Strategic management accounting

by Mark Lee Inman

Definition a form of management accounting in which emphasis is placed on information which

relates to factors external to the firm, as well as non-financial information and internally
generated information."
[in 1981, Ken Simmonds]
- the collection of management accounting information about a business and its
competitors for use in developing and monitoring the business strategy.
- The emphasis was placed upon relative levels and trends in real costs
and prices, volume, market share, cashflow and stewardship of the
resources available to the business.

Definition 2 (1994) Professor Bromwich pointed out that adding the strategic perspective to traditional
management accounting required the role of accounting to extend in two directions. First,
costs need to be integrated into strategy through strategic cost analysis, and thus align
costs with strategy. Secondly, to ascertain, albeit in a fairly general way, the cost
structure of competitors and to monitor the changes over time.

- Bromwich also sees two distinct approaches:

• costing product attributes provided by the company’s products;

• cost the functions in the value chain which are perceived as giving value to the
customer.

Trad v. SMA Traditional management accounting is perceived as inadequate since it:

• concentrates on the manufacturing and neglects the high cost post-conversion

activities;
• ignores the impact of other activities;
• fails to assess the relative cost positions of competitors;
• over-reliance on existing accounting systems;

By contrast, strategic management accounting purports to place emphasis on:

• the relative cost position;

• the ways in which a company may secure a sustainable cost advantage;

costs of differentiation i.e., what makes their product different and hence more attractive
Porter’s Five First he assesses different industries in terms of their long-term profitability. He sees five
competitive forces that will contribute to a strategic equation.
forces
[His 1985 text
on strategic (a) The threat of new entrants into the market
management is
regarded as a While it is influenced by the cost of entry into a market and perhaps the opportunity to
corner-stone] make a profit, this threat remains. In principle, the larger the organisation and the more
investment required, the less likelihood of any competition. However, students have only
to look at the recent history of commercial aviation, where deregulation has allowed
small airlines to enter the market and compete successfully, while the UK
telecommunications industry has seen a monopoly situation turned into one of fierce
competition.

New entrants can have another implication. They can expand the number of competitors
without expanding the market. Entrants into the UK supermarket business have this
 problem. In a country of less than 60 million people, who spend about 11% of their
income on food, growth in the supermarkets business can only be at the expense of
rivals and the ultimate destruction of the corner shop.

(b) The threat of substitute products or services

There was a time when communication was by letter, then the telephone entered the
communications market. Now we have the Internet, where people can conduct business
with all the advantages of letter writing, but down a telephone line. Telephones
historically relied on land lines. Now there is a whole new area of competition from
mobiles.

(c) Rivalry amongst existing organisations within the industry

Again within the UK, the student needs to look no further than his local supermarket.
There is intense rivalry between Sainsbury’s, Tesco and ASDA for a bigger share of the
grocery and food market. At the bottom end of the market, there are a number of smaller
and possibly cheaper players, while at the top, the food departments of Marks & Spencer
compete against Waitrose.

On the world scale, the volume automotive industry provides a classic example.
Historically, they were somewhat nationalistic and fought each other for a share of the
home market. Now, as major multinationals, Ford, Volkswagen, FIAT, Toyota and GM
compete on a world stage. A few smaller companies, such as Jaguar and Volvo, are
gradually being swallowed up by the major players.

(d) The bargaining power of suppliers

(e) The bargaining power of consumers

These two forces have been put together because they demonstrate the impact upon
corporate profitability. In each of the five forces are the constituents of profitability, prices,
costs and investment. Prices are influenced by the bargaining power of consumers and
the threat of substitutes. Costs are influenced by the bargaining power of suppliers and
the rivalry between competitors.

R.M.S. Wilson, in his review of strategic management accounting, illustrates how these
forces work both to the benefit and detriment of various industries. The forces work very
favourably for the pharmaceutical, soft drinks and database publishing industries. As a
result, they presently earn very attractive returns. By contrast, some of the more basic
industries, rubber and steel for example, as well as some of the high value-added
industries, such as video games, are under such intense competitive pressure that they
are unable to generate high returns.

