1. Whats value chain analysis? How is it carried out? Describe its role in strategic cost analysis.

A value chain analysis, providing both qualitative and quantitative background information, is to be undertaken for all case studies (products) included in the project before an econometric analysis is undertaken. Sources of information for this analysis may include secondary data, published or unpublished literature, surveys, focus groups, and rapid appraisal. Value analysis or value engineering is one of the most widely used cost reduction techniques. It can be defined as a technique that yields value improvement. It investigates into the economic attributes of value. It attempts to reduce cost through: a. b. c. design change, modification of material specification, change in the source of supply and so on.

Suppliers Customers

Orgnisation

Research & Development Design production Marketing Distribution Customer Service

It emphasises on finding new ways of getting equal or better performance from a product at a lesser cost without affecting its quality, function, utility and reliability.

Value Chain Analysis describes the activities that take place in a business and relates them to an analysis of the competitive strength of the business. Influential work by Michael Porter suggested that the activities of a business could be grouped under two headings: (1) Primary Activities - those that are directly concerned with creating and delivering a product (e.g. component assembly); and

(2) Support Activities, which whilst they are not directly involved in production, may increase effectiveness or efficiency (e.g. human resource management). It is rare for a business to undertake all primary and support activities.

Value Chain Analysis is one way of identifying which activities are best undertaken by a business and which are best provided by others ("out sourced").

Linking Value Chain Analysis to Competitive Advantage

What activities a business undertakes is directly linked to achieving competitive advantage. For example, a business which wishes to outperform its competitors through differentiating itself through higher quality will have to perform its value chain activities better than the opposition. By contrast, a strategy based on seeking cost leadership will require a reduction in the costs associated with the value chain activities, or a reduction in the total amount of resources used.

Primary Activities Primary value chain activities include:

 Inbound logistics: All those activities concerned with receiving and storing externally sourced materials Operations: The manufacture of products and services - the way in which resource inputs (e.g. materials) are converted to outputs (e.g. products) Outbound logistics: All those activities associated with getting finished goods and services to buyers Marketing and sales: Essentially an information activity - informing buyers and consumers about products and services (benefits, use, price etc.) Service: All those activities associated with maintaining product performance after the product has been sold

Support Activities Support activities include: Procurement: This concerns how resources are acquired for a business (e.g. sourcing and negotiating with materials suppliers) Human Resource Management: Those activities concerned with recruiting, developing, motivating and rewarding the workforce of a business Technology Development: Activities concerned with managing

information processing and the development and protection of "knowledge" in a business Infrastructure: Concerned with a wide range of support systems and functions such as finance, planning, quality control and general senior management

Role In Strategic Cost analysis:

COMPETITIVE ADVANTAGE AND CUSTOMER VALUE In order to survive and prosper in an industry, firms must meet two enter supply what customers want to buy, and they must survive competition. A ft competitive advantage derives from the difference between the value it offers to customers and its cost of creating that customer value. Competitive advantage with regard to products and services takes two possible forms. The first one is an offering or differentiation advantage. If customers perceive a product or service as superior, they become more willing to pay a premium price relative to the price they will have to pay for competing offerings. The second is a relative low-cost advantage, under which customers gain when a companys total costs undercut those of its average competitor.

Differentiation Advantage : It occurs when customers perceive that a business it's product offering (defined to include all attributes relevant to the buying decision) is of higher quality, involves less risks and/or outperforms competing product offerings. For ex-pie, differentiation may include a firm's ability to deliver goods and services in a timely manner, to produce better quality, to offer the customer a wider range of goods and services, other factors that provide unique customer value.

Once a company has successfully differentiated its offering, management may exploit the advantage in one of two ways viz., either; increase price until it just offsets the improvement customer benefits, thus maintaining current market share; or price below the "full premium" level in order to build market share.

 Low-Cost Advantage : A firm enjoys a relative cost advantage if its total costs are lower than the market average. This relative cost advantage enables a business to do one of two things ; price its product or services lower than its competitors' in order to gain market share and still maintain current profitability; or match with the price of com' . products or services and increase its profitability. Many sources of cost advantage exist; access to low-cost raw materials; innovative process technology; low-cost access to distribution channels or customers; and superior operating management. A company might also gain a relative cost advantage by exploiting economies of scale in some markets. The relationship between low-cost advantage and differentiation advantage has been illustrated in Diagram 2.

