STRATEGIC COST MANAGEMENT

Anil B Malali

Many of the terms are not new: cost reduction, target costing, total cost management, or cost avoidance.
These efforts have been targeted in several organizations. But how many purchasing and supply
organizations have adopted these tactics for the short-term gain and how many have taken a strategic
approach that spans several links in the supply chain? More and more will be taking the strategic
approach, focusing on strategic cost management. It has now a days become a buzz word in the street of
corporate houses. Corporate houses are now searching out for ways to manage their huge conglomerates.
The downsizing and reengineering initiatives so prevalent in the early '90s have largely proved
financially short-sighted. With hindsight, we now know that almost half of downsizing companies
reported lower profits the year following their cutbacks. Cost-cutters' stock prices grew more slowly
than those of companies which successfully grew both their top and bottom lines. Less than one in five
cost-cutters were subsequently able to put their companies back on a profitable growth track. Pressures
on costs come from many external quarters, including shifting customer priorities, the emergence of new
competitors and channels, and increasingly inquisitive financial mark.
Concept of Strategic Cost Management:
Trying to define strategic cost management requires looking at today's leading organizations who are
venturing in this area. Some of the processes are new and uncharted territory, so there's no textbook to
spell it out.

Strategic Cost Management:

Strategic cost management is a tool for improving competitiveness and is defined as the study of the
interface between business strategy and cost system.
Strategic cost management can also be defined as"scrutinizing every process within your organization,
knocking down departmental barriers, understanding your suppliers' business, and helping improve their
processes"
Scope of SCM:
1.
2.
3.
4.
5.

Strategic Analysis of the business

Value chain analysis
Continuous cost improvement programmes
Reducing costs and eliminating wastes
Ability to meet the challenges from competitors.

Applications of Strategic Cost Management:

There are three basic business areas where strategic cost management can be applied.
Strategy:
A strategy in general terms refers to a plan of action that will shape the direction of organization's
success. Companies of late have realized the importance of clear articulation of strategy and its effective
implementation. Before formulating any strategy, the management should think about the business
model whether it is still relevant or need to be changed? Or whether the objectives of the business are
going to be accomplished through laid out strategy.

Operations:
By setting the priorities according to its significance we can operate the tasks effectively and efficiently.
Organization:
Company should time and again check whether it is allocating its limited resources in the businesses
which generate more value for the entire organization. Resources as such are the liming factors for any
organization and that's why the company should be focus on the structure of the business and it should
decide well in advance whether it should own all resources or not?

Strategic Cost management framework:

The Strategic cost management framework provides a clear plan of attack for addressing costs and
decisions that affect them. Following are the three core components of this framework.

Core Functions:
Core functions elaborate on the nature of the business. It answers the very obvious question what type of
business are we in? At this stage the company has to clearly identify its courses of actions with respect
to strategy planning, research and development, and product development.
Customer Delivery Function:
This step emphasizes more on value addition with various activities such as marketing, sales,
manufacturing, quality assurance and control, sourcing, procurement and logistics, engineering and
maintenance, customer service and technical support etc. Excellence in those activities can create a sort
of competitive advantage for the company if it could harness its resources intelligently than its
competitors.
Support Functions:
As the name suggests, to support the core activities of business some secondary activities are to be
carried out which includes IT, Finance and Accounting, HR management General administration. These
activities will facilitate the performance of the core activities in a way that goals of the business can be
accomplished successfully without wasting limited resources. They will also help in synchronizing the
different tasks which are to be carried out simultaneously.

Levels of Strategies

Strategic Management Programme Steps:

SCM Programme includes following five steps. These steps can be detailed out as follows:

1. Focus:
Focus state starts with reviewing the different strategies of the company. Reviewing the strategies will
lead to clear identification of performance gaps and this will help to bridge the gap by improving targets
already set beforehand. Modifying the targets will lead to developed plan of attack which will foster
better internal communication within the organization.
2. Planning and Training:
Planning plays a crucial role in implementing strategic cost management programme. To implement the
planning, a manager should gather very efficient team members and train them accordingly. Setting up
of project management structure will facilitate the implementation of strategic cost management by
clearly identifying the day to day activities, steering guidance and offering ad hoc assistance.
3. Fact Finding:

This stage includes the tasks such as data gathering, conducting interview, developing benchmarks,
conducting and customer surveys.
4. Analysis and Recommendations for changes:
Analysis of activities plays a crucial role in ascertaining the cost of the company. It can be done by
various strategic cost management analytical tools viz. cost driver analysis, activity-based costing,
selective business process reengineering etc. An action plan for proposed change should address the
following questions what, who, when how aspects of the activities.
5. Implementation:
In implementation stage the first task to be done is to define responsibilities and accountability of each
individual and controlling i.e. monitoring and corrective action should be the taken at each stage of
programme. And this is how the continuous improvement can be achieved. The third, fourth and fifth
sate in the above process indicates continuous improvement.
Strategic cost management issues in various elements of cost:
Material : The material has a major cost implications and has been researched to find better &
economical substitute like Steel to Aluminum, Glass to fiber etc. The following are some of the strategic
cost management issues related to material:
1.
2.
3.
4.
5.

Make or buy decisions

Value analysis
Vendor analysis
Ordering system
Substitute

Labour: Labour has also changed in dimensions in modern business. The following strategic cost
management issues relate to the Labour:
1.
2.
3.
4.
5.