You should also be aware that the relative strengths of individual forces
can change with time. For example, look very closely at the
pharmaceutical industry. Once it was able to operate a jealously-guarded
price maintenance system. The argument was always based upon the high
cost of R&D and the long lead time because of testing and the need for
government approval. This view is now being challenged, especially in
the patent and over the counter section of the market, by the
supermarkets.
Porter’s Secondly, Porter poses the question about the enterprise’s relative position within its
Generic industry. The question of position is important because it influences the ability of a
business to generate profits greater or less than the industry average. Above average
Strategies returns may be achieved by sustainable competitive advantage. This is achieved by
three basic generic strategies.

(i) Cost leadership

Here an enterprise aims at being the lowest cost producer in the industry. This is
achieved by scale economies, capitalising on experience curve effects, tight cost control
and cost minimisation in such areas as R&D, service, and advertising. The student
should think very carefully about the latter two. Tight or over-excessive or over-zealous
cost control could lead to penny wise, pound/dollar foolish decisions being made.
Equally, while advertising may be an easy target for cost savings, well-directed R&D is a
positive advantage. Corporations which concentrate on this strategy are Texas
Instruments, Black and Decker and BIC.

(ii) Differentiation

Here an enterprise seeks to offer some different dimension in its products/services that is
valued by its customers and may command a premium price. This can be achieved by
image (e.g., Coca-Cola), superior customer service solutions (IBM and Dell), dealer
network and support (e.g., Caterpillar), and product design (Hewlett Packard).

(iii)Focus

This has two variations — cost focus and differentiation focus. Strategies that are based
upon focus i.e., the narrow segments to the exclusion of others. One obvious example
was the review of the hotel portfolio held by THF when it was acquired by Granada. The
basic focus strategy was to eliminate all five and two star and below hotels. These were
sold off. Then the middle three and four star hotels were reviewed under the Post House
and Heritage banners. Those not meeting the agreed criteria were also sold.

Porter identifies the value chain as the next approach in strategic management
accounting. Value is what the customers are prepared to pay, and this is a function of the
image of the product. You will see this most pronounced in the automotive industry. The
volume car manufacturers Ford, GM, Rover, FIAT, Toyota, Nissan, Renault etc., have a
ceiling beyond which the customer will not pay. It does not matter what refinements are
fitted to a volume car, there comes a point where the customer will not pay because it is
a volume car and he can move up into the next level. Market research found that this
figure was about $40,000 (£24,000). At that price, a top of the range Ford with every
imaginable extra could be acquired. However, $40,000 also buys an AUDI, a BMW or
even a Mercedes. This is why, to move into the lucrative big luxury car market, Ford
produce the Lincoln and have acquired Jaguar and Volvo, while Toyota produce the
Lexus. Likewise, FIAT keep Alfa Romeo and Ferrari separate
Porter’s The value chain
Value Chain This has nine elements, each with operating costs and allocated assets driven by one or
more cost drivers. Some of these cost drivers may be controllable. The elements of the
value chain are:

Support activities

1. firm infrastructure;
2. human resources management (and perhaps development);
3. technology development (and perhaps level);
4. procurement.
 Primary activities

5. Inbound logistics;
6. Operations (or traditional production);
7. Outbound logistics;
8. marketing and sales;
9. services.

In making the analysis, attempts must be made to assess the impact of the
cost drivers on each of the elements. Also, the cost of the nine elements
must produce a satisfactory margin.
Application Once this exercise is complete, an attempt must be made to analyse one’s competitors
in the same way. Strategic advantage will then be identified if the total cost of the
of strategy elements is less than that of the competitors. Taking a more positive approach, assess if
the margins are better than those of the competition. If they are not, then a strategy must
be developed to achieve a lower cost position through controlling the cost drivers. This
may mean cost savings by cost cuttings, or improving productivity.

