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Management Decisions in Cost Management

Matches of cost management techniques and management decisions are:

Learning about how operations work ___ The design of incentive bonuses of up to 12% of salary by Electricity Corporation (ECNZ) for middle managers based on meeting difficult profit goals

Management Decisions in Cost Management

Organizing resources into efficient activities and operations __ The use of seminars called What if I owned the business? by Television Corporation (TVNZ) to introduce staff to issues of competition Measuring actual and expected costs of activities, products, and services __ ECNZs decision to restructure into four major operating divisions: Production, Marketing, Power Transmission, and Construction

Management Decisions in Cost Management

Identifying profitable products, services, customers, and distribution___ The decision by Coal Corporation (CoalCorp) to evaluate every job currently performed by employees to determine which jobs were essential to the goal of profitability Identifying opportunities for improvements in the value of products and services___ TVNZs new focus on estimating the costs of television programming and production

Management Decisions in Cost Management

Communicating effectively__ The decision by Public Works Corporations (WORKS) to sell its poorly performing Property and Computing Services divisions Motivating and evaluating personnel___ TVNZs analysis of TV3s programming and advertising practices, its new commercial rival

Short-term and long-term Performance Measures

Short-term performance measures are those based on periods less than a year, such as accounting earnings or total sales. These measures are used to assess the achievement of an employee or business unit for a given short period of time. In contrast, long-term performance measures, while quantified in terms of current achievement, are used to assess both the current and potential performance of the employee or unit. Examples of long-term measures include customer satisfaction, product quality, manufacturing cycle time, and productivity.

Critical Success Factors (CSFs)


Critical success factors are strategic financial and non-financial measures of success. Critical success factors are used to define and measure the means by which a firm achieves a competitive advantage. Strategic cost management involves the development, understanding, and use of critical success factors to manage business firms and other organizations.

CSFs for Chemical Manufacturer

Several potential critical success factors for an industrial chemical manufacturer might include: 1. cost and price, since most chemicals are commodities which compete principally on price 2. speed of delivery, since many applications for these chemicals require prompt delivery 3. quality of the chemicals, so that they meet the required specifications of the customers 4. location and cost of storage, to enhance customer service and reduce overall costs 5. modernization of production and processing facilities, to produce the highest quality chemicals at the lowest prices 6. research and development, to introduce new and improved products

CSFs for Savings & Loan Institution


Several potential critical success factors for large savings and loan institution might include: 1. Spread between the cost of funds and the earnings on investments and loans 2. Amount of total deposits, number of depositors, number of new offices, number of loans 3. Decrease in loan losses, number of bad loans, losses due to theft and fraud 4. Training hours per employee, employee turnover, 5. Customer satisfaction as measured by phone survey or other means

CSFs for Small Chain of Retail Jewellery Store

Several critical success factors for a small chain of retail jewelry stores might include: 1. Growth in sales, number of new customers, number of new products, number of branch stores 2. Operating costs, by category 3. Customer satisfaction as measured by phone survey or mail survey 4. Identification and introduction of new products 5. Effective promotion and advertising using a variety of media 6. Competitive service policies 7. Identification of attractive store locations 8. Effective control of inventory to prevent fraud and theft

CSFs for a Large Retail Discount Store

Several potential critical success factors for a large retail discount store might include: 1. Growth in sales, number of new branch stores 2. Operating costs, by category 3. Customer satisfaction, as measured by phone survey or mail survey 4. Identification and introduction of new products 5. Effective promotion and advertising using a variety of media 6. Competitive service policies 7. Identification of attractive store locations 8. Effective inventory management, both to reduce employee theft and also to reduce waste, overstocking and excessive out-of-stock conditions 9. Choice of merchandise mix, to attract customers

CSFs for a Small Auto Repair Shop


Several potential critical success factors for a small auto-repair shop might include: 1. reliability of service 2. fair pricing 3. warranty for service; and policies for satisfying customer complaints when they occur 4. inventory management to reduce loss, waste and to reduce the cost of carrying inventory of parts 5. proper location with sufficient parking and easy access 6. effective marketing using the appropriate media

Balanced Score Card

The balanced scorecard is an accounting report that includes the firms critical success factors in four areas: customer satisfaction, financial performance, internal business processes, and innovation and learning (human resources). The primary objective of the balanced scorecard is to serve as an action plan, a basis for implementing the strategy expressed in the CSFs. The balanced scorecard is important to integrate both financial and non-financial information into management reports. Financial measures reflect only a partial and short-term -- measure of the firm's progress. Without strategic non-financial information, the firm is likely to stray from its competitive course and to make strategically wrong product decisions -- to choose the wrong products, the wrong customers. The balanced scorecard provides a basis for a more complete analysis than is possible with financial data alone.