Differentiation Differentiation Superior Advantage with Cost Advantage Relative Differentiation Position Inferior Stuck in theMiddle Low-CostAdvantage

Inferior

Superior

Relative Cost Position

 THE ROLE OF THE MANAGEMENT ACCOUNTANT The management accountant in the past were considered an expert on cost analysis; cost estimation; cost behaviour; standard costing; profitability analysis by product, customer or distribution channel; profit variance analysis; and financial analysis.

Today, management accountants are expected to make use of activity-based costing, benchmarking, re-engineering, target costing, life-cycle costing, economic value analysis, total quality management and value chain analysis for decision making.

Value chain analysis requires a team effort. Management accountants of today has to collaborate with engineering, production, marketing, distribution and service professionals to focus on the strengths, weaknesses, opportunities and threats identified in the value chain analysis results. By championing the use of value chain analysis, the management accountant enhances the firm's value and demonstrates the value of the finance staff to the firm's growth and survival.

THE VALUE CHAIN APPROACH FOR ASSESSING COMPETITIVE ADVANTAGE Most corporations define their mission as one of creating products or services. For these organizations, the products or services generated are more important than any single step within their value chain. In contrast, other companies are acutely aware of the strategic importance of individual activities within their value chain.

They thrive by concentrating on those activities that allow them to capture maximum value for their customers and themselves. These firms use the value chain approach to better understand which segments, distribution channels, price points, product differentiation, selling propositions and value chain configurations will yield them the greatest competitive advantage.

The way the value chain approach helps these organisations to assess competitive advantage includes the use of following steps of analysis : (i) Internal cost analysis to determine the sources of profitability and the relative cost positions of internal value-creating processes;

(ii)

Internal differentiation analysis to understand the sources of differentiation (including the cost) within internal value-creating processes; and

(iii)

Vertical linkage analysis to understand the relationships and associated costs among external suppliers and customers in order to maximise the value delivered to customers and to minimise cost.

These types of analysis are not mutually exclusive. Rather, firms begin by focusing on their internal operations and gradually widening their focus to consider

their competitive position within their industry.

The value chain approach used for assessing competitive advantage is an integral part of the Strategic planning process. Like strategic planning, value chain analysis is a

continuous process of gathering, evaluating and communicating information for business decision-making.

By stimulating strategic thinking, the analysis helps managers envision the company's future and implement decisions to gain competitive advantage.

Internal Cost Analysis : Organisations use the value chain approach to identify sources of profitability and to understand the cost of their internal processes or activities. The principal steps of internal cost analysis are : 1. 2. Identify the firm's value-creating processes. Determine the portion of the total cost of the product or services attributable to each value- creating process. 3. 4. 5. Identify the cost drivers for each process. Identify the links between processes. Evaluate the opportunities for achieving relative cost advantage.

2. What is target costing? What are the characteristics of successful target costing in a company?
Target Costing is a simple, straightforward process that can have significant impact on the health and profitability of many, if not most, businesses. It doesn't require an army of specialists, large-scale software implementations, or complex management structures and procedures. It's mostly logical, disciplined common sense that can be imbedded into a company's existing procedures and processes. Target Costing is applied to a wide range of products, processes and procedures in a large manufacturing company. Target Costing helps to: assure that products are better matched to their customer's needs. align the costs of features with customers willingness to pay for them. reduce the development cycle of a product. reduce the costs of products significantly. increase the teamwork among all internal organizations associated with conceiving, marketing, planning, developing, manufacturing, selling, distributing and installing a product. engage customers and suppliers to design the right product and to more effectively integrate the entire supply chain. It is also the process of determining the maximum allowable cost for a new product and then developing a prototype that can be profitably manufactured and distributed for the maximum target cost figure. Target costing involves setting a target cost by subtracting a desired margin from a competitive market price. Target cost = anticipated selling price desired profit

Examples of decisions made at the design stage which impact on the cost of a product include; 1. The number of different components. 2. Whether the components are standard or not. 3. The ease of changing over tools.

Definition Target Costing is a disciplined process for determining and realizing a

total cost at which a proposed product with specified functionality must be produced to generate the desired profitability at its anticipated selling price in the future.

Traditional Approach and Concept As a totally new product and its industry develops, it starts to compete based on its new technology, concept, and/or service. Competitors emerge and the basis for competition evolves to other areas such as cycle time, quality, or reliability. As an industry becomes mature, the basis of competition typically moves to price. Profit margins shrink. Companies begin focusing on cost reduction. However, the cost structure for existing products is largely locked in and cost reduction activities have limited impact. As companies begin to realize that the majority of a product's costs are committed based on decisions made during the development of a product, the focus shifts to actions that can be taken during the product development phase. Until recently, engineers have focused on satisfying a customer's requirements. Most development personnel have viewed a product's cost as a dependent variable that is the

result of the decisions made about a products functions, features and performance capabilities. Because a product's costs are often not assessed until later in the development cycle, it is common for product costs to be higher than desired. This process is represented in Figure 1.

