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Cost Management
Planning Organising Directing Monitoring Control
Target costing
2005 2006
(a)Set up, production order , materials Rs 8,000 Rs 7,500
handling cost per batch
(b)Total Manufacturing Operating Costs per 55 50
machine hour
(c)Cost of engineering changes that vary with 12,000 10,000
the number of engineering changes made
1
Prepared by Dr Ahindra Chakrabarti, Professor and Director PGDM Programme at
Great Lakes Institute of Management, Gurgaon.
1
The management of Medical Instruments Co wants to evaluate
whether value engineering has succeeded in reducing the target
manufacturing cost per unit of one of its products HJ6, by 10%. Actual
results for 2005 and 2006 are :
2005 2006
Units of HJ6 produced 3500 4000
Direct Materials Cost per unit of HJ6 Rs 1200 Rs 1100
Total number of batches required to 70 80
produceHJ6
Total Machines hours required to produced HJ6 21000 22000
Number of Engineering Changes made 14 10
2005 2006
Per Total Per Total
Unit Unit
Per Unit 3500 4000
Direct Material2 1200 42000 1100 44000
00 00
Batch Level Costs3 160 56000 150 60000
0 0
Manufacturing Operations Cost4 330 11550 275 11000
00 00
Engineering change costs5 48 16800 25 10000
0 0
Total 1738 1550
2
1200 X 3500; 4000x1100..
3
Rs 160=(70 X8000)/3500; Rs 150=(80 x 7500)/4000
4
Rs 330 =(Rs 55 x 21000)/3500; Rs 275 =(Rs 50 x 22000)/4000
5
Rs 48 =(14 x12000)/3500; Rs 25 =(10 x10000)/4000
2
Below presented a diagram of how Toyota applied target costing system
in improving the value and reducing cost of Lexus Car.(Taken from
Japanese Management Accounting –published by Productivity Press
Tokyo)
3
Life Cycle Costing: We will explain this with an example
Rs (‘000)
Costs
R &D 700 0 700 450 0 450 2400 0 240
0 0 0 0 0
Design of 185 150 200 110 100 120 800 160 960
Product 0 0 0 0
Manufactu 750 225 300 105 105 210 1430 650 208
ring 0 0 0 0 0 0
Marketing 140 360 500 120 150 270 2400 208 448
0 0 0 0 0 0 0 0
Distributio 150 600 750 240 360 600 600 360 960
n
Customer 500 325 375 450 105 150 2200 388 608
Service 0 0 0 0 0 0
B.Total 116 985 215 854 406 126 983 713 169
Cost 50 0 00 0 0 00 0 0 60
C.Profit/ (66 101 350 (25 494 240 170 (11 (96
(Loss) 50) 50 0 40) 0 0 30) 0)
4
Growth Imperatives and Strategic Cost Management
To address the issue a way of thinking about growth that balances the
competing demands of running existing businesses and building new
ones, and that offers a language that leaders at all levels of an
organization can use can be termed as the “three horizons” of growth.
Horizon 3
Create viable options
Horizon 2
Build emerging business
Revenue/
Profit Horizon 1
Extend and defend
Core businesses
6
What is horizon 2: Horizon 2 comprises businesses on the rise: fast-
moving, entrepreneurial ventures in which a concept is taking root or
growth is accelerating. The emerging stars of the company, these
businesses are attracting investors’ attention. They could transform
their company, but not without considerable investment. Though
substantial profits may be four or five years away, they have customers
and revenue and may already generate some profit. More important,
they are expected to become as profitable as horizon 1 business in
time.
What is horizon 3:Horizon 3 contains the seeds of tomorrow’s
businesses – options on future opportunities. Although embryonic,
horizon 3 options are more than ideas; they are activities and
investments, however small. They are the research projects, test-
market pilots, alliances minority stakes, and memoranda of
understanding that mark the first steps towards actual businesses,
even though they may not produce profits for a decade, if ever. Should
they prove successful, they will be expected to reach horizon 1 levels of
profitability.
A company that thinks it has a promising horizon 3 just because it
compiles a long list of whiteboard ideas at a management retreat is
fooling itself. Without deliberate initiatives to develop good ideas into
horizon 3 opportunities, a company’s long-term growth prospects will
fade. The options in horizon 3 are rarely proven opportunities, but they
need to be promising and to have the support of management.
Building successful businesses means seeding numerous options.