Qualitative and Quantitative Information in Cost Management

The principal implication of strategic analysis for cost management is that new types of information must be provided in addition to that provided in the traditional cost accounting system. The focus of cost management is now on critical success factors including the types of nonfinancial information not often associated with accounting reports: product quality, customer satisfaction, information on plant operations, etc. Another implication of strategic analysis is that cost management must become more integrated with the other management functions: operations, finance, and marketing. Accounting reports must facilitate cross-functional management decision making, and thus must include information relevant to marketing, finance and operations managers. Accounting reports must extend beyond needs for the determination of product costs and external financial reporting.

Value Chain Analysis

Value-chain analysis is a strategic analysis tool used to identify where value to customers can be increased or costs reduced, and to better understand the firms linkages with suppliers, customers, and other firms in the industry. The value chain is a way to describe relations among an organization's operations. The value chain describes how an organization assigns its resources to these operations and how one operation affects other operations. It is important for managers to understand the value chain because it can be the basis for competitive advantages and is the starting point for making improvements in the organization.

Examples of Firms Emphasizing Cost Management

Firms Using Cost Management. Here are some examples; there are many possible answers. 1. Wal-Mart: to keep costs low by streamlining restocking and sales 2. COMPAQ: to keep costs low by improving manufacturing performance and by using target costing and other management techniques 3. Citicorp: to keep costs low by using activity analysis (see problem 1-31) to identify key operations and to find those that add little or no value 4. A local school district or public agency: to keep costs low in order to provide the best possible service given available funds 5. Procter & Gamble: to assess the profitability of its different products

Firms Emphasizing Cost Management

6. Any other large, diversified manufacturer, like Procter & Gamble: which needs to be able to analyze the relative profitability of its different products, using cost management 7. A small machine shop: which needs cost management to determine whether it should repair or replace a machine 8. A dance studio: to analyze and choose between different compensation plans for its teachers; and to determine whether it should open a new studio

Firms not expected to be significant users of cost management information: 1. Microsoft: here the focus is on forming strategic alliances, innovation and competition; cost management is more important for other firms in the information technology business, such as COMPAQ, Hewlett Packard, and IBM that compete in part on innovation but also on price 2. Versace: a high fashion firm competes on innovation and product leadership; the development and communication of attractive new ideas is the key to competitive success rather than cost management 3. Other firms in the fashion industry, such as Chanel, Givency, and Armani: for reasons similar to Versace 4. Major league sports: dependent primarily on the development of fan support, good coaching and player acquisitionFirms not expected to be significant users of cost management information:

Factors affecting Business Environment


The factors in the contemporary business environment that affect business firms and cost management are: 1. Increased global competition, which means an increasingly competitive environment for all firms and thus the need for cost management information to become more competitive; the need for competitive non-financial information in addition to financial information in cost management reports; 2. Changes in manufacturing and information technologies, and thus the need for cost management information to facilitate the introduction of new manufacturing and product technologies (e.g., determining which technologies will most contribute to profitability), and to incorporate in cost management reports the information needed to manage the new technologies effectively; the importance of life cycle costing -- considering the total costs of the product or service over its entire cost life cycle, from raw materials to sales and service;

Factors affecting Business Environment


3. A focus on the customer, which requires cost management reports to include critical information about customer satisfaction, changing customer preferences, etc.; 4. Changes in management organizations, new reporting practices to recognize the new focus on cross-functional teams in which employees from all areas of the firm work together to make the firm successful; 5. Changes in the social, political, and cultural environment of business, which requires an expansion of cost management reporting to include critical success factors related to the expectations of those beyond the ownership of the firm including employees, local government officials, and community leaders.

