Teaching Strategic Cost Management

Ed Blocher

University of North Carolina, Chapel Hill Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

1.

Overview

The Strategic Approach: an Introduction 2.

Tools for Integrating Strategy: Value Chain Analysis, The Strategy Map, and the Balanced Scorecard (BSC) 3.

Sample Course Outlines 4.

Sample Course Topic: Activity-Based Costing (ABC), Time Drive ABC (TDABC), and ABM 5.

Sample Course Topic: Customer Profitability Analysis 6.

Sample Course Topic: The Management and Control of Quality and Accounting for Lean 7.

Sample Course Topic: Performance Measurement 8.

Using Software in the Cost Management Course Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Part 1: the Strategic Approach to Teaching Cost/Management Accounting Topics —An Introduction

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Teaching Strategic Cost Management What?

Why?

How?

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Three Levels to Teaching

…



First Level:

Explain the topic



Second Level:

As above, plus require homework



Third Level:

As above, plus include the topic on exams

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Strategic Cost Management

Prior Perspective The Strategic Perspective

• •

Focus on Financial Reporting

•

Common emphasis on standardization and standard costs The accountant as functional expert and financial scorekeeper # View cost management as a tool for developing and implementing

business strategy

# The accountant as a

business partner

# Focus on cost management

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Consequences of Lack of Strategic Cost-Management Information

 Decision-making based on guess and intuition  Lack of clarity about direction and goals  Over time, lack of a clear and favorable perception of the firm by customers and suppliers  Incorrect decisions: choosing products, markets, or manufacturing processes that are inconsistent with the organization’s strategy  For control purposes, cannot link performance effectively to strategic goals  … Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Definition of Management Accounting: IMA

Management accounting

is a profession that involves partnering in management decision making, devising planning and performance management systems, and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization’s strategy .

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Introducing Strategy

Strengths Weaknesses Strategic Positioning Opportunities Threats Value Chain Strategy Map Balanced Scorecard (BSC) Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Michael Porter: Strategic Positioning



Cost Leadership

—outperform competitors by producing at the lowest cost, consistent with quality demanded by the consumer 

Differentiation

—creating value for the customer through product innovation, product features, customer service, etc. that the customer is willing to pay for Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Aspects of the Two Competitive Strategies Aspect Basis of competitive advantage Product line Production emphasis Marketing emphasis Cost Leadership Lowest cost in the industry Often, a limited selection Lowest possible cost with high quality and essential product features Differentiation Unique product or service Wide variety, differentiating features Innovation in differentiating products Low price Premium price and innovative, differentiating features

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Part 2: Tools for Integrating Strategy into Cost Accounting/Cost Management Courses

-- The Value Chain -- Strategy Maps & the Balanced Scorecard (BSC)

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Value Chain Analysis: A Detailed Look at Strategy…

The

Value Chain

is a linked set of value adding activities used by an organization to deliver its value proposition to its customers. It consists of: o “Upstream” Activities o Manufacturing/Operations o “Downstream” Activities Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Value-Chain Analysis

 Identify value-chain activities  Develop competitive advantage by:  Identifying opportunities for adding value for the customer  Identifying opportunities for eliminating non value added activities and reducing cost  Understand linkages among suppliers, the entity, and customers Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Strategy Maps & the Balanced Scorecard (BSC)

The BSC and Strategy Map are used to align the organization’s activities with achieving strategic goals, using the four perspectives: •Financial •Customer •Internal Processes •Learning and Growth Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Financial Diversify income stream vision & mission Exceed shareholder expectations Increase sales volume Improve profit margins Customer Diversify customer base Attract new customers Increase sales to existing customers Internal Process Target profitable market segments Develop new products Optimize internal processes Attract new customers Learning & Growth Develop employee skills Integrate systems

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

The Balanced Scorecard (BSC):

Feedback to Strategy

Strategic Positioning Value Chain Strategy Map Balanced Scorecard (BSC) Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Educational Resource: Tartan Manufacturing Case

Key Issues:

• Tartan emphasizes

product leadership

and

quality

•

Limited

manufacturing

capacity

• Fast sales growth in certain lines • The “Classic” Line has

falling sales

and is increasingly difficult to manufacture

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Part 3: Sample Course Outlines

• • •

Management Accounting Cost Accounting Advanced Management Accounting

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Introduction to Management Accounting

 Strategic Positioning  Ethics

Implementing Strategy Product Costing Cost Behavior

(Planning and Operational Control)

Product Life Cycle

  The Value Chain The Balanced Scorecard   Volume Based (Job Costing) Activity based Costing  Cost Estimation  CVP Analysis  Master Budget  Decision Making  Flexible Budgets   Target Costing Life Cycle Costing  Management Control Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

 

Cost Accounting

Strategic Positioning Ethics

Implementing Strategy Product Costing Cost Behavior

(Planning and Operational Control)

