Chapter 14

Contemporary cost management

Cont.
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
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
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
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
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 customer’s perspective or for the business
and, therefore, can be eliminated without
detriment to either
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
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
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
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
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.
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
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
company’s business objectives and strategies

Cont.
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
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
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
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
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
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
Target costing
A tool for planning profits and reducing
costs
Reducing a product’s 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
 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
Exhibit 14.3