Strategic cost analysis 2 FDM6 Strategic cost analysis 2

Strategic cost analysis 2 Alternative costing approaches Common features Implementation issues Making use of tools and techniques Reading: Management Accounting for Business chapters 14 and 15 FDM6 Strategic cost analysis 2

Alternative costing approaches Aim – understand costs better in order to manage and make decisions more effectively Activity based costing alternative to absorption costing Target costing Lifecycle costing Kaizen costing Quality costs Environmental accounting FDM6 Strategic cost analysis 2

FDM6 Strategic cost analysis 2 Target costing Target for product cost derived from market price Aim to achieve target cost May be less than planned initial cost but should be achieved by mature production stage. Originated in Japan – Toyota Carried out in development phase Aim to reduce costs before ‘designing’ them in Change of focus to cost reduction rather than recording Setting target cost forces business to think about managing costs downwards FDM6 Strategic cost analysis 2

FDM6 Strategic cost analysis 2 The process Estimate selling price to capture required share Reduce this by required profit, taking into account: Required return on new investment Working capital requirements Estimate target cost Estimate expected cost of manufacture Identify gap between target and expected cost Cost reduction Re-estimate expected cost and gap Repeat cost reduction Decide whether to go ahead Manage costs in production using control systems FDM6 Strategic cost analysis 2

Life cycle costing - the product life cycle FDM6 Strategic cost analysis 2

Costs and the product life cycle Product related costs vary throughout life cycle Very high costs at the beginning Initial research, development and launch costs may be significant Need to consider revenues and costs incurred over whole life-cycle Traditional methods based on steady state, annual periods may not be appropriate Especially important as life cycles shorten FDM6 Strategic cost analysis 2

FDM6 Strategic cost analysis 2 Life-cycle costing Profile costs over product’s life Track actual costs and revenues from start to finish Prices based in total life-cycle costs rather than current period Timetable of costs helps to show what costs need to be recovered over the product’s life Emphasises importance of control over designed-in costs Traces costs such as R&D, marketing to individual products FDM6 Strategic cost analysis 2

Questions for discussion What do these approaches have in common? What challenges to they present to organisations implementing them? FDM6 Strategic cost analysis 2

FDM6 Strategic cost analysis 2 Common features Most recognise the importance of the external environment Broader perspective than traditional approaches Relate costing to strategic plans and decisions Better match to today’s approaches to managing organisations Emphasise improvement rather than cost containment May use more than one method at the same time FDM6 Strategic cost analysis 2

Implementation issues Demand high level of commitment May be costly to set up Force focus on customer Multidisciplinary approaches E.g. designers need to work closely with manufacturing teams Need to consider all costs related to production and distribution throughout life cycle May need to begin early in development phase Involves whole supply chain Need to feed into performance monitoring system But - new ideas and new ways of working can lead to more proactive approach in future FDM6 Strategic cost analysis 2

FDM6 Strategic cost analysis 2 Kaizen costing Kaizen – making improvements to processes by incremental amounts Focus on elimination of waste – of materials and in processes Similar to target costing but applied during manufacturing part of product life cycle Cost reductions through improvements to efficiency of production processes Incremental improvements based on target cost reductions FDM6 Strategic cost analysis 2

Total quality management – quality costs Measuring costs of quality central to TQM system Principle – costs of prevention less than costs of correction Four categories of cost: Prevention costs Appraisal costs Internal failure costs External failure costs FDM6 Strategic cost analysis 2

Environmental accounting Identifying costs of environment-related activities Ensure that environment-related costs part of decision making Separate monitoring of usage and cost of resources such as water, electricity and fuel to identify cost reductions Performance monitoring includes environment-related indicators Assess impact and likelihood of environmental risks Benchmark against environmental best practice FDM6 Strategic cost analysis 2

Making use of tools and techniques Applications in marketing and product decisions Using information for strategic purposes within the organisation Apply in a range of performance management models Examples of specific uses: Customer profitability analysis Benchmarking – internal and external Value chain analysis – extending cost analysis beyond the organisation FDM6 Strategic cost analysis 2