Some will fail for internal reasons; others will fall victim to shifting
industry winds. Most will never grow to become successful new
businesses. Given these odds, a great deal of horizon 3 activity is
needed to cover the multitude of possible futures. A company’s goal
should be to keep the option to play without committing too much
capital or other resources. The challenge is to nurture promising
options wile ruthlessly excising those with diminishing potential. When
companies adopt a very conscious growth strategy , it also focuses on
cost management through scalability ; through this approach
companies will be able to offer products and services at competitive
prices.
Core Inputs ,
7 Produ
Physical Compete Raw The
cts
ncies Material
Assets and Chan Custo
s
Servic nels mer
e
Offeri
ngs
It’s paradigm shift from product-focused culture , to a customer-
focused culture, where success is measured more by customer
satisfaction rather than short-term profits from product sales.
Customer
Customer
Customer Centricity requires Customer Care and Insight
Channels
Channels
Priorities
Priorities Inputs,
Inputs, Physica
Physica
Offerings
Offerings Raw Compet
Raw ll Assets
Assets
Material encies
Material
ss
8
Organizations need to Create Information Agenda
Creating a vision guide decisions &help the
Strategy organization determine how to best support
business goals
Informati Identifying the technology components &
on Informatio capabilities to establish a common
Agenda n information framework
Infrastruct
ure
Implementing policies & practices for
Informatio managing ,using, improving & protecting
n organizational information
Governanc
e
Establishing a plan for executing discrete
Roadmap projects to realize short and long-term returns
on investment.
INSIGHT
Customer Business Insight Search and Threat and
Analytics Discovery Fraud
Analytics Intelligence
Segmentation Branch Analyze Form Entity Analytics
Performance Notes
Customer Financials Monitor Service Name
Profitability Levels Recognition
Predictive Product Churn Title
Analytics Profitability Detection Investigation
Channel Planning Legal
Preference Discovery
9
BUSINESS PROCESS
Marketing Sales Processes Service Compliance
Processes Processes Process
Enterprise Enterprise Enterprise Enterprise
Business Business Business Business
Process Process Process Process
Content Content Content Content
Management Management Management Management
Business Business Business Business
Applications Applications Applications Applications
Too much focus on Too much focus While too much We must find
cost reduction on customer focus of revenue right balance
experience and profit
Can lead to poor Can hinder cost Can ruin the Or Optimally
customer reduction and customer ,maximize all
experience and profit growth experience and three.
there by affect hinder cost
revenue reduction
10
opportunities
Creating a
Strategy vision guide
INFORMATION decisions
Agenda &help the
organization
determine
how to best
support
business goals
Identifying
Information the
Infrastructure technology
components &
capabilities to
establish a
common
information
framework
Implementing
Information policies &
Governance practices for
managing
,using,
improving &
protecting
organizational
information
12
Establishing a
Roadmap plan for
executing
discrete
projects to
realize short
and long-term
returns on
investment.
INSIGHT
Customer Business Search Threat and
Analytics Insight and Fraud
Discovery Intelligence
Analytics
13
Segmenta Branch Analyze Entity
tion Performan Form Analytics
ce Notes
Customer Financials Monitor Name
Profitabilit Service Recognition
y Levels
Predictive Product Churn Title
Analytics Profitabili Detection Investigatio
ty n
Channel Planning Legal
Preferenc Discovery
e
BUSINESS PROCESS
Marketing Sales Service Compliance
Processes Processes Processes Process
Enterprise Enterprise Enterprise Enterprise
Business Business Business Business
Process Process Process Process
Content Content Content Content
Managem Managem Managem Manageme
ent ent ent nt
Business Business Business Business
Applicatio Applicatio Applicatio Application
ns ns ns s
CHANNEL INTEGRATION
14
5.0 Optimization of Customer Care and Insight
with Information Innovation in FS/Insurance
Industry
15
16.0 Strategic Business Design
Value migrates from outmoded business designs to new ones that are
better able to satisfy customers’ most important priorities. A business
design is the totality of how a company selects its customers, defines
and the tasks it will perform itself and those it outsource, configures
its resource , goes to market ,creates utility for customers and captures
profit. It is the entire system for delivering utility to customers and
earning a profit from that activity. Companies may offer products, they
may offer technology, but that offering is embedded in a
comprehensive system of activities and relationships that represents
the company’s business design.
In steel industry value can flow within industry from the integrated
steel makers to alternative business designs and the next generation
integrated mills in Japan and Korea. Value can still flow out of entire
steel industry -as companies in other industries – plastic and
aluminium - emerged with business designs that better satisfied the
emerging priorities of specific customer groups such as canners and
auto makers.
