1.

HOW A FIRM SUCCEEDS: THE COMPETITIVE STRATEGY

A firm succeeds by finding a sustainable, long-term strategy, that is, a set of policies,
procedures, and approaches to business that produce long-term success. Finding a strategy
begins with determining the purpose and long-range direction, and therefore the mission, of the
company. The mission is developed into specific performance objectives, which are then
implemented by specific corporate strategies, that is, specific actions to achieve the objectives
that will fulfill the mission.
Firms have responded to the changes in business in many ways, including reengineering
operational processes, downsizing the workforce, outsourcing service functions, and developing
smaller, more efficient, and more socially responsible organizational policies and structures.
They have attempted to become more adaptable as the pace of change increases.
Firms also are beginning to use cost management to support their strategic goals. Cost
management has shifted away from a focus on the stewardship role: product costing and
financial reporting. The new focus is on a management-facilitating role: developing cost and
other information to support the management of the firm and the achievement of its strategic
goals. Before the changes in business processes, a focus on detailed methods for product costing
and control at the departmental level was appropriate for the high-volume, standardized,
infrequently changing manufacturing processes of that time. Now a firm’s cost accounting
system must be more dynamic to deal with the more rapidly changing environment and the
increasing diversity of products and manufacturing processes. The cost management system
must be able to assist management in this dynamic environment by facilitating strategic
management. The contemporary business environment focuses on critical success factors,
including both financial and nonfinancial factors

2. IMPLICATIONS OF STRATEGIC ANALYSIS FOR COST MANAGEMENT

Changes in the business environment have transformed the role of cost management. The
introduction of new manufacturing and information technologies, the focus on the customer,
the increase and growth of worldwide markets, and other changes require firms to develop
strategic information systems to effectively maintain their competitive advantage in the
industry. This means that cost management must pro-vide appropriate types of information
that have not been provided under traditional cost accounting systems.
 First is a need for information that addresses the strategic objectives of the firm. Reports
that focus only on operational issues, such as those often summarized in financial reports, no
longer suffice. The critical success factors to which the firm must attend are diverse, and many
of them relate to long-term issues such as new-product development, quality, customer
relations, and other CSFs. Only by succeeding at these CSFs can the firm maintain its
competitive advantage. The role of cost management then must be to identify, collect, measure,
and report information on the CSFs reliably and in a timely manner. Many of the CSFs are
nonfinancial measures, such as delivery speed, cycle time, and customer satisfaction. The cost
manager is thus involved in developing both the financial and nonfinancial information
reported in the balanced scorecard.
Second, the efforts to sustain a competitive advantage require long-term plans. SWOT
analysis and value-chain analysis are used to identify the firm’s strategic position in the
industry, and the balanced scorecard is used to maintain that position. Success in the short term
is no longer a measure of ultimate success since long-term success requires strategic, long-
term planning and action.
Third, the strategic approach requires integrative thinking, that is, the ability to identify
and solve problems from a cross-functional view. Instead of viewing a problem as a marketing
problem, a production problem, or a finance and accounting problem, the integrative approach
utilizes skills from many functions simultaneously, very often in a team setting. The integrative
approach is necessary because the firm’s attention is focused on satisfying the customers’
needs, and all of the firm’s resources, from all different functions, are directed to this goal.
Spurred by the increasing importance of strategic issues in management, cost management
has adopted a strategic focus. The role of cost management has become that of a strategic
partner, no longer simply a function of record keeping and reporting.

3. STRATEGIC MEASURES OF SUCCESS

The strategic cost management system develops strategic information, including both
financial and nonfinancial information. In the past, firms tended to focus primarily on financial
performance measures, such as growth in sales and earnings, cash flow, and stock price. In
contrast, firms in the contemporary business environment use strategic management to focus
 primarily on strategic measures of success, many of which are nonfinancial measures of
operations, such as market share, product quality, customer satisfaction, and growth
opportunities. The financial measures show the impact of the firm’s policies and procedures on
the firm’s current financial position and, therefore, its current return to the shareholders. In
contrast, the nonfinancial factors show the firm’s current and potential competitive position as
measured from at least three additional perspectives: (1) the customer, (2) internal business
processes, and (3) innovation and learning (i.e., human resources). Additional perspectives
include community and social impact, governmental relations, and ethical or professional
management behavior. Strategic financial and nonfinancial measures of success are also
commonly called critical success factors (CSFs).
Without strategic information, the firm is likely to stray from its competitive course, to
make strategically wrong manufacturing and marketing decisions: to choose the wrong
products or the wrong customers.

