal Process/operating efficiency Perspective – At what must we excel?
• Identification of processes and activities needed to achieve financial and customer objectives
• For example, if maintaining net earnings is a financial goal and after-sales service boosts
customer retention, the company should improve after-sales services.
Learning and Growth/Innovation Perspective
• Activities and infrastructure needed for long-term growth
• It focuses on People (employee capabilities) + Systems (IT capabilities) + Organizational
procedures such as motivation and empowerment
Responsibility to devise and implement a Balanced Scorecard:

• Managers working with the business
• Every company is unique – hence appropriate financial and non-financial measures to be
selected
• Management reporting tool both for internal and external reporting – manager needs to decide
what should be disclosed and take care of confidentiality problem
• Three non-financial perspectives are highly people oriented – change in human behaviour
possible – manage staff is critical to launch balanced scorecard
Why Balanced Scorecard fails to achieve the desired results:

• Seniors delegate responsibility of scorecard implementation to middle level + Copying measures
and strategies of other companies + Balanced scorecard is understood as only for reporting
purpose
• Above issues are for internal use of scorecard – if internal is not handled properly then no
external reporting
Linkage between performance measures:

• Diverse performance measures are needed for sustainability + Inter-connected measures
[Enhancing customer satisfaction improves financial performance + Improving internal
processes improve customer, financial and innovation performance)
• Performance measures are connected through central core (strategy)
Performance Pyramid – Link Strategy, Operations and Performance:
• Businesses have pyramid structure – it connects overall strategy with daily operations –
individual workers can see how they contribute to strategy/vision and hence motivates workers
• Objectives from top to bottom – Goals are displayed from top of the pyramid down to bottom
• Measures from bottom to top – Measures start at bottom and go up to top
• Four levels: Top Level (L1) (Overall corporate vision and objectives) + Second level (L2) (Market
and financial measures (CSF)) + Third level (L3) (Customer satisfaction, Flexibility and
Productivity) + Bottom level (L4) (Operational measures such as quality, delivery, cycle time
and waste)
• Focuses on only two stakeholders (customers and shareholders) – this was addressed by
performance prism which focuses on all stakeholders

Performance Pyramid vs Balanced Scorecard:

• Both are similar as they focus on financial and non-financial measures – internal as well as
external + integration of measures (financial and non-financial can complement each other)
• Advantages over Balanced Scorecard: Hierarchy (set objectives at every level)
• Issues: Conflicting measures (Example: Quality vs Productivity, customer satisfaction vs cycle
time)
Building Block Model - link between achievement of the corporate strategy and the management of
human resources
• Useful for service industries – can also be used for manufacturing and retail businesses
• Keeping employees motivated is the objective of the model as they are the most critical resource
in service industries
• Clear standards (Equity (equally challenging) + Achievable (realistic) and ownership (acceptable
and participative approach)
• Reward System [Motivating + clear (clearly communicated) + controllable (controllable factors)
• Dimensions:
o Determinants (Areas which influence results) – Quality (Consistent goods and services)
+ Flexibility (responsiveness to change) + Innovation (New products/services) +
Resource utilization (Proper utilization of resources)
o Results (reflects success of determinants) – Financial performance + Competitive
Performance (our performance vs competitor performance)
Triple Bottom Line:
• TBL = Environmental (Planet) + Social (People) + Economic (Profit)
• Take decisions in socially responsible manner
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
Benefits of tools starting from Balanced Scorecard to TBL:
• Overcome shortcomings of financial measures – but at same time consider financial measures
by developing a balance between financial and non-financial measures

• Considers all significant factors + external as well as internal + link measures with strategy +
link motivation with performance
Role of quality in performance management systems:
• Quality is essential to stand out, improve performance and gain advantage
• Impact on PMS and cost performance: Implementing quality practices can boost performance
+ Cost of conformance and cost of non-conformance + Monitoring these with KPI can enhance
efficiency
• Quality Management Systems Support: Strong QMS reduces non-conformance costs +
optimizes quality expenses + Raises quality + improves staff morale and productivity
• Lean Production Systems Support: Focus of waste elimination + Closely connected with quality
practices + Getting things right the first time
• Quality in Management Information Systems (MIS): High quality information leads to
informed decisions + Reliable, accurate, timely and objective information is critical

