Pearson Education Management Accounting for Decision Makers_10 ppt

accounting can play a useful role here by providing information relating to the onment, such as the performance of the business’s competitors and the profitabilityto help a business oper

Strategic management accounting is concerned with providing information that willsupport the strategic plans and decisions made within a business We saw in Chapter 1that strategic planning involves five steps:

1 Establishing the mission and objectives of a business.

2 Undertaking a position analysis, such as a SWOT (strengths, weaknesses,

opportun-ities and threats) analysis, to establish how the business is placed in relation to itsenvironment

3 Identifying and assessing the possible strategic options that will lead the business

from its present position (identified in Step 2) to the achievement of its objectives(identified in Step 1)

4 Selecting the most appropriate strategic options (from those identified in Step 3) and

formulating long- and short-term plans to pursue them

5 Reviewing business performance and exercising control by assessing actual

perform-ance against planned performperform-ance (identified in Step 4)

To some extent, conventional management accounting already supports this tegic process We have seen in Chapter 7, for example, how budgets can be used tocompare actual performance with earlier planned performance We have also seen inChapter 8 the role of investment appraisal techniques in evaluating long-term plans.Nevertheless, there is scope for further development It can be argued that if manage-ment accounting is fully to support the strategic planning process, it must develop inthree broad areas:

stra-l It must become more outward looking There is general agreement that the

conven-tional approach to management accounting does not give enough consideration toexternal factors affecting the business These factors, however, are vitally important

to strategic planning and decision making For example, we need to understand the environment within which the business operates when we are undertaking

a position analysis or when we are formulating plans for the future Management

What is strategic management accounting?

LEARNING OUTCOMES

When you have completed this chapter, you should be able to:

l Discuss the nature and role of strategic management accounting

l Explain how management accounting information can help a business gain abetter understanding of its competitors and customers

l Describe the techniques available for gaining competitive advantage throughcost leadership

l Explain how the balanced scorecard can help monitor and measure progresstowards the achievement of strategic objectives

l Discuss the role of shareholder value analysis and economic value added instrategic decision making

accounting can play a useful role here by providing information relating to the onment, such as the performance of the business’s competitors and the profitability

to help a business operate more efficiently, these techniques are not always enough.Rather than seeking simply to count and manage the costs incurred, costs and coststructures may need to be transformed Thus, management accounting has a role toplay in helping to shape the costs of the business to fit the strategic objectives

l There must be a concern for monitoring the strategies of the business and for bringing these strategies to a successful conclusion This means that management accounting should

place greater emphasis on long-term planning issues and on developing a hensive range of performance measures to try to ensure that the objectives of thebusiness are being met The objectives of a business are often couched in both finan-cial and non-financial terms and so the measures developed must reflect this fact

compre-Let us now turn our attention to the ways in which management accounting canhelp in each of the three areas identified

If a business is to thrive, it needs to have a good understanding of the environmentwithin which it operates In particular, it should have a good understanding of thethreat posed by its competitors and the benefits obtained from its customers There is

a strong case for reporting certain information relating to competitors and customers,frequently and routinely to managers By so doing, managers can respond morequickly to any changes in the environment that may occur In this section we considersome of the techniques and measures that may help managers gain a better under-standing of these two important groups

Competitor analysis

To compete effectively, a business needs to acquire a sound knowledge of its maincompetitors As well as helping in strategic planning, this knowledge can also help inpricing and business acquisition decisions When appraising competitors, a businessneeds to understand

l what strategies and plans they have developed;

l how they may react to the plans the business has developed; and

l whether they have the capability to pose a serious threat to the business

To gain this understanding, a careful analysis of each main competitor should be carried out

To illustrate the benefits of competitor analysis, let us say that a business proposes

to reduce its sales prices by 10 per cent What would be the reaction of competitors?

Facing outwards

‘

Would this reduction be matched by them and thereby cancel out any advantage to begained? Would it lead to a price war where sales prices follow a downward spiral? Ifcompetitors could not match the price reduction, would they be able to continue tosupply, given the likely sales volume reduction that they would suffer? We can see thatthe proposal to reduce prices cannot be fully evaluated until competitors’ likely reac-tion to the proposal is known.

