The scope of strategic cost management

Robin Cooper; Regine Slagmulder

Management Accounting; Feb 1998; 79, 8; ABI/INFORM Global
pg. 16

trategic Cost
Management
Robin Cooper and Regine Slagmulder, Editors

THE 5COPE OF 5TRATEGIC

(OST MANAGEMENT
lhe objective of strategic cost management is to reduce costs while simultaneously strengthening the strategic position of the firm (see last month's
column). Given this objective, strategic
cost management cannot, like traditional management accounting, limit
itself to either the four walls of the factory or the boundaries of the firm.
The dominance of financial over
managerial accounting for the majority
of the 20th Century led to an atrophy
of cost management practices. l ln particular, traditional cost systems are
limited to the walls of the factory and
are used to determine the cost of products only. Other potential cost objects
such as suppliers and customers are
treated either as general overhead and
arbitrarily allocated to products or as
period costs and assigned directly to
the income statement (Figure 1). The
problem with this approach
is that these nonmanufacturing costs cannot be managed
Figure
effectively because the underlying reasons for their occurrence are masked by the
way they are treated by the
firm's cost system.

ers and customers as well as products.

Armed with the insights provided by
this extension of cost management, a
firm can begin to manage these costs
strategically.
To enable these costs to be managed
strategically, they must be allocated
causally (Figure 2). One of the primary
techniques for meaningfully assigning
nonmanufacturing costs is activitybased cost management. The advantage of this technique over traditional
costing methods lies in its ability to assign costs in a causal manner to a
broad range of cost objects including
products, suppliers, and customers.f

Managing procurement costs. In traditional cost systems, procurement costs

are allocated to products arbitrarily.
Without pro per assignment of procurement costs, purchasing managers typically select suppliers based on the purchase price of their products. This
pattern leads to a number of suboptimal buying behaviors that weaken a

1. Traditional Management

COST MANAGEMENT
BEYOND THE
FACTORY WALLS
The implications of extending cost management beyond
the factory walls means that
costs are assigned to suppli16

MANAGEMENT ACCOUNTING

Product Costs

Accounting

firm's strategic position, for example,

purchasing components from suppliers
whose quality, reliability, and delivery
performance are below acceptable
levels.
These purchasing decisions hinder
the firm's ability to satisfy its customers and earn adequate profits. How
can a product be high quality and delivered on time if its components are
low quality and delivered late? The answer, of course, is that they cannot! Yet
any attempt to improve the purchasing
process appears to increase purchasing
costs as the so-called low-cost suppliers
no longer are deemed satisfactory. If
purchasing managers are rewarded
solely on the purchase prices they negotiate with their suppliers, it will be
almost impossible to change their approach to supplier selection.
Strategic cost management resolves
the conflict in two ways-first, by taking a broader view of component costs
and, second, by assigning procurement
costs to products causally. lnstead of
just looking at the purchase
price, strategic cost management includes the costs assoView
ciated with low quality, reliability, and delivery
performance. Purchasing
managers now are expected
to evaluate suppliers on total
cost, not just purchase price.
The resulting buying behavior leads to a strengthening
of the firm's strategic position because suppliers are
chosen on the basis of their
ability to help the firm produce high-quality products
timed to customer demand.

FEBRUARY 1998

Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.

ln the next step of the

through higher serprocess, supplier costs are
Figure 2. Strategic Cost Management View
vice levels. Second,
assigned causally to prodthey can lower selling
ucts using activity-based
prices
for customers
principles. Now products
Procurement
Manufacturing
SG&A
whose profits are high
are assigned their specific
Expensas
Expensas
Expenses
and where there is a
procurement costs, not the
perceived
risk of losaverage for all products.
ing them to competiConsequently, reported
tors. Third, they can
product costs are more accuSupplier Costs
and should identify
Product
Costs
Customer Costs
rate. For example, products
new
ways to serve
that contain large numbers
customers
so that
of unique components that
while costs to serve
rely upon specialty suppliers now will
revenue generated) or on the relationare low, satisfaction is high.
be seen to be more expensive than
ship between the selling price of the
For unprofitable customers, there
products that contain only standard
products and reported product costs
are also three types of action that can
components. Product designers can
(if they are evaluated on product
be taken. First, they can try to deliver
better make the trade-off between
profitability).
the services that these customers refunctionality and costas they design
If SG&A costs are insgnificant,
quire more efficiently. Second, they can
new products. If the specialty compotreating them as period costs creates
increase prices to reflect the cost of the
nents add value to the product and it
few problems. But ifthey are signifiresources consumed. Third, they can
is reflected in its selling price, then the
cant, the treatment can lead to a
reduce selling efforts to unprofitable
use of such components is justified.
strategic weakening of the firm becustomers. ln the limit, this means reBut if the selling price is not increased
cause there is no way that individual
fusing to serve unprofitable customers.
sufficiently, then the market is telling
customer profitability can be deterThe overall aim is to increase the ratio
the designers that simpler products
mined accurately. Therefore, the sales
of profitable to unprofitable customers.
are preferable. Without strategic cost
representatives are unable to manage
However, extending beyond the walls
management to help them make this
customer mix effectively. A customer
of the factory is not sufficient. The next
trade-off, the designers are forced to
that places considerable demand on
step in the strategic cost management
rely on their intuition. Thus assigning
the firm's SG&A resources can look
process is to extend the process beyond
supplier costs to products generates a
just as attractive as one that places
the firm's organizational boundaries.
more accurate view of product profvirtually no demands on them.
This extension enables a firm to take
itability and provides better insights
Strategic cost management provides
advantage of cost management synerinto the design of new products.
a more balanced view of customer profgies between it and its suppliers and
itability by assigning customer-related
customers. ln particular, the firm can
Managing customer service costs. ln
costs to the customers that cause them
actively seek to find ways to reduce
traditional cost systems, SG&A exusing activity-based principles. For excosts across the value chain while sipenses are treated as period costs and
ample, customers who order in small,
multaneously strengthening its strateare expensed to the income statement.
unpredictable quantities and require
gic position. lt achieves these objecUnder this treatment, essentially they
considerable post-sales support will be
tives by coordinating its cost
disappear from view, but often they are
seen to be more costly than customers
management programs with those of
taken into account through rules of
who order in high, predictable quantiits suppliers and customers. This coorthumb about how profitable products
ties and require little or no support.
dination is the focus of our next
should be. For example, "SG&A costs
Consequently, a more accurate view of
column.
are 20%; therefore, we need to make
customer costs and hence profitability
35% profit margin (on product cost) to
is generated.
make an adequate return." Essentially
Robin Cooper is professor of management,
Using this enhanced knowledge of
Peter F. Drucker Graduate Management
this rule of thumb spreads the SG&A
customer profitability, sales represenCenter, Claremont Graduate University, and
costs evenly over products based on
tatives can strengthen the strategic pohonorary visiting professor of strategic cost
their sales dollars. The outcome often
management at Manchester Business School.
sition of the firm by attracting and reRegine Slagmulder is professor ofmanageis a totally distorted view of the cost of
taining high-profitability customers,
ment accounting. Tilberg University (the
serving customers. Either customers
even at the risk oflosing low-profNetherlands) and visiting professor at the
University ofGhent (Belgium).
appear to cost nothing to serve, or they
itability ones. There are two major
all appear to cost the sarne percentage
classes of actions they can take. The
of their sales revenue. Without proper
first relates to profitable customers
1
See H. Thomas Johnson and Robert S. Kaplan.
assignment of customers' costs, sales
and the second to unprofitable ones.
Relevance Lost: The Rise and Fal/ of Management
Accounting, Boston, Mass., Harvard Business School
representatives are forced to select cusFor profitable customers there are
Press, 1987.
tomers almost exclusively based upon
three types of actions that can be tak2See Robert S. Kaplan and Robin Cooper, Cost and
Effect, Boston, Mass., Harvard Business School Press,
the way they are rewarded. Typically,
en. First, they can identify clusters of
1997.
this means either on the volume sold
31naddition
to supplier and customer costs, there are
high-profitability customers and set
corporate costs that can be treated in the sarne
(if the representa tives are evaluated on
out to increase their satisfaction
manner.
18

MANAGEMENT ACCOUNTING

FEBRUARY 1998

Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.