Why Strategic Cost Management is Important to a Business Enterprise

Traditionally, business enterprises thought of cost control and cost reduction as effective techniques to reduce expenses using budgeting process and thereby increase their profits. Here, I will delve into its limitations and the growing importance of strategic cost management for managing costs as well as for driving growth of the organization and its ability to constantly improve the quality of products offered to customers.

Cost Control is a technique or process which measures variances from the cost baseline/budgeted costs/standard norms, provides analytical reports to the management for taking effective corrective action and thereby to achieve minimum cost overruns/reduce the costs. Procedures are applied to monitor expenditures, measure and evaluate the performance.

Cost Reduction is a technique which we used to save the unit cost of the product without compromising its quality. Cost reduction is the process of decreasing a company's expenses to maximize profits. It involves identifying and removing expenditures that do not provide added value to customers while also optimizing processes to improve efficiency. Cost reduction typically focuses on generating short-term savings.

Cost reduction may lead to cost cutting which has an adverse implications on the organization performance when viewed from a long term basis. For example, substitution with low quality raw materials may reduce the product quality and employee layoff may impact the employee morale adversely.

Cost cutting refers to measures implemented by a company to reduce its expenses and improve profitability. Cost cutting measures are typically implemented during times of financial distress for a company or during economic downturns.  This is a very defective approach and should be used as a last resort.

Strategic cost management (SCM) is a cost management technique that aims to reduce costs and boost the strategic position of an organization. It’s the process of combining cost information with the structure of decision-making to reinforce the overall business strategy. Cost is measured and managed to align it with the organization’s business strategy. It is seen as managing costs as well as driving growth of the organization. Business leaders see it as a strategic initiative that is part of a larger transformation process.

The primary importance of strategic cost management lies in its ability to constantly improve the quality of products offered to customers. To reduce heavy cost failure, an organization must implement strategic cost management in the initial stages of production.

Importance of strategic cost management:

   

• SCM improves the overall position of an organization
• SCM can be used to analyze cost information and achieve sustainable competitive advantage  by developing various measures 
• It offers a better understanding of an organization’s overall cost structure to gain a competitive advantage in a market

 Traditional Cost Management vs. Strategic Cost Management

	Traditional     Cost Management	Strategic Cost Management
Concept	Short term concept	Long term concept
Focus	Internal	Both internal and external.
Perspective	Value-added	Value chain
Cost driver concept	Based on volume of the product.	Each value activity has a separate cost driver. So, not based on volume but on activities associated with the manufacturing of the product.
Cost analysis-Objective	Score keeping, attention directing and problem solving without regard to the strategic context	Strategic positioning of the organisation either by-Cost leadership or product differentiation.
Primary Objective	Cost reduction	Cost control plus cost reduction, Value improvement and Revenue enhancement at the same time.
Utilisation of cash flow generated	Increase cash flow for working capital	Increase cash flow for investment opportunities.
Management responsibility	Risk-averse approach	Risk taking approach and ability to adapt itself with changing environment.

 

The cost management techniques should be such that they improve the strategic position of a business apart from focusing on controlling costs. The basic aim of Strategic Cost Management is to help the organization to achieve the sustainable competitive advantage through product differentiation and cost leadership.

Cost management simultaneously improves the strategic position of the organization while reducing the costs.  It must cover all aspects of production and delivering the product, the supply of purchased parts, the design of products and the manufacturing of these products. So, it is inherent to each stage of the life cycle the product, i.e. during the development, manufacturing, distribution, and during the service lifetime of a product. It is important to include strategic cost management at the early stages of a product development process to reduce high failure costs. Life cycle costing is a time-consuming process but it can uncover costs that can ease the decision-making process.

To achieve the above, instruments for strategic cost management are:

1.      Activity Based Costing
2.    Bench-marking
3.    Target Costing
4.     Value Engineering
5.     Value Chain Analysis
6.    Total Quality Management

Activity Based Costing

Activity-based costing (ABC) is a costing method that identifies activities in an organization, determines cost of each activity based on resources consumed during the relevant period and assigns the cost of each activity to all products and services according to the product consumption by or customer use of that activity.