Chapter 10 – Strategic Performance Measures in the Not-For-Profit Organisations
Characteristics:
• Perform non-economic activities + Required funds to arrange resources + Wealth creation is not
objective + Fiduciary of Trust towards contributors + Surplus is not distributed and retained as
part of corpus
Need for performance measurement:
• Fiduciary responsibility + Give reasonable assurance (regular reports and Audits) that funds are
used for intended purpose + Critical to link resources used to outcomes achieved (Example:
Number of Children reached + Improvement in literacy + Effectiveness of education program
in Education NGO) + Financial/Non-financial measures to assess effectiveness (Total funds
raised/fund utilization/corpus fund/quality of education/impact of programs) + Maintaining
corpus (to secure resources)
Challenges and Way out:
Difficult to quantify • Issue: Difficult to measure the impact (Example: Benefit of providing
the costs and benefits free education can only be realized in long-term)
• Issue: Difficult to measure cost as well as certain costs are auxiliary on
environment and society (Example: Affordable housing impact other
costs such as roads, pollution)
• Way out: Assign relative value to costs and benefits – this also lacks
reliability – To summarize just financial measures cannot be done
Performance and • Issue: NGO handles high public value functions (Food Security,
commitment of State Education, Health) + Primary responsibility of State Government +
(or Government of Hence performance of NGO depends on the commitment of state +
State Also NGO can be dependent on state for Funds
• Way out: External factor – Beyond control – No way out
Measuring the utility • Issue: Depends on budgets for expenses (no income against expenses)
of funds + Sometime underspending/overspending can happen + Difficult to
measure utility
• Way out: Value for Money Framework
Multiple Objectives • Issue: Diverse stakeholders + Different needs [Donors (transparency)
+ Beneficiaries (Quality) + Staff (Adequate resources) + Community
(Long-term benefits) + Conflicts can arise (Donor priority is to cut
down cost conflicts with beneficiary priority of having quality)
• Way out: Prioritization based on importance and urgency
Models for measuring performance:
• Value for Money (VFM) Framework
• Adapted Balanced Scorecard
• Other Performance Measures
VFM Framework:
• Measuring performance of non-for-profit sector – Company should provide best possible value
from available money. Focus on 3E (Effectiveness, Efficiency and Economy)
• Effectiveness (Spend wisely – Output measure – Goal Approach – is mission and vision
achieved)
• Efficiency (Spend well – Link between input and output – process approach – maximum output
is achieved with minimum input)
• Economy (Spend less – an input measure – resource approach - Appropriate quantity and
quality of Input secured with lowest cost)
• Additional 2E’s have been added – Equity (Spend fairly) and Ethics (Spend Properly)
Adapted Balanced Scorecard:
• Focusing on achieving mission rather than profit as central goal
• Customer Perspective - Satisfaction of beneficiary, Market Growth and other stakeholder’s
interest
• Financial Perspective - Fund raising, funds growth and funds distribution

• Internal process perspective - Internal efficiency, volunteer development, Information
communication and quality
• Innovation and Learning Perspective – Adjust to changing environment and innovation
• Note: Positioning of financial perspective (Second) is switched with customer perspective
(first) – this is because it does not focus on financial success
Other Performance measures:
• Quality of service + Attainment of objectives and mission + Ability to raise funds + Transparent
and periodical reports + Long-term impact (benefit) of the activities
Performance Measurement Process:
• Identify mission and objectives (continuous evaluation of mission/vision/strategy)
• Map objectives to various perspectives (strategies) of balanced scorecard
• Develop KPI for each perspective

