What is strategic cost management?

Strategic Cost Management (SCM) is a form of management accounting that focuses explicitly on the relationship between a business’s strategic goals and its resources, costs, and capabilities. SCM aims to reduce costs while improving the strategic position of a business.

This approach to cost management goes beyond traditional, typically inward-looking methods, such as standard or variable costing. Instead, SCM considers the big picture of the business, including its position in the marketplace, its competition, and its long-term goals.

Strategic cost management can be complex, requiring a deep understanding of the business, industry, and markets. But when it’s done well, it can help a business to improve its competitive position, increase its profitability, and achieve its strategic objectives.

Some of the elements of strategic cost management include:

Cost Reduction

In Strategic Cost Management (SCM), cost reduction is identifying and cutting unnecessary expenses, thereby improving profitability without compromising the quality of products or services.

Here’s how cost reduction operates within the framework of SCM:

Identification of Costs: The first step in cost reduction is identifying all the costs incurred in running the business. This includes direct costs like raw materials and labor and indirect costs like administration, marketing, and distribution. It also involves categorizing costs into fixed and variable costs for better analysis and understanding.
Cost Analysis and Evaluation: The next step is determining these costs’ necessity and efficiency. This process involves analyzing each cost in terms of its contribution to the overall value of the product or service and its impact on the company’s strategic objectives.
Identifying Cost Reduction Opportunities: Once the costs have been analyzed, the company can identify potential opportunities for cost reduction. This might involve finding cost-effective materials or processes, eliminating wasteful practices, or streamlining operations.
Implementation of Cost Reduction Strategies: The company then implements the identified cost reduction strategies. This could involve negotiations with suppliers, redesigning processes, retraining employees, investing in more efficient technology, or other potential changes.
Monitoring and Control: After implementation, it’s crucial to continuously monitor the results of the cost reduction strategies to ensure they have the desired effect. This involves comparing actual costs with budgeted costs and making adjustments as necessary.
Continuous Improvement: Cost reduction in SCM is not a one-time task but an ongoing process. Regular reviews should be conducted to identify opportunities for further cost reductions and efficiency improvements continuously.

While cost reduction is an important aspect of SCM, it’s also crucial that these cost reductions don’t come at the expense of quality. The ultimate goal is to increase customer value while reducing costs, which requires a careful balance. Furthermore, it is also important to align cost-reduction efforts with the company’s overall strategic objectives.

What is a Cost leadership strategy | Explained with Examples

Value Chain Analysis

Value chain analysis in the context of Strategic Cost Management (SCM) is a method used to understand how business activities contribute to creating customer value and competitive advantage. The concept was first introduced by Michael Porter in 1985, and it involves dissecting a business into its strategically relevant activities to understand the behavior of costs, existing and potential sources of differentiation, and the linkages between activities.

The value chain itself is composed of two types of activities:

Primary Activities: These are directly involved in creating and delivering the product or service. They typically include inbound logistics (receiving and storing inputs), operations (converting inputs into outputs), outbound logistics (delivering the product or service), marketing and sales, and service (post-purchase activities).
Support Activities: These provide the infrastructure enabling the primary activities. They include procurement (purchasing inputs), technology development, human resource management, and infrastructure (company systems, culture, structure, etc).

Here’s how value chain analysis works in SCM:

Identify Activities: The first step is to identify all of the company’s primary and support activities.
Analyze Activities: Analyze each activity to understand how it adds value and incurs cost. This involves understanding each activity’s inputs, processes, outputs, and cost drivers.
Identify Linkages: Look for linkages between activities. These are interactions where how one activity is performed affects the cost or effectiveness of another. Optimizing these linkages can often lead to significant cost savings or improvements in differentiation.
Identify Opportunities for Competitive Advantage: The ultimate goal of the value chain analysis is to identify activities where the company can create superior customer value and competitive advantage, either by reducing cost or differentiating the product or service.
Implement Changes: Based on the analysis, make strategic decisions about how to optimize the value chain. This could involve outsourcing non-core activities, investing in technology to improve efficiency, reconfiguring the company’s processes, or other strategic changes.

By analyzing and optimizing the value chain, a company can achieve more efficient use of resources, better product quality, superior customer service, or other competitive advantages that contribute to strategic objectives. It’s important to note that a company’s value chain doesn’t operate in isolation; it’s part of a larger system that includes the value chains of its suppliers, channels, and customers. This more extensive system is often called the “value system.”

Value Chain Analysis: Explained with Examples

Lifecycle Costing

Lifecycle Costing (LCC) is a method used in Strategic Cost Management (SCM) to understand and manage the total cost of a product or service over its entire life cycle. It provides a comprehensive view of cost from initial design and development through manufacturing, marketing, delivery, customer usage, and finally, disposal.