Product Life Cycle

 The Value Chain  Job Costing 

Cost Estimation



Target Costing

 ABC Costing  The Balanced Scorecard  Process Cost 

CVP Analysis (ABC)



Life Cycle Costing

 Joint Costs 

Master Budget

(ABC) 

Managing Constraints

 Standard Costing  Decision Making (ABC) Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Implementing Strategy Advanced Management Accounting

 Strategic Positioning  Ethics

Cost Behavior (ABC-based) Product Life Cycle

  The Value Chain The Balanced Scorecard (BSC)  Management Control (TP)  Executive Compensation  Business Valuation 

Cost Estimation (Regression)



CVP Analysis



Master Budget

 Decision Making (LP)  Target Costing  Life Cycle Costing Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Part 4: Sample Course Topic — Activity-Based Costing (ABC), RCA, and TDABC

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Evolution of Cost Accounting Systems

Traditional Costing ABC (simple & minimal) ABC (multidimensional) Resources

Allocated to

Cost Objects Resources Resources

Consumed by

Activities

Consumed by

Cost Objects

Consumed by Consumed by

outputs Activities channels Cost Objects Users

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

ABC/M Framework Resource Costs Resource Drivers What Things Cost Root Causes of Costs Work Activities Activity Cost Assignment Performance Measures

•

Cost Reduction

•

Process reengineering

•

Cost of quality

•

Continuous improvement

•

Waste elimination

•

Benchmarking Cost Objects Activity Drivers Why Things Cost

•Design for manufacturing •Make versus Buy

Better Decision Making

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Resource Consumption Accounting (RCA)

Resource consumption accounting (RCA)

is an adaption of ABC that emphasizes resource consumption by greatly increasing the number of resource cost pools, which allows more direct tracing of resource costs to cost objects than an ABC system with fewer cost centers.

8 RCA is particularly appropriate for large organizations with repetitive operations and high-level information systems such as those provided by SAP, Oracle, and SAS.

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Time-Driven ABC

When a substantial amount of the cost of a company’s activities are in a highly repetitive process (much like in the RCA example above), the cost assignment can be based on the average time required for each activity.

Time-Driven Activity-Based Costing (TDABC)

assigns resource costs directly to cost objects using the cost per time unit of supplying the resource, rather than first assigning costs to activities and then from activities to cost objects.

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

TDABC Example

TDABC computes the cost per minute of the resources performing the work activity. Assume 2 clerical workers paid $45,000 annually perform a certain activity that is expected to require 17 minutes. TDABC calculates the total cost as $45,000 x 2 = $90,000; TDABC then calculates the total time available for the activity as 180,000 minutes (assuming 30 hours per week with two weeks vacation: 2 workers x 50 weeks x 30 hours x 60 minutes per hour = 180,000 minutes per year). The TDAC rate for the activity is $0.50 per minute ($90,000 / 180,000). The cost of a unit of activity is $0.50 x 17 min = $8.50; if the activity required 20 min, then the allocation would be $.50 x 20 = $10.

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Part 5: Sample Course Topic —Customer Profitability Analysis

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Overview of Customer Profitability Analysis

• Activity Based Costing (ABC) • Customer Relationship Management (CRM): • Customer Lifetime Value (CLV) • Customer Equity Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Customer Profitability Analysis: The Whale Curve: 80% from the top 20% (or more!) The Whale Curve Cumulative Profits

300 % 100 % 50 % 20%

Most Profitable

100 %

Least Profitable

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

What Makes for a Profitable Customer?

Profitable and unprofitable customers are distinguished by the demands they place on the organization



Less profitable customers

    

Small order quantities Special products ordered Heavy discounting Unpredictable demands Delivery times change

 

High technical support Slow payment (imputed interest)



More profitable customers

      

Large order sizes Standard products ordered Little discounting Predictable demands Delivery times standard Low technical support On-time payment (imputed interest) These demands can be estimated by activity costs and activity cost drivers

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Migrating Customers to Higher Profitability – A Strategic Analysis Very Profitable High (Creamy) Types of Customers Product Mix Margin Low (Low Fat) Low Cost-to-Serve High Very unprofitable

Customer Relationship Management (CRM) Requires Strategic Cost Management Data

Who is more important to pursue with the scarce resources of our marketing budget?

 Our most

profitable

customers? Our most

valuable

customers?

  What is the difference?

The “customer lifetime value” (CLV) measure is intended to answer this question.

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

You are a pharmaceutical supplier: which customer is more important?

Dentist A

Sales = $750,000 profits = $100,000 Age 61

Dentist B

Sales = $375,000 profits = $40,000 Age 25

Which is more profitable?

Which is more valuable?

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Customer Lifetime Value (CLV) What is it?

The projected economic value of customer relationships during the whole period of the relationship between the customer and company.