Chapter 11 – Preparation of Performance Reports
Performance Report:
• Process of Performance Reporting: Outlines the results of activity + Compare actual vs
budget/standard + Note variances + Take corrective action
• Critical part of the report: Baseline (standard – starting point) – if baseline is unreasonable,
outcome will be invalid
Role of Performance Reports:
• Responsibility Accounting = Frequent performance reports + Highlighting deviations + Help
in understanding and control activity changes
• Reports start from the bottom and move upward – Receive information on unit which he is
directly responsible + summary of performance of other lower-level managers
• Utility: Bottom levels (Determining what corrective measures are required) + Top management
level (Informed on performance of all segments)
• Focus: Issues causing poor performance + Prioritize significant concerns + Benchmarking +
Resource Planning + Enhance performance + External reports
Aspects involved in performance reports:
• Understand the user’s needs – Meet needs of senior management (primary user) as well as for
other two levels of management
• Set objectives in line with organizational Goals – CSF and KPI identification
• Add an executive summary – Brief overview
• Conduct performance assessment – Compare performance against benchmark and industry
standards – Financial measures – Non-financial Quantitative – Non-financial Qualitative
(Qualitative information is also called as construct which is an attribute that cannot be directly
measured- Example: Reputation/employee motivation/enthusiasm)
• Use visual elements and Narrative commentary – Tables, charts, graphs and add narrative
commentary (explaining charts and graphs) – Performance report can take any form
• Cross-Check details – verify accuracy/reliability – do proofread – more important for external
reports
Types of Performance Reports:
• Earned value report – Part of Status report – Compare planned value (work scheduled) vs
earned value (work performed) vs Actual cost – Scheduled performance compares planned
value with earned value – cost performance compares actual cost with earned value
• Forecasting Report – Estimated what is expected to happen – for resource utilization
• Progress report – What has been completed since last progress report
• Status report – Used in providing snapshot of the project performance at a particular point
• Trend report – Compares performance against same period of previous report
• Variance report – Difference between actual vs planned outcome
Sample Earned Value Report:
Suppose a software development project has a planned budget of $100,000 and is scheduled to be
completed in 6 months. After 3 months, the project manager prepares an Earned Value Report.
• Planned Value (PV): $50,000 (50% of $100,000 budget)
• Earned Value (EV): $45,000 (based on completed deliverables assessed at 90% completion)
• Actual Cost (AC): $48,000
Cost performance Index:

• Cost Performance Index (CPI): CPI = EV / AC = $45,000 / $48,000 = 0.9375
• Interpretation: The project is slightly over budget as CPI is less than 1.
Schedule Performance Index:

• Schedule Performance Index (SPI): SPI = EV / PV = $45,000 / $50,000 = 0.9
• Interpretation: The project is behind schedule as SPI is less than 1.
Schedule Variance:

• Schedule Variance (SV): SV = EV - PV = $45,000 - $50,000 = -$5,000
• Interpretation: The project is behind schedule by $5,000.
External reporting frameworks that are relevant for SPM [Sustainability based]
• TBL Framework – Focuses on adding performance of environmental and social impact
• Global Reporting Initiative (GRI) – Report based on guidelines of GRI – GRI develops globally
acceptable sustainability reporting guidelines
• ESG Reporting – Environmental + Social + Governance data to enhance transparency
• Integrated Reporting – Value creation is combined effect of six capitals (Financial +
Manufactured + Human + Natural + Intellectual + Social & Relationship) – consider all these in
reporting – Developed by International Integrated Reporting Council (IIRC)
Analyze the performance reports to take required action:
• Corrective/prevention actions: Senior managers/experts need to analyze performance report
and take corrective/preventive action
• Steps: Set Goals (objective of analysis) + Analyze data (Quantitative and qualitative) + Time
frame (monthly/quarterly/annual) + Identify trends + Summarize findings + Create action plan
of improvement

Chapter 12 – Transfer Pricing
Introduction:
• Transfer price refers to the price charged by supplying division to the receiving division.
• TP is revenues for supplying division + TP is cost for receiving division. TP is neither cost nor
revenue for the company/group
• Responsibility centres
o Cost centre – Responsible for controlling costs
o Revenue centre – Responsible for earning revenues
o Profit centre – Responsible for both costs and revenues
o Investment centre – Reponsible for costs, revenues as well as authority to make
investments
Objective:
• Performance evaluation+ Compensation + Resource allocation + Taxation and Profit remittance
Intermediate product:
• Product which is getting transferred by supplying division to receiving division
Fixation of Transfer Price:
Transfer Price
Maximum TP
Minimum TP
(Receiving division
(Supplying division
point of view) - Lower
point of view)
of two
Affordability criteria:
Variable cost + Availability criteria - Net marginal revenue =
Additional outlay cost External purchase price External selling price -
+ Opportunity cost + change in cost cost of receiving
division
TP Methods:
• Market Price method (It has one variant called share profit relative to cost-based transfer price)
• Cost-based Transfer Price
o Marginal-cost based Transfer Price
o Standard-cost based Transfer price
o Full-cost based Transfer Price
o Cost plus a mark-up based transfer price
• Negotiation based Transfer Price
TP computation under shared profit method:

• Compute overall profit of company and distribute the same to two divisions on the basis of the
cost incurred by them
• Transfer price = [Cost of Division 1 + Shared Profit]. This will be divided by number of units to
get TP per unit

Impact of Different Capacity and Demand Levels on Transfer Pricing

• Capacity Levels: Opportunity cost varies with capacity; zero OC if spare capacity and opportunity
cost exist if there is limited capacity
• Demand Levels: Increase in external demand will impact opportunity cost and hence the transfer
price
Benefit or loss on transfer:

• Benefit or loss on transfer = No of units transferred x (Maximum TP – Minimum TP]
• In case max TP > Min TP, transfer should happen and above formula will give profit
• In case max TP < Min TP, transfer should not happen and above formula will give loss
Who is at more advantage?