The life cycle of a product or service can be broken down into several stages:

Design and Development: These are the costs of researching, designing, and developing a new product or service. This includes costs for prototype testing, market research, and any capital investments needed to manufacture the product.
Production: Once the product design is finalized, it goes into production. Production costs include raw materials, labor, overheads, and quality control.
Marketing and Distribution: These costs are associated with promoting the product, selling it, and getting it into customers’ hands. This includes advertising costs, salesforce expenses, and logistics costs.
Usage, Maintenance, and Repair: Depending on the nature of the product, there might be costs associated with customer use, routine maintenance, and repairs. While the customer often bears these costs, they can affect the total cost of ownership and therefore influence customer purchase decisions.
Disposal: Finally, the costs are associated with the end of the product’s life. This might include costs for recycling or disposing of the product in an environmentally friendly way.

Here’s how lifecycle costing works in SCM:

Identify Lifecycle Stages and Costs: The first step is to identify the stages in the product’s life cycle and the costs associated with each stage.
Analyze Costs: Analyze these costs to understand their behavior and how they contribute to the total cost of the product. This analysis can reveal opportunities to reduce costs, improve product design, or alter pricing strategies.
Make Strategic Decisions: Based on the lifecycle cost analysis, make strategic decisions about product design, pricing, marketing, and other factors. For instance, if a significant proportion of the total cost occurs at the disposal stage, the company might redesign the product to make it more recyclable.
Monitor and Adjust: Continuously monitor the actual costs over the product’s life cycle and adjust the analysis and decisions as necessary.

Companies can make more informed decisions about product design, pricing, marketing, and other strategic issues by considering the full lifecycle cost. It can help a company to identify opportunities to reduce costs, improve customer value, and gain a competitive advantage. It also encourages more sustainable decision-making by highlighting the cost implications of waste, pollution, and other environmental factors.

Target Costing

Target costing is a systematic process of cost management and profit planning. It is a proactive cost control technique that begins with a market-driven target price and then deducts the desired profit margin to determine the allowable cost of a product. The challenge is designing and manufacturing the product to meet that target cost.

Here’s how target costing works in Strategic Cost Management (SCM):

Determine the Market Price: The first step in target costing is to determine the product’s market price. This is typically done through market research, competitive analysis, and understanding the product’s perceived value to customers.
Set the Target Profit Margin: The company sets a target profit margin based on strategic objectives, such as return on investment, market share goals, or other financial targets. This profit margin is deducted from the market price to establish the target cost.
Determine the Target Cost: The target cost is the maximum amount that can be spent on developing, producing, and delivering the product while still achieving the target profit margin. It is calculated by subtracting the target profit margin from the market price.
Design to Cost: The company uses various cost management techniques to design and produce the product to meet the target cost. This might involve value engineering, process improvement, supply chain optimization, or other cost reduction strategies.
Cost Control Throughout the Product Lifecycle: The target cost is maintained and controlled throughout the product lifecycle, from design and development through production and delivery.
Continuous Improvement: Target costing encourages a continuous focus on cost reduction and process improvement to maintain the target cost as prices and costs change over time.

The key benefit of target costing is that it aligns the product development process with the company’s strategic objectives and market expectations. By starting with the price that customers are willing to pay and then working backward to determine the allowable cost, companies can avoid launching products that are too expensive to produce profitably or that fail to deliver the desired profit margins. It’s a powerful tool for cost management and strategic decision-making, but it requires a strong understanding of the company’s costs, market conditions, and strategic objectives.

Benchmarking

Benchmarking is a process in Strategic Cost Management (SCM) that involves comparing a company’s products, services, or processes against those of best-in-class companies, either within the same industry (competitive benchmarking) or in different industries (functional benchmarking). The goal is to identify performance gaps and generate ideas for improvement.

Here’s how benchmarking works in SCM:

Identify What to Benchmark: The first step is identifying the processes, products, or services to benchmark. These could be key cost drivers, strategic business processes, or areas where the company’s performance is perceived to be suboptimal.
Identify Benchmarking Partners: Next, identify best-in-class companies against which to benchmark. These could be direct competitors or companies in other industries that excel in the area being benchmarked.
Collect and Analyze Data: Data collection could involve public sources, industry reports, site visits, or even direct contact with benchmarking partners. The data is then analyzed to understand the performance gap and the practices that lead to superior performance.
Identify Opportunities for Improvement: Based on the benchmarking analysis, identify areas where the company can improve. This might involve adapting best practices from the benchmarking partners or developing new ways to close the performance gap.
Implement Changes: Develop and implement a plan to make the necessary changes. This could involve process redesign, training, organizational changes, or other interventions.
Monitor Progress: Continuously monitor the results of the changes to ensure they’re leading to the desired improvements. This involves establishing performance metrics and setting up a system for regular review.
Repeat the Process: Benchmarking is not a one-time activity. It’s a continuous process of comparison and improvement.

Benchmarking can lead to significant improvements in cost efficiency and effectiveness. It forces a company to look outside its operations and learn from others. However, it’s important to remember that what works well for one company may not work well for another due to differences in strategy, culture, resources, and other factors. Therefore, the goal of benchmarking is not to copy other companies but to learn from them and adapt their practices to fit the company’s unique situation and strategic objectives.