COST ANALYSIS

Kelompok 1:
Dading Damas (123012001023)
Yuliani (123012001105)
Andi Nurlailiah (123012001010)
Nurhidayah (12301201071)
 Introduction

 Traditional Cost:
1. Functional approach: divides cost and expenses according to its specific functional uses.
2. Cost behavior approach
• Variable costs: can be traceable and identifiable to activity
• Fixed costs: the paid expenses irrespective if activities are involved or not
 Activity-based costing (ABC) ABM approach
 Cost Structure
Why is cost structure important?
 Contribution Margin (CM)
In application analysis, contribution margin can be further rearranged into two CM calculators:
1. Contribution margin ratio (CMR) = contribution margin/Sales

(i) what is the contribution margin ratio;

(ii) what is the break-even sale;
(iii) what is the sale amount with a target profit of $200,000?

(i) CMR = (Sale price − Variable cost per unit)/Sale price = ($500 − $100)/$500  = 0.8

(ii) Break-even Sale = Fixed Cost/CMR = $400,000/0.8 = $500,000
(because contribution margin is equal fixed cost at a break-even sale with a zero profit )
(iii) Sale at a target profit of $$200,000 = (Fixed Cost + Profit)/CMR 
= ($400,000  + $200,000)/0.8 = $750,00
 Contribution Margin (CM)
In application analysis, contribution margin can be further rearranged into two CM calculators:
2. Contribution margin per unit(CMU) = Contribution margin for each unit

CMU can be used to compute sale units:

(iv) Break-even sale quantity = Fixed Cost/CMU = $400,000/$400 = 1000 units
(v) Sale at a target profit of $$200,000 = (Fixed Cost + Profit)/CMU = $600,000/$ 400 = 1500 units
 Special Price Decision

KK garment factory wants to consider a special order to an overseas customer who promises not to
reimport the special garment back to the local market, so the potential to disturb the existing local
customers is low. The factory has spare capacity to take this special order of 5000 dozens of T-shirt
without additional fixed cost. If each T-shirt costs a variable cost of $ 120 per dozen and KK wants to
makes a profit of $20 per dozen. What should be the minimum ex-factory price for the special order?

Solution

The minimum ex-factory price should be:

Variable Cost + Target Profit = ($120 + $20) = $140 per dozen

Extra order amount: 5000 × $140 = $700,000

Extra profit margin: 5000 × $20 = $10,00
 Sale Incentive

King’s Arm has a sale team with a salary based on a monthly fixed payroll. The management wants to
increase sale incentive to promote sales, and proposes to change 30% of the fixed salary into a bonus
based on sale amount, assuming that the current monthly sale is $250,000 and the sale can increase by
15% if the new salary structure is implemented. Total fixed cost is 40% of the current sale amount, and
variable cost is 40%. Salary cost for the sale team is 20% of the total fixed cost. What should be the
proposed sale commission system to make benefits for both sale team and the firm from the scheme?

Solution

Total salary payment for the sale team: $250,000 × 40% × 20% = $20,000

Portion of the fixed salary converted into commission: $20,000 × 30% = $6000
Commission rate based on sale amount: $6000/$250,000 = 2.4% on sale amount
For target sale exceeding 15% of $250,000 (assuming no capacity problem):
Salespersons’ additional commission: $250,000 × 15% × 2.4% = $900
The firm’s additional profit: $250,000 × 15% × (1–40%) − $900 = $21,600
 Capacity Management

Sam’s company has an operating capacity of 10,000 units of output per year. Sam’s current sale is 80%
of the current capacity. Sam can double sale if sale price is decreased by 15%. However, Sam needs to
increase capacity by 10,000 units with a capital investment of $34,000 with a depreciation life of
2 years. If the current unit sale price is $10 and variable cost is $5, should Sam implement this low
price strategy for market expansion?

Solution

Contribution margin under the current scenario:

($10 − $5) × 10,000 × 80% = $40,000 Contribution margin under the low price strategy:
($10 × (1 − 15%) − $5) × (10,000 units × 80% × 2) − ($34,000/2) = $39,000
 Strategic Cost Analysis
Focus

“ How cost position changes with respect to the change in competitive advantage position of a firm &
an optimal cost structure of a firm.”

