Strategic Positioning analysis & Cost Driver analysis

 Strategic

Cost Management is a way to address cost concern while preserving the key parts of the business Strategic cost management is the use of cost data to develop and identify superior strategies that will
produce a sustainable competitive advantage.

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Strategic decision making is choosing among alternative strategies with the goal of selecting a strategy, or strategies, that provides a company with reasonable assurance of long-term growth and survival
The

key to achieving this goal is to gain a competitive advantage.

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Competitive advantage is the process of creating better customer value for the same or lower cost than that of competitors or creating equivalent value for lower cost than that of competitors. Customer value is the difference between what a customer receives (customer realization) and what the customer gives up (customer sacrifice). customer satisfaction The total product is the complete range of tangible and intangible benefits that a customer receives from a purchased product.

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 Value

- chain Analysis Strategic Positioning Analysis Cost Driver Analysis

There are three general strategies that have been identified:

cost leadership product differentiation focusing

It happens when the same or better value is provided to customers at a lower cost than a companys competitors.

Example: A company might redesign a product so that fewer parts are needed, lowering production costs and the costs of maintaining the product after purchase.

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Economies of scale Learning Curve benefits learning refers to increase in efficiency that is possible at a given level of scale through having performed the necessary tasks. Experience can be brought into the company by hiring experienced staff and enhanced through training. Cost control Process innovation Reduce manufacturing time and cost Reengineering activities

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Strives to increase customer value by increasing what the customer receives (customer realization). Implemented effectively when the business provide unique or superior value to customer Higher price Uniqueness: product quality, features, after sales support

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It

happens when a firm selects or emphasizes a market or customer segment in which to compete. By operating in a niche markets not attractive to larger competitors
Example: Paging Network, Inc., a paging services

provider, has targeted particular kinds of customers and is in the process of weeding out the nontargeted customers.

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New Entrants

Suppliers

Rivalry among current competitors

Buyers

Substitutes

Source: Adopted from Porter's 5 force model (Competitive Advantage (1980).

Rel ativ e Diff ere ntia tion pos itio n

Differentiation

Differentiation with cost advantage

Stuck in the middle

Low cost advantage

Inferior

Superior

Relative cost position

 An

activity which generates cost A factor such as the level of activity or volume that causally affects cost. Existence of a cause-and-effect relationship between a change in the level of activity or volume and change in the level of total costs of that cost object. Thus cost drivers signify factors, forces or events that determine the costs of activities

 Direct

costs do not need cost drivers They are themselves cost drivers since they can be traced directly to a product. All other factory or manufacturing costs need cost drivers.

They are the links between a pool of costs in an activity centre and the product
A pool of costs COST DRIVERS Product

Therefore in order to trace overhead costs to products, appropriate cost drivers should be identified.

There are two categories of cost driver: Resource Cost Driver: A measure of the quantity of resources consumed by an activity. Used to assign the cost of a resource to an activity or cost pool. Activity Cost Driver: Measure of the frequency and intensity of demand, placed on activities by cost objects. Used to assign activity costs to cost objects.

Organizational activities are of two types: structural and executional. Structural activities are activities that determine the underlying economic structure of the organization. Executional activities are activities that define the processes and capabilities of an organization and thus are directly related to the ability of an organization to execute successfully.

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Structural Activities Building plants Management structuring Grouping employees Complexity

Selecting and using process technologies

Structural Cost Drivers Number of plants, scale, degree of centralization Management style and philosophy Number and type of work units Number of product lines, number of unique processes, number of unique parts Types of process technologies, experience

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Executional Activities
Using

Executional Cost Drivers

Degree of involvement Providing quality Quality management approach Providing plant layout Plant layout efficiency Designing and producing products Product configuration Providing capacity Capacity utilization

employees

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One of the keys to strategic cost management is the determination of the appropriate cost drivers. By identifying the key cost drivers, or the cause of the cost, strategic cost management not only tells managers where to start, but also what to start on.

First, examining the basic economics of activity; Examining the internal experience of the company The third way to identify cost drivers is interviews The final method for determining cost drivers is competitive cost analysis

 Examining

the internal experience of the company is the second way to identify cost drivers. This way is more useful especially if the events within the company have changed over the time because of new method of production, new design of product, operate multiple units, change of product mix, etc.