Real World 9.1provides an example of how one business came to realise that it had

to pay more attention to the competition

To find out what drives a competitor and how it might act, four key aspects of itsbusiness must be analysed These are:

1 Objectives Where is the competitor going? In particular, what are its profit

objec-tives, what rate of sales growth is it trying to achieve, what market share does it seek?

2 Strategies How does the competitor expect to achieve its objectives? What

invest-ments are being made in new technology? What alliances and joint ventures arebeing created? What new products are to be launched? What mergers and acquisi-tions are planned? What cost reduction strategies are being developed?

3 Assumptions How do the competitor’s managers view the world? What assumptions

are held about

l future trends within the industry;

l the competitive strengths of other businesses; and

l the feasibility of launching into new markets?

4 Resources and capabilities How serious is the potential threat? What is the

compet-itor’s scale and size? Does it have superior technology? Is it profitable? Does it have

a strong liquidity position? What is the quality of its management?

These four features provide the framework for analysing competitors, as shown inFigure 9.1

Gathering information to answer the questions posed above is not always easy.Businesses are understandably reluctant to release information that may damage theircompetitive position Nevertheless, there are sources of information that can be used

We shall now consider some of these and, given the management accounting focus of

REAL WORLD 9.1

Angling for recovery

House of Hardy is a world-famous manufacturer of fishing rods and tackle It enjoys anunrivalled reputation for its products and has a highly skilled workforce In recent years,however, it has experienced problems, which have been partly caused by global competi-tion The business is trying to recover and, in analysing its past mistakes, has recognisedthat it has been rather too complacent in its approach to competitors As part of its recov-ery plan it is now paying much more attention to what they are doing It is now analysingthe products offered by competitors and reviewing its own pricing policies in an attempt

to compete more effectively

Source: Based on information from ‘How Hardy lost the lure of heritage’, ft.com, 1 December 2003.

FT

this book, will concentrate on those sources providing information about the financialresources and capabilities of competitors.

A useful starting point is to examine a competitor’s annual report In the UK, all ited companies are legally obliged to provide information about their business in anannual report that is available to the public Similar provisions relate to limited com-panies in most countries in the world The income statement, cash flow statement andstatement of financial position (balance sheet) found in the annual report of a com-petitor can be examined to gain insights about its financial performance and position.Financial ratios may be used to help gain an impression of the profitability, liquidity,efficiency and financing arrangements of the business Trends may be detected overtime and particular strengths and weaknesses identified

lim-Where the competitor is not the whole business, but simply an operating division,the annual reports are likely to be less helpful This is because the results of the relev-ant division will normally be obscured as a result of its aggregation with the rest of the competitor’s operations Though large businesses operating as limited companiesmust publish some information about the sales revenues and profits of their variousoperating divisions, this is often not enough to enable a full picture of the competitor

to be built up Nonetheless, a competitor’s annual report should still offer some useful information Furthermore, a business will have detailed knowledge of its ownprofitability, liquidity, efficiency and so on, which may well help in compiling a pic-ture of the competitor’s position

It may be possible to gain other information from both published and unpublishedsources This could be from

l press coverage of the competitor’s business;

l statements by managers made at conferences or on the competitor’s website;

Framework for competitor analysis

Figure 9.1

There are four key aspects of a competitor that should be examined.

l house journals, brochures and catalogues produced by the competitor;

l market share data and discussions with financial analysts;

l discussions with customers who trade both with the business and with the competitor;

l discussions with suppliers to both the business and its competitor;

l physical observation, such as insights from ‘mystery shopping’;

l detailed inspection of the competitor’s products and prices;

l industry reports; and

l government statistics on such matters as the total size of the market

By examining such sources, it may be possible to deduce likely capital investments,acquisitions, promotional campaigns, new products and prices, cost structures and

so on It is worth mentioning that specialist agencies can be employed to provide aprofile of competitors These agencies normally rely on the kind of information sourcesdescribed above

Of particular value to the business is knowledge of its competitors’ cost structures

in terms of the extent to which costs are fixed and variable This would enable the business to make some estimate of the effect on the competitors’ profit of an increase

or decrease in sales volume This might, in turn, enable the business to assess how wellplaced each competitor might be to react to a change in sales volume and/or salesprice For example, a competitor with a high level of fixed costs (high operating gear-ing) and, consequently, a low margin of safety may not be able to withstand a down-turn in sales volume as comfortably as another business with lower operating gearing

