CFO Service Finance & Accounting

Detailed Analysis of Strategic Cost Management

What is a Strategy?

A strategy is a method that is derived by individuals to solve a particular issue. Plans are developed daily by various individuals. The strategies that are developed will help in setting multiple goals for an organization and also achieving them. So basically, a strategy is the process of effective management with the use of resources.  Strategies are used by all forms of organizations to meet specific priorities. Business Strategies can be implemented by the organization during the following situations:

• When the market factors affect the progress of the organization,
• Or the organization is not able to achieve its stated outcomes in the business,
• For consumer satisfaction

Therefore strategies can be developed at an internal level and external level.

Strategies can be adopted in the following situations:

• To create goals of the business to reach priorities;
• To ensure that the organization meets the necessary mission, vision and goal priorities that create the success of the organization;
• Ensure that maximum value is added from the effective use of assets and resources in the organization;
• Strategic planning also helps in making effective decisions- this can be through a change in marketing and advertising channels; and
• Cost control and cost reduction process can also be carried out through the means of a proper strategy.

Therefore, a strategy can be understood as the ability of a business/organization to meet the short and long term goals of the organization. These goals can be achieved through developing effective strategies. Cost Management is one of the strategies. Strategic Cost Management (SCM) is considered as the procedure in which the costs of the organization are reduced without compromising on the value that is added to the business. Therefore to achieve a sufficient balance of strategic cost management in an organization, it is vital for the development of the organization. This can be achieved by balancing the costs and delivering the business goals of an organization. The Institute of Cost Accountants of India has come up with various meanings for Strategic Cost Management. Handling internal costs in a way that allows the business to achieve its goals comes under the purview of strategic cost management.

These goals can be made and understood through the management of a business. By analyzing the costs of the company, the management would understand what costs are essential for achieving the main priorities of the business. The business would also understand the critical costs and insignificant costs.  However, some costs help the company to improve the priorities. These costs would be considered as the costs which directly affect the business. Such costs are the significant costs of the business. Therefore by categorizing the costs as per the company, the costs can be effectually managed.

Concept behind Strategic Cost Management in an Organisation

Businesses are affected by various factors. These may be market, technology, economic, and consumer-related factors.  A depression in the economy would be one of the main factors for a company to implement the system of Strategic Cost Management. This has been one of the significant factors for companies to survive in the market. Through effective strategic cost management, the organization can improve the overall development of the products and also find practical solutions to various problems. Strategic Cost Management is, therefore, effectively managing the cost priorities of the business.

Case Study of E-Commerce Business for Strategic Cost Management

Take a newly formed E-Commerce Business. The business would have spent a lot of money initially. Some sectors on which the funds would be spent are compliance with the regulatory authorities, research and development on the number of consumers and market, geographical areas, the launching of the platform, and supply chain. Revenues generated from this would add to the cost, which is used on a working capital basis. The cost that is used on a working capital basis would form the part of the day to day cost of the business. The e-commerce business would also have to spend costs on the hiring of delivery executives and transportation.  In this form of business, strategic cost management would be to have some mechanism of cost control. However, the e-commerce business would have to keep in mind that by having a mechanism of suitable cost control, the priorities of the business should not be compromised. This would be considered as a challenge for the shareholders and the management of the business.

If the e-commerce business wants to manage its costs effectively, they would have to plan. This would be by controlling the costs for activities that would directly help their business in the long run. They would have to reduce the costs for unnecessary expenses and overheads. Therefore the business has to manage the costs and achieve objectives.  If the e-commerce business is spending too many expenses on hiring more delivery drivers, then they should control the costs in this area.

One of the solutions would be to reduce the number of delivery drivers for the e-commerce business. If drivers work on a 24/7 basis, products can be delivered to customers continuously. Another added advantage of this is the company would not have to hire delivery drivers and spend more on transportation of the delivery. The existing delivery drivers can be rotated on a shift basis, and through this, the costs of the e-commerce company can be controlled. By considering this option, the e-commerce business would be satisfying customers and controlling the costs of the business. These costs would go into increasing the brand image of the products, an increase in the supply chain of the business and markets for the products. This is how the business would implement strategic cost management goals. By considering various options available in the business, the management would have to go with the best possible solution to ensure their business reputation is maintained. Added to this, they would also achieve optimum customer satisfaction.

Case Study of Railway Ticket Counter for Strategic Cost Management

A company that is operating railway services can also implement strategic cost management at all levels in the organization. At a designated station, the company operates by having only one railway counter for instant tickets. Having this process would make the production of railway tickets slowly. This would have an impact as the number of customers who want to purchase instant tickets would be affected. One of the main aims of a business is customer satisfaction. The company will not achieve this if they continue to have just one ticket counter at a station. The business can achieve strategic cost management, if more costs are incurred on having more than one ticket counter at a railway station.

The added value of customer satisfaction would be achieved by following this type of situation. Plus, the business can also identify the potential costs which would be utilized by the business.  By considering the above model, the business can ensure that it can be achieved. Apart from this, customer satisfaction can be maintained by the business at an optimum level. The costs which are spent in other departments of the business can be utilized in one area to maximize maximum value in the business.

Analysis of Strategic Costs

Strategic Cost Management in a business comes through the effective implementation of broad-based strategies in the business. The directors/ shareholders and the management of the business make the policies related to the business. Therefore analysis of strategic costs can only be obtained by understanding the business goals of the organization.

The objectives of the business directly depend on the products and services offered. For example, a company that is established as a Non-Government Organisation would also have some business goals. These goals are the provision of services to the lesser developed classes in a society. The goals are obtained through the offering of grants and donations which are made by the government.

