Total Cost Management – Why?

“Market determines the price,

Cost determines the
profitability”
Companies have more control over cost
than the price
therefore they maximize the value to the
customer by managing its Cost i.e.
[Offer more value at lesser price and still maintain
profitability.]
This necessitated an integrated approach
in cost management. i.e. at strategic as
well as at operational level. This approach
is called ……
“Total Cost
Management”
10/17/08 hmahesh45@yahoo.com; VIM Pune 1
Total Cost Management – Concept

 company-wide systematic and structured approach

 provides a holistic framework to control, reduce

and eliminate costs , throughout the value chain

 process of managing the financial outcome of

activities encompasses all operations, internal and
external.
 A must tool for competitive advantage.

10/17/08 hmahesh45@yahoo.com; VIM Pune 2

 Total Cost Management – an example

How well informed are Which are our

our sourcing decisions profitable customer
segments

What are our Do our costs go up

product costs and TCM despite our cost
their profitability? cutting efforts?

Can we reduce our prices and yet

increase the customer value

10/17/08 hmahesh45@yahoo.com; VIM Pune 3

 Total Cost Management – Process
 Identify Inefficiencies
* BECAUSE as business environment becoming more
& more competitive, inefficiency of one is becoming an
opportunity for the other.

* Inefficiency is in terms of the non-value–adding

activity present in the system.
 To identify, to gauge the extent and to
eliminate the inefficiency, guiding principle are
…………
• “if you can measure it, you can manage it”
• “ it is better to be approximately right, than
to be precisely wrong”
• “a structural change in the measurement
systems is preferred than a temporal /
apparent
10/17/08
change”hmahesh45@yahoo.com; VIM Pune 4
 Total Cost Management – Techniques

• Activity based costing

• Activity based management
• Target costing

10/17/08 hmahesh45@yahoo.com; VIM Pune 5

 Activity Based Costing - Concept

Complaint by product design manager:

“Why is it when I use a capacitor costing Rs 20 ,
the procurement overhead charge is 20 paise per unit,
but when I use a coprocessor part costing Rs100,
the procurement charge is Rs.10?
Procuring and handling a coprocessor does
not consume 50 times (Rs. 0.2 x 50 = Rs 10)
the resources used to procure and handle a capacitor.
This overhead costing approach is irrational.”

10/17/08 hmahesh45@yahoo.com; VIM Pune 6

 Activity Based Costing - Concept
Allocation
basis is
Activity Based rational
Costing
Allocation
basis is
vague Departmental
Overhead i ty
ex
Rates pl
om
f C
Plant wide o
el
Overhead v
Rate Le
Overhead Allocation
10/17/08 hmahesh45@yahoo.com; VIM Pune 7
 Activity Based Costing
One of the most difficult tasks in computing accurate
unit costs lies in determining the proper amount of
overhead cost to assign to each job or to each unit
of product.
• Activity based costing is a method that measures cost
of a
product/service, based on the activities performed to
produce that product/service.
• This enables to allocate overheads to products,
more accurately.

• In this method, we recognize that many activities

within a
department drive overhead costs
10/17/08 hmahesh45@yahoo.com; VIM Pune 8
 ABC – Process
 Conduct process Analysis.
 Identify activity centers.
 Assign cost to the activity center as they
accumulated while pending for allocation to
product.
 Select Cost Drivers
 Determine amount of activity consumed by the
product.
 Once costs are collected by activities, they are
charged to products using cost drivers.

10/17/08 hmahesh45@yahoo.com; VIM Pune 9

 ABC - Examples

Product O/H allocation-

Activities: - Prod X Prod Y
Order Processing. 40% 60%
Machine set up. 80% 20%
Material receipt. 10% 90%
Machine Hrs 75% 25%
Inspection 60% 40%

Cost Driver = Number of units of X and Y

10/17/08 hmahesh45@yahoo.com; VIM Pune 10

 Activity Based Management

10/17/08 hmahesh45@yahoo.com; VIM Pune 11

 Activity-Based Management
A value-added cost is the cost of an
activity that cannot be eliminated without
affecting a product’s value to the
customer.
In contrast, non-value-added costs are
costs that can be eliminated without
affecting a product’s value to the
customer.

10/17/08 hmahesh45@yahoo.com; VIM Pune 12

 Thanks……

10/17/08 hmahesh45@yahoo.com; VIM Pune 13