Lecture 10 Chapter 15, LS, T

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Lecture 10Chapter 15, L-S, T H

• Managing costs and time for customer value

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Outline

• Define cost management and explain how it
  differs from conventional approaches to cost
  control.
• Use the four steps of activity-based management
  to reduce costs and increase customer value.
• Identify opportunities for cost reduction by
  undertaking value analysis.

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Outline continued

• Select activity-based performance measures to
  manage cost, time and other sources of customer
  value.
• Understand the impediments to implementing
  activity-based management.
• Understand the four major steps involved in
  business process re-engineering, to manage costs
  and other sources of value.

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Outline continued

• Analyse lifecycle costs and revenues and
  understand how to use lifecycle management to
  reduce costs.
• Estimate target costs and describe the processes
  of target costing that lead to cost reduction and
  enhanced customer value.

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Outline continued

• Estimate how time-based management can be used to
  manage time drivers as well as costs and other
  sources of value
• Undertake analyses using the theory of
  constraints and throughput accounting to manage
  costs and time.

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Cost management

• Improvement of an organisations cost
  effectiveness through understanding and managing
  the real causes of cost
• It is a philosophy, an attitude, a set of
  techniques to create more value at a lower cost

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Conventional cost control vs contemporary cost
management

• Drivers of cost
• conventional - managers control costs by bringing
  them into line with some predetermined goal
• focus is on cost results or outcomes
• contemporary - reduces costs by identifying waste
  and eliminating it through identifying the real
  cost drivers
• focus is on determinants of cost

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Conventional cost control vs contemporary cost
management

• Strategic perspective
• conventional - control costs within the
  organisation
• internal perspective
• contemporary - cost management also concerned
  with achieving value for the customer
• a strategic perspective

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Conventional cost control vs contemporary cost
management

• Process perspective
• conventional - control costs by reporting results
  for responsibility centres based on functional
  areas of the business
• contemporary - recognises that customers needs
  are met by processes which flow across the
  business
• may cross functional areas

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Activity-based management (ABM)

• Process of using information from activity-based
  costing to analyse activities, cost drivers and
  performance so that customer value and
  profitability are improved
• Customer value
• features of a product which customers are willing
  to pay

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Activity-Based Management
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Activity-Based Management (ABM)
Evaluates the costs and values of process
activities . . .
. . . To identify opportunities to improve
efficiency.
Process Improvements, Customer Value, Reduced
Costs
Activity-Based Costing
Valued-Added Analysis


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Activity-Based Management
How can we increase our market share for this
product?
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Activity-Based Management
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Activity-Based Management
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Activity-Based Management
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Activity-Based Management
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Activity-Based Management
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Two-Dimensional ABC and Activity-Based Management
Cost Assignment View
Assign resource costs to activity cost pools.
Resource costs
Performance Measures
Root Causes
Activity Triggers
Assign activity costs to cost objects using cost
drivers.
Cost Objects
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Using ABM to reduce costs

• Identify the major opportunities for cost
  reduction
• Determine the real causes of these costs
• Develop a program to eliminate the causes, and,
  therefore, the costs
• Introduce performance measures to monitor the
  effectiveness of cost reduction efforts

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Identifying the major opportunities for cost
reduction

• Value-added activities
• provide essential value to the customer, or are
  essential to the functioning of the business
• Non-value-added activities
• do not add value to a product or service from the
  customers perspective or for the business and,
  therefore, can be eliminated without detriment to
  either

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Elimination of Non-Value-Added Costs
Activities
Analysis andClassification
Value-AddedActivities
Non-Value-AddedActivities
Reduce orEliminate.
Continually Evaluate and Improve.
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Elimination of Non-Value-Added Costs
Non-Value-AddedActivities
Can be eliminatedwithout reducingproduct
qualityor performance.
Add costs but not value to the product.
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Elimination of Non-Value-Added Costs

• Examples of non-value-added activities are
• Storage of materials, work-in-process, or
  finished goods.
• Moving parts, and materials in the factory.
• Waiting for work.
• Inspection.

Get ridof them!
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Using ABM to Eliminate Non-Value-Added Activities
and Costs

• Identify Activities.
• Identify Non-Value-Added Activities.
• Understand Activity Linkages, Root Causes, and
  Triggers.
• Establish Performance Measures.
• Report Non-Value-Added Costs.