• TP fixed closer to Min TP, receiving division is at more advantage and if TP is fixed closer to Max
TP, supplying division is at more advantage
Methods for resolving TP Conflict:

• Let us assume Min TP = Rs.100; Max TP = 110. However Division 1 wants the price to be 110 so
that they can earn profits whereas Division 2 wants it at Rs.100 so they can earn profits
Method 1: Dual rate TP
• Unit 1 = RS.110 [Record it at normal selling price]
• Unit 2 = Rs.100 [Record it at variable cost]
• Promotes goal congruence but can complicate accounting records
Method 2: Two-part TP System:
• Record transfers at variable cost [Part 1] and pay a lump-sum consideration [Part 2]
• TP = Rs.100 per unit + Rs.10,00,000
International TP:
Income tax • Earn more PAT in low-tax country
• India transfers to USA; India has high tax; Fix TP as low as possible
Customs duty • Fix low TP and lower customs tax
• Balance this with Income tax
Exchange rate • USD asset; Fix high TP if USD will appreciate; low TP if USD asset will
depreciate
• USD liability; FIx low TP if USD liability will appreciate; Fix high TP if USD
liability will depreciate
Profit • Manipulate TP in such a way that we are able to repatriate money
repatriation
Limiting factor:
• Limiting factor = Demand for the factor > Supply of the factor
• Labour is limiting factor = Contribution per unit of limiting factor (Contribution per labour hour)
Statement of ranking:
Particulars Product 1 Product 2 Product 3
Selling price
Less: Variable cost
Contribution per unit
No of hours of limiting factor
Contribution per unit of limiting factor
Rank

Chapter 6 – Strategic Revenue Management
Decision Making:
• Types: Strategic + Tactical + Operational; Needs quantitative and qualitative analysis
• Based upon time horizon: Long-term decision based on DCF/NPV vs short-term decision based
on contribution analysis
• Based upon nature: Decision with limited/scarce resources (Linear programming/key factor
analysis) vs Decision considering risk and uncertainty (decision tree/excepted value/scenario
analysis/sensitivity analysis)
Short-term decisions vs long-term decisions:
• Short-term decisions ignore time value of money + considers fixed costs as irrelevant
• Short-term decision making should be based on relevant cash flows
• Methods of short-term decision making: CVP Analysis including activity based CVP Analysis
+ Key factor Analysis + Linear Programming
CVP Analysis (Cost volume Profit Analysis)
• Examines the relationship between revenues, costs, activity levels and profits.
CVP Analysis
CVP Analysis in service

Activity based CVP CVP Analysis in JIT
and non-profit
analysis environment
organizations
Computation of BEP Can be applied - focus on VC is reduced and

where fixed cost will be measuring output which increase in FC - this is
revised based on is different from tangible because labour is treated
consumption of activities units as fixed cost
Activity Based CVP Analysis:

Types of Activities
Unit level activities Activity performed each time a product is manufactured. Example: Direct
Material
Batch level Activities which are done for a batch of production. Example: Machine set-up
activities cost
Product sustaining Activities performed to support production/sale of a specific type of product.
activities Example: Design cost of new product
Facilities level Activities for general operation of business and cannot be traced to any
activities particular product. Example: Depreciation of factory building
Computation of BEP:
[Fixed cost + (Batch level cost driver x CDR) + (Product sustaining cost driver x CDR)]
BEP =
SP − VC
Relevant Cost Approach:
• Short-term decision should be based on relevant cash flows. Relevant means pertinent to the
decision in hand

• Relevant costs are those expected future costs which are essential but differ for alternative course
of action
Rules of relevance:
Opportunity cost Relevant
Sunk cost Irrelevant
Variable cost Relevant unless provided otherwise
Fixed cost Irrelevant unless provided otherwise
Relevant cost of Material:
RC of Material
In stock Out of stock
Replacement
Fast Moving Slow Moving
Cost
Replacement Can be used as