Real World 9.2concludes this section by revealing that many businesses are not alert

to the moves made by competitors and so fail to gain competitive advantage

REAL WORLD 9.2

Too little, too late

A global survey of 1,825 business executives by McKinsey, the management consultants,found that businesses were not as active as they should be in responding to competitivethreats or monitoring the behaviour of competitors The survey asked executives how theirbusinesses responded to either a significant change in prices or to a significant change ininnovation The answers of executives were strikingly similar across regions and industries

A majority of executives stated that their businesses found out about the competitivemove too late to respond before it hit the market Thirty-four per cent of those facing aninnovation threat and 44 per cent of those facing a pricing change said that they found outabout the competitors’ moves either when they were announced or when they actually hitthe market An additional 20 per cent of the respondents facing a price change didn’t findout until it had been in the market place for at least one or two reporting periods

These findings suggest that businesses are not conducting an ongoing, sophisticatedanalysis of their competitors’ potential actions That view was supported by the execu-tives’ responses to questions on how they gather information about what competitorsmight do Executives most often said that they track information using news reports,industry groups, annual reports, market share data and pricing data Far fewer respon-dents obtained information from more complex sources such as detailed examination ofthe products or mystery shopping

Customer profitability analysis

Businesses wish to attract and retain customers that produce profitable sales orders It

is, therefore, important to know whether a particular customer, or type of customer,generates profits for the business Modern businesses are likely to find that much of thecost incurred is not related to the products sold but to the selling and distribution costsassociated with those sales This has led to a shift in emphasis from product profitabil-ity to customer profitability

Customer profitability analysis (CPA)assesses the profitability of each customer ortype of customer In order for CPA to be undertaken, the total costs associated with sell-ing and distributing goods or services to particular customers must be identified Theseinclude the cost of

l Handling orders from the customer This covers the costs involved with receiving the

order and activities relating to it up to the point where the goods are despatched,

or the service rendered, including the costs of raising invoices and other accountingwork

l Visiting the customer by the business’s sales staff Many businesses have a member of

staff visit customers, perhaps to take orders, but often to keep the customer up todate with the latest developments in the business’s products

l Delivering goods to the customer, using either a delivery service provided by another

business, or the business’s own transport Naturally, the distance involved and thesize and fragility of the goods will have an effect on this cost

l Inventories holding Some customers may require a particular level of inventories

to be held by the business: for example, a customer operating a ‘just-in-time’ rawmaterial delivery policy This can require deliveries to be made frequently and atshort notice, in effect putting pressure on the supplier to hold higher inventorieslevels (We shall discuss ‘just-in-time’ inventories management in more detail inChapter 11.)

l Offering credit The business will have to finance any credit allowed to its customers.

This could vary from customer to customer, depending on how promptly they pay

l After-sales support Technical assistance or servicing may be offered as part of the

sales agreement

These customer-related costs are probably best determined using an activity-basedcosting approach to cost allocation This means that, once customer-related costs areidentified, cost drivers must be established and appropriate cost driver rates deduced

Once customer-related costs are derived, a CPA statement, which is essentially anabbreviated income statement, can be produced for each customer and/or type of customer The CPA statement will show the relevant sales revenues and, in addition

to the customer-related costs identified earlier, will include the basic cost of creating

or buying-in the goods or services supplied (that is, cost of goods sold) and any general selling and administration costs of the business Example 9.1 illustrates a CPAstatement

Imam plc – CPA statement for December

Where all customers are sold products at the same price, the top part of the CPAstatement, which is concerned with deducing the gross profit, may be viewed asrelating to product profitability The bottom part of the CPA statement, which isthe part below the gross profit figure, may be viewed as relating to customerprofitability

To analyse customer profitability, we can express each of the costs found in thispart as a percentage of gross profit The following table provides the results

Example 9.1

We thought of the following:

Customer-related cost Possible cost driver

Order handling Number of orders placedInvoicing and collection Number of invoices sentShipment processing Number of shipments madeSales visits Number of sales visits madeAfter-sales service Number of technical support visits madeThese are only suggestions Other factors may be found that drive each cost

Activity 9.1 continued

The information generated shows that one customer, A plc, is generating a loss.