Select vendor
Receive parts
Produce goods
Rework defective products
Specify parts
Inspect finished goods
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Building activities into processes

• Eliminating non-value-added activities requires a
  clear understanding of the way work is done in an
  organisation
• Linking activities into processes
• a series of activities that are linked together
  to achieve a specific objective
• often cross the boundaries of responsibility
  centres, such as functional departments

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Cost driver analysis

• Identification of root-cause cost drivers for the
  major non-value-added activities
• Analysis of root-cause cost drivers of
  value-added activities may also lead to more
  efficient use of resources
• Value-added management (or value analysis)
• the process of targeting and eliminating
  non-value-added activities

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Measuring performance in cost reduction

• Activity-based performance measures can be used
  to monitor the effectiveness of cost reduction
  effort
• Performance measures may be based on previous
  activities

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Using the costing dimension of ABC to help manage
costs

• Customer cost analysis
• the costs of products purchased by the customer
  are assigned to the customer, along with the cost
  of any other customer-driven activities
• Customer profitability analysis
• estimating the profits from individual customers,
  or customer groups, by comparing customer costs
  and revenues

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Other activity-based management issues

• Impediments to implementing ABM
• lack of awareness of ABM
• uncertainty over potential benefits
• extensive resource requirements to implement
• resistance to change

Cont.
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Other activity-based management issues

• Behavioural aspects of activity-based management
• resistance to change
• using activity-based information to create
  particular incentives
• The role of strategy and activity-based costing
• enables strategies to be managed taking a
  customer perspective

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Implementation Of Activity-Based Costing
Management
The Focus of ABC
The Focus of ABM
Developing improved product or service costs
given current processes
Identifying opportunities for improving processes
Consider cost-benefits
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Keys to Successfully Implementing ABC and ABM
1. Organisational Culture.
2. Top-Management Commitment.
3. Change Champion.
4. Change Process.
5. Continuing Education.
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Implementation Of Activity-Based Costing And
Management
What Organizations Adopt ABC and ABM?
Companies facing price competition
Companies producing many different, complex
products from common facilities
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Achieving Cost Reduction
Activity Reduction
Activity Selection
Reduce Non-Value-Added Costs
Activity Elimination
Activity Sharing
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Business Process Re-engineering

• The complete redesign of a process, with an
  emphasis on finding creative new ways to
  accomplish an objective.

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Business process re-engineering

• The fundamental rethinking and radical redesign
  of business processes to achieve dramatic
  improvements in critical areas of performance
  such as cost, quality and delivery
• Focus is on strategic processes
• those processes that focus on achieving a
  companys business objectives and strategies

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Business process re-engineering

• Four major steps
• preparing a business process map
• a flow chart of the activities that make up the
  business process
• establishing goals
• reorganising work flow
• implementation of the program

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Business process re-engineering vs ABM

• ABM focuses on process improvement
• the incremental, continuous improvement of
  processes
• Business process re-engineering involves
  fundamental changes to the way processes are
  structured
• Both use activity analysis to identify processes
  and activities

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Product life cycle costing

• A strategic approach to product costing and cost
  management
• Broadens the perspective of costing beyond
  manufacturing
• Encourages a multidisciplinary approach to cost
  management
• Results in decisions which can directly support
  the strategies of the business

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Life cycle costing

• Analyse the costs of activities, including both
  upstream and downstream costs, that occur over
  the life cycle of the product
• Four stages of the product life cycle
• product planning and initial concept design
• product design and development
• production
• distribution and customer (logistic) support

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Life cycle budgeting

• Involves estimating the expected costs and
  revenues for each year of the expected life of a
  product
• Useful in product mix or pricing decisions

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Managing costs through a life cycle costing

• A lack of awareness, or uncertainty about how to
  calculate life cycle costs
• Not easy for products with longer lives as it is
  more difficult to assess
• Changes in consumer tastes
• Impact of competitors actions
• Effects of inflation

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Impediments to life cycle costing

• A lack of awareness, or uncertainty about how to
  calculate life cycle costs
• Not easy for products with longer lives as it is
  more difficult to assess
• changes in consumer tastes
• impact of competitors actions
• effects of inflation

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Target costing

• An extension of product life cycle costing
• Strategically-oriented approach to cost
  management
• Involves examining competitors market prices for
  a product
• Determine the level of product cost that needs to
  be achieved in order to price the product
  competitively

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Target costing

• A tool for planning profits and reducing costs
• Reducing a products cost to a target cost, by
  working on the design to decrease production (and
  customer support) costs
• Target cost - the product cost that must be
  achieved for a product to be viable in the long
  term

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Target Costing

• Design a product, and the manufacturing process,
  so that the product can be manufactured at a cost
  that will enable the firm to make a profit when
  the product is sold at an estimated market-driven
  price.

