STRATEGIC COST MANAGEMENT - BA122B – Fall Value Chain Analysis (VCA) & Target Costing

STRATEGIC COST MANAGEMENT - BA122B – Fall Michael Porter’s Value- Chain n Developed in 1985 by Michael E. Porter in Competitive Advantage cost advantages distinctive capabilities n Highlights cost advantages and distinctive capabilities--the value processes no one template n But note that there is no one template.

STRATEGIC COST MANAGEMENT - BA122B – Fall Value Chain and the QCT Triangle quality n VC allows alignment of processes with customers. This generates a quality advantage. cost n VC focuses cost management efforts. timeliness n VC provides for efficient processes which improves the timeliness of operations.

STRATEGIC COST MANAGEMENT - BA122B – Fall Value Chain Benefits n Identifies value processes n Identifies areas for cost improvement n Identifies areas for operational improvement

STRATEGIC COST MANAGEMENT - BA122B – Fall Value Chain Model from Michael E. Porter’s Competitive Advantage Firm Infrastructure (General Management) Human Resource Management Technology Development Procurement Inbound Logistics Ops. Outbound Logistics Sales & Marketing Service and Support PRIMARY ACTIVITIES SUPPORT ACTIVITIES Customer Value Margin

STRATEGIC COST MANAGEMENT - BA122B – Fall Value Chain Elements n Customer value added n Margin orientation n Primary activities n Inbound logistics n Operations n Outbound logistics n Sales and marketing n Service and support n Support Activities n Human resources (general and admin.) n Tech. development n Procurement

STRATEGIC COST MANAGEMENT - BA122B – Fall Goal of Value Chain n Driven by customer perceptions n Increase margins n Focus on value processess n Distinctive capabilities n Cost advantages n Some examples n Southwest Airlines n Intel Corporation

STRATEGIC COST MANAGEMENT - BA122B – Fall Value Chain Analysis n Document the activities n Understand the cost and margins at each step. n Use Activity Based Costing n Map the value chain to the industry value chain n Look for core competencies n Map the cost structure n Note that external values drive cost advantages

STRATEGIC COST MANAGEMENT - BA122B – Fall Discovering Your Own Value Processes summary n Distribute a summary of the value chain model. process lists n Create functional process lists. labels n Transfer lists to color-coded labels. n “Pin the process” n “Pin the process” on a large VC diagram. n Identify n Identify appropriate processes as: n $ (cost advantage) n CC (core competency)

STRATEGIC COST MANAGEMENT - BA122B – Fall Using the Value Chain n Helps you to stay out of the “No Profit Zone” n Presents opportunities for integration n Aligns spending with value processes n Provides for reconfiguration of the value chain n outsourcing n off-shoring n co-location with customers or suppliers n redesign for efficiency n Involves chain partners: customers & suppliers

STRATEGIC COST MANAGEMENT - BA122B – Fall Value Chain and the TBC Triangle n Technical: n Increases knowledge of no profit zones n Increases knowledge of forward and/or backward integration opportunities n Identifies value processes n Identifies win-win alliance opportunities n Behavioral: n Focus shifts to “the customer” n Focus shifts from conflict to partnering with customers & suppliers n Cultural n Creates externally focused mindset n Generates information sharing environment with respect for confidentiality

STRATEGIC COST MANAGEMENT - BA122B – Fall Life Cycle Costing Product Specification Target Price Target Profit Target Cost Major Product and Process Design Changes Does the design meet target cost? Estimate Life Cycle Cost Is project life cycle cost acceptable? Put product into production Minor Product and Process Design Changes Product Abandonment Target Costing On-going improvement Abandonment

STRATEGIC COST MANAGEMENT - BA122B – Fall Product Cost Life Cycle n R & D n Design n Production n Marketing & Distribution n Customer Service Upstream (focus for early settlement here) Downstream

STRATEGIC COST MANAGEMENT - BA122B – Fall Shift in Strategic Impact n Shift focus from manufacturing costing to… n Upstream or downstream focus using the value chain

STRATEGIC COST MANAGEMENT - BA122B – Fall Target Costing n Customer Orientation n Sets costs in the commitment phase- concurrent engineering n Supports keiretsu model via the value chain n Price led costing n Cross functional product teams n Focuses on life cycle costing

STRATEGIC COST MANAGEMENT - BA122B – Fall Target Costing Process n Establishment phase n Market research n Competitor analysis n Niche definition n Customer requirement definition n Product feature definition n Market price determination n Profit rate

STRATEGIC COST MANAGEMENT - BA122B – Fall Target Costing Process n Attainment phase n Cost gap computation n Design costs out n Design release and continuous improvement

STRATEGIC COST MANAGEMENT - BA122B – Fall Cost Reduction n Cost analysis n Components list n Functional analysis n Customer requirement ranking n QFD Matrix n Relative functional rankings n Value engineering n Identify components for cost reduction n Generate cost reduction ideas n Testing and implementation n Cost estimates required at each design iteration

STRATEGIC COST MANAGEMENT - BA122B – Fall Value-Index Analysis n Choose features and options based upon customer preference n Value-Index = Cust. Preference % Feature Cost % n VI > 1…increase spending n VI < 1…decrease spending

STRATEGIC COST MANAGEMENT - BA122B – Fall TC-Strategic Implications n Quality is improved through the customer focus of target costing n Cost reduction is the heart of target costing n Time reduction is a natural by-product due to concurrent engineering

STRATEGIC COST MANAGEMENT - BA122B – Fall TC-Attribute Implications n Technical n Decision relevance improves (quality, cost and time issues are integrated) n Process understanding improves n Behavioral n Early finance involvement and teamwork are mandated n Undesirable attributes of longer development, burnout, feature creep & internal conflict can be managed

STRATEGIC COST MANAGEMENT - BA122B – Fall TC-Attribute Implications, cont. n Cultural n Organizational culture must be prepared n Commitment to sustaining values must be established n Customer focus n Cross-functional cooperation n Open sharing of information