The Measure

The net present value (NPV) of all

future

profits from that customer; it is a

projection

, from when the customer is acquired or from the current date.

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Customer Equity What is it?

The economic value of ALL customer relationships.

The Measure

The sum of the CLVs for all customers.

How Used

Provides a measure of the value of the company from the perspective of customer profitability.

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Part 6: Sample Course Topic —The Management & Control of Quality (including Six-Sigma and Lean)

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Relationship between TQM & Financial Performance

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

A Strategic Model for Managing Quality

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Lean Manufacturing

• At the heart of

lean manufacturing

is the Toyota Production System (TPS): • a long-term focus on

relationships with suppliers

and coordination with these suppliers; • • an emphasis on

balanced, continuous flow

manufacturing with stable production levels;

continuous improvement

in product design and manufacturing processes with the objective of eliminating waste ; and

flexible manufacturing systems

in which different vehicles are produced on the same assembly line and employees are trained for a variety of tasks Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Accounting for Lean

There are

three reasons

why the improvements in financial results typically appear later than the operating improvements from implementing lean.

• Customers will benefit from the improved manufacturing flexibility by ordering in

smaller, more diverse quantities

. • Improvements in productivity will create

excess capacity

; as equipment and facilities are used more efficiently, some will become idle. • The

decrease in inventory

that results from lean means that, using full cost accounting, the fixed costs incurred in prior periods flow through the income statement when inventory is decreasing. Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Accounting for Lean

Lean accounting

uses value streams to measure the financial benefits of a firm’s progress in implementing lean manufacturing. Each

value stream

or services.

is a group of related products Accounting for value streams significantly reduces the need for cost allocations (since the products are aggregated into value streams) which can help the firm to better understand the profitability of its process improvements and product groups. Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Lean Accounting – Value Streams

Rimmer Company Value Stream Income Statement Digital Cameras Video Cameras

Sales Operating Costs Materials Labor Equipment related costs Occupancy costs Total Operating Costs Less Other Value Stream Costs Manufacturing Selling and Administration Value Stream Profit before inventory change Less: Cost of decrease in inventory Value Stream Profit $ 25,200 168,000 92,400 11,200 120,000 10,000 $ 585,000 296,800 130,000 158,200 (10,000) $ 148,200 $ 12,800 88,000 48,400 240,000 10,000 $ 540,000 154,000 250,000 136,000 (20,000) $ 116,000

Total

$ 1,125,000 $ 450,800 380,000 294,200 (30,000) $ 264,200 Less Nontraceable Costs Manufacturing Selling and Administration Total Nontraceable Fixed Costs Operating Income 155,000 54,000 209,000 $ 55,200 Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Part 7: Sample Course Topic — Operational and Management-level Performance Measurement

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Performance Measurement

• Motivation and Evaluation –

Incentives

: right decisions • Align performance measurement with strategy –

Incentives

: working hard • Compensation and bonus plans –

Equity/fairness

• Controllability • Cost allocations • Operational-level and Management-level Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Operational Performance Measurement with a Flexible Budget

Data Item for Analysis

Units Sold

Schmidt Machinery Company

Analysis of Operations 2010

Sales Actual

780 Sales Variable Expenses Contribution Margin Fixed Expenses Operating Income $639,600 350,950 $288,650 $160,650 $128,000

Flexible Budget Variance

0 $15,600 50 $15,650 $10,650 $5,000

F F F U F Flexible Budget

780

Volume (Activity) Variance

220

U

$624,000 351,000 $273,000 $150,000 $123,000 $176,000 99,000 $77,000 $0 $77,000

U F U U Master (Static) Budget

1000 $800,000 450,000 $350,000 $150,000 $200,000 Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Management Performance Measurement Cost Centers

• Engineered Cost (cost driver: volume based) •Flexible Budget • Discretionary Cost (cost driver?) •Master Budget • “Profit Center” – one step from outsourcing… Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Management Performance Measurement

•

Profit Centers:

• Variable costing income statements • Issue of transfer pricing • Role and importance of nonfinancial • performance indicators

Investment Centers:

• ROI vs. RI vs. EVA® •Measurement issues • Issue of transfer pricing • Role and importance of non-financial performance indicators Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Management –Level Performance Measurement: When to Use Profit or Cost Center

Plant Customer Warehouse Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Part 8: Using Software in the Strategic Cost Management Course

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Using Software in the Strategic Cost Management Course

1. Excel: Goal Seek Solver 2. ABC: OROS (SAS), SAP, … Excel 3. Simulation: Crystal Ball, @Risk, Excel(Formulas/Functions)

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

ABC Software: OROS Quick (from SAS)

• Comprehensive: resources through objects • Allow a couple of classes • Short Tutorial, 13 pages, couple of hours • Blue Ridge Manufacturing Case Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Have a great Meeting and Visit in San Francisco!

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010