Strategic cost management

From CEOpedia | Management online

Strategic cost management is a process connecting financial management, cost management and strategic management. It involves cost optimization and financial resources preparation which are needed to achieve desired strategic market position in cost effective manner. Strategic cost management involves identification and categorisation of most important cost for perform critical strategic projects and reduction of cost which are not important or less critical to achieve strategic objectives. From a strategic perspective cost management and financial resources management are very important task and responsibilities for the CEO of the enterprises.

Total Cost of Ownership as Strategy Cost Management

Total cost of Ownership (TCO) is a financial estimate and philosophy which is on purpose understanding actual cost of purchasing a specific good or service from a specific supplier. It also helps buyers and owners establish direct and indirect cost of a product or system. This analysis meant to uncover all the lifetime costs that follow from owning certain kinds of assets.

Total Cost of Ownership is real when is on strategic standard as support the organization operation. Analysis TCO can be qualified as strategic cost management, if the organization take into account both internal and external costs. All Analysis help strategic cost management thanks to the wide impact of decisions purchasing for organization costs. Relationship Total Cost of Ownership and Strategic cost management is contained in three different types of techniques:

  • Value Chain Analysis
  • Cost Drivers Analysis
  • Strategic Positioning Analysis[1]
Fig.1. Strategic cost management process

Value Chain Analysis

Value Chain Analysis is a strategic tool used to analyze internal activities company. The goal of the company is internal activities is to determine which activities are the most valuable for the company and which can be improved to provide an advantage over the companies. This concept was first described by Michael Porter. He suggested that all activities should be at an optimal level if the organization is to gain a real competitive advantage. Companies conduct a value chain analysis, analyzing each production step required to create a product and identifying ways to improve the performance of the chain. The Value Chain analysis tends to the maximum value at the lowest total cost and creation of a competitive advantage.

Cost Drivers Analysis

Cost Driver Analysis requires understanding what causes costs. Analysis of driver costs is the study and explanation of the effects of cost factors. The purpose of the cost analysis is to search for the underlying causes of operating costs.The cost driver for short term indirect variable costs may be the volume of output or activity. In case of long term indirect variable costs, the cost drivers will not be related to volume of output or activity.

Strategic Positioning Analysis

Strategic Positioning Analysis is an approach for researching what future environments might be like in your internal corporate structure as well as your external environment and determining how you can use the choice of business strategies to get from your current situation to these desirable goals. Strategic positioning is translate in two things: lower cost for the company or offer the best products.Driving down costs is way to increase profitability. To compete on cost, companies must balance price with acceptable quality (cost leadership). Driving up prices also increase profitability. The company must deliver distinctive value to customers to achieve higher price (Product Differentation). [2]

Stages of Strategic Cost Management

  1. Formulating Strategies
  2. Communication of Strategies in the entire organization.
  3. Planning and improving tactics, to execute those strategies.
  4. Developing and realizing controls to track the success.

Implementation of strategies involves all those means related to executing the strategic plans. It is managing forces during the action which requires coordination among many individuals.It is mainly an Administrative Task based on strategic and operational decisions which emphasizes on efficiency. Implementation of strategy is the translation of chosen strategy into organizational action so as to achieve strategic goals and objectives.

Implementation of strategies is defined as the manner in which an organization should develop, use, and connects organizational structure, control systems, and culture to follow strategies that lead to competitive advantage and a better performance. Organizational structure allocates special value developing tasks and roles to the employees and states how these tasks and roles can be synchronized to maximize efficiency, quality, and customer satisfaction[3]

Examples of Strategic cost management

  • Identification and measurement of critical cost drivers: It is an important step in strategic cost management which involves identification and measurement of the most important cost drivers associated with the strategic projects and activities within the organization. This helps in identifying the cost which can be reduced or eliminated to improve profitability of the company. For example, a company may decide to measure the cost associated with its advertisement campaigns and identify the cost drivers which can be reduced to improve overall profitability.
  • Cost reduction initiatives: Strategic cost management also involves identification of cost reduction initiatives which can be implemented to reduce the cost and improve overall profitability. For example, a company may decide to outsource some of its non-core activities to third party vendors to bring down the costs associated with those activities.
  • Cost optimization: Cost optimization is an important step in strategic cost management which involves optimizing the cost associated with strategic projects and activities in order to maximize profitability. For example, a company may decide to reduce the cost associated with its production process by using cheaper and more efficient raw materials or by streamlining its production process.

Advantages of Strategic cost management

The advantages of strategic cost management are as follows:

  • Improved decision making - Strategic cost management allows for better decision making since it takes into account the cost and resource implications of a particular strategy. This can help to identify cost-effective solutions and ensure that resources are allocated in the most efficient way possible.
  • Cost savings - Strategic cost management helps to reduce costs by focusing on the most important and critical costs that need to be addressed in order to achieve the desired strategic objectives. This can include cost reduction strategies such as outsourcing, automation, and process optimization.
  • Increased competitiveness - Strategic cost management helps to gain competitive advantage by increasing efficiency and reducing costs. This can help to gain market share and increase profitability.
  • Improved performance - Strategic cost management helps to improve performance by focusing on the most important costs and resources. This can help to identify areas of improvement and ensure that resources are allocated in the most efficient way possible.
  • Increased efficiency - Strategic cost management helps to increase efficiency by streamlining processes and eliminating wasteful activities. This can help to increase productivity and reduce costs.

Limitations of Strategic cost management

  • Strategic cost management has certain limitations, which include:
  • Costs can be difficult to manage, as they can be very complex and vary from industry to industry.
  • Strategic cost management requires a long-term outlook and commitment from senior management to ensure its success.
  • It is difficult to accurately measure the impact of cost management initiatives since it is difficult to quantify the costs and benefits of such efforts.
  • It can be difficult to motivate staff to accept cost management initiatives and also to ensure that they are implemented properly.
  • Strategic cost management is not always feasible or practical due to the time and resources required to execute it.
  • There is a risk that cost management initiatives can have unintended consequences, such as reducing employee morale or reducing service quality.

Other approaches related to Strategic cost management

In addition to the Strategic cost management, there are several other approaches related to cost management which are important for achieving desired objectives:

  • Activity-based costing: It is a methodology which allocates cost of activities to the products and services based on the usage of activities. It is an important approach used in cost management to allocate resources to the most profitable activities.
  • Target costing: This is an approach used to control cost of production, services and operations. It involves predicting future cost of operations, setting target cost and then working to achieve it.
  • Lean costing: It is a methodology which is used to identify and eliminate non-value added cost, improve efficiency and reduce cost of production.
  • Quality costing: It is an approach which is used to identify cost of producing quality services and products and cost of not producing quality products and services.

In summary, Strategic cost management is an important approach to manage cost for achieving desired objectives. There are other approaches such as activity-based costing, target costing, lean costing and quality costing which are also important for cost management.


Strategic cost management — recommended articles
Activity-based management — Value management — Classification of goals and functions — Goal intensity matrix — Capability mapping — Managerial controlling — Benefits of strategic management — Planning and control — Budgetary control

References

Footnotes

  1. ↑ Lisa M Ellram, Sue P Siferd, p. 57-60
  2. ↑ John K. Shank, Dartmouth College, p. 50-60
  3. ↑ Vijay Govindarajan and John K. Shank, s. L3-1 - L3-6

Author: Weronika Góra

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