Bench Marking

Benchmarking is the practice of comparing business processes and performance metrics to industry bests and best practices from other companies. The information collected about a company’s own processes analysed in relationship to the best-in-class practices provides insight into the actions the company can take to improve its performance. The company processes are improved to the level of performance of its competitors or even reach to a better level

Target Costing

In target costing method, setting targets for costs based on the market conditions. First step is to determine the product selling price by analysing the market conditions and then determine the target cost of the product according to their desired profit margin.

Target Cost = Selling Price – Desired Profit Margin

In industries such as FMCG (Fast Moving Consumer Goods), construction, healthcare, and energy, competition is so intense that prices are determined by supply and demand in the market. Producers can’t effectively control selling prices and hence focus on controlling costs by setting up target cost.

Goal-oriented costing system focuses on the design stage and requires the participation of all specialized units

Value Engineering

Value engineering is a design engineering technique involving critical examination and analysis of the design of a component with reference to its functional value. The purpose of value engineering is eliminating or modifying any factor that leads to the imposition of unnecessary costs, without hurting the core and essential functions of the system. Value engineering is the continuous improvement of design and implementation and it is not merely a program to reduce costs, but is a way to maximize the value of designs

Value Chain Analysis

Value chain analysis is a strategy tool used to analyze internal firm activities. Its goal is to recognize, which activities are the most valuable (i.e. are the source of cost or differentiation advantage) to the firm and which ones could be improved to provide competitive advantage. If it competes through cost advantage, it will try to perform internal activities at lower costs than competitors would do. When a company is capable of producing goods at lower costs than the market price or to provide superior products, it earns profits.

 Total Quality Management

Total quality management technique is useful for identification of internal and external failure factors in the companies. Total quality management (TQM) is the continual process of detecting and reducing or eliminating errors in manufacturing, streamlining supply chain management, improving the customer experience, and ensuring that employees are up to speed with training. TQM is considered a customer-focused process that focuses on consistently improving business operations

Other Tools

For finding the precise systems of measurement of the cost, in-time production system and kaizen costing are useful tools for manufacturing companies. In-time production system is a system based on the volume of demand. In this system, a piece of product will be purchased or produced only when a sign of its consumer is received. This prevents the accumulation of inventory in workstations. Among the main objectives of this system we can mention improvement of quality and increase in productivity with an emphasis on the kaizen concept.

Along with the above mentioned cost management strategies and tools, the following marketing strategies also help in managing costs:

•        Bundling of products or services and package it as single product or service
• .     Selling on E-Commerce platform

There are four stages towards the development of cost management systems in the organization.

 First and second stage: The cost management systems are basic transaction reporting systems. Once the transaction reporting systems are implemented, the focus shifts to external financial reporting in which usefulness of cost management is limited as financial reporting is for external stakeholders and gives an overall picture of the company and its business.

Third stage: The cost management systems track key operating data and develop more accurate and relevant cost information for decision making and hence, there is the development of the cost management information system.

Finally Fourth Stage: Strategically relevant cost management information is an integral part of the management information system which is fully integrated with other management systems and a part of the overall organizational strategy. This requires the identification of the critical success factors of the organization and the use of analytical, forward-looking decision support. Critical success factors are the measures of those aspects of the organizational performance which are essential to its competitive advantage and, hence, to its success. Many of these critical success factors are financial, but many are non-financial.

Strategic cost management needs the support of employees, management as well as information technology because effective and timely communication is a prerequisite for implementing it.

In a nutshell, the meaning of strategic cost management isn’t cost control but a method to use the information for efficient managerial decision-making. The fundamental objective is leveraging cost leadership and product differentiation and gaining a sustainable competitive advantage. Moreover, successful strategic cost management is required to help the organization to develop and identify superior strategies which produce a sustainable competitive advantage. Competitive advantage is creating better customer value for the same or lower cost than offered by competitors or creating equivalent value for lower cost than offered by competitors. Customer value is the difference between what a customer receives and what the customer gives up. What customer receives includes such things as product functionality (features), product quality, reliability of the delivery, delivery response time, image, and reputation. What customer gives up or sacrifice includes product price, time required to learn to use the product, operation cost, maintenance cost, and disposal cost. Strategic cost management is required to influence the attributes associated with the dimensions of customer value (decrease the customer sacrifice and improve the customer receives) in order to help the organization increase customer value and therefore improve the strategic positioning.