Target costing represents a fundamentally different approach. It is based on three premises: 1.) orienting products to customer affordability or market-driven pricing, 2.) treating product cost as an independent variable during the definition of a product's

requirements, and 3.) proactively working to achieve target cost during product and process development. This target costing approach is represented in Figure 2.

Target costing builds upon a design-to-cost (DTC) approach with the focus on marketdriven target prices as a basis for establishing target costs. The target costing concept is similar to the cost as an independent variable (CAIV) approach used by the U.S. Department of Defense and to the price-to-win philosophy used by a number of companies pursuing contracts involving development under contract.

TARGET COSTING CHARACTERISTICS

1. The Target Sales Price is set during Product Planning, in a Market- Oriented Way : Establishing the target sales price is the starting point in the target costing process. This implies that the target sales price is decided during product planning, when the characteristics of the future product are determined. The target sales price is set realistic in companies using target costing, and that the process of setting the target price is taken very thoroughly at most firms. The sales price of existing products or the price levels of competitors offerings typically provide an initial starting point for firms using target costing. A higher price point is only justified if the perceived value for the customer is much better than the existing product or competitors offerings.

2. The Target Profit Margin is determined during Product Planning, based on the Strategic Profit Plan : The second characteristic of a target costing system is the early establishment of the target profit margin during the product planning of the future product. Corporate strategic profit planning should drive the target profit margin for a particular future product. Total target profit for a future product should be derived from the medium-term profit plans, reflecting management and business strategies over a period of three to five years. These target profits should then be decomposed into target profits for each product over its expected life cycle. With the estimation of the future sales volumes, the target profit for a future product can be converted to a target profit margin. It is quite a difficult task to imagine a future product portfolio in todays environment, but adds that without doing this it is impossible to decompose the total target profit into targets for each product. The

procedures to compute target profits should be scientific, rational and agreed, otherwise nobody will accept his/her responsibility for achieving the target profit.

3. The Target Cost is set before New Product Development(NPD) really starts The third and most well-known characteristic of the target costing process is that the target cost is set early in the new product development process, before design and developing really starts. The decision on the appropriate level of the target cost for the new product to be developed involves a number of calculations. First, the ongoing cost is calculated and then the as-if cost is estimated. Third, the allowable cost is determined and finally the target cost is set between the allowable cost and the as-if cost. Each of these cost items will be discussed next. Figure 12 shows the global picture by a numerical example. 4. The Target Cost is subdivided into Target Costs for Components, Functions, Cost Items or Designers For target costing to work, the target cost for the future product needs to be decomposed in order to have specific targets for designers internally and subcontractors externally. This is the fourth typical characteristic of target costing. Decomposing the target cost to target costs for subassemblies is a difficult issue, since it indirectly determines the necessary cost reduction objectives for the different design teams. 5. Detailed Cost Information is provided to support Cost Reduction The fifth typical characteristic of the target costing process is the provision of detailed cost information. To see the impact of their design decisions on cost and to monitor the progress towards the cost reduction objective, design engineers need to estimate the cost of the future product during design and development.

Information systems such as the target costing support system must provide cost information anytime the designers require it, and not only at the so called milestones in the NPD process. 6. The Cost Level of the Future Product is compared with its Target Cost at Different Points during NPD The sixth characteristic of target costing involves the comparison of the estimated cost level of the future product with its target cost at different points during NPD. The progress towards the target cost is essential in target costing. Therefore the cost level of the future product needs to be compared to the target cost, either formally at different points, either continuously during new product development. 7. Aiming for the General Rule that The Target Cost can never be Exceeded The seventh and last characteristic of target costing involves the policy not to exceed the target cost. Without the strict application of such a rule, the cardinal rule, target costing typically lose its effectiveness. The general rule that the target cost can never be increased requires a strong commitment of managers and design engineers to attain the target cost. The general rule that the target cost can never be increased has three consequences. First, whenever costs increases somewhere in the product during NPD, costs have to be reduced elsewhere by an equivalent amount. Second, launching a product with a cost above the target is not allowed; only profitable products are launched. Third, the

transition to manufacturing is managed carefully to ensure that the target cost is indeed achieved.