There are several benefits associated with value migration. Gaining and
maintaining a competitive advantage is one of the most common
advantages arising from using this type of marketing strategy. By
constantly thinking of where consumer demands and preferences will
move next, it is possible to stay ahead of competitors, sometimes
seizing business opportunities and creating a presence before others
begin to notice a newly developing avenue to a niche audience. This
type of value migration is especially pronounced when a company is
18
able to project the popularity of an emerging technology early on, and
adapt its products for use in that new technology. An example would be
paper companies who made copy paper in the middle 20th century but
envisioned the advent of the desktop computer and home publishing,
and adapted their product lines to meet those needs before those
markets actually began to grow.
20
Tata 30 27159.2 31118. 1913.4 81014 5149 303 17
Motors 7 22 6 6
GAIL 31 26092.0 19261. 2386.6 40249 4904 4022 34
8 37 7 7
Coal India 18629 1155 9794 5
8 6
HCL 59033 19
Techno
Axis Bank 57810 20
Cairn India 57353 21
Mahindra 55145 22
&M
Bajaj Auto 53521 23
Kotak 53451 9281 24
Mahindra
Ultratech 25
Cement
Power Grid 26
Nestle India 27
7
Booz &Company Study carried out by Ashok Divakaran and Vinay Couto
21
Many companies have been trying to figure out the best way to
reposition themselves for greater performance and success in the
future. The answer involved some combination of
growth strategy and cost management. Booz Allen &Hamilton found :
When companies do three things has made successful performance
among other things. They first created clarity and coherence in their
strategy ,articulating the differentiating capabilities that they will need
to win in the market place . Second they put in place an optimized cost
structure and approach to capital allocation, with continual investment
in the capabilities critical to success, while proactively cutting costs in
less-critical areas ,to fund these investments. Third they build up
supportive organizations .They redesign their structures, incentives,
decision rights, skill sets, and other organisational and cultural
elements to more closely align their behaviour to their strategy , and
to harness the collective actions of their people.
This approach is expected to build competitive muscle while cutting
corporate fat that weighs a company down. Companies that use this
approach ,cost actions are proactive and strategic (as opposed to
reactive and tactical ), freeing up funds to be reinvested in those parts
of the business that are most important for growth.
At the same time, an organizational fabric is put in place that guides
employees to do right things day in and day out ,thus helping the
entire enterprise build and sustain competitive advantage.
Strategic Clarity
• Clearly articulated and coherent Strategy
• Sustainable and Differentiated capabilities for Growth;
• Presence in critical product ,market and customer segments
Resource Alignment
• Systematic investments in differentiating capabilities;
• Proactive and tailored cost reduction actions;
• Lean cost structure in low criticality areas;
Supportive Organization
• Organizational Structure that is market-back and tied to the basic
characteristics of the business;
• Coherent and supportive incentives ,decision rights, skill sets,
cultures
22
Adrift; Constrained; Growth
Strategically Adrift
Low score on Strategic Clarity and Coherence (regardless of
scores in resource alignment and supportive organization)
• Strategy and critical priorities are unclear and not widely
understood even among top management;
• Differentiating capabilities needed to win in the market are not
clearly articulated or exhibit large gaps.
Distracted
Medium score on strategic clarity and coherence , and low or
medium score in both resource alignment and supportive
organization .
• Generally middle of the pack in effectiveness and efficiency;
which jeopardizes the longer term right to win.
• Core elements of strategy and some critical capabilities exist at
the table stakes level, but are not distinctive enough to serve as
a competitive advantage.
• Lack of a focused and differentiated strategy makes it difficult to
mobilize investment and elevate performance to top quartile
level.
Capability Constrained
High score on strategic clarity and coherence and low and
medium score in both resource alignment and supportive
organization.
• Category includes many companies traditionally thought of as
competent performers;
• Have strong strategies , and a coherent and clearly articulated
set of capabilities;
• However ,execution isn’t keeping pace with intent -critical areas
of the business may not be receiving enough investments , and
cost structure may be misaligned with strategic priorities;
• May be held back by inadequate practices, processes or
technologies;
• Have a big picture understanding of what it takes to win, but
they need more discipline in execution.
In the Game
High scores on both strategic clarity and coherence and on
resource alignment ;low or medium score on supportive
organization.
• From a market effectiveness perspective ,doing almost everything
right;
• Strategy is clear, differentiated and well articulated;
• Capabilities are distinctive, well developed and drive clear
competitive advantage
23
• But are held back from achieving full potential by organizational
attributes ( complicated matrix structures, onerous governance
processes, high leadership turnover; talent gaps or a misaligned
culture)
24