Chapter 14 Contemporary cost management

Cost management §Improvement of an organisation’s cost effectiveness through understanding and managing the real causes of cost

Conventional cost control vs contemporary cost management §Drivers of cost l conventional - managers control costs by bringing them into line with some predetermined goal focus is on cost results or outcomes l contemporary - reduces costs by identifying waste and eliminating it through identifying the real cost drivers focus is on determinants of cost Cont.

Conventional cost control vs contemporary cost management §Strategic perspective l conventional - control costs within the organisation internal perspective l contemporary - cost management also concerned with achieving value for the customer a strategic perspective

Conventional cost control vs contemporary cost management §Process perspective l conventional - control costs by reporting results for responsibility centres based on functional areas of the business l contemporary - recognises that customers’ needs are met by processes which flow across the business may cross functional areas

Activity-based management (ABM) §Process of using information from activity- based costing to analyse activities, cost drivers and performance so that customer value and profitability are improved §Customer value l features of a product which customers are willing to pay

Using ABM to reduce costs §Identify the major opportunities for cost reduction §Determine the real causes of these costs §Develop a program to eliminate the causes, and, therefore, the costs §Introduce performance measures to monitor the effectiveness of cost reduction efforts

Identifying the major opportunities for cost reduction §Value-added activities l provide essential value to the customer, or are essential to the functioning of the business §Non-value-added activities l do not add value to a product or service from the customer’s perspective or for the business and, therefore, can be eliminated without detriment to either

Building activities into processes §Eliminating non-value-added activities requires a clear understanding of the way work is done in an organisation §Linking activities into processes l a series of activities that are linked together to achieve a specific objective l often cross the boundaries of responsibility centres, such as functional departments

Cost driver analysis §Identification of root-cause cost drivers for the major non-value-added activities §Analysis of root-cause cost drivers of value- added activities may also lead to more efficient use of resources §Value-added management (or value analysis) l the process of targeting and eliminating non- value-added activities

Measuring performance in cost reduction §Activity-based performance measures can be used to monitor the effectiveness of cost reduction effort §Performance measures may be based on previous activities

Using the costing dimension of ABC to help manage costs §Customer cost analysis l the costs of products purchased by the customer are assigned to the customer, along with the cost of any other customer-driven activities l Customer profitability analysis l estimating the profits from individual customers, or customer groups, by comparing customer costs and revenues

Other activity-based management issues §Impediments to implementing ABM l lack of awareness of ABM l uncertainty over potential benefits l extensive resource requirements to implement l resistance to change Cont.

Other activity-based management issues §Behavioural aspects of activity-based management l resistance to change l using activity-based information to create particular incentives §The role of strategy and activity-based costing l enables strategies to be managed taking a customer perspective

Business process re-engineering §The fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical areas of performance such as cost, quality and delivery §Focus is on strategic processes l those processes that focus on achieving a company’s business objectives and strategies Cont.

Business process re-engineering §Four major steps l preparing a business process map a flow chart of the activities that make up the business process l establishing goals l reorganising work flow l implementation of the program

Business process re-engineering vs ABM §ABM focuses on process improvement l the incremental, continuous improvement of processes §Business process re-engineering involves fundamental changes to the way processes are structured §Both use activity analysis to identify processes and activities

Managing throughput §Another approach to managing costs and improving performance in quality and delivery §The theory of constraints l focuses on identifying and removing bottlenecks to improve the rate of throughput l recognises that the rate of production is limited to the capacity of the constraints (or bottlenecks) that exist in the organisation

Life cycle costing §Analyse the costs of activities, including both upstream and downstream costs, that occur over the life cycle of the product §Four stages of the product life cycle l product planning and initial concept design l product design and development l production l distribution and customer (logistic) support

Life cycle budgeting §Involves estimating the expected costs and revenues for each year of the expected life of a product §Useful in product mix or pricing decisions

Impediments to life cycle costing §A lack of awareness, or uncertainty about how to calculate life cycle costs §Not easy for products with longer lives as it is more difficult to assess l changes in consumer tastes l impact of competitors’ actions l effects of inflation

Target costing §A tool for planning profits and reducing costs §Reducing a product’s cost to a target cost, by working on the design to decrease production (and customer support) costs §Target cost - the product cost that must be achieved for a product to be viable in the long term

The three steps in target costing §Developing the target cost §Driving down the planned cost towards the target cost during the design phase l value engineering (or value analysis)- reviewing the product or process design to make changes to reduce cost, while still maintaining the functionality of the product l Pursuing continuous improvement once production begins

Exhibit 14.3