Can be sold Both Options
Cost substitute
Realizable Cost of
Higher of Two
Value substitute
• In case of toxic items, saving in disposal cost is considered as relevant revenues
Relevant cost of Labour:

RC of
Labour
Not
Available
Available
Wages
Busy Idle
Payable
Can be Cannot be Can be Cannot be

substituted substituted Terminated terminated
Cost of Lost Contribution Wages

Nil
Substitute + Wages Payable Payable
Ethics and non-financial considerations:
• Ethics: Honesty, fairness, integrity, value people over profit are ethical requirements. Common
sense and long-term focus can avoid ethical problems

• Non-financial considerations (Long-term focus): Quality, employee satisfaction, customer
satisfaction, CSR, environmental factors, intellectual property, intangible assets, competitor
actions, brand name are common non-financial considerations
• Non-financial consideration (limitations): Subjective + Lack of statistical reliability + improper
measures/wrong objectives + time and cost to company
Decision Model Framework:
• Define problem + Identify alternatives + Calculate relevant cost & benefit of each alternative +
Assess non-financial factors and ethical issues + Select alternative with greatest overall benefit
Application of CVP Analysis:
Decision Qualitative Factors
Outsourcing Decision (or) Make or Quality of goods + Supplier reliability + Impact on customer
buy decision (or) Subcontracting + impact on supplier
decision
Sell or Further Process Decisions Resource availability such as readiness of employees to work
extra hours and availability of material
Keep or Drop Decisions Termination of employees + Effect of layoff on employees
who are not terminated + Effect on suppliers + effect on
customers
Minimum Pricing Decisions/ Special Possibility of future orders + Impact on pricing of normal
order decisions operations
Product Mix decision Impact on customers/suppliers of products whose demand
is not met
Note:
• All decision should be based on relevant costs
• Outsourcing Decision: Compare variable cost of production (not total cost) with purchase price
– This is because fixed costs are irrelevant – Compare relevant cost of make/buy and decide
• Sell or Further Process Decisions: Joint process costs are irrelevant. In case of joint product, all
fixed and variable costs incurred post split-off point is relevant.
Dangers of excessively focus on short-term:
Relevant Costs and Time Fixed costs are irrelevant in short-run whereas relevant in long-run. Use
Horizon right-time horizon to avoid misleading analysis
Maximize long-term Use idle capacity and focus on maximizing long-term cash inflows
cash inflows
Long-term consideration Consider long-term effects of special pricing decision + Special order can
in pricing give short-term benefits overlooking long-term impact on resources
Capacity Decisions Special orders are used as resort in case of inadequate demand – however
company can save cost if capacity is reduced – consider benefit of using
excess capacity vs saving in cost by reducing capacity
Pricing Policy:
• Pricing decision and strategies are subsets of Pricing Policies; Policy is guiding pricing while
strategy is plan of action
• Importance: Long-term survival + Increase sales + Maximize Profit
• Key determinants: Consumer demand + Competitive environment
• Goals: Encourage technology adoption + Maximize production + Optimize resources + balance
demand and supply
Pricing Decision:
• Most crucial and difficult decision + Price can be fixed based on cost/market driven
• Objective: Maximize profits/sales/output/resource utilization
• Factors influencing: Internal factors (Objective/costs/product life-cycle) + external factors
(market competition/bargaining power of buyers/Govt control/economy state)
Theory of Price:
• Objective of firm should be to maximize profits; Optimum price is finding a level at which
marginal revenue is equal to marginal cost

Profit Maximization Model:
• Price = a – bQ
• Marginal Revenue = a – 2bQ
Where:
• P = Price; a = Price at which demand is zero; Q = Quantity demanded
• b = Slope of demand curve [Change in Price/Change in Quantity]
Pricing under different market structures:
Perfect Large number of buyers and sellers + Homogenous product + Free entry/exit +
Competition No specific pricing policy + Price takers
Example: Wheat/Rice
Monopoly Single seller + Price setter + Fix price based on elasticity of demand
Example: Gas Distribution/Electricity in TN
Monopolistic Large number of sellers selling similar product but not identical + Demand is
Competition normally elastic + Follow Profit maximization model
Example: Domino’s Pizza/Clothing brand
Oligopoly • Few firms selling homogenous product + Price determined based on
demand and price action of competitors + Maintain price by
cooperation/collusion
• Strategies (Predatory pricing (price lower than cost) + Limit-pricing
strategy (to discourage entrants) + Cost-plus pricing + Collude and raise
together)
Principles of Product Pricing:
• Factors impacting price: Cost + Market Competitiveness + Elasticity of demand
• Major Principles: Price customization + Price Sensitivity
Price Customization [changing/customizing price based on certain factors]