 The

third way to identify cost drivers is interviews. Cost drivers can be also determined from interviews with experts. Workers or managers who have extensive knowledge of a value activity can be asked "what if" questions about the effects of chaining various parameters on the cost

 The

final method for determining cost drivers is competitive cost analysis. By calculating competitors relative costs of value chain activities, and pinpointing their specific cost drivers, managers and accountants can understand why a company does or does not possess competitive advantage, and recommend to management opportunities to improve the firms competitive positioning

Thank you

Activity Based Costing

Activity based costing is an approach for allocating overhead costs. An activity is an event that incurs costs.

According to Sundem and Strotton , Activity Based Costing is defines as A system that first accumulates overhead costs for each of the activites of an organisation and then assigns the costs of activities of the products, services or other cost objects causing the activity.

Basics of A B C
Cost of a product is the sum of the costs of all activities required to manufacture and deliver the product. Products do not consume costs directly Money is spent on activities Activities are consumed by product/services

Basics of A B C (contd.)
ABC assigns Costs to Products by tracing expenses to activities. Each Product is charged based on the extent to which it used an activity
The primary objective of ABC is to assign costs to activities.

 ABC

is a methodology that measures the performance of resources, activities, and cost objects assigns resources to activities and activities to cost objects based on their use, and incorporates causal relationships between cost objects and activities as well as between activities and resources

Conventional Costing

AB Costing Economic Element

Expenses

Resources

Activities Cost Objects

Work Performed

Cost Objects

Product or service

1. Identifying the major activities that take place in an organization 2. Assigning costs to cost pools/cost centres for each activity 3. Determining the cost driver for each major activity 4. Assigning the cost of activities to cost objects

Activities are identified by carrying out an activity analysis. Activity analysis includes gathering data from existing documents and records, and using survey, questionnaires, observation, and ongoing interviews etc.

What work or activities do you do? How much time do you spend performing the activities? What resources are required to perform the activities? What value does the activity have for the organization?

Once activities are identified and described, the next task is determining how much it costs to perform each activity. This requires identification of the resources being consumed by each activity. Activities consume resources such as labor, materials, energy, and capital. (Although the companys general ledger is a good starting point to find information about the cost of resources used to perform activities, most general ledger systems report the costs of different resources such as indirect labor, electricity, equipment, and supplies, but do not report the cost of activities performed)

In order to assign the costs attached to each activity cost center to products or other cost objects, a cost driver must be selected for each activity center, such cost drivers used at this stage are called activity cost drivers. Three types of activity cost drivers: transaction( number of setups, receipts, and products supported, count how often an activity is performed) Duration (Duration drivers represent the amount of time required to perform an activity, setup hours and inspection hours ) and intensity (Intensity drivers directly charge for the resources used each time an activity is performed)

In manufacturing organizations, activities are grouped on the basis of different levels at which activities are performed and hence are identified and classified into broadly four different categories:
Unit Level Activities Batch Level Activities

Product Level Activities

Facility Level Activities

Activities performed each time a unit is produced. Unit level costs arise from the activities that are performed atleast once for each unit of product.

Example: Direct labour hours, Machine hours, Power are used each time a unit is produced Costs of unit level activities vary with the number of units produced

Activities performed each time a batch of goods or products is produced Batch level costs arise the cost for each batch or lot of products is produced Costs of batch level activities vary with the number of batches but are fixed with respect to the number of units in each batch Example: No. of (Machine setups, inspections, production scheduling, materials handling, purchase orders) etc..

Activities performed to support the production of each different type or model of product. These costs arise activities performed to support the production of products. Example: Product modifications, product design, product specification, Maintenance of equipment, engineering charges, testing routines, maintaining bills of materials

Activities needed to sustain a factorys general manufacturing process These costs arise from all remaining activities required to sustain the overall operation of the manufacturing organisation. Examples: Security, maintance insurance, administration Factory management, plant depreciation etc.

Examples of costs driven by activities at each level:

ACTIVITY LEVEL 1. Unit Level EXAMPLES OF ACTIVITY COST Cost of raw materials Cost of inserting a component Utilities cost of operating equipment Some costs of packaging Sales Commissions Cost of processing sales order Cost of issuing and tracking work order Cost of equipment setup Cost of moving batch between workstations Cost of inspection (assuming same number of units inspected in each batch)

2. Batch Level

ACTIVITY LEVEL 3. Product Level

EXAMPLES OF ACTIVITY COST Cost of Product Development Cost of Product marketing such as advertising Cost of specialized equipment Cost of maintaining specialized equipment Cost of maintaining general facilities such as buildings and grounds Cost of non-specialized equipment Cost of maintaining non-specialized equipment Cost of real property taxes Cost of general advertising Cost of general administration such as the plant managers salary