Changing Business Environment

Changing Business Environment

Cost Management Techniques


The eleven contemporary management techniques are: 1. Benchmarking, a process by which a firm identifies its critical success factors, studies the best practices of other firms (or other units within a firm) for these critical success factors, and then implements improvements in the firm's processes to match or beat the performance of its competitors. 2.Total Quality Management, a technique in which management develops policies and practices to ensure that the firm's products and services exceed the customer's expectations. 3. Business Process Improvement, a management technique in which managers and workers commit to a program of continuous improvement in quality and other critical success factors. 4.Activity-based Costing and Management: Activity-based costing is used to improve the tracing of manufacturing costs to products and therefore the accuracy of product costs. Activity-based management (ABM) uses activity analysis to help managers improve the value of products and services and to increase the firms competitiveness.

Cost Management Techniques


5. Reengineering, a process for creating competitive advantage in which a firm reorganizes its operating and management functions, often with the result that jobs are modified, combined, or eliminated. 6. The Theory of Constraints, a strategic technique to help firms to effectively improve the rate at which raw materials are converted to finished product. 7. Mass Customization, a management technique in which marketing and production processes are designed to handle the increased variety of delivering customized products and services to customers. 8. Target Costing, a management technique that determines the desired cost for a product upon the basis of a given competitive price, such that the product will earn a desired profit.

Cost Management Techniques

9. Life-Cycle Costing, a management technique used to monitor the costs of a product throughout its life cycle. 10. Value-Chain Analysis, a too that hels the firm identify the specific steps required to provide a product or service. 11. The Balanced Scorecard, an accounting report that includes the firms critical success factors in four areas: customer satisfaction, financial performance, internal business processes, and innovation and learning (human resources).

Theory of Constraints (TOC)

The concept of throughput in the theory of constraints (TOC) is central to TOC to reduce the time and waste in producing the product or service. The concept also applies to the service context as well as to manufacturing. In service firms, TOC is used to identify bottleneck operations in the set of steps and operations that are needed to provide the service. For example, in banking, the bottleneck might be the movement of cash and transaction forms between the branches and to the central bank processing point. Similarly, in providing a professional service such as accounting, legal or medical, the bottleneck might be the scheduling of specialized professionals to a given client or patient. In a hospital, the bottleneck might be the admitting process. In each case, the proper design of systems to speed the service to the customer is the objective of the TOC analysis. This is done by an activity analysis of the operations necessary to provide the service.

TOC for Service and Manufacturing Firms

A difference between service and manufacturing firms is the presence of inventory in the manufacturing setting. An objective of TOC for a manufacturer is to reduce inventory levels; the presence of large quantities of inventory is evidence of bottlenecks for a manufacturer. In contrast, inventory is not an important matter in the service firm. Rather, it is important to identify people/processes where the delivery of the service to the customer is stalled, that is, the bottleneck. This might be a stack of forms waiting to be processed by a clerk, a waiting room of patients waiting to be seen by a doctor, etc. The application of the concept of TOC is however, the same. That is, how to get the service to the customer as quickly and with as little waste as possible. Retail and auto repair businesses are among the good examples.

TOC at different firms

At Wal-Mart, or any other retail firm, TOC can be applied to speed the product to the customer, that is quick re-stocking of items in the stores, quick introduction of new products into the stores, and fast customer check out. In an auto repair business, TOC is applied to determine ways to serve the customer more quickly, with less wasted time during and between jobs.

Firm Characteristics using Target Costing

The types of firms which would demand Target Costing would be firms that are in very competitive industries, where cost/price competition is critical, such as consumer products. Examples of firms that might use target costing also include those that have short product life cycles (the time from introduction of the product into the market until its withdrawal from the market). The firm must be very deliberate in planning about costs when there are short life cycles, since there is a short time to recover the development costs -- the product must be careful designed, using target costing, so that it is profitable in its short life cycle.

Firm Characteristics using Life Cycle Costing

Appropriate firms that would use Life Cycle Costing would be the same types of firms as for target costing. Intense competition on price/cost and short product life cycles are indicators of firms that are likely to use life-cycle costing. The reason is that in both cases, the focus is on the management of design and therefore the management of downstream costs, so as to achieve profitability for the product over its life cycle. Some Japanese firms, for example, will introduce a product that is not profitable at the first phase of its life cycle, but as costs are expected to come down in the manufacturing process through continuous improvement efforts, the product will become profitable later in its life cycle.