• Product line [16GB vs 32GB Memory card] + Customer Past Behaviour [Good payment track
record given discounts] + Demographics [Age wise concession in railways] + Time differential
[Airline Tickets]
Price Sensitivity [Response of customers to price changes – also called as elasticity of demand]
• Nine factors: Unique value (low sensitivity for unique products) + Substitute awareness (high
if customer aware of substitutes) + difficult comparison (low if buyer cannot compare 2
alternative products) + total expenditure (low if proportion of expense of total expenses is low)
+ end-benefit effect (low if proportion of expense on total product cost is low) + shared cost
effect (low if cost is shared by multiple people) + sunk investment effect (low if product is used
with assets already bought) + price quality effect (low if quality is good) + inventory effect (low
if inventory cannot be stored)
• How to measure: Controlled experimentation = Offering products at different prices to check
customer response + Price at which demand start declining is when price sensitivity starts
Structured approach to Pricing Decisions:
• Company and marketing objectives – Set pricing objectives and policy - assess target markets –
assess costs/cost structure – assess customer’s demand – assess competitors - select pricing
method – select specific pricing
Pricing Objectives:
• Maximum current profit + maximum long-term profit + company survival + maximum market
penetration/skimming
Pricing of New Products:
• Complex issue – Uncertainty in demand – experiment sales in different markets at different
prices – market study/consumer behavior analysis
Classification of New Products:

• Revolutionary Product – New to market – Potential to create its own value – Premium price due
to innovation and first-mover advantage

• Evolutionary Product – Upgraded version with few additional features – Price based on
competitor and demand – demand-based pricing
• Me-too Product – Copy of revolutionary/evolutionary product – price takers as price is
determined by market – Market Price
New Product Pricing Strategies:

Skimming Pricing (Charge high price initially) Penetration pricing (charge low price
initially)
Inelastic demand + Cater to cream of market who are Elastic demand + Savings in large scale
price insensitive + Demand is unknown production + Threat of competition
Note: Charging high price because of high sales
promotion/R&D expense is logic of this strategy
Pricing and Product Life Cycle:

Introduction Stage Growth Stage Maturity Stage Decline stage
Skimming policy with high prices, Reduce price to Price to match or Cut price if not
but low profit margin due to high penetrate beat competitor repositioning
fixed costs market further
Penetration pricing to enter the Retain higher Some increases in price
market and gain a high share prices in some may occur in the late
quickly or to prevent competitors market segments decline stage
from entering
Pricing of Existing Products:
Cost-Based Mark-up Pricing:
Pricing Method • Price = Full Cost + Profit; Determination of full cost can be difficult due
to OH and hence we can also do Variable cost + Appropriate mark-up
• Suitable for less competitive environment/product customized to user
Target rate of return method:

