CHAPTER

3
CONTEMPORARY BUSINESS
ENVIRONMENT AND STRATEGIC
FOCUS OF COST MANAGEMENT
EXPECTED LEARNING OUTCOMES
After studying this chapter, you should be able to...
1. Describe the more recent changes in
contemporary business environment such as
The Global Business Environment
Advances in Manufacturing Techniques
Advances in Information ...
A greater focus on customers
New forms of organization
Changes in the Social, Political & Cultural
Environment
cost
2. Explain the strategic focus of cost management
3. Describe the relationship between
management and the accounting systems
4. Explain the concept of integrative framework on
how the accounting system is used in the firm's
organizational architecture

CHAPTER 3
CONTEMPORARY BUSINESS ENVIRONMENT AND
STRATEGIC FOCUS OF COST MANAGEMENT
CONTEMPORARY BUSINESS ENVIRONMENT
The business environment in recent years has been characterized by increasing
competition and relentless drive for continuous improvement. These changes
include (1) an increase in global competition (2) advances in manufacturing
technologies; (3) advances in information technologies, the Internet, and
commerce; (4) a greater focus on the customers (5) new forms of management
organization, and (6) changes in the social, political, and eultural environment
of business. As businesses turned global and product lines expanded, operations
have become more complex, forward-looking companies saw a tremendous need
for management oriented data that was separate from financial oriented data,
a
Corporate executives are now using cost data to chart successful futures for their
companies. Adapting management accounting system to better meet
management's needs for information is crucial to an organization's survival when
competing in global markets, Global competitors now have relatively free access
to markets around the world. As a result, domestic markets on virtually every
country face greater challenges from foreign competition. With increased reliance
on global markets, companies need not only respond quickly to changing market
conditions but also tailor products to different consumer tastes and demands and
this has to be done at a level that assures profit and gives satisfactory returns to
shareholders.
In today's automated environment management accountants use their management
control systems to support and reinforce manufacturing and other operating
strategies. It is in this light that one learns to appreciate the role of a management
accountant which is more of an influencing role rather than just an informing role,
The change in the business environment in at least the last two decades where
organization have to transform themselves to become more competitive, have
profound effect in the practice of management accounting. Of particular
importance are the changes in business, especially the increase in global
competition and the changes in management techniques, that have created the need
for a new, strategic approach to management and to cost management.

56
Chapter 3
The Global Business Environment
The growth of international markets and trade are the key development that drive
the extensive changes in the contemporary business changes in the contemporary
business environment. Profit-oriented business and not-for-profit organization,
consumers and regulators are all affected significantly by the rapid growth of
economic independence and increased competition from other continues. The
growing number of alliance among large multinational, the increasing trade
agreements among countries indicate clearly that the opportunities for growth and
profitability lie in global markets. As low-cost, high quality goods are traded
worldwide, most consumers are benefited. Manager, business owners and
investors benefit likewise when sales and production activities are pursued in
foreign countries.
Global business environment is very competitive and firms need cost management
information to sustain competitiveness. They also need financial and nonfinancial
information about doing business and competing effectively.
Advances in Manufacturing Technologies
Firms around the world adopt new manufacturing technologies to remain
competitive in the face of the increased global competition. Many firms adopt
methods applied in some Japanese manufacturing firms that produced significant
cost and quality improvements using quality teams, and statistical quality control.
Some firms include just-in-time inventory method in order to reduce the cost and
waste of maintaining large levels of raw materials and unfinished product. A key
competitive edge that forms have is the ability to deliver the product or service
faster than the competition. This is known as speed-to-market.
Advances in Information Technologies, The Internet and E-Commerce
The increasing use of information technology, the internet and e-commerce is
perhaps the most fundamental of all business changes in recent years. This new
economy is manifested in the rapid growth of Internet-based firms (the dot-com's
such as Amazon, eBay, and E-trade) and the increased use of the Internet for
business data processing, communication, and sales. These technologies have
resulted in the growing focus in cost management by reducing the time required to
process transactions, thereby expanding the individual's access to information
within the firm, the industry and the business environment around the world.

