L31 Total Cost Management

Total Cost Management – Why? “Market determines the price, Cost determines the profitability” Companies have more control over cost than the price therefore they maximize the value to the customer by managing its Cost i.e. [Offer more value at lesser price and still maintain profitability.]

This necessitated an integrated approach in cost management. i.e. at strategic as well as at operational level. This approach is called ……

“Total Cost Management”

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Total Cost Management – Concept  company-wide systematic and structured approach  provides a holistic framework to control, reduce and eliminate costs , throughout the value chain  process of managing the financial outcome of activities encompasses all operations, internal and external.  A must tool for competitive advantage.

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Total Cost Management – an example Which are our profitable customer segments

How well informed are our sourcing decisions

What are our product costs and their profitability?

TCM

Do our costs go up despite our cost cutting efforts?

Can we reduce our prices and yet increase the customer value

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Total Cost Management – Process  Identify Inefficiencies * BECAUSE as business environment becoming more & more competitive, inefficiency of one is becoming an opportunity for the other.

* Inefficiency is in terms of the non-value–adding activity present in the system.

 To identify, to gauge the extent and to eliminate the inefficiency, guiding principle are ………… • “if you can measure it, you can manage it” • “ it is better to be approximately right, than to be precisely wrong” • “a structural change in the measurement systems is preferred than a temporal / apparent change” 10/17/08 4 [email protected]; VIM Pune

Total Cost Management – Techniques

• Activity based costing • Activity based management • Target costing

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Activity Based Costing -

Concept

Complaint by product design manager: “Why is it when I use a capacitor costing Rs 20 , the procurement overhead charge is 20 paise per unit, but when I use a coprocessor part costing Rs100, the procurement charge is Rs.10? Procuring and handling a coprocessor does not consume 50 times (Rs. 0.2 x 50 = Rs 10) the resources used to procure and handle a capacitor. This overhead costing approach is irrational.”

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Activity Based Costing - Concept

Allocation basis is vague

Activity Based Costing Departmental Overhead Rates

Plant wide Overhead Rate 10/17/08

Allocation basis is rational

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f o l e v

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Overhead Allocation [email protected]; VIM Pune

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Activity Based Costing One of the most difficult tasks in computing accurate unit costs lies in determining the proper amount of overhead cost to assign to each job or to each unit of product. • Activity based costing is a method that measures cost of a product/service, based on the activities performed to produce that product/service. • This enables to allocate overheads to products, more accurately. • In this method, we recognize that many activities within a department drive overhead costs 10/17/08

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ABC – Process  Conduct process Analysis.  Identify activity centers.  Assign cost to the activity center as they accumulated while pending for allocation to product.  Select Cost Drivers  Determine amount of activity consumed by the product.  Once costs are collected by activities, they are

charged to products using cost drivers. 10/17/08

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ABC - Examples Product O/H allocationActivities: Prod X Order Processing. Machine set up. Material receipt. Machine Hrs Inspection

40% 80% 10% 75% 60%

Prod Y 60% 20% 90% 25% 40%

Cost Driver = Number of units of X and Y

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Activity Based Management

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Activity-Based Management A value-added cost is the cost of an activity that cannot be eliminated without affecting a product’s value to the customer. In contrast, non-value-added costs are costs that can be eliminated without affecting a product’s value to the customer. 10/17/08

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Thanks……

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