To find out whether this is a persistent problem, trend analysis can be undertakenwhich plots the customer-related costs as a percentage of gross profit over time

An example of a trend analysis for A plc is shown in Figure 9.2

Trend analysis for A plc

Figure 9.2

The trend in customer-related costs is shown as a percentage of gross profit for A plc, the loss-making customer.

In practice, it is often the case that a small proportion of customers generate a largeproportion of total profit Where this occurs, the business may decide to focus its mar-keting and customer support efforts on these customers The less profitable customersmay then be targeted for price increases or, perhaps, reduced customer support, as wesaw in Activity 9.2 above.

Where a business has many customers, the analysis of individual customers’profitability may not be feasible In such a situation, it may be better to categorise cus-tomers according to particular attributes and then to assess the profitability of each cat-egory Thus, the support services division of one large computer business divides itscustomers into three categories based on technical capabilities, how they use the prod-uct and the type of service contract they have (see reference 1 at the end of the chapter).However, identifying appropriate categories for customers can sometimes be difficult

Real World 9.3provides some impression of the extent and frequency to which tomer profitability is assessed in practice

cus-What steps might be taken to deal with the problem of A plc?

The problem appears to be the cost of both sales visits and technical support visits for Aplc They are much higher than for those of other customers, whereas other customer-related costs, when expressed as a percentage of gross profit, are broadly in line with theother three customers The cost of sales visits and technical support visits have shown apersistent rise over time and do not appear to be due to a unique factor such as the sale

of faulty goods In view of this, the managers may decide to cut down on the number ofsales and technical visits or to charge for them, perhaps through increased prices

account-Many businesses try to compete on price: that is, they try to provide goods or services

at prices that compare favourably with those of their competitors To do this fully over time, they must also compete on costs: lower prices can only normally besustained by lower costs A strategic commitment to competitive pricing must there-fore be accompanied by a strategic commitment to managing the cost base

success-In Chapter 5 we saw that, to manage costs in an active way, new forms of costinghave been devised Some of these new costing techniques reflect a concern for long-term cost management and so fall within the broad scope of strategic management

accounting Total life-cycle costing, target costing and kaizen costing provide three

examples In this section, we shall briefly review these forms of costing and then go on

to consider other ways in which costs may be strategically managed

Competitive advantage through cost leadership

We can see that there are wide variations to be found in practice Whereas nearly halfthe respondents undertake CPA on a monthly basis, nearly a quarter do not undertakeCPA analysis at all

Source: Based on information in Tayles, M and Drury, C., ‘Profiting from profitability analysis?’, University of Bradford Working Paper

series No 03/18, June 2003, p 8.

Extent and frequency of customer profitability analysis

Figure 9.3

Approximately three-quarters of respondents indicated that CPA was undertaken, with a monthly analysis being the most common.

Total life-cycle costing

We saw in Chapter 5 that total life-cycle costing draws management’s attention to thefact that it is not only during the production phase that costs are incurred Costs begin

to accumulate at earlier phases, such as design, development and setting up the duction process (For some businesses, such as pharmaceutical businesses, these early-phase costs may represent a high proportion of the total costs incurred.) Furthermore,costs continue to accumulate after production, such as those relating to distributionand after-sales service In certain cases there may also be abandonment costs, such asthe costs of decommissioning an oil rig operating in the North Sea

pro-Total life-cycle costing is concerned with tracking and reporting all costs relating to

a product from the beginning to the end of its life If the revenues generated over thelife cycle of the product are also tracked, we can assess its profitability Conventionalaccounting reports do not attempt to do this and so it is difficult for managers to knowwhether the decision to launch a new product will ultimately generate profits or losses.Total life-cycle costing can be used to manage costs Managers will be able to see, at

an early stage, the cost consequences of incorporating particular designs or particularelements into products Where the costs are unacceptable, changes may be made Where

a number of equally acceptable designs for a particular product are being considered,knowledge of the total life-cycle costs of each may help decide the final outcome

Real World 9.4shows how one well-known business operates a life-cycle approach

to both costing and environmental issues

REAL WORLD 9.4

Life cycle

Rolls-Royce provides engines for use in the air, at sea and on land, and is concerned withthe environmental impact as well as the costs over the whole life of its products Rolls-Royce states:

The environmental performance of our products has always been a priority for Rolls-Royce A large part of our research and development has been directed towards new products with increased efficiency, together with reduced emissions and noise.