Target Price
Target Cost
Target Profit
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Target Costing
Market researchdetermines the priceat which a
new product will sell.
Management then computes a manufacturing cost
that will provide an acceptable profit margin.
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The target costing process

• Market-driven costing
• Determine target selling prices
• Determine target profit margin
• Calculate allowable cost
• The target cost at which a product must be
  produced if it is to be sold at the target
  selling price and generate the required rate of
  return

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The target costing process

• Product-level costing
• Cost reduction objective is the degree of cost
  reduction needed to achieve the allowable cost
• Need to estimate the current costthe cost that
  the product could be manufactured for, prior to
  any cost reduction objectives
• Product level target cost is the difference
  between the current cost and the target cost
  reduction objective

continued
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The target costing process

• Component-level costing
• Breaking down the product-level target cost into
  target costs for components
• Value engineering (VE) reviewing the product or
  process design to make changes to reduce cost,
  while still maintaining the functionality of the
  product
• Pursue continuous improvement once production
  begins

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The three steps in target costing

• Developing the target cost
• Driving down the planned cost towards the target
  cost during the design phase
• value engineering (or value analysis)- reviewing
  the product or process design to make changes to
  reduce cost, while still maintaining the
  functionality of the product
• Pursuing continuous improvement once production
  begins

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Target Cost Example
After conducting a market research study, Garden
Lights decides to produce a new light fixture to
complement its outdoor lighting line. According
to the estimates, the new fixture can be sold for
a target price of 20, and the estimated annual
sales target is 100,000 light fixtures. Garden
Lights has a 20 expected return on sales target.
What is the target cost?
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Target Cost Example
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Key features of target costing for cost management

• It is price led
• Focuses on the customer and customer expectations
• Based on principles of life cycle management,
  placing primary emphasis on managing downstream
  and manufacturing costs
• Cross-functional, involving managers from across
  the value chain

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Managing time

• Time dictates the rate at which products are
  produced and revenue generated
• Time determines how long resources are tied up in
  processes, and unavailable for other uses
• Time delays lead to inventory build-ups
• Time to develop new products and delivering
  products to customers may be key to innovation

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Time-based management

• Measures for developing new products and services
• New product development time time from
  identification of initial concept to release of
  product to the market
• Break-even time (BET) the time from
  identification of initial concept to when a
  product has generated enough profit to pay back
  the original investment

continued
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Time-based management

• Time take to fulfil a customers order
• Measures of customer response time, order receipt
  time, waiting time, production time and
  production lead time (cycle time),
• Reliability in meeting scheduled delivery dates

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Measuring Cycle Time
The average time necessary to complete and
deliver all good units and dispose of units that
have to be reworked or scrapped because of
defects.
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Time Drivers

• Any factor that changes the duration of an
  activity.

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Time Drivers

• Poorly structured order, production and delivery
  processes
• Bottlenecks in order, production and delivery
  processes
• Poor quality
• Inefficient inventory management
• Poorly structured RD processes in developing new
  products and services.

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Managing throughput

• Another approach to managing costs and improving
  performance in quality and delivery
• The theory of constraints
• focuses on identifying and removing bottlenecks
  to improve the rate of throughput
• recognises that the rate of production is limited
  to the capacity of the constraints (or
  bottlenecks) that exist in the organisation

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Theory of Constraints

• A management approach seeking to maximise
  long-run profit through proper management of
  organisational bottlenecks or constrained
  resources.

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Managing throughput

• The theory of constraints
• Focuses on identifying and removing bottlenecks
  to improve the rate of throughput
• Recognises the rate of production is limited to
  the capacity of the constraints (or bottlenecks)
  that exist
• Throughput accounting
• Measuring effects of bottleneck and other
  operational decisions using measures of
  throughput, inventory and operating expenses