MODULE 1

Accounting Introduction

SESSION TOPIC 1: Introduction: Need for Strategic Management

LEARNING OUTCOMES:
The following specific learning objectives are expected to be realized at the end of the session:
1. For students to appreciate the importance of Strategic Cost Management in the business.
2. Explain what a Strategic Management is, and its distinct purpose in the business organization contributing to
efficient management performance.

KEY POINTS

Strategic Cost Management Cost Accounting Management Accounting

Traditional Cost Management

CORE CONTENT
Introduction:
This module covers a discussion of the nature, purpose and importance of Strategic Cost Management. As what
was said in the Journal for Business and Retail Management Research, “strategic cost management is a philosophy, an
attitude, and a set of techniques to contribute in shaping the future of the company”.

Oftentimes, Cost Management is misinterpreted to be synonymous to Cost Accounting. However, these two
means different things as one is broader than the other. It is not even the same with Management Accounting, although it
includes working capital management (inventory management, in particular), breakeven analysis, and variance analysis.
Cost Accounting is the determination of how much things costs. Cost Management is broader in scope than the other two
mentioned. Cost Management is far more concerned with the use of cost information for decision making.

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 Traditional Cost Management cuts expenses by any means necessary (ex. Cutting employees, cutting product
components etc.) while Strategic Cost Management also cuts costs in consideration of the business strategies and
specific objectives such as increasing profitability, gaining strategic advantage, achieving grater competitive advantage
etc.

Strategic cost management (SCM) is the application of cost management techniques that simultaneously improve
the strategic position of a firm and reduce costs (R. Cooper, 1998). It is a philosophy of improving cost and revenue;
strategic cost management is not only cost management but also revenue management, therefore, its objective is seeking
to improve productivity, maximize profit, and improve customer satisfaction. This philosophy plays a vital role in
determining the future of the company because it promotes the idea of continually finding ways to help organizations
make the right decisions to maximize customer value at lower cost (Kumar & Shafabi, 2011). Through seeing the
company as an integrated part of the global market and as an interface between supplier and customer through the
supply chain they will be able to resist the intense global competition. The traditional management accounting has evolved
in strategic management accounting (SMC) by taking in consideration the external factors that contribute in a value added
for the company and that have impact on the products’ costs. The SMC makes a wider and deeper analyzes of the
economical events that surround the company by using not only quantitative data, but qualitative data too, providing long-
term strategic insights to its management. The strategic management accounting will enable the companies to identify
their strong and weak points by improving the company’s position in among the competitors and in the market.

For example, the strategy of a manufacturing firm is to be able to offer rapid turnaround of customer orders by
maintaining tight control over its bottleneck production operation. To do so, the company incurs extra costs to keep the
bottleneck running 24x7. Expending extra funds here directly contributes to the profitability of the business. Conversely,
cutting costs at the bottleneck operation will reduce the production capacity of the business and will have an immediate
negative impact on its profits. From a strategic perspective, the company would do better to cut costs in non-bottleneck
areas that are downstream from the bottleneck operation, since these cuts would have no impact on the delivery times
quoted to customers.

It is almost never worthwhile to cut costs in strategically important areas, since doing so reduces the customer
experience and therefore will eventually lead to a decline in sales. Consequently, management needs to be involved in
cost reduction activities, so that they can provide input regarding how certain costs must be incurred in order to support
the competitive position of the firm.
Strategic cost management is a continuing process, since the strategy of a firm may change over time. Thus,
certain costs may be sacrosanct when one strategy is being used, but can be readily eliminated when the strategy shifts.

Need for SCM

1. It is an updated form of cost analysis, in which the strategic elements are more clear and formal and improves the
overall position of the company.
2. It is used to analyse cost information, and use it to develop various measures to achieve a sustainable
competitive advantage.
3. It provides a better understanding of the overall cost structure in the quest of gaining a sustainable competitive
advantage.
4. It uses cost information specifically to govern the strategic management process – formulation, communication,
implementation and control.
5. It helps in identifying the cost relationship between value chain activities and its process of management to gain
competitive advantage.
The strategic cost management must be implemented at the initial stages of production, so as to reduce heavy
cost failure.