4. MEANING OF STRATEGIC COST MANAGEMENT

Strategic Cost Management is the provision and analysis of Cost and Management
Accounting data about a firm and its competitors for use in developing and monitoring the
business strategy. Strategic Cost Management focuses on the cost reduction and continuous
improvement and change than cost containment only. It has been observed that the traditional
cost control systems mostly maintain status quo and the ways of performing the existing
activities are not reviewed. Hence the strategic cost Management goes a step ahead and uses
several approaches for efficient management of cost.

The basic aim of strategic cost Management is to help the organization to achieve the cost
leadership and as per Michael Porter’s model, get the sustainable competitive advantage. A
well-conceived cost reduction strategy enables the managers to capture maximum value in the
form of direct savings. It is an effective way of reducing cost, increasing revenue and
facilitating survival in the competitive world. There is no doubt however that accounting
information plays a vital role in determining the most appropriate strategic direction for the
 organization; particularly cost information is a critical type of information needed for effective
management.

In short, Strategic cost management is the development of cost management information

for strategic management purpose. Strategic cost management can be defined as “scrutinizing
every process within your organisation, knocking down departmental barriers,
understanding your suppliers’ business, and helping improve their processes.”

5. IMPORTANCE OF STRATEGIC COST MANAGEMENT

Strategic cost management has become an essential area now a day. While formulating
the strategy for the accomplishment of organizational overall objectives, different cost drivers
should be clearly identified. Identification of key cost drivers helps companies to focus on key
activities that will constitute almost 90% of the total costs.

In view of this, the importance of strategic cost management should not be

underestimated. This implies that an organization should be installing appropriate framework
of strategic cost management to reduce its costs in key areas on which the success of
organization is mainly dependent. Strategic cost management is understood in different ways
in literature.

Strategic cost management can be defined as “scrutinizing every process within your
organization, knocking down departmental barriers, understanding your suppliers’
business, and helping improve their processes” Cooper and Slagmulder argued that
strategic cost management is “the application of cost management techniques so that they
simultaneously improve the strategic position of a firm and reduce costs”.

The Framework of Strategic Cost Management 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 lay emphasis on the nature of the business. It answers the very obvious
question what type of business are we in? At this stage the firm 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, engineering
and maintenance, customer service and technical support etc. Excellence in these activities
can create a sort of competitive advantage for the firm 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 include IT, Finance and Accounting, HR management,
General administration etc.

These activities will facilitate the performance of the core activities in a way that goals
of the firm can be accomplished successfully without wasting limited resources. They will
also help in synchronizing the different tasks which are to be carried out simultaneously to
become cost leader.
5.1 Advantages of Strategic Cost Management:

Strategic Cost Management provides number of benefits to different organizations. It

has provided the business with an improved understanding of its sources of profits.

Some benefits are given below:

(i) It has developed a framework for reviewing the strategic allocation of resources across
the business based on core business processes and activities.

(ii) It has improved the businesses understanding of its cost drivers leading to improved
articulation of its strategic plans in cost terms.

(iii) It has enabled the business to assess, at a high level, how activity-based techniques can
be deployed at different levels in the business to improve its cost management process,
such as in budgeting and in process improvement.

5.2 Three General Strategies Have Been Identified

1). Strategic Positioning: A company's relative position within its industry matters for
performance. Strategic positioning reflects choices a company makes about the kind
of value it will create and how that value will be created differently than rivals.
2). Differentiation: Driving up prices is one way to increase profitability. To command
a premium price, a company must deliver distinctive value to customers. This is
differentiation.
3). Cost Leadership: Driving down costs is another way to increase profitability. To
compete on cost, companies must balance price with acceptable quality. This is cost
leadership.
The choice between cost leadership and product differentiation is very typical to
the strategic goal of firms which is set at the discretion of management and the
standard doesn't favor one over another. Cost leadership is an appropriate choice in
commodity business where market is matured and a cost is usually targeted. On the
 other hand, product differentiation is more market driven and mostly chosen in fast
changing rapidly growing market.
Once chosen, management's action should be very much particular aligning it with
the chosen strategy. Cost is a function of strategic choice about the structure of how
to compete and managerial skill in executing the strategic choices between structural
cost drivers and executional cost drivers.

5.3. Composition of Strategic Cost Management

The emergence of strategic cost management has resulted from a blending of key
concepts: cost drivers and value chain, each taken from the area of strategic management
(Shank and Govindarajan 1993:8). Value chain analysis is used to decompose the firm into
strategically important activities and understand their impact on the cost and value (Hergert
and Morris 1989:177). These activities include not only in-company activities but also
activities outside the company (e.g., at the supplier, distribution and disposal/recycling
levels). The company is viewed as part of an overall chain of value-creating processes
focused on the customer. Each activity that a firm performs will have an underlying cost
structure and behavior. Porter (1998a:70) defined the determinates of activity cost as "cost
drivers". It is accepts that costs is caused by many factors (cost drivers) that affect the costs
of activities, and, therefore, identify and analysis the cost drives can contribute directly to
the success of the firm.