Cost Management and Profitability Analysis

Budget cutbacks, increased customer (taxpayer) demands, increased operational complexity many of todays managers have to deal with these challenges. Every organization, be it public or private, operates in an environment that is going through fundamental and ongoing changes. It is vital, therefore, that these organizations equip themselves with the management tools that will allow them to progress at the same rapid pace. Knowing how your costs break down and especially how they behave depending on a variety of different situations and decisions are two elements vital to sound organizational management. Knowing how fast things change today is yet one more reason to deploy a strategic cost management enabling you to react quickly. In the public sector, taxpayers demand more services while requiring the use of technology and new distribution means such as the internet. The rapid transformation of the government sector has had a major impact on its cost structure. For the federal government, knowing your costs is part of knowing your business. Departments with external user fees are required to know their costs and report on them. Cost management is part of a sound governance process and leads to an accountable environment.

Nature of Costs in Private Sector

In the private sector, managers have to deal with exchange rate fluctuations, aggressive and increasingly numerous competitors in an ever-expanding global market. As company equipment ages, managers wonder how they can modernize it without negatively affecting customer service and productivity. The ability to determine the consequences of such decisions in advance is thus not only a vital component of managerial decision-making but also confers a strategic competitive advantage. Indirect costs continue to climb as a result of the companys increasing focus on improving the way it manages both itself and its relationships with external partners. All these elements combine to modify your companys cost structure and behavior. All too often, the limitations of conventional cost models prevent the company from seeing the complete cost mix picture.

Profitability Analysis

Profitability Analysis The Pareto Principle states that 20% of a companys customers generate 80% of its sales. This law has been part of our lives for quite some time already, and our guess is that it will be around for a long time. For example, for most manufacturers, Walmart usually represents a huge customer (in top dollars) and is most definitely part of the top quadrant of the 80-20 rule. But where does profitability fit into that law? Is Walmart a profitable customer? Is your best customer always in the top most profitable quadrant? In these times of budget cutbacks and rigorous cost management, managers have a tendency to look solely at costs and possible ways of reducing them. However, it is now more than ever necessary to know the mix of elements that makes up your profitability. How would you answer the following questions? Exactly how much profit does each of your customers generate? Which are the most, which are the least profitable, and why?

Pareto Analysis in Profitability Studies

Some studies show that a mere 20% of your clientele generate anywhere from 150 to 300% of your profits, while as few as 10% reduce your profits by 50 to 200%. The following figure shows the results of one study in table form. Thus, if you had made $1 million in profit by year-end, 10% of your customers would have generated losses of between $500,000 and $2 million. It would seem logical to try and identify those particular customers. This brings us to another question:

Client Profitability

Loyal Customers Profitable Customers?


Are your most loyal customers also your most profitable ones, or are they merely profitable? Here is what the authors of a study on this subject had to say about customer loyalty and profitability: "Specifically, we discovered little or no evidence to suggest that customers who purchase steadily from a company over time are necessarily cheaper to serve, less price sensitive, or particularly effective at bringing in new business. (1) Find answers to the following questions:

Loyal Customers Profitable Customers?


Which are my most profitable clients and, by the same token, my least profitable ones? Which are my most profitable products and services? Which sources of information do I rely on to review my marketing strategy? How should I respond to my clients increasingly complex demands? Would reviewing my production mix generate more profits? How is it possible for my production costs to remain steady while my profit margin steadily decreases?

Commodity - Definition
A

commodity is a product or service that is difficult to differentiate from competitors: gasoline, paper products, are some examples. The crucial point for a commodity: is there any reason you would pay more for this item? As such, commodities are natural cost leadership products or services.

Differentiation vs Cost Leadership

Most people will argue that they chose their bank because of service and location, thus differentiation. Others will say the rates are better, and then perhaps cost leadership. It is useful to distinguish the banking needs of say, a student, versus a small business like a car dealership which will rely more heavily on a variety of customer services and will likely see banks as more differentiated entities.

Industry Characteristics in Cost Leadership

The main point of the question is that the cost leadership or differentiation classification applies across different types of firms in different industries. There are some industries (particularly those with commodities) which tend to be characterized by cost leaders and others (biotech,..) which tend to be characterized by differentiators. Other industries may have a mix of different types of competitors. Now consider the automobile industry and try to identify cost leaders and differentiators.