To achieve this, the student could recall his studies of quality costs and TQM, a popular
topic in recent examinations. The problem of increasing margin could be resolved by
examining internal failure costs in the context of operations. Marketing, sales and service
costs could be more productive if external failures were reduced. An obvious example
might be the provision of an excellent customer support service provided by Volkswagen.
If a Volkswagen breaks down while under warranty, a rescue vehicle comes out to it and
fixes it. If it cannot be fixed, then a replacement is provided. This is very good, but very
expensive, and begs the question would better investment in machinery, technology and
education at the production operations level eliminate this expensive and image
damaging cost?

There is always a danger with cost reduction. It just may be that the lower cost
component may save money in the short term, but again create a serious failure which
will damage the image of the product. Quick, efficient and courteous rectification is
always impressive, but is it too late? Has irreparable damage been done to product
image and customer confidence?

E,g the use of The Bromwich Ideal

Porter’s The strategy of cost leadership tends, at best, to develop the well-worn traditions of cost
accounting. Emphasis is placed upon:
generic
strategies and • the questionable merits of standard costing for performance
valu chain measurement;
• the dubious use of flexible budgeting for manufacturing cost control;
• a veneration of budgets;
• a strict adherence to traditional product costs in pricing decisions;
• a consideration of competitors’ costs;
• lack of formal consideration of marketing costs.

This serious shortcoming is a direct result of the slavish adherence of cost accountants
to what Johnson and Kaplan call in Relevance Lost (p195) "the financial accounting
mentality." The excessive focus on production costs almost to the exclusion of non-
conversion costs has proved disastrous. You should think carefully here. Traditional blue-
collar labour costs have shrunk to around 10% of product cost. Costs of marketing,
promoting, supporting the product or service must be brought into the equation for
effective and meaningful strategic cost analysis.

Professor Bromwich offers an interesting potential solution. Table 1 is based upon a

fast food supplier which provides prepared and partly processed products to its network
of selling outlets.

The first thing that you should note is the emphasis on consumer benefits. Clearly the
strategy has been to look at what the customer wants, what he looks for and then place
emphasis on the costs of providing those benefits. It is these benefits that sell the
product and provide the differentiation from rival products.
Table 1: The Bromwich fast food example

Product-volume
related costs
Activity related
costs
Capacity
related costs
Decision related
costs
Total costs

Illustrative Costs
PRODUCT BENEFIT
1 Texture
2 Nutritional Value
3 Appearance
4 Taste
5 Consistency of above over outlets and time
6 Quality
7 Low cost relative to competitors
OUTLET BENEFITS
8 Service
9 Cleanliness
10 Outlet facilities
11 Location and geographical coverage
OTHER BENEFITS
12 Product advertising

TOTAL COSTS ATTRIBUTABLE

TO CONSUMER BENEFITS
PRODUCT COSTS NOT
ATTRIBUTABLE TO CONSUMER
BENEFITS
TOTAL PRODUCT COSTS

The categories in Table 1 may need some explanation, and clarification of illustrative
costs.

(i) product-volume costs include materials, labour (both preparation and

serving) and variable overheads. Obviously the materials used must provide
 adequate nutritional value, taste good and be consistent between outlets. UK
students might be interested to know that the Harvester chain achieve this by
strict control over food buying and not allowing any discretionary purchases by
local managers. Labour costs will also include ensuring an outlet is clean, the
service is rapid and efficient without being obsequious;

(ii) activity related costs include material handling, transport and

distribution, quality control, monitoring quality and service and site and facilities
maintenance. Many of these costs can be readily related to outlet benefits;

(iii) capacity costs include land and building occupancy costs, depreciation
and leasing charges. Again, the emphasis is on the outlet and location. Many of
the fast food chains rely on trade from motorists and thus favour locations along
trunk roads and major junctions;

(iv) decision related costs include product and site design, product and
site engineering, quality improvement, marketing, product advertising,
personnel and administration. The important point you should observe here is
that costs are not just about placing a meal in front of a customer. It is about the
cost of a meal at a certain location and the provision of the right facilities and
ambience that makes that meal desirable. Oddly enough, the food forms a very
small portion of the costs, it is the labour and the facilities that form both the
costs and the important value-added elements, and it is this that ultimately
impresses the customer.