4. Facility Level

After cost pool is defined and cost drivers identified, per unit cost of the cost driver is calculated. This is called the Pool rate or activity cost driver base rate . It links costs and cost drivers with the resources used symbolically Cost per unit = u+ b+p+S Total unit level costs Total units Total Batch level costs Number of units Total product level cost Number of units Total cost of other remaining activities Number of units produced

u = b = p = S =

Thus, at the final stage, the cost pool, cost driver and the pool rate combine to determine, how much cost should be assigned to each product/Unit The cost function assumed is stated as follows

= Vu + bB + pP +S

V = Per unit variable cost B = Per batch variable cost P = Per product line variable cost

FUNCTIONAL AREAS Materials Management Stores Management

ACTIVITIES Issue of purchase orders Inspection of materials Storing of materials Servicing of requisitions Inspection & Verification

SUITABLE COST DRIVERS Number of purchase orders Number of purchase orders Value of materials stored Number of requisitions Number of times inspected

Stock Taking
Quality Control Testing of Samples

Value of stock
Number of batches produced

Marketing

Demand Creation
Advertising Despatches

Increase in sales
Increase in sales Number of orders

FUNCTIONAL AREAS

ACTIVITIES

SUITABLE COST DRIVERS

Personnel Management

Recruitment of employees
Maintenance of leave records & attendance

Number of employees recruited

Number of employees

Research & Development Machining

Research Setup Cost Power cost

Number of research Projects Number of production runs Machine hours

Mapping
Accounting Records Salaries 313,000 Depreciation Electricity Supplies Travel Total 155,000 132,000 25,000 100,000 725,000
Total 313,000 155000 132000 25000 100000 725,000 Activities Business Development ABC Records Salaries Depreciation Electricity Supplies Travel 20,000 25000 60000 50000 10000 10000 5000 50000 20000 2000 50000 5000 25000 5000 20000 5000 Total 55,000

Maintianing Present Business 80,000 Purhcasing Material Set up Machines Running Machines Resolve Quality Problems 125,000 25,000 50,000 13,000

10000 205,000 60000 275,000 37,000 110,000 43,000

Activities Drivers Unit Level Acquire and Use material for containers No. of Containers Acquire and Use material for baby-care products No. of products Batch Level Set up manually controlled machines Set up computer controlled machines Product Level Design and manufacture moulds Use manually controlled machines Use conputer controlled machines Customer Level Consult customers Provide warehousing for customers

No. of batches of contain No. of batches of B. Prod

No.of moulds required Product type (containers) Product type (B.Products

No. of consultations No. of cubit feet

Faciltiy Level Manage workers

Salaries

Activities Drivers Unit Level Acquire and Use material for containers No. of Containers Acquire and Use material for baby-care products No. of products Batch Level Set up manually controlled machines No. of batches of containers Set up computer controlled machines No. of batches of B. Produst Product Level Design and manufacture moulds No.of moulds required Use manually controlled machines Product type (containers) Use conputer controlled machines Product type (B.Products) Customer Level Consult customers No. of consultations Provide warehousing for customers No. of cubit feet

Activity Cost Activity Volume Activity Rate 40,000 80,000 1,000,000 8,000 0.04 10

3,000 12,000

10 20

300 600

5,000 15,000 40,000

5 1 1

1000 15000 40000

4,000 2,000

40 10,000

100 0.2

Faciltiy Level Manage workers Salaries Use main building Square feet 3,000 48,000 15,000 16,000 0.2 3

Ascertaining Cost
Activities A. Rate A.Volume Containers Baby Product Unit Level Acquire and Use material for containers 0.04 1,200,000 48,000 Acquire and Use material for baby-care products 10 7,000 70000 Batch Level Set up manually controlled machines Set up computer controlled machines Product Level Design and manufacture moulds 1000 1 4 1 1 1,000 4000 15,000 40000

300 600

12 16

3,600 9600

Use manually controlled machines Use conputer controlled machines Customer Level Consult customers Containers B.products Provide warehousing for customers Containers B.products Faciltiy Level Manage workers Containers B.products Use main building Containers B.products Total Cost

15000 40000

100 2 40 0.2 8,000 2,000 0.2 4,000 10,000 3 5,000 7,000 15,000 85,200 21000 151,000 800 2000 1,600 400 200 4000

Building an ABC Model

Identify Resources Identify Activities Identify Cost Objects

Define Activity Drivers

Define Resource Drivers

Enter Resource Costs

Enter Resource Driver Qty.

Enter Activity Driver Qty.

Calculate Costs

Thank you