[Desired Rate of Return x Invested Capital]
Price = Unit Cost +
Number of units to be sold
Competition • Pricing based on what competitors are charging; Competitive pricing
based Pricing can be higher (premium)/lower (discount) to competitors
Going rate pricing:
• Going rate price = Average price of industry; Useful in case of
homogenous products; It can also be used in case of pure oligopoly;
Least disruptive for industry harmony
Sealed-bid pricing:
• Pricing through bids to tenders floated by companies; Price bid would
be based on what competitor is likely to bid. Example: Defense contract
Psychological • Fixing based on psychological barrier. Pair of shoes being priced at
Pricing Rs.999 and not Rs.1,000. Also knows as Bata pricing as they popularized
the same
Value-based • Pricing based on customer perception of value – value is created by
Pricing Strategies developing a product which satisfies the customer need
Objective value or True Economic Value:
• True Economic Value = Value of next best alternative + Value of
performance differential
Perceived Value:
• Value that consumer understands the product deliver to it – Fixing price
between perceived value and cost of production will lead to win-win
situation
• Seller’s benefit = Selling price – cost of production
• Buyer’s benefit = Perceived value – Selling Price
Types of Services:
People Processing Person is involved (physical presence Hair cut and Spa
Services of the customer at the service system
[People + Tangible] or location).
Product/Possession Such services are related to a specific Packers and Movers or
Processing Services product (limited or no involvement of Washerman
[Product + Tangible] the customer)
Mental Stimulus The services which influence the Watching the match at
Processing Services consumer’s mental abilities, beliefs, stadium, Light show, Movie
[People + Intangible] behaviour, and perception or Visiting Zoo
Information Processing These are a unique form of intangible Buying Insurance,
Services products where the information acts as Consultancy
[Product + Intangible] a product
Pricing of Services:
• Customized service will have pricing complexity as each service will involve different levels of
effort
• Intangible costs for customer as he may be needed for service delivery – this needs to be factored
in computation of price to be charged
• Price regulation by Government (education/healthcare) + Price determined by Association
(ICAI) + Pricing can be driven by demand scenario (high prices on weekend/discounts during
weekdays)
Pricing in case of Emerging Business Models:
Hyper Disruptive Pricing decision based on underlying disruption and cost/resources
Business Models needed to imitate the same
Example: Uber priced based on convenience, ease of use, surge pricing and
market penetration
Models related to Social/environmental consideration during pricing Example: Luxury/sin
sustainability goods have high pricing vs essential commodities have low prices through
statutory means
Models related to Emerging national markets have huge consumption but also price sensitive
emerging national – hence pricing based on value of money (cost effective solution) is key
markets determinant in pricing decision
Sensitivity Analysis in Pricing Decisions:
• Choosing the critical parameters upon which the computations are done to assess how changes
will impact the overall profit + It can be based on demand/market price/exchange rate
fluctuation/initial outlay/R&D/production cost/marketing cost
• This helps in striking the right balance and determine the price which is good enough to generate
enough sales as well as remain profitable
Pricing Decisions in Special Circumstances:
Pricing in Firm can sell product at price below total cost but above marginal cost – Benefits
recession (continuation of skilled employees/Maintenance of P&M due to usage + Avoid
competition taking extra share + Business ready to take benefit of improved market
conditions)
Pricing below Perishable products + Stocks accumulated in large quantities and prices have fallen
marginal cost + Popularize new product + Boost sales of other products having high margin
Ethical and non-financial considerations:
Ethical • Identify ethical issues that hinder fair pricing
consideration • Ethical means not only following law but also morally right. Example:
Prices of essential commodities during Pandemic
Ethical issues:
• Price fixing through collusion/cartelization: Horizontal price fixing
(people at same level) is illegal + Vertical price fixing is sometimes
allowed (wholesaler telling retailor how much can they charge for
products)

• Price skimming: Selling products initially at high price and then later
reducing it
• Bid rigging: Allotting tender based on favoritism. Example: Highway
tender allotted to high price company which ultimately results in high
toll charges for consumer
• Price discrimination: Charging different prices to different customers
depending on ability to pay
• Super Pricing for article with high perceived value – Supra
Competitive pricing: Customer values a product very high than cost –
Business is not justified in charging very high price just because customer
put a higher value
Non-financial Brand image + Product life-cycle stage + Competition intensity + Buyers’
considerations bargaining power + features/quality + Govt control + Societal considerations
Pricing Strategies:
• Involves methods used by businesses to set prices for products – This is also known as price
adaptation strategy – Strategies are cost-plus pricing, market skimming, penetration pricing,
complementary product pricing (pricing two products together), product-line pricing (different
prices for same product based on features Example: Nike Shoes), volume discounting, price
discrimination and relevant cost pricing
Price Adjustment Strategies – Altering price based on various factors which are explained below
Geographic • Shipping cost is crucial component in deciding price
Pricing • Buyer can pay all freight expenses (OR) seller can bear freight expenses
(OR) both parties can share freight expenses
Geographic Pricing Adjustments:
• Compensation deals: Part payment in cash and the rest in products
• Barter: Exchange of goods without involving currency
• Buy-back Arrangement: Sale of equipment to another country and
acceptance of partial equipment with goods manufactured through
equipment
• Offset: Full payment in cash but need to spend money in the country from
which payment is made
Discounted • Distributor discount/Functional discount: Discount based on function
Pricing such as wholesaler, retailer and dealer
• Quantity discount: Discount based on quantity purchased
• Cash discount: Discount based on promptness of payment
• Seasonal discount: Discount during off days or off-hour
• Allowance: Extra allowance given to re-seller to encourage sale of product.
Example: Advertising allowance by manufacturer to reseller
Promotional • Encourages customers to buy products sooner
Pricing • Longer payment terms + Special event pricing (big billion days) + loss
leader pricing (lower price for well-known products to make customers
purchase other profitable products) + cash rebates + warranties and
discounts + Psychological discounting (artificially increasing prices and
then offering discount)
Price • Charging different prices based on customer/product/place or time
Discrimination • Conditions: Clear segmentation (MS Teams pricing for individuals vs
business users) + No possibility of resale (discounted flight tickets for
students) + chances of competitor underselling is not there (high prices for
patented products in pharma industry)
• Usually done as time discrimination Example: Airline prices for closer to
travel date vs pre-planned travel
Product Mix • Product line pricing: Different prices for product ranges – Example:
pricing Basic/Standard/Premium version of mobile phone