From Differentiation to Cost Leadership


It

is certainly likely that a new product, with technologically advanced features, may begin as a differentiator and then as the market for the product matures and competitors enter the market for the product, then the industry as a whole moves to more of a cost leadership type of competition. Consider cell phones as an example.

Key Job Skills in the context of Critical Success Factors


Key Job Skills required these days: Business Knowledge/Understanding strategy Has a good understanding of business fundamentals; cost and revenue drivers, the regulatory environment in banking, etc. Understands the strategy and business environment of bank customers he or she works with. Customer Focus Employee works well with customers and other employees Efforts are customer-focused Creative Problem Solving Thinks creatively Understand complexities

Key Job Skills


Persuasive Is able to present ideas concisely and clearly Understands who owns a problem, and who can solve it Flexibility Not easily disappointed; handles conflict well Is able to see multiple viewpoints while asserting a position Can be a business partner, customer advocate, as well as loyal employee and friend Embraces change Good supervisor Creates a positive climate Provides opportunities for development, learning and promotion Can make tough personnel decisions Is able to delegate, and teaches others how to do the same Looks for new ideas and rewards suggestions Builds commitment

Key Job Skills

Performance Shows enthusiasm Has high standards Willing to work extra hours when necessary Is willing to take risks Keeps supervisors informed Works well on a team Effectively manages time Communication Skills Communication is clear and focused Good sense of confidentiality where appropriate

Key Job Skills


Technology

Skills Fully versatile in using computer applications that apply in the banking industry Develops new skills where appropriate Professional Ethics Displays high standard for ethical behavior

ABC in Banks Identifying Activities


Example activities might be to: process deposits process withdrawals answer customer inquiries sell traveler checks balance cash drawer (at the end of the day) receive an installment loan application process an installment loan application provide advice regarding investments, including an explanation of investment services provided by the bank receive a mortgage loan application process a mortgage loan application mail out monthly statements: checking customers, savings customers, loan customers

ABC in Banks
The activity analysis for processing deposits, for example, would include a detailed description of the number of different ways the activity is initiated and performed, the time required, the skills required, resources required (e.g. labor, technology, facilities), etc.

Importance of Ethics in Firms

Even if the fault will occur in very rare and unusual circumstances, if the consequence could be some damage to a user, the firm should advise users of the fault and the potential implications. On the other hand, there should be no need to advise users if the fault is not likely to have any noticeable consequence on the use of the chip, as for example, if the chip simply takes much longer for a very rare type of processing, but returns the proper result. The effect of the delay is not likely to have a damaging effect on any known user.

GM Differentiation or Cost Leadership?

The strategy adopted by GM is consistent with the differentiation strategy, a focus on quality, style, and innovation rather than price and cost. Unfortunately, the dealers and some analysts were infuriated by GMs move, believing that the reality is this is a price-driven market (Merrill Lynch & Co auto analyst Nicholas Lobaccaro). GMs response to the criticism was to state that brand value is what creates market share and profits, although it can take time to do so. The incident shows that it can be difficult to determine the firms strategy, and experts can disagree. How do you think GM competes? See: GM Dealers Arent Buying It, Business Week, February 8, 1999, pp 46-47.

Calvin Klein Differentiation Strategy

Calvin Klein products are clearly differentiated on the basis of high fashion and cost. What remains at issue is whether some differentiated products can be sold in discount retail stores. Thinking that the presence of so much of his products in discount retail stores could hurt his brand, Calvin Klein sued Warnaco to stop this practice. The suit was settled out of court in January 2001 and Warnaco was allowed to retain the lucrative Calvin Klein contract.

See: Behind a Bitter Suit Filed by Calvin Klein Lies Grit of Licensing, The Wall Street Journal, June 1, 2000, p 1.