1). The Concept of Cost Drivers

Accountants usually define cost as a resource sacrificed (consumed) or foregone
(give up opportunity) to achieve a specific objective. It is usually measured as the
monetary amount that must be paid to acquire goods and services (Horngren et al.
 2000:28). All costs incurred by an organization result from activities that are pursued
by the organization. "Know your organization's costs" is an essential theme for any
manager. Thus, cost concepts are relevant only if they influence a decision, and cost
data are relevant only if they are useful to a cost concept (Harper 1995:174). It is well
known in an industry that a company can manage what it can measure. Unfortunately,
some companies may cannot identify their costs precisely; determining how costs
behave and best cost structure. Managers need to understand how costs behave and what
cost structure is to make informed decisions about products, processes, and resources,
to plan, and to evaluate performance.
What does it mean to say an organization understands its costs? It means that the
organization's managers can predict, with some clarity, how costs will responds to
management actions. In other words, it means managers can predict how cost will
change, if at all, when they direct the organization to do something differently than it
is being done today. To say an organization understands its costs implies that the
managers understand the underlying cause-and-effect relationship between the work of
the organization and the costs of the organization (Harper 1995:174). Cost driver is a
characteristic of an activity or event that causes that activity or event to incur costs and
can be more or less under a firm's control (Blocher et al. 1999:57). In other words,
factors that causally affect costs (over a given time span) are called cost drivers. That
is a cause-and-effect relationship exists between a change in the level of activity and a
change in the level of the total costs of that cost object.
Some companies, especially those following the cost leadership strategy, use cost
management to maintain or improve their competitive position (Blocher et al. 1999:60).
Cost management requires a good understanding of how the total cost of an object changes
as the cost drivers change. It is well-recognized now that costs are driven not only by output
volume and its related measures such as direct labor hours or machine hours, but also by
non-volumerelated output variables that result from the diversity of company's product
lines and complexity of its production process. That is why many companies have
transformed their traditional cost management systems into for example, activity-based
cost management systems. In addition, in today's competitive business environment, to
achieve a major cost advantage, an organization must focus not only on traditional cost
drivers but also on strategic cost drivers. Strategic cost drivers determine the long-run cost
position of a company (Siau and Lindt 1997:40). They explain the differences that exist in
unit costs across companies of the same industry. For example, economies of scale will
give larger companies a major strategic cost advantage. Technology affects the way
activities are performed and the mix of resources (materials, machinery, and human
resources) that are used to carry out those activities. Technology determines the
competitive advantage of a company if it has a significant role in determining the relative
cost or differentiation position (Porter 1998a:179).
2). Value Chain Analysis
The idea of the value chain is based on the process view of companies, the
idea of seeing a manufacturing (or service) company as a system, made up of
subsystems each with inputs, transformation processes and outputs (Stabell and
Fjeldstad 1998:416 and Dess and Picken 1999a:102). Inputs, transformation processes,
and outputs involve the acquisition and consumption of resources - money, labor,
materials, equipment, buildings, land, management, etc. Many companies engage in
hundreds, even thousands, of activities in the process of converting inputs to outputs.
A company cannot reduce costs and/or create value for customer by looking at its
activities as a whole. Creating competitive advantage originates from many separate
activities a company performs in designing, production, marketing, delivering, and
supporting its products (Porter 1998a:33). Each of these activities can contribute to
improve a company's cost position and customer value. For example, a superior product
design, a highly efficient assembly process, procurement of high quality inputs, a
responsive order entry system, a low-cost products distribution system, etc., may enable
a company to improve its cost position and also customer value. Examining all
activities a company performs and how they interact is necessary for improving cost
position and customer value, the value chain is a systematic way for doing so. Porter
(1998a:33) argued that the value chain approach, which involves disaggregating a
company's operations into its strategically relevant activities, can be an important
managerial tool to understand how value chain activities are performed, to identify
what cost drivers of value chain activities are and the existing and potential
opportunities for improving cost position and customer value. The value chain
describes the activities within and around a company, and relates them to an analysis
of the competitive strength of the company (Dess and Picken 1999a:102). Therefore, it
considers a systematic way to make a company able to evaluate which activity can add
value to the products or services to its customers. Thus, this idea was built upon the
insight that a company is more than a random compilation of machinery, equipment,
people and money (Evans and Wurster 1997:72). Only if these things are arranged into
systems and systematic activities it will become possible to produce something for
which customers are willing to pay a price. While one can define or group the activities
a company performs at different levels of detail, the figure represents a common
approach (Porter's value chain) to categorize such activities.