• Optional feature pricing: Extra optional features are provided and based
on the same price can change – Example: Purchase of car
• Captive Product Pricing: Setting low price for main product (captive
product) and earning from ancillary product – Example: Printer and
cartridges
• Two-part fees: Fixed fees + Variable component – Example: Landline has
fixed fees component plus variable charges based on calls made
• By-product pricing: Income of by-product can be used to reduce price of
main product: Example: Sale of milk and cow dung
• Product bundling Pricing: Offering multiple products together – Pure
bundle (Only products can be purchased as bundle) – Mixed bundling
(Products are offered both as bundle/individual items with price of bundle
being cheaper)
Kano’s Performance Attributes:
• Model of product development/customer satisfaction for prioritizing the most important
features of a product
• Threshold attributes (Must-be qualities) (M): Basic quality – taken for granted – No positive
impact if available but negative impact if not there Example: Touchscreen in smartphones (or)
reliable performance of car
• Performance attributes (One-dimensional qualities) (O): Features that increase customer
satisfaction and are directly related to price paid by customer– crucial for customers who are
well-informed. Example: Battery life/camera quality
• Excitement or Delight attributes (Attractive qualities) (A): WOW factor – absence has no
impact but presence leads to satisfaction. Example: Foldable display/Augmented Reality
• Indifferent qualities (I): No positive/negative effect on customer. Example: Design of product
packaging/color of packaging
• Reverse qualities (R): Presence leads to dis-satisfaction. Example: Software bugs/ Too many
ads in online content
• Questionable attribute (Q): Similar to reverse quality – presence is doubtful/questionable.
Example: Non-essential app features/extra buttons on remote control
Implications:
• Higher threshold + Performance + Excitement = Higher customer willingness to pay
• Attributes can change over time – excitement attribute can become performance/threshold
attribute. Example: 2 GB RAM/5 MP camera
• Exclude indifference/reverse/questionable

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STRATEGIC COST AND PERFORMANCE MANAGEMENT CA.

STRATEGIC COST &

BY CA. DINESH JAIN

BHARADWAJ INSTITUTE (CHENNAI) 1

SCPM Summary Notes ............................................................................................................ 3

BHARADWAJ INSTITUTE (CHENNAI) 2

BHARADWAJ INSTITUTE (CHENNAI) 4

Evolution of cost concepts over time horizon:

BHARADWAJ INSTITUTE (CHENNAI) 5

Tools for SPA:

BHARADWAJ INSTITUTE (CHENNAI) 6

Mendelow’s matrix for identification of stakeholders:

Structural vs Executional Drivers:

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Differentiation Advantage (Product Differentiation) – DRIVING UP PRICES (QUALITY):

Low-Cost Advantage (Cost Leadership) – DRIVING DOWN COSTS:

Relationship between strategies and cost management emphasis:

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Industry Profitability Analysis [Porter’s Five Forces Model]

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Impact of entry and exit barriers on industry profitability:

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Modern Business Environment:

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Steps of Target costing:

Additive approach of finding target cost:

Principles of Target Costing:

Pros of Target Costing:

Cons of Target Costing:

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Impact of Target Costing on Profitability – Improves profitability in two ways

Approach 2 – Feature based cost reduction:

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Average time of desired units = Time

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Major change Drivers [Technology is the major factor]

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Components of Disruptive Innovation:

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Traditional vs Lean Start-up:

Lean Start-up Methodology:

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Stage of development of Start-up:

Approaches to supply chain innovation:

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Elements of Sustainable Business Model:

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Approaches for developing sustainable business model:

Caution against sustainable business models:

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Points to consider in strategy: Customer expectations (no compromise on

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Table for calculation: