Strategic Cost Management: An Overview

In this article we will discuss about Strategic Cost Management:- 1. Meaning of Strategic Cost Management 2. Importance of Strategic Cost Management 3. Advantages.

Meaning of Strategic Cost Management:

In global competitive environment, the most efficient firms view all of their spending as an investment. They make efficient spending decisions based on a strategic vision and their internal capabilities to deliver value from that investment. Traditionally firms have been under pressure to cut costs in the short term without really thinking about sustainable growth and integration with the overall business strategy.

In today’s business environment of increased global competition, new markets, increasing regulation and changing demographics, successful companies must develop a multifaceted cost competence. It has been observed that traditional firm’s tactical solutions, despite consuming considerable resources, have failed to deliver the planned reduction of costs and have not resulted into competitive advantage.

In many cases the cost savings achieved in the short term have leaked away and the cost base has returned to previous high levels and considerable damage to corporate structure, image, culture and morale has been done.

Therefore it should be understood that ‘Cost’ is a strategic issue. There is a need to continuously strive to optimize the same in the context of the entire business model of the firm. Execution of any chosen strategy has to be carefully managed to ensure the appropriate balance between revenue growth and cost.

It has also been observed that firms that are taking the investment approach to managing cost are thriving in this new environment, striking a balance between a competitive cost structure, cost effective strategy execution and investment in the future. They are delivering a very good response to the cost challenge. Thus it becomes necessary to link the Cost Management to strategies of the organisation.

It is quite natural that most important objectives for any organisation are its long term growth and survival. Profit maximisation is the key to attainment of these objectives, which in turn depends on how efficiently the revenues are bolstered and how effectively the costs are minimised.

Due to volatile and constantly declining revenue stream, organisations are forced to realign their cost structure and to invest in effective cost management strategy so as to improve their bottom lines.

Many of the cost systems followed in the organisations are desperately obsolete, so they have to get rid of these systems and to redesign them or to attune them to the changed requirements. Effective cost management helps companies to achieve business performance improvement.

Fuelled by these requirements, the cost management scenario, of late has witnessed the emergence of a new perspective of strategy namely Strategic Cost Management as an important player for solving cost related problems.

Strategic Cost Management is the provision and analysis of Cost and Management Accounting data about a firm and its competitors for use in developing and monitoring the business strategy. Strategic Cost Management focuses on the cost reduction and continuous improvement and change than cost containment only.

It has been observed that the traditional cost control systems mostly maintain status quo and the ways of performing the existing activities are not reviewed. Hence the strategic cost Management goes a step ahead and uses several approaches for efficient management of cost.

The basic aim of strategic cost Management is to help the organisation to achieve the cost leadership and as per Michael Porter’s model, get the sustainable competitive advantage.

A well-conceived cost reduction strategy enables the managers to capture maximum value in the form of direct savings. It is an effective way of reducing cost, increasing revenue and facilitating survival in the competitive world.

There is no doubt however that accounting information plays a vital role in determining the most appropriate strategic direction for the organisation; particularly cost information is a critical type of information needed for effective management.

In short, Strategic cost management is the development of cost management information for strategic management purpose. Strategic cost management can be defined as “scrutinizing every process within your organisation, knocking down departmental barriers, understanding your suppliers’ business, and helping improve their processes.”

Michael Porter in competitive advantage prepared the way for a strategic emphasis in cost management by developing a framework for identifying a firm’s competitive strategy.

Porter’s concepts of cost leadership and differentiation have had a strong influence on management education. These concepts provide the basis on which the strategic approach to cost management is based because they explain what a firm should do to succeed.

Thus there are two steps in Strategic Cost Management: first, to identify (using Porter’s framework) what managers must do to make the firm succeed, and second, to develop cost management methods and practices to facilitate management’s efforts.

Importance of Strategic Cost Management:

Strategic cost management has become an essential area now a day. While formulating the strategy for the accomplishment of organisational overall objectives, different cost drivers should be clearly identified. Identification of key cost drivers helps companies to focus on key activities that will constitute almost 90% of the total costs.

In view of this, the importance of strategic cost management should not be underestimated. This implies that an organisation should be installing appropriate framework of strategic cost management to reduce its costs in key areas on which the success of organisation is mainly dependent. Strategic cost management is understood in different ways in literature.

Strategic cost management can be defined as “scrutinizing every process within your organisation, knocking down departmental barriers, understanding your suppliers’ business, and helping improve their processes” Cooper and Slagmulder argued that strategic cost management is “the application of cost management techniques so that they simultaneously improve the strategic position of a firm and reduce costs”.

The Framework of Strategic Cost Management provides a clear plan of attack for addressing costs and decisions that affect them. Following are the three core components of this framework.

Core Functions:

Core functions lay emphasis on the nature of the business. It answers the very obvious question what type of business are we in? At this stage the firm has to clearly identify its courses of actions with respect to strategy planning, research and development, and product development.

Customer Delivery Function:

This step emphasises more on value addition with various activities such as marketing, sales, manufacturing, quality assurance and control, sourcing, procurement, engineering and maintenance, customer service and technical support etc. Excellence in these activities can create a sort of competitive advantage for the firm if it could harness its resources intelligently than its competitors.

Support Functions:

As the name suggests, to support the core activities of business some secondary activities are to be carried out which include IT, Finance and Accounting, HR management, General administration etc.

These activities will facilitate the performance of the core activities in a way that goals of the firm can be accomplished successfully without wasting limited resources. They will also help in synchronizing the different tasks which are to be carried out simultaneously to become cost leader.

Advantages of Strategic Cost Management:

Strategic Cost Management provides number of benefits to different organisations. It has provided the business with an improved understanding of its sources of profits.

Some benefits are given below:

(i) It has developed a framework for reviewing the strategic allocation of resources across the business based on core business processes and activities.

(ii) It has improved the businesses understanding of its cost drivers leading to improved articulation of its strategic plans in cost terms.

(iii) It has enabled the business to assess, at a high level, how activity-based techniques can be deployed at different levels in the business to improve its cost management process, such as in budgeting and in process improvement.