Cost analysis is required for every business. Managers need to know this for the business to operate regularly.  Knowledge of cost analysis would allow the business to measure the costs which are incurred in the business.

By having an effective mechanism for analyzing strategic costs, the management of the business would understand the following:

• Reasons behind making the costs;
• Categorizing the costs according to the importance of the cost;
• Whether the costs of the business can be reduced if the business considers the principles related to outsourcing;
• Areas in which the amount of cost can be reduced;
• Concentrating the cost in other areas related to investment; and
• Consumer Preference and demand life cycles of product.

Strategic Cost Analysis has the following under it:

• Target Costing
• Life Cycle Costing

These two methods of cost analysis are the modern form of cost analysis. While the traditional approach for costing follows the perspective of considering cost from an internal level, these two types of costing take the significance of the modern method of costing.

Target Costing

Target Costing in the form of the costing method to market products based on the cost. To maximize the value of Target costing, companies use this form of costing to perceive the market and identify the requirements of consumers.

Target Costing covers the following:

• Examples of products that are required by the customer;
• What will be the price that is paid by the customer for the product;
• Amount of prices that are charged by the competitors and the products offered by them; and
• Cost which is involved in marketing the product.

By considering the above factors related to target pricing, the business would set up specific parameters for them to achieve. Using this form of pricing would target the real expectations of the consumers. The business would have an upper edge at satisfying the consumers.

Lifecycle Costing

This is another process of costing.  Target costing specifies importance regarding the development of the product and customer satisfaction.  However, it does not cover the other important aspects of the product. Some of these aspects would relate to the warranty or the insurance of the product. These aspects are covered under Lifecycle Costing. This type of costing considers all the elements of cost related to the product. This will include specific requirements such as pre-product production costs and also post product production costs. The whole life cycle costs of the product are taken into consideration before producing the product. Hence it would cover areas such as:

• Compliance related to the product;
• Research and development for the product;
• Shelf Life of a product; and
• Operations of the product.

From this, it can be understood that life cycle costing would cover a broad-based analysis for the product. Strategic Cost Management can be carried out by following the above costing methods for a business.

Difference between Cost Reduction and Cost Control

It is essential to understand the difference between cost reduction and cost control under strategic cost management. Cost reduction can be understood as a process which acts as a part of a reaction. This reaction for carrying out cost reduction can be due to change in business structures, economic conditions. Cost reduction is a permanent measure for a business to consider they are reducing cost. On the other hand, cost control can be carried out by the business from the beginning. Controlling costs does not happen suddenly. Costs can be controlled at an optimum level for the development of the business.

The management of the business will determine both the processes of cost reduction and cost control. However, there are circumstances in which these are individually developed. Cost control will affect all the departments of a business. Cost reduction will only affect a few segments of the business.

For example- Economic recession affects the volatility of the market. Companies in this phase consider reducing costs. The common terminology used here is cost cutting. Terminating an employee’s work contract is considered as a strategy for reducing costs. Once the agreement of employment is terminated, the employee is permanently removed from work.

Therefore the process of cost reduction is permanent, and cost control can either be temporary or permanent. The management has the power to control costs at any stage of the life cycle of the business. This cannot be done for a cost reduction process. For a business to have a proper system of Strategic Cost Management, both cost reduction and cost control are necessary. However, cost control would be more crucial for Strategic Cost management.

Strategic Cost Management- Ways to Reduce Costs

Reduction of cost is one of the main priorities of the business.  This would directly reflect on the revenues which a business would make. The following are the ways to reduce costs:

1. Planning/ Implementation-

One of the ways of cost control/ reducing costs can be through effective planning and implementation. Understanding the long term and short term goals of the business is required for this process.

2. Cost Accounting/ Cost Management-

Cost control for a business forms part and parcel of the cost accounting system. This would also come under the purview of cost management. Analyzing this mechanism would help the company ensure that there is a steady flow of cash into the business. The principles of cost accounting will also be achieved if the above is followed.

3. Control by Management-

Ways to reduce and control costs will be affected by the way the business works. The shareholders and directors of the business will have direct control over the development processes of the business. Management has to guide the business when it comes to areas related to planning. Apart from this, protocols have to be followed. By following specific protocols, the management would know whether the cost has been reduced or not.

4. Assessing Standards-

External consultants produce individual reports. These reports will indicate the cost control/ reduction mechanisms, which are followed by an organization. Through these reports, the standards of cost can be analyzed and compared. By comparing the actual standards of the expenses to the standards which are reduced, the business would know the outcome of the reports.

5. Cost Reduction for Micro Businesses-

Cost reduction and control are not a complicated task for a small business^[1]. The business would have to analyze and differentiate the costs incurred in the business. After segregating various costs, they would have to control the unwanted costs. Independent Consultants and Advisors can be recruited by small companies to develop strategic cost management objectives.

By considering the above procedures, strategic cost management would be useful in a business.

Conclusion for Strategic Cost Management

Strategic Cost Management (SCM) is the process in which the cost of the business is controlled. As the cost is controlled, there must be no compromise in the quality of products and services offered by the business. A company runs to maximize profit. The main objectives of the business can only be met if there is customer satisfaction.  To establish a balance between customer satisfaction and reducing the costs of the company would be one of the main goals of strategic cost management. Strategic Cost Management can be achieved by having a proper system of costing. The types of costs are target costing and life cycle costing. By implementing the modern methods of costing, the business can maximize the value of its products and services. However, before considering the strategy for the business, it is essential to classify and differentiate cost reduction and cost control. By following the above process, an efficient system of Strategic Cost Management can be streamlined in the company, and the costs can be controlled.