Chapter 1 Cost control & cost reduction Cost management Chapter 1 Cost control & cost reduction

Introduction Meaning of cost control and cost reduction. Areas covered by cost control and cost reduction – product design, target costing, value analysis, value engineering, value chain analysis, Business Process ReEngineering (theory only).

cost control The practice of identifying and reducing business expenses to increase profits, and it starts with the budgeting process. A business owner compares actual results to the budget expectations, and if actual costs are higher than planned, management takes action.

cost reduction the process used by companies to reduce their costs and increase their profits. Depending on a company's services or product, the strategies can vary. Every decision in the product development process affects cost.

Product design Product design is the efficient and effective generation and development of ideas through a process that leads to new products or changes in existing products. It includes Ensuring correct production design so that faulty design can be discontinued Making research a regular feature to modify the existing minimum cost and optimum quality.

Target costing A structured approach for determining the cost at which a proposed product with specified functionality and quality must be produced to generate a desired level of profitability at its anticipated selling price.

Steps in target costing

Objectives of target costing To lower the cost of new products, so that required profit level can be ensured. The new products should meet the level of quality, delivery timing and price required by the market To motivate all company employees to achieve the target profit while in product development stage.

Target costing process

Advantages of target costing a. It reinforces top to bottom commitment to process and product innovation to achieve some competitive advantages. b. It helps to create a company’s market-driven management for designing and manufacturing products that meet the price required for the market success. c. It uses management control system to support and reinforce manufacturing strategies, and to identify market opportunities that can be converted into real saving to achieve the best value for money rather than simply achieving the lowest cost. d. Assures that products are better matched to their customers’ needs.

Advantages of target costing e. Aligns the costs of features with customers’ willingness to pay for them. f. Reduces the development cycle of a product. g. Reduces the costs of products significantly. h. Increases the teamwork among all internal organizations associated with conceiving, marketing, planning, developing, manufacturing, selling, distributing and installing a product. i. Engages customers and suppliers to design the right product and to more effectively integrate the entire supply chain.

Value analysis It is a disciplined approach which ensures the necessary functions for the minimum cost without diminishing quality, reliability, performance and appearance

Procedure Value analysis Identification and defining a problem The feasibility of alternatives and exploring best methods of performing work at minimum cost Investments if any required for the alternative Percentage of return on new investments Costs resulting indirectly out of a decision to change to alternative

Procedure Value analysis Benefits of alternative like reduction in cost and increased revenue Recommendation of the final proposal for implementation after considering above points which will increase the use value.

Types of value Use value – characteristics of a product which make it useful for certain purposes Primary use value indicates the attributes of a product which are essential for its performance as engine Eg – steering, engine without which car cannot run Secondary use value are like bonnet or mud gaurd without which car can be driven but these are necessary for protection Auxiliary value – it is essential for better control and operation as speed meter,electric horn

Types of value Esteem value – certain properties of a product do not increase its utility or performance but they make it estimable which would induce customers to purchase the product Cost value – value measured in cost involved eg: for manufacturing concern it refers to cost of production of the product produced and if some part of the product is purchased from outside

Type of value Exchange value – certain characteristics of a product facilitate its exchange for something else and what we get is the exchange value of that product

Value chain analysis Meaning Value chain analysis is a strategy tool used to analyze internal firm activities. Its goal is to recognize, which activities are the most valuable (i.e. are the source of cost or differentiation advantage) to the firm and which ones could be improved to provide competitive advantage.

Primary activity

Secondary activity

Difference between traditional management accounting and value chain analysis Difference # traditional management accounting : 1. Focus – Internal 2. Perspective – Value added 3. Cost driver concept – Single cost driver (cost is function of volume). Application at the time overall firm level (cost volume profit analysis) 4. Cost containment philosophy – Across the board cost reductions 5. Insight for strategic decisions – Limited. Difference # Value Chain Analysis (VCA): 1. External 2. Entire set of linked activities from suppliers to end users 3. Multiple cost drivers i. Structural drivers ii. Executionel drivers A set of unique cost drivers for each activity 4. View cost containment as a function of the cost drivers regulating each value activity 5. Identify cost drivers at the individual activity level, develop cost differentiation advantage either by controlling those drivers better than competitors by configuring the value chain.

Business process re engineering Meaning Business process reengineering (BPR) is the analysis and redesign of workflows within and between enterprises in order to optimize end-to-end processes and automate non-value-added tasks. Reengineering is the radical rethinking and redesign of business processes to make dramatic improvements in performance, such as costs, quality, service, and speed. Business process reengineering is the analysis and redesign of workflow within a company.

Objectives of BPR Customer focus; Customer service oriented processes aiming to eliminate customer complaints. Speed; Dramatic compression of the time it takes to complete a task for key business processes. For instance, if process before BPR had an average cycle time 5 hours, after BPR the average cycle time should be cut down to half an hour. Compression; Cutting major tasks of cost and capital, throughout the value chain. Organizing the processes a company develops transparency throughout the operational level reducing cost. For instance the decision to buy a large amount of raw material at 50% discount is connected to eleven cross checkings in the organizational structure from cash flow, inventory, to production planning and marketing. These checkings become easily implemented within the cross-functional teams, optimizing the decision making and cutting operational cost.

Objectives of BPR Flexibility; Adaptive processes and structures to changing conditions and competition. Being closer to the customer the company can develop the awareness mechanisms to rapidly spot the weak points and adapt to new requirements of the market. Quality; Obsession with the superior service and value to the customers. The level of quality is always the same controlled and monitored by the processes, and does not depend mainly on the person, who servicing the customer. Innovation; Leadership through imaginative change providing to organization competitive advantage. Productivity ; Improve drastically effectiveness and efficiency.