Diverse and cross cultural workforce

Both spouse working
Women employment
Pay structures
Nature of employments

Overheads: Overhead cost is the element which forms the major part in total costs in the organizations
today. Most of the overhead activities are outsourced or the company forms the strategic alliance to
share overhead costs.
1. Outsourcing
2. Strategic Alliances

Value Analysis and Value Engineering

Value Analysis: VA is defined as organized creative approach, which emphasizes efficient identification
of unnecessary cost i.e., cost that provides neither quality, nor use, nor life, nor appearance, nor
customer satisfaction. VA is based on the philosophy there is always scope for improvement.
It was first applied by Lawrence D.Miles of general electric co. in 1947.
Aspects/ Elements of Value Analysis:
There are three aspects of Value Analysis:
1. Value
2. Function
3. Cost
Value: The term Value is synonym for the term worth. Nothing can have value without being an
object of utility.
Values can be of following types:
a.
b.
c.
d.

Use value
Esteem value
Cost value
Exchange value

Function: This answers a simple questions like

what does it do?
Is it valid?
What else it can do?
Cost: Cost is all the resources sacrificed for manufacturing and selling the product.
Function
Value =

--------------------------Cost

Higher the ratio higher is the value. Decrease the cost or increase the value or both.
Steps in VA:
1.
2.
3.
4.
5.

Identify and record facts collecting information about process and costs
Speculation- Thinking process and idea generation
Analysis- analyse each idea and perform feasibility study
Develop New Idea- short list the best idea and develop plans with consultation of exprts.
Conclusion and Report- to be considered by the management.

Benefits/ Advantages of VA:

a. Identifies areas of improvement
b. Increases Productivity and Quality

c.
d.
e.
f.

Cost Reduction tool

Concentrates on customer satisfaction
Optimal use of resources
By continuous improvement as a concept, it increases efficiency

Application of Value Analysis:

VA can be applied at all the levels like:

Material
Methods
Process
Services

Value Engineering: VE is the systematic analysis and evaluation of the techniques and functions in the
various spheres of an organization with a view to exploring channels of performance improvement so
that the value of the particular product can be bettered.
The VE is same as VA except that the VE is done at the design and development stage of the product and
VA concentrates on the entire process of reducing costs and increasing economic value.
Distinction between VA and VE:
1. VA is applied to the existing product and VE is applied to the design and development stage of
the product.
2. VA is concerned with Value- Use, Esteem, Cost, Exchange. VE is concerned with Use value.
3. Value analysis aims at reducing costs and increasing productivity and is a continuous process.
Value engineering is at design stage.
Both the terms are used interchangeably. Objective of both the techniques is the same.

Product Design:
Product design is the process of creating a new product to be sold by a business to its customers. A very
broad concept, it is essentially the efficient and effective generation and development of ideas through a
process that leads to new products.
The design process follows a guideline involving three main sections:

Analysis

Concept

Synthesis

Analysis

Accept Situation: Here, the designers decide on committing to the project and finding a solution
to the problem. They pool their resources into figuring out how to solve the task most efficiently.

Analyze: In this stage, everyone in the team begins research. They gather general and specific
materials which will help to figure out how their problem might be solved. This can range from
statistics, questionnaires, and articles, among many other sources.

Concept
Define: This is where the key issue of the matter is defined. The conditions of the problem become
objectives, and restraints on the situation become the parameters within which the new design must be
constructed.
Synthesis

Ideate: The designers here brainstorm different ideas, solutions for their design problem. The
ideal brainstorming session does not involve any bias or judgment, but instead builds on original
ideas.

Select: By now, the designers have narrowed down their ideas to a select few, which can be
guaranteed successes and from there they can outline their plan to make the product.

Implement: This is where the prototypes are built, the plan outlined in the previous step is
realized and the product starts to become an actual object.

Evaluate: In the last stage, the product is tested, and from there, improvements are made.
Although this is the last stage, it does not mean that the process is over. The finished prototype may
not work as well as hoped so new ideas need to be brainstormed.

Business Process Re- engineering (BPR)

Business process re-engineering is a business management strategy, originally pioneered in the early
1990s, focusing on the analysis and design of workflows and processes within an organization. BPR
aimed to help organizations fundamentally rethink how they do their work in order to dramatically
improve customer service, cut operational costs, and become world-class competitors.

Business process re-engineering is also known as business process redesign, business

transformation, or business process change management.
BPR is defined as a critical analysis and radical redesign of the existing business processes to achieve
improvement in performance measures.
BPR Methodology/ Steps in BPR
BPR is an exercise to bring change to improve performance. It comes through 6Rs.
1. Realization/ System Proposal : The need for change and improvement is realized and ways to
bring about required change is thought about. In the process SWOT analysis and Cost Benefit
analysis are conducted.
2. Requirement/ System Study: This is the step were the conceptualization of need is developed.
The drawbacks of the current system are analyzed and imaginary new system is developed on the
bases of the requirements to improve.
3. Rethinking/ System review: Re-examining the existing condition and risks and benefit of
proposed system is carried out.
4. Redesign /System design: In this stage the proposed new system is designed for
implementation. The flowcharts showing information flow is drawn such that the right
information is delivered to the right person at the right time to take necessary decisions.
5. Retool / System Implementation: The next very important phase is to implement the new
process or system. There might be resistance from employees, unions etc, the same should be
identified and addressed.
6. Reevaluation / System evaluation: The critical evaluation is made to see if system is
performing as expected. If not the necessary changes be made.
Drawbacks/Pitfalls in implementation of BPR has following:
1.
2.
3.
4.
5.
6.

Many processes at the initial stage.

Inadequate training of the members.
Lack of will and understanding/ resistance to change.
Time consuming
Fear of Faliure
Delay in showing results
7. Lack of recourses