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THE ACCOUNTING INSTRUMENTS OF SCM

SCM uses a wide range of instruments in performing its main objectives of delivering customer oriented products with the
minimal costs as well as establishing new strategies for increasing the company performance. There is a considered
number of accounting related instruments that SCM uses to reach company’s strategic goals, but we can classify them
into five main categories: costing, planning control and performance management, strategic decision-making, competitor
accounting and customer accounting (Cadez & Guilding, 2008). Below we will list some of the most used and popular
accounting instruments of SCM from each perspective:

Activity based costing: Is a methodology of “costing” category that attempt to make e detailed analysis of the
indirect cost by converting them into direct costs (Cooper & Slagmulder, 1999). According to this method the
costs are derived from the activities rather than the products, and the products absorb these costs from the
activities. In the ABC method more than one cost drivers are used.

Benchmarking: Is a process included in “planning control and performance measurement” category where a
company is in a continuous attempt of comparing the business processes with the industry best companies’
practices (McNair & Leibfried, 1992). In benchmarking not only quantitative variables are taken in consideration
but also qualitative like quality of competitor’s products, timing processes, results etc.

Competitive position monitoring: Is the analysis of competitor positions within the industry by assessing and
monitoring trends in competitor sales, market share, volume, unit costs and return on sales. This information can
provide a basis for the assessment of a competitor's market strategy (Cinquini & Tenucci,2010). It is a method of
“competitor accounting” category.

Customer accounting: it takes in consideration the cost benefit analysis from the customer’s aspects and analysis
like customer profitability, customer segment profitability, lifetime customer profitability, valuation of customers or
customer groups as assets and customer accounting (Smith & Dikolli, 1995).

Environmental Management Accounting: is an approach that is mostly focused on the external cost drivers of the
company that affect the environment and concerning the sustainable growth by increasing material efficiency and
reducing the possible environmental costs (UNDSD , 2001). Is a methodology included in “planning control and
performance measurement”.

Life cycle costing: Is a technique of “costing” and includes a set of cost evaluation of procedures and production
techniques that considers all the lifecycle of the products from its design and manufacturing till the end life or the
abandonment of the products, which has in focus the determination of the most optimal cost (Flanagan et.al 1989).

Quality costing: Quality costs are the costs associated with preventing, detecting, and remediating product issues
related to quality. Quality costs do not involve simply upgrading the perceived value of a product to a higher
standard. Instead, quality involves creating and delivering a product that meets the expectations of a customer.
This method takes part in “costing” category of SCM.

Strategic costing: is a “strategic decision making” tool that process and develops cost information to help
managers making strategic choices. It examines the basic relationship between the cost of providing a product or
a service and the value delivered to sustain competitive advantage (Porter & Michael, 2009).

Strategic pricing: the analysis of different strategic factors in the pricing decision process. These factors may
include various data, including qualitative data like competitor price reaction, price elasticity, market growth,
economies of scale and experience (Guilding et. Al 2000). This tool is a “strategic decision making” category.

Target costing: Is a “costing” tool techniques. target cost is the maximum amount of cost that can be incurred on a
product and with it the firm can still earn the required profit margin from that product at a particular selling price.
The estimated cost is calculated by subtracting a desired profit margin from an estimated (or market- based) price
to arrive at a desired production, engineering, or market cost. The product is then designed to meet that cost
(Takao, 1993).

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The main objective of cost management is to reduce the costs expended by an organization while strengthening the
strategic position of the firm. Three ways to institute cost management techniques are as follows:

 Establish systems to help streamline the transactions between corporate support departments and the operating
units.
 Devise transfer pricing systems to coordinate the buyer-supplier interactions between decentralized
organizational operating units
 Use pseudo profit centers to create profit maximizing behavior in what were formerly cost centers.
These cost management systems will not only manage costs, but also enhance profit consciousness. This will help the
organizations’ ability to serve its customers because divisions will become increasingly more focused on operating more
efficiently.