Our products typically remain in service for many years and consequently much of our ness is directed towards the whole life cycle of the product Our product development processes have evolved to address issues associated with manufacturing, assembly, operation, repair and overhaul This approach has much in common with the concept of Design for Environment (DfE) which is a process for designing to minimise the overall impact of the product during its whole life .

busi-We are also using Life Cycle Analysis techniques to benchmark the total environmental impact associated with our products and ultimately to inform our decision-making processes This approach has proved the importance of the ‘in service’ phase of the life cycle for our products, when the vast majority of the environmental impacts occur Rolls-Royce has long applied life-cycle management in the form of life-cycle costing to products We incorporate environmental life-cycle thinking into our design processes alongside cost measurement to ensure that our products are the most cost-effective solutions while protecting the environment as far as possible.

Target costing

Target costing is a market-based approach to managing costs We saw in Chapter 5 thatthe starting point is to set the target price of a product on the basis of market research,which may include an analysis of competitors’ prices The target price, less the requiredprofit from the product, will be the target cost of the product Target costing placesdemands on managers because the target cost is usually lower than the current full cost

of the product Thus, to achieve the target cost, a systematic approach to cost tion is often required

reduc-A team of managers, drawn from each of the main functional areas, such as design,production, purchasing and marketing, will normally be charged with achieving thetarget cost Together they will examine all aspects of the product and the productionprocess to try to eliminate anything that does not add value This can place consider-able pressure on designers, as they are likely to be asked to redesign the product to aspecification that is more acceptable

Kaizen costing

Once the product design and the production process have been agreed, the production

phase can begin Kaizen costing may be used to manage the efficiency of this phase.

We saw in Chapter 5 that kaizen costing aims at continual and gradual incremental

improvements to the product design and the production process Like target costing,

it also involves target setting: a cost reduction rate will be specified for a period andactual performance will be compared against it To achieve the required cost reduction,the involvement of employees is normally essential The suggestions they make can often

lead to significant savings Kaizen costing is closely associated with lean manufacturing,which is committed to the elimination of waste through continuous improvement

Figure 9.4 shows the phases of the product life cycle covered by the three forms of costing discussed

‘

The relationship between the three types of costing

Figure 9.4

Total life-cycle costing covers all three phases of the product life cycle, whereas target costing

and Kaizen costing are each concerned with only a single phase.

Value chain analysis

To secure competitive advantage, a business must be able to perform key activitiesmore successfully than its competitors This means that it must either obtain some costadvantage over its competitors, or differentiate itself in some way from them To helpidentify particular ways in which competitive advantage may be achieved, it is useful

to analyse a business into a sequence of value-creating activities This sequence isknown as the value chain, and value chain analysisexamines the potential for eachlink in the chain to add value

For a manufacturing business, the value-creating sequence begins with the tion of inputs, such as raw materials and energy, and ends with the sale of completedgoods and after-sales service Figure 9.5 sets out the main ‘links’ in the value chain for

acquisi-a macquisi-anufacquisi-acturing business We cacquisi-an see thacquisi-at five primacquisi-ary acquisi-activities acquisi-are supported by foursecondary activities

Value chain analysis applies as much to service-providing businesses as it does tomanufacturers Service providers similarly have a sequence of activities leading to pro-vision of the service to their customers Analysing these activities in an attempt toidentify and eliminate non-value-added activities is very important

Each link in the value chain represents an activity that will incur costs and affectprofits Ideally, each will add value – that is, the customer will be prepared to pay morefor the activity than it costs to carry out If, however, a business is to outperform itsrivals, it must ensure that the value chain is configured in such a way that it leadseither to a cost advantage or to differentiation

To achieve a cost advantage, the costs associated with each link in the chain must

be identified and then examined to see whether they can be reduced or eliminated For example, a business may identify a non-value-added activity, such as the inspec-tion of the completed product by a quality controller The introduction of a ‘quality’culture in the business could lead to all output being reliable As a result, inspectionwould no longer be needed and therefore this cost can be eliminated To achieve

differentiation from its rivals, a business must achieve uniqueness in at least one part

of the value chain A large baker, for example, may try to differentiate its products bymoving production facilities to its retail shops to ensure that the products are freshlyavailable to customers