Porter’s Value Chain

Porter (1998a:39) distinguished between primary activities and support activities.
Primary activities are directly involved in creating and bringing value to the customer.
They deal with physical products. They can be grouped into five main areas: inbound
logistics, operations, outbound logistics, marketing and sales, and service. Each of
these primary activities is linked to support activities, which help to improve their
effectiveness or efficiency. There are four main areas of support activities:
procurement, technology development (including R&D), human resource
management, and infrastructure (systems for planning, finance, quality, information
management, etc.). As shown in the figure 6.10, the value chain contains the element
of margin. The term "margin" implies that a company realizes a profit margin that
depends on its ability to manage the linkages between all activities in the value chain
(Hax and Majluf 1991:79). In other words, the company is able to deliver a
product/service for which the customer is willing to pay more than the sum of the costs
of all activities in the value chain. In many industries, it is rather unusual that a single
company performs all activities from product design, production of components, and
final assembly to delivery to the final user by itself. Most often, a company is an
element of a value system. Hence, Porter (1998a:34) explained that a company's value
chain is embedded in a broader value system that provides inputs into the company and
helps transfer outputs to the ultimate consumer.

The Value System According to Porter

suppliers have value chains that create and deliver the purchased inputs used in a
company's chain. Suppliers not only deliver a product but also can influence the costs
and performance within the company by many ways e.g. through quality control,
meeting delivery dates and price. In addition, many products pass through distribution
channels on their way to the customer. The value chains of these channels perform
additional activities that affect the customer (e.g. a dealer network in the case of
automobiles), as well as influence the company's own activities. The linkages between
a company and its suppliers and customers should be managed so that all parties
benefit. Gaining and sustaining competitive advantage depends not only on
understanding a company's value chain activities and the linkages between these
activities, but also on recognizing and managing the relationships between the company
and the value chains of its suppliers and customers (Dess and Picken 1999a:110).

The value system and value chain are important tools for understanding how a
company can position itself against its competitors. The value chain represents the
interrelated value creating activities inside the company (Partridge and Perren
1994a:22). These activities affect each other and cannot be treated in isolation. To
achieve competitive advantage, cost management of value chain activities requires
them to be managed and optimized together instead of viewing them as separate and
independent cost centers. The idea in the value chain was to capture the fact that a
company does a series of functions (e.g. operations, technology development, etc.).
Analyzing how these functions are done relatively to their competitors can provide
useful insights. On the other hand, the value system is the set of interdependent value
chains all the way from the suppliers of raw materials to the end-user. To gain
competitive advantage a company has to realize that the costs and benefits, i.e. values
associated with the product, must be examined from the final consumer’s point view.
For a product to be competitive, it must pass through the whole value system
efficiently. Thus, the following section discusses the fundamental methodology of
value chain analysis for cost management.

3) Strategic Positioning Analysis

In reality, many firms will choose not just one general strategy, but a
combination of the three general strategies. Strategic positioning is the process of
selecting the optimal mix of these three strategic approaches. The mix is selected
with the objective of creating a sustainable competitive advantage. A strategy,
reflecting combinations of the three general strategies, can be defined as: "...
choosing the market and customer segment the business unit intend to serve,
identifying the critical internal business processes that the unit must excel at to
deliver the value propositions to customers in the targeted market segments, and
selecting the individual and organizational capabilities required for the internal,
customers, and financial objectives" (Kaplan and Norton 1996:37). As used in
definition, "choosing market and customer segments" is actually focusing;
"delivering value propositions" is choosing to increase customer receives and/or
decrease customer sacrifice, and, therefore, entails cost leadership and/or
differentiation strategies, or a combination of two. Developing the necessary
capabilities to serve the segments is related to all three general strategies.
 Firms have responded to the changes in business in many ways, including
reengineering operational processes, downsizing the workforce, outsourcing
service functions, and developing smaller, more efficient, and more society
responsible organizational policies and structures. They have attempted to become
adaptable as the pace of change increases. Firms also are beginning to make use
cost management to support their strategic goals. Cost management has shifted
away from a focus on the stewardship role - product costing and financial reporting.
The new focus is on management facilitating role - the development of cost and
other information to support the management of the firm and the achieving of its
strategic goals. Before the changes in business processes, a focus on detailed
methods for product costing and control at the department level was appropriate for
the high–volume, standardized, infrequently changing manufacturing process of
that time. Now, a firm’s cost management systems must be more dynamic to deal
with the more rapidly changing environment and the increasing diversity of
products and manufacturing processes. The cost management systems must be able
to assist management in this dynamic environment by facilitating strategic
management.