Bromwich emphasises that all these costs can be collected and reported separately,
doubtless in a very traditional way. You may well be relieved by this. Certainly allocation
in the way Bromwich suggests would seem difficult. Even so, what is more important is
that relative costs positions can be determined in the areas where the product competes,
ways of ensuring a cost advantage can be readily identified, and the costs of
differentiation can be highlighted and justified. This emphasises again the primary
activities identified by Porter, particularly the operations, outbound logistics, (in the case
of fast food — serving and presentation) and the full range of marketing.

2 Other areas of analysis

Having examined how Strategic Management Accounting differs from conventional or
traditional management accounting, it is now necessary to explore further Ken
Simmonds’ area of ideas. The first area must come under the general heading of
competition.

The impact of competition

Before any of the analysis alluded to by Professor Bromwich can be meaningfully

undertaken, it is essential to identify who or even what the competition is. Mistakes have
been made in this area e.g., in the United States, Ford and GM fought each other and
overlooked Toyota stealing their market, while in Europe they failed to tackle the real
market leader — FIAT. In certain markets, the competition may not be another brand.
Florists compete with chocolates in the social gift market, but also with wine stores and
even restaurants. The tradition of taking mum out for Mother’s Day rather than giving
flowers has seriously eroded one of the florist’s traditional markets.

Kotler’s analysis of competitors

Kotler in Marketing Management: Analysis, Planning and Control identifies four types of
competitor:

(i) Desire

This is the initial stage. The customer has a desire, (say) to buy a present for
someone;

(ii) Generic

These are the alternative ways that such a desire can be met. It could mean a
choice between flowers, chocolates or something more permanent.

(iii)Form

These are the forms that the selected choice can take. Flowers could mean
purchasing a bouquet or ordering flowers by telephone.

(iv) Brand

Flowers do not lend themselves to brands. Sending them usually involves

Interflora, but there are alternatives. Flowers can be posted from the Channel
Islands, or another flowers by wire service chosen. If the delivery is local, then
the flowers may be delivered by the local florist.

Porter has also identified barriers to entry. Any review of competition must consider how
easy it is to enter a particular market, and how lucrative and hence attractive a particular
market might be. Analysis under this heading will cover:

(i) Economies of scale

Many industries such as the automotive industry, require large scale operations just to
compete. The cost of establishing and equipping from scratch would be prohibitive. The
Japanese achieved their success from a home-based critical mass that gave them the
requisite scale economies to compete. You should also remember that scale economies
are not just confined to production. The prohibitive costs of entry may be developing
effective distribution and service channels. The Japanese automobile companies had to
establish dealer networks, service confidence and parts availability. This was achieved
by granting dealerships to disenchanted former British Leyland dealers. More recently,
the Korean Daewoo, have resolved this problem by integrating distribution with their own
brand name, and effectively owning the distribution and service network.

(ii) Brand loyalty

Many consumer brands have a high level of customer loyalty which would be extremely
difficult to destroy. The cost of wooing loyal customers away from an established well-
known brand is high. But it has been achieved, e.g., Canon has taken a substantial slice
of the office copier market.

(iii) Capital requirements

This relates to economies of scale. Daewoo have broken into the volume car market
backed by the other enterprises that the Daewoo Corporation is involved in. The
Japanese had their home critical mass and hence economic base for moving into the
world markets.

(iv) Switching costs

There is always the possibility that the customers cannot readily change. In the
aerospace industry there is limited choice worldwide for major components. Certificates
of airworthiness depend on aeroplanes being built of components that have been
certified by the licensing authorities.

(v) Access to distribution channels

Any food product, to be successful, must get on the supermarket shelves. If the big three
are prepared to add it to their array of existing products, then success is virtually
assured. One obvious example is wine. Most large supermarkets provide a wide choice
of wines selected from the traditional parts of Europe and on an increasing scale from
Australia, New Zealand and South Africa, as well as parts of South America and
California. However, wines from England are difficult to find, as are many wines from
Eastern Europe and the former Soviet Union.

(vi) Non-scale disadvantages

Established companies may have advantages not readily available to new entrants. The
English wine industry lacks image, it is inherently small, often forced to pool processing
facilities, and has difficulty getting into major outlets.