BMW Differentiation Strategy

The critical question for BMW is how the use of another manufacturer might affect customers confidence in the BMW brand. Most would say that BMW is a differentiated firm, and its customers expect quality and features over cost. The X3 has been a great success for BMW (both in sales and reviews), so it is apparent that customers have accepted the contract manufacturing of the vehicle Perhaps more interesting is BMWs plan to protect its brand by not entering the minivan market. According to BMWs CEO, We do not have a van because a van as it is in the market today does not fulfill any of the BMW group brand values. On balance, BMW has succeeded in the luxury, high-end of the SUV market, but has determined that the luxury, high-end market currently has no place for a minivan. Source: BMW;s CEO Just Says No to Protect Brand, The Wall Street Journal, November 26, 2003, p B1; Ah, That Excellent German Engineering Straight from Southern Austria, The Wall Street Journal, September 10, 2003, p B1

Innovation Critical to Software and Services

1. The rate of innovation is higher in software and services, semiconductors, drugs, biotech, and technology hardware because the firms in these industries compete largely on innovation. For example, a drug firm is successful to the extent it is able to develop new drugs; cost efficiency is not a key to its success, and it is unlikely to be a cost leader. The only exception to this might be a manufacturer of generic drugs, where quality as well as cost leadership would be important. 2. Somewhat lower levels of innovation are seen in the food and beverage, consumer goods, and household products, because a larger portion of these products and firms will compete on cost leadership. These are the products we buy in Wal-Mart, Kmart, Best Buy and Home Depot, all costconscious retailers. The automobile industry has some firms that are more innovative than others, while others are less innovative. Note however, that William Ford, the CEO of Ford Motor has stressed in recent months the importance of innovation to that firms strategy going forward. Source: Peter Coy, The Search for Tomorrow, Business Week, October 11, 2004, pp 216-220.

From Cost Leadership to Differentiation

SanDisk is apparently trying to move from a cost leadership strategy that fits well the commodity business it is in to a differentiated strategy. This approach has been successful for other tech firms, such as Intel, which has established itself as a differentiated brand in a commodity market. The innovations described in the article are significant and point to success, but at the time of publication it is too early to tell.

Differentiation in Tyre Company

Michelins continued success at selling high-end tires at premium prices is evidence that this firm is succeeding at differentiation in an industry that is largely characterized as a commodity business based on cost leadership. Michelin also effectively markets the importance of the quality it provides in advertisements that note the importance of safety in choosing an auto tyre.

Importance of Ethics in Firms

Even if the fault will occur in very rare and unusual circumstances, if the consequence could be some damage to a user, the firm should advise users of the fault and the potential implications. On the other hand, there should be no need to advise users if the fault is not likely to have any noticeable consequence on the use of the chip, as for example, if the chip simply takes much longer for a very rare type of processing, but returns the proper result. The effect of the delay is not likely to have a damaging effect on any known user.

Ethics in WorldCom-MCI

The WorldCom scandal is one of the most significant and extensive frauds in U.S. history. The important part of this story is that the survivor organization, MCI, is doing well under new leadership and has begun an ethical compliance program. The question is intended primarily as a basis for class discussion, and there are likely to be a wide range of views. I begin by noting that the announcement of a Chief Ethics Officer is a good strategic move for MCI, given the recent history of the company. It is important for the firm to make a clear statement about the importance of ethical behavior in the years ahead.

Role of Ethics Officer

It is difficult to determine the precise role for an ethics officer; the concept is new and there is not much experience to provide guidance. The functions set out in the MCI announcement make sense employee training, hotline, pledge, and code of ethics. It is clear in the MCI case that the officer has the strong support of top management. So the role and responsibilities of the chief ethics officer should be watched closely at the top management level -- both CEO and CFO. From the experience with WorldCom and other frauds, where both the CEO and CFO were culpable, it is probably also important that the chief ethics officer report not only to the CEO and CFO, but also to the firms audit committee (a subset of the firms board of directors with responsibility for managing the audit function and providing oversight of internal control procedures within the firm).

Green Acres and Ethics

Though Green Acres is benefiting financially from its consumers misperception and has not purposely done anything misleading (since it has never labeled its products as organic), it cannot continue to allow consumers to think its products are organic. As it knows that its consumers perceive its products as organic and that many consumers buy Green Acres products specifically for this reason, Green Acres has a moral obligation to inform them about its true practices. Even if the health and environmental consequences of genetically modified organisms are yet unknown, the potential for harm to the consumer necessitates that Green Acres advise consumers of its use of genetically modified crops and notify them that risks might potentially exist from consuming its products.