In some cases, value chain analysis may result in significant operational changessuch as the introduction of new manufacturing or service-provision technology, or thedevelopment of new sales policies In other cases it may result in significant strategicshifts A manufacturing business, for example, may find that it is unable to match themanufacturing costs achieved by its rivals Nevertheless, it has competitive strengths

in the areas of marketing and distribution In such circumstances, a decision may

be made to focus on the business’s core competencies This may lead it to outsourcethe manufacturing function and to concentrate on the marketing and distribution ofthe goods

Real World 9.5provides an example of how focusing on the value chain may helptransform the performance of a business

An alternative view

Whilst the costing methods just described are used and are regarded as useful by manybusinesses, some believe that they fail to provide the key to successful strategic costmanagement It has been suggested that undue emphasis on costing methods, such

as total life-cycle costing, is misplaced and what is really needed is for businesses to

REAL WORLD 9.5

What a sauce

Ahold is a major Dutch retailer that has recently been recovering its fortunes, under itschief executive Anders Moberg The business has a recovery plan that involves ‘re-engineering the value chain’ and according to Mr Moberg, the key is a detailed analysis

of the cost of goods sold

‘That is probably the single biggest opportunity [for savings] that we have.’

Take a bottle of tomato ketchup ‘What are the costs of the growers of the tomatoes? What are the components of the value chain, production, marketing, packaging and distribution? Can you add a component in a different way, for example with standardised bottles? You are looking at how to re-engineer the value chain [in order] to lower the price.’

Manufacturers’ brands do this, he says, ‘but they keep the savings, hence they have a better return on capital’ With supermarket own-label brands on the rise – they account for 50 per cent

of Ahold Dutch store sales, and 15 per cent in the US – Mr Moberg can reduce what it costs him

to make products while at the same time lowering prices, attracting more shoppers to Ahold stores and thereby raising volumes .

Armed with intricate knowledge of supply chain costs, Ahold can press big brand turers to cut the prices they ask of the retailer It is a delicate balancing act Both Grolsch, the Dutch brewer, and Peijnenburg, a bakery group, have quarrelled with Ahold about the damage inflicted on their brands by pricing policy, while Unilever, the consumer goods group, took Ahold

manufac-to court, claiming it had copied its packaging.

It appears, however, to be a battle Mr Moberg is winning Not only is customer perception of the quality of own-label products rising – a fact confirmed by independent industry research – but Ahold has a strong position with big consumer brands through its control of distribution channels, especially in the Netherlands, where its Albert Heijn chain is market leader and has 700 stores.

Source: Bickerton, I., ‘It is all about the value chain’, ft.com, 23 February 2006.

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develop ways of learning and adapting to their changing environment To managecosts successfully, businesses should continually review them in the face of new threatsand pressures rather than relying on particular techniques to provide solutions.Hopwood (see reference 2 at the end of the chapter) suggests that to transform costsover time in order to fit the strategic objectives, businesses do not need very sophistic-ated techniques or highly bureaucratic systems Rather, they need to change the ways

in which costs are viewed and dealt with He suggests that the following broad ciples should be adopted

prin-1 Spread the responsibility

Employees throughout the business should share responsibility for managing costs.Thus, design experts, engineers, store managers, sales managers, and so on should allcontribute towards managing costs and should see this as part of their job The involve-

ment of non-accountants is, of course, a feature of target costing and kaizen costing,

and so this point already appears to be widely accepted

Hopwood suggests that employees should be provided with a basic understanding ofcosting ideas such as fixed and variable costs, relevant costs and so on, to enable them

to contribute fully As cost-consciousness permeates the business, and non-accountingemployees become more involved in costing issues, the role of the accountants willchange They will often facilitate, rather than initiate, cost management proposals andwill become part of the multi-skilled teams engaged in creatively managing them

2 Spread the word

Throughout the business, costs and cost management should become everyday topicsfor discussion Managers should seize every opportunity to raise these topics withemployees, as talking about costs can often lead to ideas being developed and actionbeing taken to manage costs