Contemporary Business Environment and Strategic Focus of Cost Management

A Greater Focus on Customers
To succeed in this era, customer value is the key focus that businesses of all types
must be concerned with. A key change in increased customer demand for product
functionality and quality. As business firms seek to add new features and new
products as quickly as possible, shorter product life cycle thereby increasing the
overall intensity of competition. The new business process focuses on customer
satisfaction.
Producing value for the customer has changed the orientation of managers trom
low-cost production of large quantities to quality, service, faster delivery and the
ability to respond to the customer's desire for specific feature. Today, many of the
critical success factors are customer oriented. Cost management practices are also
changing, cost management reports now include specific measures of customer
preference and customer satisfaction.
The value of a product or service to the customer is affected by such diverse
attributes as product price, quality, functionality, user-friendliness, customer
service, warranty and maintenance costs. By managing activities that will increase
customer value, the firms can establish a competitive advantage by creating better
customer value for the same or lower cost than that of competitors. Cost
information plays an important part in the process called strategic cost
management. Generally, firms chose a strategic position corresponding to one of
two general strategies:
(a) cost leadership, and
(b) superior product through differentiation.
A focus on customer value means that the management acounting system should
produce information about both realization and sacrifice. The system should be
able to measure various attributes of customer value.
Successful pursuit of cost leadership and/or differentiation strategies requires an
understanding of a firm's value chain (intermal) and supply chain (external).

58 Chapter 3
New Forms of Management Organization
Management organization has changed in response to the changes in marketing
and manufacturing. Because of the focus on customer satisfaction and value, the
emphasis has shifted from financial and profit-based measures of pertormance to
customer-related, nonfinancial performance measures such as quality, time to
delivery and service. Similarly, the hierarchical command-and-control type of
organization is being replaced by a more flexible organizational trom that
encourages teamwork and coordination among business functions. Ins response to
ucsc Cnanges, cost management practices are also changing to include reports that
are useful to cross-functional teams of managers; the reports retlect the
muitinational roles of these teams and include a variety of operating and financial
Oaton: product quality, unit cost, customer satisfaction, and production
bottlenecks. The changes in management organization and marketing in the
environment of business are summarized in Figure 3-1.
Figure 3-1: Comparison of Prior and Contemporary Business Environments
Contemporary Business
Environment
Prior Business
Environment
Management Organization
Financial and operating
data, the firm's strategic
Success factors
Network-based
organization forms,
teamwork focus
Type of information
recorded and reported
Almost exclusively financial
data
Hierarchical, command and
Management
organizational structure
control
employee has more
responsibility and control,
coaching rather than
command and control
Emphasis on the long
term, focus on critical
success factors,
commitment to the long
term success of the fimm,
including adding
shareholder value
Management focus
Emphasis on the short tem,
short-term performance
measures and compensation,
Concem for sustaining the
current stock price, short
tenure and high mobility of top
managers

awompanaN Shsimess Eviroeneent and Strategic Focus of Cost Marnagement

Manufacturing
Basis of compensatior
Standardization, economies
of scale
High volume, long production
runs, significant levels of in-
process and finished
inventory
Quality, functionality
customer satistaction
Low volume, short
production runs, focus on
reducing inventory levels
and other non-value-added
Manufacturing process
actvities and costs
Robotics, flexible
manufactuning systems,
integrated technology
applications connected by
networks
Individually and team
paced, high-level skills
Goal of zero defects
Manufacturing
technology
Assembly-line automation,
isolated technology
applications
Required labor skils
Machine-paced, low-level
skills
Acceptance of a normal or
usual amount of waste
Emphasis on quality
Marketing
Large number of
variations, short product
life cycles
Global
Relatively few variations, long
product life cycles
Products
Markets
Largely domestic
Changes in the Social, Political, And Cultural Environment of Business
Significant changes have taken place in the social, political, and cultural
environments that affect buşiness. Although the nature and extent of these changes
vary a great deal from country to country, they include a more ethically and racially
diverse workforce, a renewed sense of ethical responsibility among managers and
employees, and an increased deregulation of business by the national government
The new business environment requires firms to be flexible and adaptable and to
place greater responsibility in the hands of a more highly skilled workforce.
Additionally, the changes tend to focus the firm factors outside the production of
its product or provision of its service to the ultimate consumer and the global
sOCiety in which the costumer lives.

