Teaching Strategic Cost Management: Ed Blocher University of North Carolina, Chapel Hill

Teaching Strategic Cost
Management
Ed Blocher
University of North Carolina, Chapel Hill
Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010
Overview
1. 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
Part 1: the Strategic
Approach to Teaching
Cost/Management
Accounting Topics—An
Introduction
Teaching Strategic Cost
Management
What?
Why?
How?
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
Strategic Cost Management
The
The Strategic
Strategic
Prior
Prior Perspective
Perspective Perspective
Perspective
•• Focus
Focus on
on Financial
Financial ## View
View cost
cost
Reporting
Reporting management
management as as aa
Common tool
tool for
for developing
developing
•• Common emphasis
emphasis on
on
standardization and
and implementing
implementing
standardization and
and
standard business
business strategy
strategy
standard costs
costs
## The
The accountant
accountant as
as aa
•• The
The accountant
accountant as
as business
business partner
partner
functional
functional expert
expert and
and ## Focus
Focus onon cost
cost
financial
financial scorekeeper
scorekeeper management
management
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
…
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.
Introducing Strategy
Strengths Strategic
Opportunities
Weaknesses Positioning
Threats
Value
Chain
Strategy Balanced
Map Scorecard
(BSC)
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
Aspects of the
Two Competitive Strategies
Aspect Cost Leadership Differentiation
Basis of competitiveLowest cost in the Unique product or
advantage industry service
Often, a limited Wide variety,
Product line
selection differentiating
Lowest possible cost features
Innovation in
with high quality and
Production emphasis differentiating
essential product
products
features
Premium price and
innovative,
Marketing emphasis Low price
differentiating
features
Part 2: Tools for Integrating
Strategy into Cost
Accounting/Cost Management
Courses
-- The Value Chain

-- Strategy Maps & the Balanced
Scorecard (BSC)
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
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
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
vision &
mission
Exceed shareholder
expectations
Financial Diversify income Increase sales Improve profit

stream volume margins
Diversify Increase sales to

Customer customer base existing customers
Attract new
customers
Internal Target profitable Develop new Optimize internal

Process market segments processes
products
Attract new
customers
Learning
& Growth Develop Integrate
employee skills systems
The Balanced Scorecard (BSC):
Feedback to Strategy
Strategic
Positioning
Value
Chain
Strategy Balanced
Map Scorecard
(BSC)
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
Part 3: Sample
Course Outlines
• Management Accounting
• Cost Accounting
• Advanced Management
Accounting
Introduction to Management Accounting
 Strategic Positioning
 Ethics
Implementing Product Cost Behavior

Strategy Costing (Planning and Product Life
Operational Cycle
Control)
 The Value  Volume  Cost Estimation  Target

Chain Based Costing
(Job  CVP Analysis
 The Costing)  Life
Balanced  Master Budget Cycle
Scorecard Costing
 Activity -  Decision
based Making
Costing
 Flexible Budgets
 Management
Control
Cost Accounting
 Ethics
Implementing Product Cost Behavior Product Life

Strategy Costing (Planning and Cycle
Operational
Control)
 Job Costing
 The Value  Target
 Cost Estimation Costing
Chain
 ABC Costing
 The  CVP Analysis  Life Cycle
Balanced (ABC)
Scorecard  Process Cost Costing
 Master Budget
 Joint Costs (ABC)  Managing
Constraints
 Decision
 Standard Making (ABC)
Costing
Advanced Management Accounting
 Ethics
Implementing Cost Behavior

Strategy (ABC-based) Product Life
Cycle
 The Value Chain  Cost Estimation  Target

(Regression) Costing
 The Balanced
Scorecard (BSC)  CVP Analysis
 Life
Cycle
 Master Budget Costing
 Management Control (TP)
 Executive Compensation  Decision

Making (LP)
 Business Valuation
Part 4: Sample Course Topic—
Activity-Based Costing (ABC),
RCA, and TDABC
Evolution of Cost Accounting Systems
ABC ABC
Traditional (simple & (multidimensional)
Costing minimal)
Resources Resources Resources
Consumed Consumed
Allocated by by
to Activities
Activities
Consumed Consumed
by by
Cost Objects Cost Objects outputs
channels
Cost Users
Objects
ABC/M Framework What Things
Cost
Resource Resource
Costs Drivers
Root
Work Activities Performance •Cost Reduction
Causes •Process
of Costs Measures reengineering
•Cost of quality
Activity Cost •Continuous
Assignment improvement
•Waste elimination
•Benchmarking
Activity
Cost Objects Drivers
•Design for manufacturing
Why Things •Make versus Buy Better Decision
Cost Making
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.
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.
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.
Part 5: Sample Course Topic
—Customer Profitability
Analysis
Overview of Customer Profitability
Analysis
• Activity Based Costing (ABC)
• Customer Relationship Management
(CRM):
• Customer Lifetime Value (CLV)
• Customer Equity
Customer
The Whale Profitability
Curve: 80% Analysis:
from the top 20% (or more!)
The Whale Curve
Cumulative Profits
300 %
100 %
50 %
20% 100 %
Most Profitable Least Profitable
What Makes for a Profitable Customer?
Profitable
Profitable and
and unprofitable
unprofitable customers
customers are
are distinguished
distinguished
by
by the
the demands
demands they
they place
place on
on the
the organization
organization
 Less profitable customers  More profitable customers

