CONTEMPORARY BUSINESS CHAPTER ENVIRONMENT AND STRATEGIC FOCUS OF COST MANAGEMENT

EXPECTED LEARNING OUTCOMES

After studying this module, students 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

2. Explain the strategic focus of cost management

3. Describe the relationship between cost 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

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 customer; (5) new forms of management
organization; and (6) changes in the social, political, and cultural 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.

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.

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.

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 from 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 accounting 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

fim's value chain (internal) and supply chain (external).

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 to 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 from that encourages teamwork and coordination among business
functions. In response to these changes, cost management practices are also changing to include reports
that are useful to cross-functional teams of managers; the reports reflect the multinational roles of
these teams and include a variety of operating and financial information: 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.
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.

STRATEGIC FOCUS OF COST MANAGEMENT

A competitive firm incorporates the emerging and expected change in the contemporary environment
of business into its business planning and practices. The firm is 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: Cost management systems are basic transaction reporting systems.

Stage 2: 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 success. Many of these critical success factors are financial,
but many are nonfinancial. The CSF’s for any given firm depend on the nature of the competition it faces.

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 decision 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 designs. 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
and internal users wanting information for decision making and control. Surviving organizations must
meet the demands of changing technologies and markets by revising their business structures 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 is not working well. One sign is
dysfunctional behavior on the part of managers because of poorly chosen performance measures.
Managers will make decisions to positively influence performance measures. If those 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). If your major customers are 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.

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.
INTEGRATIVE FRAMEWORK

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.

Figure 3-2: The determinants of business strategy, organizational architecture and firm value.
Three significant managerial implications are derived from these two observations. First, before
implementing an accounting or other organizational change, it is important to understand what is
driving the change. Second, an accounting system should not be adopted merely because other firms
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.