1. Cost Management Session 3

2. Overview Theory Exercise: 1.39; 1.42; 1.50; 1.51 2

3. Theory is measured at one specific time, and represents a quantity existing at that point in time 3 A stock variable Flow variables can be measured over an interval of time

4. 4 -Operational performance analysis -Strategic performance analysis -Characteristics of cost management analysis -Cost benefit analysis and variance analysis -Cost and expense

5. Operational performance analysis Measure whether performance of current operations is consistent with expectations 5 Strategic performance analysis Measure whether long run performance of operations is consistent with expectations

6. Cost benefit analysis Measure effects of a plan by comparing its expected cost and benefits ( can be quantitative, and qualitative) 6 Qualitative : impact on customer’s perception of service quality Quatitative: cost ( in euros, dollars, numbers)

7. variance analysis Difference between actual and expected quantities 7

8. Exercise 1.39 (pag.33) (a)Based on quantifiable benefits and costs of the decision, would you recommend that Lillis outsource its accounts receivable function? 8

9. Exercise 1.39(1a) Net Benefit= £ 405,000- £ 200,000= £ 205,000 9 Benefits (£)Costs (£) Personnelcost savings230,000Contract costs150,000 Facilitiessavings100,000Training costs35,000 Other supportservice75,000Contract administration15,000 Total 405,000200,000

10. Exercise 1.39(2a) What qualitative factors should Lillis also consider? Qualitative factors to consider include: service quality (timeliness, accuracy), impacts on existing customers, contacts with existing customers, impacts on current and future employees. 10

11. Exercise 1.39(3b) (b) Prepare an analysis similar to the one in Exhibit 1.6 (pag. 21) 11

12. Exercise 1.39(4) 12 Benefits of outsourcing accounts receivable Expected amount Actual amount Variance Qualitative Information 1. Personnel cost savings 230,000 170,000 (60,000) Large overestimate of savings 2. Facilities cost savings 100,000 120,000 20,000 3. Support cost savings 75,000 100,000 25,000 4. Quality of service -- Fewer billing complaints Total quantifiable benefits 405,000 390,000 (15,000)

13. Exercise 1.39(5) 13 Costs of outsourcing Expected amount Actual amount Variance Qualitative Information 1. Contracted service 150,000 150,000 0 2. Training costs 35,000 40,000 5,000 2. Contract administration. 15,000 17,000 2,000 3. Loss of direct contact with customers -- Lower sales growth 4. Adverse effects of personnel reductions -- Increased personnel turnover Total quantifiable costs. 200,000 207,000 7,000 Net quantifiable annual benefits 205,000 183,000 ( 22,000) Net benefits lower than expected

14. Exercise 1.39(6c) On balance do you agree with the outsourcing decision? Why or why not? 14

15. Exercise 1.39 (7) Although quantitative benefits were lower than expected, they are still positive. Unknown is whether the outsourcing contract is responsible for lower sales growth and increased personnel turnover. This looks like a close call, and deserving of more investigation. 15

16. Exercise 1.42 (pag. 35) (a) Given the following information compute MST’s cost-reduction target Input Data: 16 Expected market price$200 Required return on sales25% Product life2 years Currently feasible cost$ 30,000,000 Expected average annual sales, units75,000

17. Exercise 1.42 (1) 17 Target costing analysis Sales price $200 Return on sales x 25% Dollar return on sales $ 50 Target cost per unit ($200 - $50) $ 150 Product lifecycle sales 150,000 Total target cost $22,500,000 Currently feasible cost $30,000,000 Cost reduction $7,500,000 (2 x 75,000) ($150 x 150,000)

18. Exercise 1.42 (2) (b) If MST believes it can reduce the cost of the device by no more than 18%, is this a feasible product for MST? Why or why not? 18

19. Exercise 1.42 (3) MST expects to reduce costs by 18% Expected cost reduction= 0.18 x $30,000,000 = $5,400,000 Required cost reduction is $7,500,000 $5,400,000 < $7,500,000  so unless further cost reductions are possible or the price can be raised, this is not a feasible product 19

20. Exercise 1.50 (pag. 39) (a) and (b) What costs would be incurred as a result of taking the contract? If the contract will pay £ 250,000 for the six months, should Change Management accept it? 20

21. Exercise 1.50 (1) 21 Statement of income New contract changes Monetary impact of new contract Income with new contract Sales revenue $ 1,750,000 $ 250,000 250,000 $ 2,000,000 Costs Labour 650,000 225,000 875,000 Equipment lease 105,000 12% 12,600 117,600 Rent 130,000 - - Supplies 70,000 15% 10,500 80,500 Officers' salaries 420,000 Other costs 48,000 15% 7,200 55,200 Total costs 1,423,000 255,300 1,678,300 Operating profit (loss) 327,000 (5,300) $ 321,700

22. Exercise 1.50(2) Technically, the new contract reduces profit of the company by £5,300. By itself, this one-year contract appears not to be worth the effort of hiring and training new, part-time consultants. 22

23. Exercise 1.50 (3c) (c) What considerations, other than costs, are necessary before making the decision? 23

24. Exercise 1.50 (4) Other considerations include: (1) whether this will enable the company to get into a new, profitable line of business; (2) what other opportunities the company has for expansion; (3) whether the contract will provide for more revenues in the future; (4) what obligations the company makes to its employees. 24

25. Exercise 1.51 (pag. 39) Input Data: 25

26. Exercise 1.52 (1) 26 Annual Customer profitability Large Customer Small customer Revenues€3,000,000 €210,000 Cost of supplies 2,400,000 157,500 Gross margin 600,000 52,500 Operating costs Ordering costs 90,000 9,000 Delivery costs 240,000 16,800 Internet access costs 2,500 Total operating costs 332,500 28,300 Customer profit €267,500 €24,200 (3,000 x $1,000, 300 x $700) (80%, 75% of revenues) (3000x$30, 300x$30) (8% of revenues)

27. Exercise 1.51 (2) Is it worth adding 10 small customers to replace 1 large customer? Gains: 10 x €24,200 = €242,000 profit Losses: €267,500 profit of large customer Gains< Losses  Unless Corporate Express feels that these companies will grow to be more profitable than its current average customer, this can be an unwise tradeoff. 27

28. Exercise 1.52 (3) (c) On average, each small customer would have to increase its profitability from €24,200 to €26,750: by increasing the value of its orders, by paying a premium for services, by demanding less costly service, or a combination of these actions. 28

29. Exercise 1.51(4d) (d) Do you recommend that Corporate Express consider this business alternative further? 29

30. Exercise 1.51 (5) Consider pilot program with a few companies  Avoids risk of full-scale implementation 30

31. See you next week! 31