3 Think local

Emphasis should be placed on managing costs within specific sites and settings.Managers of departments, product lines or local offices are more likely to becomeengaged in managing costs if they are allowed to take initiatives in areas over whichthey have control Local managers tend to have local knowledge not possessed by man-agers at head office They are more likely to be able to spot cost-saving opportunitiesthan are their more senior colleagues Business-wide initiatives for cost managementwhich have been developed by senior management are unlikely to have the samebeneficial effect

4 Benchmark continually

Benchmarking should be a never-ending journey There should be regular, as well asspecial-purpose, reporting of cost information for benchmarking purposes The costs ofcompetitors may provide a useful basis for comparison, as we saw earlier In addition,costs that may be expected as a result of moving to new technology or work patternsmay be helpful

5 Focus on managing rather than reducing costs

Conventional management accounting tends to focus on cost reduction, which is,essentially, taking a short-term perspective on costs Strategic cost management, how-ever, means that in some situations costs should be increased rather than reduced

Hopwood argues that the above principles, when used in conjunction with overallfinancial controls, provide the best way to manage costs strategically.

Real World 9.6 gives an example of how local managers who are not accountantscan identify potential cost savings and not resent their implementation

Once the strategic objectives of a business have been set, progress towards these tives must be monitored This means that there must be appropriate measures bywhich progress can be assessed Financial measures have long been seen as the mostimportant ones for a business They provide us with a valuable means of summarisingand evaluating business achievement and there is no real doubt about the continuedimportance of financial measures in this role In recent years, however, there has beenincreasing recognition that financial measures alone will not provide managers withsufficient information to manage a business effectively Non-financial measures mustalso be used to gain a deeper understanding of the business and to achieve the objec-tives of the business, including the financial objectives

objec-Translating strategy into action

Under what kind of circumstances might it be a good idea to increase costs?

This may include situations that could lead to

l additional revenues being generated

l lower costs being incurred over the longer term

l lower costs being incurred in other areas of the business

Activity 9.3

REAL WORLD 9.6

Costing problem? Call a doctor

One research study contrasts the difference in approach to cost management in UK andFinnish hospitals In the UK, cost management is seen as the domain of financial staff Thiscan lead to problems as financial systems that have been introduced to manage costshave led to more complex organisational structures In addition there is often an em-phasis on cost savings, which can lead to conflict between financial staff and medicalstaff The latter often resent cost cuts being imposed on them by the financial staff

In contrast, medical staff in Finnish hospitals share responsibility for cost management

Doctors and other medical professionals recognise the need to use resources in an cient way and are committed to ensuring that resources are not wasted Rather than fight-ing cost-cutting initiatives from financial staff, they see both medical knowledge and costawareness as being necessary to successful medical practice

effi-Source: Based on information in Hopwood, A., ‘Costs count in the strategic agenda’, ft.com, 13 August 2002.

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Financial measures portray various aspects of business achievement (for example,sales revenues, profits and return on capital employed) that can help managers deter-mine whether the business is increasing the wealth of its owners These measures arevitally important but, in an increasingly competitive environment, managers also need

to understand what drives the creation of wealth These value drivers may be suchthings as employee satisfaction, customer loyalty and the level of product innovation.Often they do not lend themselves to financial measurement, although non-financialmeasures may provide some means of assessment

Financial measures are normally ‘lag’ indicators, in that they tell us about outcomes

In other words, they measure the consequences arising from management decisionsthat were made earlier Non-financial measures can also be used as lag indicators, ofcourse However, they can also be used as ‘lead’ indicators by focusing on those thingsthat drive performance It is argued that if we measure changes in these value drivers,

we may be able to predict changes in future financial performance For example, a ness may find from experience that a 10 per cent fall in levels of product innovationduring one period will lead to a 20 per cent fall in sales revenues over the next threeperiods In this case, the levels of product innovation can be regarded as a lead indica-tor that can alert managers to a future decline in sales unless corrective action is taken.Thus, by using this lead indicator, managers can identify key changes at an early stageand can respond quickly

busi-The balanced scorecard

One of the most impressive attempts to integrate the use of financial and non-financialmeasures has been the balanced scorecard, developed by Robert Kaplan and David

‘

‘

How might we measure:

(a) employee satisfaction?

(b) customer loyalty?