Chpter3
STRATEGIC FOCUS OF COST MANAGEMENT
A competitive fim incorporates the emerging and expected change in the
Contemporary environment of business into its business planning and practices
1nis irmis customer-driven, uses advanced manufacturing technologies when
appropriate, anticipates the effect of changes in regulatory policies and customer
tastes, and recognizes its complex social, political and cultural environment.
Guided by strategic or long-term thinking, the management accountant focuses that
make the company successful rather than just focusing on cost control and other
financial measure.
Cost management should focus not on the measurement per but on the
Identification of those measures that are critical to the firm's success.
Phases of the development of cost management systems should consider the
following
Stage 1:
Stage 2:
Cost management systems are basic transaction reporting system.
As they develop into the second stage, cost management systems
focus on external financial reporting. The objective is reliable
financial reports; accordingly, the usefulness for cost management
is limited.
Stage 3:
Cost management systems track key operating data and develop
more accurate and relevant cost information for decision making:
cost management information is developed.
Stage 4: Strategically relevant cost management information is an integral
part of the system.
Stages 1 and 2 of cost system development focus on the management accountant's
measurement and reporting role. Stage 3 shifts to operational control. Stage 4, the
management accountant becomes an integral part of management, not just a
reporter but a full business partner, with the skills of identifying, summarizing and
reporting critical factors necessary for the firm's success.
Critical Success Factors (CSFs) are measures of those aspects of the firm's
performance essential to its competitive advantage and, therefore, to its succbss.
Many of these critical success factors are financial, but many are nonfinancial. The
CSFs for any given firm depend on the nature of the competition it faces.

Contemporary Busimess Environment and Strategic Focus of Cost Management o

coST MANAGEMENT AND ACcOUNTING SYSTEMS
The term cost management is widely used in businesses today. Unfortunately, there
is no uniform definition. We use cost management to describe the approaches and
activities of managers in short-run and long-run planning and control decisions
that increase value for customers and lower costs of products and services. FOr
example, managers make decisions regarding the amount and kind of material
being used, changes of plant processes, and changes in product aesigns
Information from accounting systems helps managers make such decisions, but the
information and the accounting systems themselves are not cost management.
Cost management has a broad focus. For example, it includes- but it not confined
to the continuous reduction of costs. The planning and control of costs is usually
inextricably linked with revenue and profit planning. For instance, to enhance
revenues and profits, managers often deliberately incur additional costs for
advertising and product modifications.
Cost management is not practiced in isolation. It's an integral part of general
management strategies and their implementation. Examples include programs that
enhance customer satisfaction and quality, as well as programs that promote
"blockbuster" new product development.
WHEN SHOULD THE INTERNAL ACCOUNTING SYSTEM BE
CHANGED?
The succeeding sections will analyze organizational innovations. These
innovations illustrate that internal accounting systems are an integral part of the
organization's architecture. When managers change the architecture of their
organization by decentralizing decision rights and empowering employees via
TQM programs because the firm's business strategy changes, accounting systems
are likewise modified. Similarly, when JIT production systems are installed,
accounting system changes follow, However, there were no organization changes
associated with productivity measurement systems and these accounting systems
were not widely implemented.
There is no such thing as the ideal management accounting system. Each
organization has different Circumstances that lead to different management
accounting decisions. Also, accounting must continually deal with trade-offs
among external users wanting information describing firm performance andd
internal users wanting information for decision making and control. Surviving
organizations must meet the demands of changing technologies and markets by

