CA FINAL STRATEGIC COST MANAGEMENT (SCM)

In this article we sprinkle on one important topic of CA Final Paper 5, i.e., Strategic Cost Management (SCM). From this article you will get to know about the Strategic Cost Management with Example as well as Traditional Cost Management System, Limitations of Traditional Cost Management, and a Comparison between Traditional Cost Vs Strategic Cost Management.

Let’s dive in the topic now;

What is Strategic Cost Management?

Strategic Cost Management (SCM) is the cost management technique that aims at reducing costs while strengthening the position of the business. It is a process of combining the decision-making structure with the cost information, in order to strengthen the business strategy as a whole. It measures and manages costs to align the same with the company’s business strategy.

Strategic cost management is the application of cost management techniques so that they improve the strategic position of a business along with controlling costs. It also involves integrating cost information with the decision-making framework to support the overall organizational strategy. It is not limited to controlling costs but using cost information for management decision making. The cost management techniques should be such that they improve the strategic position of a business apart from focusing on controlling costs. The basic aim of Strategic Cost Management is to help the organisation to achieve the sustainable competitive advantage through product differentiation and cost leadership.

It lays a greater focus on continuous improvement to deliver superior quality product to the customers. Strategic cost management must be an integral part of the value chain. It needs to include all aspects of the production, purchase, design, manufacturing, delivery and service. It is important that strategic cost management is involved at early stages of a product development cycle to avoid heavy costs of failure.

For Example;

The following is hypothetical information of a company producing products A & B. If the company stops producing product B, the sale of A would fall down by 20%.

`’ lacs

Now, let’s focus some light on the  Traditional Cost Management System and its limitations;

Traditional Cost Management Systemlargely focuses on cost control and cost reduction and also involves allocation of costs and overheads to the production. It involves comparing actual results with the standard expectations or we can say comparing budgeted or standard costs and analyzing the differences. A corrective action would be taken to ensure future outcomes are within the budgeted outcomes.

Following are the Limitations of Traditional Cost Management:

1. Excessive focus on cost control and reduction.
2. Short term outlook, for example – saving costs on an annual basis.
3. Reactive Approach.
4. Ignores the competition.
5. Ignores the market growth and customer requirements.
6. Less focus on analyzing and improvisation.
7. Traditional cost accounting relies on accounting data which can be misleading at times. It ignores the dynamics of Marketing and Economics.
8. An extensive cost reduction could lead to inferior quality of products or services which might turn back customers resulting in lower sales and profitability.

‘Cost’ is a tactical issue. There is a need to continuously endeavor to optimize the same in the context of the entire business model of the firm. In modern business environment of increased global competition, new markets, increasing regulation and changing demographics, successful companies must develop a multifaceted cost competence. Thus it becomes necessary to associate the Cost Management to strategies of the organisation.

In the global business environment, it is not sufficient to control costs or reduction and thus, a business must focus to manage cost as per business strategies. A strategy is a set of actions taken by managers of a company to increase the company’s performance. The businesses today operate in an environment with stiff competition, increasing consumer demands for quality products and technology revolution. The ultimate objective of abusiness is to earn better profits and create value for shareholders. This can be achieved by unique and high level performance as compared to the competitors which results in different competitive advantages.

Analysis and the Conclusion

Undertraditional cost management technique, the company might decide to stop production of B because it has a very overhead cost and also results in a loss of Rs. 2 lacs. It thus appears wise to close down the production of B.

However, with additional information that sale of product A would fall down by 20% if B is sold thenthe decision might change. The company would lose Rs. 6 lacs (20% of 30 lacs) because of reduced sales of A. The net loss for the company if it decides to stop production of B is Rs.4 lacs (2 lacs of savings from B and 6 lacs of loss of profits from A). Hence the decision to stop of production B is not prudent.

For example:

On a regular basis a manufacturing company,following the traditional approach, does not carry out preventive maintenance of its machineries to save costs. Repair of machinery is carried out as and when themachinery breaks down. Under this traditional approach focus is on cost reduction and cost saving. This is a short- term approach to manage costs.

When machinery breaks down, the company loses more in terms of loss of production timeand idle labour time. Lack of regular preventive maintenance and planned shutdown timealso reduces the life of the machinery and has a long term impact. If the loss of production is remarkable or noteable then the company might its lose market share to its competitors. Hence, it is important to look at cost management with a strategic focus.

Let’s understand with one more Example;

A telecom company closed down some of its customer service centres as a cost cutting measure. This led to overcrowding of customers at other centres and longer waiting time for the customers. The volume of work at other centres increased and it also impact the performance of employees. Due to this company’s decision both the customers and employees, two of the key stakeholders, were not happy. This type of business decision canimpact the goodwilland brand image of the company and impact the sales and profitability in the longer run.

Strategic Cost Management is the process of reducing total costs while improving the strategic position of a business. This goal can be achieved by having a thorough understanding of which costs support a company’s strategic position and which costs either weaken it or have no impact. Subsequent cost reduction initiatives should focus on those costs in the second category. Conversely, it may be useful to increase costs that support the strategic position of the business.

For example, the strategy of a manufacturing firm is to be able to increase the customer orders by maintaining tight control over its obstructive production operation. To do so, the company incurs extra costs to keep the obstructive production running for 24 hours on daily basis. Expending extra funds here directly contributes to the profitability of the business. Conversely, cutting costs at the obstructive operation will reduce the production capacity of the business and will have an immediate negative impact on its profits. From a strategic point of view, the company would do better to cut costs in non-obstructive areas that are downstream from the obstructive operation, since these cuts would have no impact on the delivery times quoted to customers.

It is almost never beneficial to cut costs in strategically important areas, since doing so reduces the customer experience and therefore will eventually lead to a decline in sales. Consequently, management needs to be involved in cost reduction activities, so that they can provide input regarding how certain costs must be incurred in order to support the competitive position of the firm.

Strategic cost management is a continuing process, since the strategy of a firm may change over time. Thus, certain costs may be sacred when one strategy is being used, but can be readily eliminated when the strategy shifts.

Strategic cost management is a philosophy, an attitude, and a set of techniques to contribute in shaping the future of the company!!

Necessity of Strategic Cost Management (SCM)

• It is cost analysis in a broader context where the strategic elements become more explicit and formal strengthening the strategic position of the company.
• Cost data is analyzed and used strategically to develop alternate measures to gaining sustainable competitive advantages.
• SCM gives a clear understanding of the company’s cost structure in search of sustainable competitive advantage.
• SCM is the managerial use of cost information explicitly directed to the four stages of strategic management – formulation, communication, implementation and control.
• SCM helps in overall recognition of cost relationships among the activities in the value chain and the process of managing theserelationships to the company’s competitive advantage.

Now as we are towards the end of the article, let’s end it with comparing the two Cost Management Systems –

Traditional Cost vs. Strategic Cost Management

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