Ed Blocher University of North Carolina, Chapel Hill

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

2. Overview • The Strategic Approach: an Introduction • Tools for Integrating Strategy: Value Chain Analysis, The Strategy Map, and the Balanced Scorecard (BSC) • Sample Course Outlines • Sample Course Topic: Activity-Based Costing (ABC), Time-Drive ABC (TDABC), and ABM • Sample Course Topic: Customer Profitability Analysis • Sample Course Topic: The Management and Control of Quality and Accounting for Lean • Sample Course Topic: Performance Measurement • Using Software in the Cost Management Course

3. Part 1: the Strategic Approach to Teaching Cost/Management Accounting Topics—An Introduction

4. Teaching Strategic Cost Management What? Why? How?

5. 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

6. Strategic Cost Management The Strategic Perspective Prior Perspective # View cost management as a tool for developing and implementing business strategy # The accountant as a business partner # Focus on cost management • Focus on Financial Reporting • Common emphasis on standardization and standard costs • The accountant as functional expert and financial scorekeeper

7. 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 • …

8. 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.

9. IntroducingStrategy Strengths Weaknesses OpportunitiesThreats Strategy Map Balanced Scorecard (BSC)

10. Michael Porter: StrategicPositioning • CostLeadership—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

11. Aspects of the Two Competitive Strategies

12. Part 2: Tools for Integrating Strategy into Cost Accounting/Cost Management Courses -- The Value Chain -- Strategy Maps & the Balanced Scorecard (BSC)

13. ValueChainAnalysis: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: • “Upstream” Activities • Manufacturing/Operations • “Downstream” Activities

14. 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

15. 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

16. vision & mission Exceed shareholder expectations Diversify income stream Increase sales volume Improve profit margins Financial Diversify customer base Increase sales to existing customers Customer Attract new customers Internal Process Target profitable market segments Optimize internal processes Develop new products Attract new customers Learning & Growth Develop employee skills Integrate systems

17. The Balanced Scorecard (BSC): Feedback to Strategy Strategy Map Balanced Scorecard (BSC)

18. 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

19. Part 3: Sample Course Outlines • Management Accounting • Cost Accounting • Advanced Management Accounting

20. Introduction to Management Accounting · Strategic Positioning · Ethics Implementing Product Cost Behavior (Planning and Strategy Costing Product Life Operational Cycle Control) · · · Volume Cost Estimation Target · The Value Based Costing Chain · (Job CVP Analysis · Costing) Life · The · Cycle Master Budget Balanced Costing Scorecard · Activity - · Decision based Making Costing · Flexible Budget s · Management Control

21. Cost Accounting · Strategic Positioning · Ethics Implementing Product Cost Behavior Product Life (Planning and Strategy Costing Cycle Operational Control) · Job Costing · Target · The Value · Cost Estimation Costing Chain · ABC Costing · The · CVP Analysis · Life Cycle Balanced (ABC) Costing · Process Cost Scorecard · Master Budget (ABC) · Joint Costs · Decision Making (ABC) · Standard Costing • Managing Constraints

22. Advanced Management Accounting · Strategic Positioning · Ethics Implementing Cost Behavior Product Life Strategy (ABC - based) Cycle · The Value Chain · Cost Es timation · Target (Regression) Costing · The Balanced Scorecard (BSC) · CVP Analysis · Life Cycle · Master Budget Costing · Management Control (TP) · · Executive Compensation Decision Making (LP) · Business Valuation

23. Part 4: Sample Course Topic—Activity-Based Costing (ABC), RCA, and TDABC

24. Evolution of Cost Accounting Systems ABC (simple & minimal) ABC (multidimensional) Traditional Costing Resources Resources Resources Consumed by Consumed by Allocated to Activities Activities Consumed by Consumed by outputs Cost Objects Cost Objects channels Cost Objects Users

25. ABC/M Framework What Things Cost Resource Drivers Resource Costs Root Causes of Costs Work Activities Performance Measures • Cost Reduction • Process reengineering • Cost of quality • Continuous improvement • Waste elimination • Benchmarking Activity Cost Assignment Activity Drivers Cost Objects • Design for manufacturing • Make versus Buy Why Things Cost Better Decision Making

26. 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.

27. 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.

28. 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.

29. Part 5: Sample Course Topic—Customer Profitability Analysis

30. Overview of Customer Profitability Analysis • Activity Based Costing (ABC) • Customer Relationship Management (CRM): • Customer Lifetime Value (CLV) • Customer Equity

31. Customer Profitability Analysis: The Whale Curve

32. What Makes for a Profitable Customer? Profitable and unprofitable customers are distinguished by the demands they place on the organization • Less profitable customers • Small order quantities • Special products ordered • Heavy discounting • Unpredictable demands • Delivery times change • High technical support • Slow payment (imputed • interest) • More profitable customers • Large order sizes • Standard products ordered • Little discounting • Predictable demands • Delivery times standard • Low technical support • On-time payment (imputed interest) These demands can be estimated by activity costs and activity cost drivers

33. Migrating Customers to Higher Profitability – A Strategic Analysis Very Profitable Types of Customers High (Creamy) Profitable Product Mix Margin Unprofitable Low (Low Fat) Very unprofitable Low High Cost-to-Serve 32

34. 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.

35. You are a pharmaceutical supplier: which customer is more important? Dentist A Sales = $750,000 profits = $100,000 Age 61 Dentist B Sales = $375,000 profits = $40,000 Age 25 Which is more profitable? Which is more valuable?

36. 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.

37. 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.

38. Part 6: Sample Course Topic—The Management & Control of Quality (including Six-Sigma and Lean)

39. Relationship between TQM & Financial Performance

40. A Strategic Model for Managing Quality

41. 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

42. 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.

43. 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.

44. Lean Accounting – Value Streams

45. Part 7: Sample Course Topic— Operational and Management-level Performance Measurement

46. 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

47. Operational Performance Measurementwith a Flexible Budget 2010 2010

48. 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…

49. 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

50. Management –Level Performance Measurement: When to Use Profit or Cost Center Customer Plant Warehouse