62 Chapier 3
evising their business struetures and organizational architectures. Because
Organizational architectures are in a constant state of change. the accounting
system must regularly adapt.
There are certain signs that indicate that the internal accounting system 1s not
working well. One sign is dysfunetional behavior on the part of managers because
of poorly chosen performance measures, Managers will make decisions to
positively influence performance measures. Ifthose performance measures are not
consistent with the goals of the organization, management will make decisions that
do not coincide with the organization's goals. Another sign of problems with the
accounting system is poor operating decisions. If product mix and pricing
decisions based on management accounting are not adding to the organizational
value, then the accounting system is either providing inaccurate estimates of
oPportunity costs and/or creating dysfunctional incentives.
Often changes in customers' organizational architectures cause suppliers to change
their architecture (and accounting systems).
modifying their organizational architectures, they are likely responding to
technological and market conditions. The way in which knowledge is generated
and disseminated has probably changed. These changes are likely affecting your
firm's organizational architecture
If your major customers are
Organizations should not necessarily look to the latest management accounting
fads to give them direction in changing their management accounting systems.
Activity-based costing (ABC), for example, is only appropriate for certain types
of organizations. Each organization must continually evaluate and improve its
management accounting system to meet the challenges of a changing environment
and a changing organization.
This text will emphasize the dual role of internal accounting systems for decision
making and control. Because the internal accounting system is performing two
separate roles (it is also being used for taxes and financial reporting), trade-offs
between these roles must be made. In its decision-making role, the accounting
system is the first place managers turn to help them estimate opportunity costs.
However, accounting numbers are not forward-looking opportunity costs
Accounting systems record historical costs, which are backward looking
Therefore, accounting numbers are useful for decision making only under very
strong assumptions, primarily that the future will look like the past.

Contemporary Business Evironment and Strategic Focus of Cost Managemen

INTEGRATIYE FRAMEWORK
Succeeding chapters of this book will describe and analyze cost management
accounting systems. Besides being used for both decision making and control,
these accounting systems support external reporting for shareholders, taxes, and
government regulations. Thus, one of the central themes of this text is that trade
offs arise when the accounting system is designed for multiple purposes. In
addition to providing a better understanding of the internal uses of accounting
system, this book reinforces the importance of viewing the accounting system as
part of the firm's organizational architecture. This analytic structure will help
readers better understand, use, and design future accounting systems as well as
other systems that evaluate and reward performance and partition decision rights.
Figure 3-2 shows the integrative framework for understanding how the accounting
system is used in the firm's organizational architecture. Starting at the top, two
external factors (technological innovation and market conditions) affect the firm's
business strategy. The business strategy then interacts with the firm's
organizational architecture to provide incentives for managers and employees.
These incentives affect the actions taken, which in turn affect the value of the firm.
Thus, Figure 3-2 emphasizes that external factors like technology and market
conditions affect investments, organizational architecture, incentives, actions, and
ultimately the value of the firm.
Figure 3-2 provides two important observations:
1. Changes in the accounting system rarely occur in a vacuum. Accounting
system changes generally occur at the same time as changes in the firm's
business strategy and other organizational changes, particularly with
regard to the partitioning of decision rights and the performance evaluation
and reward systems.
2 Alterations in the firm's organizational architecture, including changes in
the accounting system, are likely to occur in response to changes in the
firm's business strategy caused by external shocks from technology and
shifting market conditions.

64 Chapter3
Figure 3-2: The
architecture, and firm value
determinants of business strategy, Organizational
Market
conditions
Technologicai
innovation
Business strategy
Asset structure
Customer base
Nature of knowledge creation
Organizational architecture
Decision rights partitioning
Separation of decision management from decision contro
Centralization/decentralization
Performance evaluation system
Accounting system
Nonfinancial systems
Performance reward and punishment system
Compensation policy
Promotion policy
Incentives and actions
Firm value

Contemporary Business Emvironment and Strategic Focus of Cost Management65

Three significant managerial implications are derived from these two observations.
First, before implementing an accounting or other organizational change, it 1s
important to understand what is driving the change. Second, an accounting system
should not be adopted merely because other fims are doing so; they may be
reacting to a different set of external shocks. Third, an accounting system should
not be changed without concurrent, consistent changes in the way deciSion rights
are partitioned as well as in the performance reward systems. All three parts of the
organization's architecture must be internally consistent and coordinated.