Types of Cost Management

Three types of cost management are:
1. Those that strengthen the organization’s competitive position.

 An example of a cost management technique that strengthens an organization’s position is illustrated as

follows. A hospital redesigns its patient admission procedure so it becomes more efficient and easier for
patients. The hospital will become known for its easy admission procedure so more people will come to that
hospital if the patient has a choice. The strategic position of the hospital has just been increased over its
competitors.

2. Those that that have no impact on the organization’s position.

 An example of a cost management technique that has no impact on the organization’s competitive position is
illustrated as follows. An insurance company decides to reevaluate its accounts payable system to make it more
efficient. The evaluation has no positive benefits to the insurance company in the external market. The objective
of the change is to make the organization more profitable.

3. Those that weaken the organization’s position.

 An example of a cost management technique that will weaken the organization’s competitive position is illustrated
as follows. A large airline company only has two desks for administering and selling tickets. This set-up induces
long lines for the airline customer which can ultimately result in high dissatisfaction and a bad reputation for the
airline. This may reduce the amount of ticket sales when compared with the airline’s competitors. Even though
having only two desks available for customers may initially be cost effective, in the long run, it harms the company.
 As a general rule, an organization should never undertake any practices that are predicted to weaken the position
of the organization.

Costs Involved with Cost Management

Effective cost management involves managing a variety of costs. It is important to recognize these costs and
acknowledge the classification of various expenditures. As a manger, this will help you become a better cost analyst.

Direct Costs - Costs that are physically related to a project. They are subject to the influence of the project manager. An
example is a contractor that provides hardware or labor for a project.

Service Costs - Costs that cannot be specifically indetified to a project, but can be linked to a project and are assigned
based on usage or consumption. An example is an automatic data processing system.

General and Administrative (G&A) Costs - Costs which cannot be related to a specific project but benefit all activities. An
example of a G&A cost is costs associated with financial management, security, or legal activities.

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IN-TEXT ACTIVITY
Strategic Cost Management
The process of reducing total costs while improving the strategic position of a business.

Cost Management
The process of planning and controlling the budget of a business. Cost management is a form of management
accounting that allows a business to predict impending expenditures to help reduce the chance of going over budget.

SESSION SUMMARY
Strategic Management is (SCM) is the application of cost management techniques that simultaneously improve
the strategic position of a firm and reduce costs (R. Cooper, 1998). It is a philosophy of improving cost and revenue;
strategic cost management is not only cost management but also revenue management, therefore, its objective is seeking
to improve productivity, maximize profit, and improve customer satisfaction.

It is different and broader in scope from Cost Accounting and Management Accounting although it uses the cost
accounting data in its implementation.

Traditional Cost Management cuts expenses by any means necessary (ex. Cutting employees, cutting product
components etc.) while Strategic Cost Management also cuts costs in consideration of the business strategies and
specific objectives such as increasing profitability, gaining strategic advantage, achieving greater competitive advantage
etc.

SELF-ASSESSMENT
Assignment:
Understanding of Strategic Cost Management
1. Explain the nature of Strategic Cost Management, its use and purpose in the business.
2. How is it different from Cost Accounting and Management Accounting.
3. Explain how Strategic Cost Management differ from the Traditional Cost Management by citing a scenario in a
business.

REFERENCES
https://businessjargons.com/strategic-cost-management.html

https://managementstudyguide.com/strategy-implementation.htm

https://www.accountingtools.com/articles/strategic-cost-
management.html#:~:text=Strategic%20cost%20management%20is%20the,strategic%20position%20of%20a%20busine
ss.&text=For%20example%2C%20the%20strategy%20of,over%20its%20bottleneck%20production%20operation.

https://en.wikipedia.org/wiki/Strategic_control#:~:text=Strategic%20control%20is%20the%20process,handle%20uncert
ainty%20and%20ambiguity%20at

https://msu.edu/course/prr/473/oldstuff/final%20cost%20management.htm

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