(vii) Government regulation

Many governments are very protective. Japan has a highly complex distribution and legal
system to deter competition in its own home market. France also has complicated
procedures designed to keep out foreign competition.

Traditional management accounting has always ignored the impact of competition and
the market. It was so involved in the introspective aspects of control that it had almost
become a closed system within its own right. At strategic level the competition and the
market must be considered.

Under the general heading of ‘competition’ a business should:

• establish a basis for competitive strengths,

• identify the major competitors,
• compare with the major competitors,
• identify potential new competitors.

In analysing the competition, every employee should consider himself involved. A simple
example might be R. C. Townsend’s famous ‘Call Yourself Up’ technique. To test Avis’
response to potential customers, he used to call himself. The response was then
compared with that of the competition i.e., Hertz.

On a grander scale, certain industries have league tables — the automobile industry
monitors who has the top ten model sales each month in a manner not dissimilar to the
popular music charts. The media is able to monitor listener and viewer ratings.

At the lower end of the business scale, the local convenience store owner can see how
the competition has attacked him. Back in the 1960s and 1970s one of the main
advantages of these stores was that they were ‘open all hours’.

Three things have threatened these businesses. First, the major supermarkets,
themselves fighting for more and more of the share of a largely static food market, have
started to ‘open all hours’ — some even 24 hours. The major advantage of the
convenience store has been eroded. Secondly, the petrol companies, and in some cases
the supermarkets, have turned petrol stations into convenience stores. Again, they are
open all hours. However, they also have the third prong of this attack. Many corner
convenience stores have suffered from parking and waiting regulations, so the customer
has been literally driven away. The supermarket, often with an out of town site, or the
garage with its ready-made space, enables the mobile customer to stop.

Leaders, challengers and followers

The market leader is the company or product that is out in front. Leadership may be
reinforced by brand strength. Such companies must be ever vigilant. Leadership is never
permanent, the most recent casualty being Marks & Spencer, where complacency,
deteriorating quality and boring products have cost it its position as the major High Street
retailer. By contrast, the challenger attacks either the leader or other competitors. In the
UK, this is most pronounced in the battle of the supermarkets, with Tesco and
Sainsbury’s battling it out for both the top spot and a larger share of the market. While
the ‘big two’ battle it out, threats from new entrants, both from continental Europe, new
players at the bottom end and the threat of the American Wall Mart present other
challenges. The follower may recognise his position, know he may never take the No.1
spot and remain content. The Avis success story is just such an example. They were
never going to be the number 1 for size and volume, but by adopting their famous ‘We try
harder’ slogan, they increased their share of the market and became a better performing
company.

Progress measurement
Strategic management accounting focuses on a larger picture and a longer term than
traditional budgeting. The rapidly changing economic world means that planning horizons
have shortened, and even then, projections beyond perhaps twelve months are little
more than best estimates written in pencil.

Conventional financial measures have a value and under budgetary control and
Economic Value Added, may be reduced to a few, if not a single financial objective.
Control might be through profit, cash generation or a measure of financial return.

The Balanced Scorecard approach may utilise multiple objectives, comprising of a mix of
financial and non-financial measures. To the traditional financial measures of profit, cash
generation and return might be added tender success rate, reduction in rework,
proportion of revenue from new business, market share and some objective attempt at
quantifying customer satisfaction.

However, there is a popular trend to try and move away from strictly quantifiable and
financial measures. Strategy may need to look at a wider series of objectives that "meet
the needs of the present without compromising the ability of future generations." Such a
view must go beyond any limit of traditional economics and accounting measures. By
looking at a very recent (March 1999) article in the ACCA’s own Accounting & Business,
you will see a possible way forward for measuring strategic performance. Six measures
are illustrated, viz., Diversity, Added Value, Productivity, Integrity, Health, and
Development. These are then considered under different dimensions, economic, social
and environmental. Table 2 illustrates the theme of Diversity, defined as an enterprise’s
mix and balance of activities and human, ecological and economic resources.
 Table 2: Diversity categories (from Adams 1999)

Economic Dimension
Business diversification
(Assuming this is an
inherently good strategy
Social Dimension
Employee diversity, employment
of minorities, the disabled and effective
equal opportunities
Environmental Dimension
Resource use diversity
Consumption of non-renewable
natural resources; Consumption
of renewable resources

Conclusion
Having read this article, the student should now be able to:

• adequately and critically define strategic management accounting;

• be aware of the shortcomings at strategic level of traditional management
accounting;
• be aware of the different emphasis;
• understand the importance of the value chain;
• be aware of the contribution of Professor Bromwich’s ideas;
• understand the impact of competition and the market;
• be aware of potential measures of progress towards the objective..

