1. Strategic cost analysis 2
FDM6 Strategic cost analysis 2

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

3. 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

4. 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

5. 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

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

7. 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

8. 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

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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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