 Small order quantities  Large order sizes
 Special products ordered  Standard products ordered
 Heavy discounting  Little discounting
 Unpredictable demands  Predictable demands
 Delivery times change  Delivery times standard
 High technical support  Low technical support
 Slow payment (imputed  On-time payment (imputed
interest) interest)
These demands can be estimated

by activity costs and activity cost drivers
Migrating Customers to Higher Profitability –
A Strategic Analysis
Very Types of Customers
Profitable
High le
b
(Creamy) f i ta
o
Pr
Product Mix
Margin
b le
a
o fit
npr
U
Low
(Low Fat)
Low Very
High unprofitable
Cost-to-Serve
Teaching
33 Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010
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.
You are a pharmaceutical supplier:
which customer is more important?
Dentist A Dentist B
Sales = $750,000 Sales = $375,000
profits = $100,000 profits = $40,000
Age 61 Age 25
Which is more profitable?

Which is more valuable?
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.
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.
—The Management & Control
of Quality (including Six-
Sigma and Lean)
Relationship between TQM & Financial Performance
A Strategic Model for Managing Quality
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
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.
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 is a group of related products or
services.
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.
Lean Accounting – Value
Streams
Rimmer Company
Value Stream Income Statement
Digital Cameras Video Cameras Total
Sales $ 585,000 $ 540,000 $ 1,125,000

Operating Costs
Materials $ 25,200 $ 12,800
Labor 168,000 88,000
Equipment related costs 92,400 - 48,400
Occupancy costs 11,200 4,800
Total Operating Costs 296,800 154,000 $ 450,800
Less Other Value Stream Costs
Manufacturing 120,000 240,000
Selling and Administration 10,000 130,000 10,000 250,000 380,000
Value Stream Profit before inventory change 158,200 136,000 294,200
Less: Cost of decrease in inventory (10,000) (20,000) (30,000)
Value Stream Profit $ 148,200 $ 116,000 $ 264,200
Less Nontraceable Costs

Manufacturing 155,000
Selling and Administration 54,000
Total Nontraceable Fixed Costs 209,000
Operating Income $ 55,200
— Operational and
Management-level
Performance Measurement
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
Operational Performance Measurement
with a Flexible Budget
Schmidt Machinery Company
Analysis of Operations
For the period ended October 31, 20X6 2010
2010
Sales
Flexible Volume Master
Data Item for Budget Flexible (Activity) (Static)
Analysis Actual Variance Budget Variance Budget
Units Sold 780 0 780 220 U 1000
Sales $639,600 $15,600 F $624,000 $176,000 U $800,000

Variable Expenses 350,950 50 F 351,000 99,000 F 450,000
Contribution Margin $288,650 $15,650 F $273,000 $77,000 U $350,000
Fixed Expenses $160,650 $10,650 U $150,000 $0 $150,000
Operating Income $128,000 $5,000 F $123,000 $77,000 U $200,000
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…
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
Management –Level
Performance Measurement:
When to Use Profit or Cost Center
Plant Customer
Warehouse
Part 8: Using Software in
the Strategic Cost
Management Course
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)
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
Have a great Meeting and Visit
in San Francisco!

Teaching Strategic Cost Management: Ed Blocher University of North Carolina, Chapel Hill

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Teaching Strategic Cost

 First Level: Explain the topic

-- The Value Chain

 Develop competitive advantage by:

Understand linkages among

Financial Diversify income Increase sales Improve profit

Diversify Increase sales to

Internal Target profitable Develop new Optimize internal

Implementing Product Cost Behavior

 The Value  Volume  Cost Estimation  Target

Implementing Product Cost Behavior Product Life

Implementing Cost Behavior

 The Value Chain  Cost Estimation  Target

 Executive Compensation  Decision

Cost Objects Cost Objects outputs

Time-Driven Activity-Based Costing (TDABC)

 Less profitable customers  More profitable customers

These demands can be estimated

Which is more profitable?

Sales $ 585,000 $ 540,000 $ 1,125,000

Less Nontraceable Costs

Units Sold 780 0 780 220 U 1000

Sales $639,600 $15,600 F $624,000 $176,000 U $800,000

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