However, optimal cost structure is not driven by a volume-driven market strategy, as assumed in
conventional cost behavior approach. It is actually the result of composite strategic considerations
dictated by the strategic choice of generic positions. This perspective has been strongly advocated by
Shank1 in his publications. Generic positions are generic strategies defined by Michael Porter in terms
of cost leadership or product differentiation positions. These competitive advantages determine how a
firm selects its strategic position and how corporate strategies are orchestrated to serve the strategic
missions and objectives.
 Strategic Cost Analysis
From the strategic perspective, cost analysis plays a role different from the conventional cost
approach.
This approach emphasizes the strategic processes in aligning corporate missions and objectives. The
analysis of cost position should be aimed to explore how effective the cost structure is built for the
strategic choice and how efficient cost drivers are built to optimize long-term profits. The following
Fig. 2.1 outlines the role of cost analysis in different stages of the strategic processes.
 Strategic Cost Analysis
From the above elaborations of strategic cost analysis approach, it is not difficult to understand that a firm’s cost structure
is the result of strategic choice arising from a set of complicated cost factors which have both external (e.g., market,
competitors) and internal (e.g., technology, resources) origins. Strategic cost analysis approach should examine how the
strategic choice gains market power in the competitive market, not the unilateral volume consideration from traditional
cost behavior.

Strategic cost analysis places attention to two major areas. First, it stresses on the strategic choice of cost drivers3 to build
competence and competitive edge. Cost drivers evolve from structural and execution capabilities of a firm. Structural
capabilities include scale, scope, experience, technological choice, and operation complexity. Second, strategic positioning
analysis is another area of attention. It is about how well the generic strategies (cost leadership or product differentiation)
in general and specific strategies in particular (e.g., market strategy, product portfolio strategy, HR strategy, technological
strategy) serve the firm’s intended position in the market. How well cost information assists in strengthening the preferred
strategic positioning?

In fact, firms taking a cost leadership strategy tend to be internally focused, while firms seeking a differentiation strategy
are more externally focused. Differentiation strategy requires more attention on customer perceptions, innovative
technology, and product variety. This creates more difficulty in predictability for differentiation strategy than for low-cost
strategy. Therefore, differentiation strategy increases intensity of complexity. The strategic choice of low-end or
differentiation strategies affects resource orientation, quality of products, brand perception, and resource capability
requirement. All these factors affect the strategic positioning of a firm.
 Strategic Cost Analysis
Focus

Strategic Choice with Choice?

Does a firm have choices for the strategic shift? The answer is probably no. It is difficult for a firm to
make a big shift from one generic strategy to another generic strategy. Firms employing a cost
advantage strategy would also build a frugal corporate culture which looks at efficiency as the most
important value. Firms choosing a differentiation policy would choose best resources and expensive
facilities, and very often lavish corporate culture ensues. Effectiveness is their moral soul, the others
are secondary. These cultural values ingrained in their organizational growth and the change of value
would meet with strong resistance and cultural conflict. Many lessons were learnt from large telecom
equipment players in the past. They could not continue to lead (e.g., Motorola, Nokia, Ericsson) in the
fast-changing business landscape. In fact, firms possessing both cost efficiency and differentiation
advantages are the winners. Huawei is an example of these winners, which is now no. 1 global player
in telecom equipment and no. 3 in mobile phones in 2015.
 Strategic Cost Analysis
Focus

Strategic Choice in Automobiles

There are many examples how companies choose their cost drivers in beating the competitors. Their choices led to
business repercussions. Ford1 beat down the giant leader – General Motors – by trimming down cost, reducing models
series to a few, and focusing on quality control (fine-tune operations complexity). Ford gained substantial unit cost
reduction between 1985 and 1992 and beat down General Motors in 1993. GM’s complex product line portfolios made the
operations costly and quality control a challenge. BMW2 addressed the slow sale crisis in 2010 in the North America by
introducing a mass customization program on a X3 series model by increasing customer specification,
online video, and shortening lead time for delivery (transfer of production plant to the market). This increases product
differentiation. Cost drivers came from process innovation and operational excellence. Sale bounced back in 2011.
Toyota3 conquered the North America market in 1990s and bypassed GM as no. 1 in the world in 2008. It was done by
value innovation program, i.e., a massive cost cutting in no. of components, material quality, and suppliers expansion. It
worked very well with a low cost reduction of 40–50% over the period and made it very competitive in the world market.
However, the aggressive policy compromised the traditional “total quality management” practice with series of report
accidents in brakes over the period of the 2000s. The legend smoked in a serious traffic accident (brakes again) in 2009
which cost Toyota huge penalty fees, public trust, and company goodwill.

Source: Shank and Govindarajan (1993)1; Alenuska and Schotter (2012)2; Andrex et al. (2011)