(c) the level of product innovation?

(a) Employee satisfaction may be measured through the use of an employee survey Thiscould examine attitudes towards various aspects of the job, the degree of autonomythat is permitted, the level of recognition and reward received, the level of participa-tion in decision making, the degree of support received in carrying out tasks and so

on Less direct measures of satisfaction may include employee turnover rates andemployee productivity However, other factors may have a significant influence onthese measures

(b) Customer loyalty may be measured through the proportion of total sales generatedfrom existing customers, the number of repeat sales made to customers, the per-centage of customers renewing subscriptions or other contracts, and so on

(c) The level of product innovation may be measured through the number of innovationsduring a period compared to those of competitors, the percentage of sales attribut-able to recent product innovations, the number of innovations that are brought suc-cessfully to market, and so on

Activity 9.4

Norton (see reference 3 at the end of the chapter) The balanced scorecard is both amanagement system and a measurement system In essence, it provides a frameworkthat translates the aims and objectives of a business into a series of key performancemeasures and targets This framework is intended to make the strategy of the businessmore coherent by tightly linking it to particular targets and initiatives As a result,managers should be able to see more clearly whether the objectives that have been sethave actually been achieved.

The balanced scorecard approach involves setting objectives and developing priate measures and targets in four main areas:

appro-1 Financial This area will specify the financial returns required by shareholders and

may involve the use of financial measures such as return on capital employed, ating profit margin, percentage sales revenue growth and so on

oper-2 Customer This area will specify the kind of customer and/or markets that the

busi-ness wishes to service and will establish appropriate measures such as customer satisfaction, new customer growth levels and so on

3 Internal business process This area will specify those business processes (for example,

innovation, types of operation, and after-sales service) that are important to the cess of the business, and will establish appropriate measures such as percentage ofsales from new products, time to market for new products, product cycle times, andspeed of response to customer complaints

suc-4 Learning and growth This area will specify the kind of people, the systems and the

procedures that are necessary to deliver long-term business growth This area is oftenthe most difficult for the development of appropriate measures However, examples

of measures may include employee motivation, employee skills profiles and tion systems capabilities These four areas are shown in Figure 9.6

informa-The balanced scorecard approach does not prescribe the particular objectives, sures or targets that a business should adopt; this is a matter for the individual business

mea-to decide upon There are differences between businesses in terms of technologyemployed, organisational structure, management philosophy and business environ-ment, so each business should develop objectives and measures that reflect its uniquecircumstances The balanced scorecard simply sets out the framework for developing acoherent set of objectives for the business and for ensuring that these objectives arethen linked to specific targets and initiatives

A balanced scorecard will be prepared for the business as a whole or, in the case oflarge, diverse businesses, for each strategic business unit However, having prepared anoverall scorecard, it is then possible to prepare a balanced scorecard for each sub-unit,such as a department, within the business Thus, the balanced scorecard approach cancascade down the business and can result in a pyramid of balanced scorecards that arelinked to the ‘master’ balanced scorecard through an alignment of the objectives andmeasures employed

Though a very large number of measures, both financial and non-financial, exist and

so could be used in a balanced scorecard, only a handful of measures should beemployed A maximum of 20 measures will normally be sufficient to enable the factorsthat are critical to the success of the business to be captured (If a business has come

up with more than 20 measures, it is usually because the managers have not thoughthard enough about what the key measures really are.) The key measures developedshould be a mix of lagging indicators (those relating to outcomes) and lead indicators(those relating to the things that drive performance)

Although the balanced scorecard employs measures across a wide range of businessactivity, it does not seek to dilute the importance of financial measures and objectives

The balanced scorecard – for translating a strategy into operational processes

Figure 9.6

There are four main areas covered by the balanced scorecard Note that, for each area, a mental question must be addressed By answering these questions, managers should be able to develop the key objectives of the business Once this has been done, suitable measures and targets can be developed that are relevant to those objectives Finally, appropriate man- agement initiatives will be developed to achieve the targets set.

funda-Source: The Balanced Scorecard, Harvard Business School Press (Kaplan, R and Norton, D 1996) Reprinted by permission of

Harvard Business School Press, from The Balanced Scorecard by R Kaplan and D Norton Boston, MA 1996 Copyright © 1996 by