Finally, you should not be a stranger to the use of non-financial information. Concepts in
management accounting stress that the accounting function has access to all the data
within the entity so monitoring such information should not be difficult.

Strategic management accounting - part 1

by Graham Morgan
the convention of
distinguishing corporate
and business strategy
competitive advantage
Problems in multi-
divisional structure
that requires
corporate strategy
The need for the
understanding of
- identification of strategic business units (SBU's).
- the issue of transfer pricing where inter-divisional trading is at a significant
level
- headquarter costs based on the development of core competencies/skills
and the sharing of centralised facilities which have to be assigned to the
individual SBU'S
Two key choices are fundamental to the adoption of a particular business
strategy. Firstly, the choice of customers (and markets) a firm will serve.
Secondly, the competencies and strengths it will develop to serve customers
business strategy and effectively and thereby gain a competitive advantage. The concept of
competitive advantage requires that a given SBU be viewed relative to its
accounting competitors with respect to two main areas i.e., product and price. A competitive
advantage can be realised either by:

(a) providing a product with unique attributes for which customers are prepared
to pay a premium price, this premium exceeding the additional costs of
providing the unique attribute; or

(b) providing a standard product at a lower cost than competitors and charging
either the same (or a lower) price than competitors.

Porter (1986), characterised these as differentiation and least cost producer

strategies respectively.

In essence both approaches involve creating customer value more effectively

than competitors. This understanding of competitive advantage provides an
insight into two distinct areas of strategic management accounting:

1 competitor/market analysis; and

2 strategic cost management;

These two areas which have a planning orientation need to be supplemented by

a third area of activity which can be termed:

3 strategic performance review.

Refer to article to discuss the contribution of SMA in getting

competitive advantage

true value will only be The potential for this integration into a strengths and weakness analysis does
realised when the not need to be elaborated. The case for other instances, such as
information is integrated operationalising Porter's (1985) `five forces model' and the development of BCG
into existing strategy and and McKinsey/General Electrical portfolio planning matrices deserves more
marketing models. direct consideration.
Figure 1: Porter's Five Forces Model

Porter's five forces model is an analytical framework which allows competitive

dynamics to be systematically appraised in assessing existing and future
profitability of particular markets/industries. Given that an enterprise's
profitability will be influenced by the profitability of an industry, this is a critical
issue. Porter argues that there are five forces influencing the level of market
profitability as illustrated in

Figure 1 above.
Figure 2: McKinsey/GE portfolio matrix

Industry
attractiveness

High
Medium
Low

High
Invest and
grow
Invest and
grow
Selective
investments

Competitive
strenghs
Medium
Invest and
grow
Selective
investments
Harverst or
divest

Low
Selective
investments
Harverst or
divest
Harverst or
divest

Each of these forces has an influence on the level of prices and costs and
consequently profits in a market. This point can be illustrated by discussing
some of the more direct and easily understood relationships. For example,
prices can be raised when there are many customers whose buying power is
low since individual customers cannot exert pressure on the enterprise. In
converse situations, prices are subject to downward pressure. The existence of
substitutes or alternative purchases for customers and where there are low
barriers of entry into the market, limits the potential to raise prices. A market
subject to major swings in customer demand or in which excess supply capacity
exists will be subject to intense competitive rivalry and downward pressure on
prices. This is particularly so where there are high levels of fixed costs and high
contribution margins on incremental sales (e.g., package holiday operators). In
a like manner, costs are influenced by the bargaining power of suppliers and the
rivalry amongst competitors for sources of supply