STRATEGIC COST MANAGEMENT

Putu Agus Ardiana

Faculty of Economics Udayana University

Basic Concepts
Firms strategic goals: long-term growth and survival Creating competitive advantage: differentiation, cost leadership, and focus strategy (Porter, 1985) Sustaining competitive advantage: creative destruction (Sombart 1913 and Schumpeter 1942)

Value-Chain Framework (1)

Industrial value chain is the linked set of valuecreating activities from basic raw materials to the disposal of the finished product by end-use customers Fundamental to a value-chain framework is the recognition that there exist complex linkages and interrelationships among activities both within and beyond the firm

Value-Chain Framework (2)

Example of Value-Chain for the Petroleum Industry
Oil Exploration Firm B Oil Production Oil Distribution Firm A Oil Refining Gas Distribution Service Station End-Use Customers Product Disposal Source: Guan, Hansen, and Mowen 2009 p. 379 Firm C

Value-Chain Linkages
Internal linkages are the relationships among activities that are performed within a firms portion of the value-chain External linkages describe the relationship of a firms value chain activities that are performed with its suppliers and customers External linkages are two types: supplier linkages and customer linkages

Value-Chain Activities
Value-Chain activities are two types: organizational and operational activities Organizational activities are activities that determine the underlying economic structure of the organization Operational activities are day-to-day activities performed as a result of the structure and processes selected by the organization

Value-Chain Analysis
Value-chain analysis is identifying and exploiting internal and external linkages with the objective of strengthening a firms strategic position The analysis involves exploiting internal linkages, exploiting supplier linkages, and exploiting customer linkages

Internal Value Chain

Exploiting Internal Linkages (1)

Design
Service Develop

Distribute Market

Produce

Source: Guan, Hansen, and Mowen 2009 p. 383

Exploiting Internal Linkages (2)

Activities Activity Driver Activity Capacity Current Activity Demand Expected Activity Demand

Material usage
Assembling parts Purchasing parts Warranty repair

Number of parts
Direct labor hours Number of orders Number of defective products

200,000
10,000 15,000 1,000

200,000
10,000 12,500 800

80,000
5,000 6,500 500

Exploiting Internal Linkages (3)

Additional information: Material usage: $3 per part used, no fixed activity cost Assembling parts: $12 per direct labor hour, no activity cost Purchasing parts: Three salaried clerks, each earns a $30,000 annual salary; each clerk is capable of processing 5,000 purchase orders. Variable activity costs: 0.50 per purchase order processed for forms, postage, and so on Warranty repair: Two repair agents, each paid a salary of $28,000 per year, each repair agent is capable of repairing 500 units per year. Variable activity costs: $20 per product repaired

Exploiting Internal Linkages (4)

COST REDUCTION FROM EXPLOITING INTERNAL LINKAGES Material usage Labor usage Purchasing Warranty repair $360,000a $60,000b $33,000c $34,000d

Total Units
Unit savings a) b) c) d)

$487,000 10,000
$48.70

(200,000 80,000) $3 (10,000 5,000) $12 (30,000 + 0.5 (12,500 6,500)) (28,000 + $20 (800 500))

Exploiting Supplier Linkages (1)

Data for Supplier Costing Example I. Activity Costs Activity Reworking products Expediting products II. Supplier Data Fielding Electronics X1Z Unit purchase price $10 Y2Z $26 Oro Limited X1Z $12 Y2Z $28 Component Failure/Late Delivery $200,000 $50,000 Process Failure $40,000 10,000

Units purchased
Failed units Late shipments

40,000
800 30

20,000
190 20

5,000
5 0

5,000
5 0

Exploiting Supplier Linkages (2)

Reworking rate = $200,000 / 1,000* = $200 per failed component, where * is 800 + 190 + 5 + 5 Expediting rate = $50,000 / 50* = $1,000 per late delivery, where * is 30 + 20

Exploiting Supplier Linkages (3)

SUPPLIER COSTING Fielding Electronics X1Z Purchase cost Reworking products Expediting products Total Costs Units Total unit cost 400,000 160,000 30,000 590,000 40,000 $14.75 Y2Z 520,000 38,000 20,000 578,000 20,000 $28.90 $61,000 5,000 $12.20 $141,000 5,000 $28.20 Oro Limited X1Z 60,000 1,000 Y2Z 140,000 1,000

Exploiting Customer Linkages

One Large Customer Unit purchased Orders placed 500,000 2 Ten Smaller Customer 500,000 200

Manufacturing cost $3,000,000 $3,000,000 Please see Guan, Hansen, and Mowen 2009 pp.386-389 for further details Order-filling cost $303,000 $303,000 allocated

Order cost per unit

$0,606

$0.606

Cost Analysis: Competing Product Design (1)

A. Traditional Costing System Design A Direct Materials Conversion Cost $800,000 $2,000,000 Design B $480,000 $3,200,000

Total Manufacturing Costs

Units Produced Unit Cost

$2,800,000
10,000 $280

$3,680,000
10,000 $368

Cost Analysis: Competing Product Design (2)

B. Activity-Based Costing (ABC) System Design A Direct Materials Direct Labor Machining Purchasing Setups Warranty Total Product Costs Units Produced Unit Cost $800,000 $500,000 $700,000 $18,000 $200,000 $80,000 $2,298,000 10,000 $230 Design B $480,000 $800,000 $560,000 $12,000 $100,000 $15,000 $1,967,000 10,000 $197

Comparison of JIT Approach with Traditional Manufacturing and Purchasing

JUST-IN-TIME Pull-through system TRADITIONAL Push-through system

Insignificant inventory Small supplier base

Long-term supplier contracts Cellular structure Multi-skilled labor Decentralized services High employee involvement Facilitating management style Total quality control Buyers market Value-chain focus

Significant inventory Large supplier base

Short-term supplier contracts Departmental structure Specialized labor Centralized services Low employee involvement Supervisory management style Acceptable quality level Sellers market Value-added focus

End of Presentation