Management Accounting: A Road of Discovery
Management Accounting: James T. Mackey Michael F. Thomas A Road of Discovery Presentations by: Roderick S. Barclay Texas A&M University - Commerce James T. Mackey California State University - Sacramento © 2000 South-Western College Publishing
Chapter 10Should we start all over? Strategic cost management
Key Learning Objectives 1. Discuss how industry-wide value chains and accounting information aid firms in identifying their core competencies. 2. Demonstrate the use of strategic partnering and activity-based management performance measures in managing suppliers. 4. Illustrate product line management with target costing, simultaneous engineering and quality function deployment, and life cycle costing. 3. Create activity-based management measures for customer satisfaction and explain the role of ABC in managing customer relations.
Part I Strategic Value Chain Management
What Business Are We In? • Long-term value is • Created by our business choices and • Strategies we apply within our line of business. • Short-term value is • Created through the management of resources within the long-term plan and strategic value chain. • This is where traditional cost based accounting management is primarily applied. • An industry-wide value chain measures the provision of an industry’s goods or services from ‘cradle to grave’. The value chain identifies and defines the industry.
Farmers grow and harvest crops Truckers ship to processing plants Plants process and pack vege-tables and grains Truckers ship to distribution cen-ters and retailers Farmers maintain and milk dairy cattle Truckers ship to processing plants Plants process into cheese products Truckers ship to distribution cen-ters and retailers Farmers (ranchers) raise beef cattle Truckers ship to processing plants Plants process into meat products Truckers ship to distribution cen-ters and retailers Pizza restaurants purchase materials Pizza restaurants prepare pizzas Pizza restaurants serve customers and clean up Refuse companies dispose of trash Pizza restaurants deliver to customers Pizza’s Industry-Wide Value Chain
Part II Using Accounting Data to Identify Opportunities
Farmers grow and harvest crops Truckers ship to processing plants Plants process and pack vege-tables and grains Truckers ship to distribution cen-ters and retailers Farmers maintain and milk dairy cattle Truckers ship to processing plants Plants process into cheese products Truckers ship to distribution cen-ters and retailers Farmers (ranchers) raise beef cattle Truckers ship to processing plants Plants process into meat products Truckers ship to distribution cen-ters and retailers Pizza restaurants purchase materials Pizza restaurants prepare pizzas Pizza restaurants serve customers and clean up Refuse companies dispose of trash Pizza restaurants deliver to customers Return on Investment Ratios in the Pizza Industry ROI = 3%-8% ROI = 5%-10% ROI = 10%-15% ROI = 5%-10% ROI = 10%-20% ROI = 15%-30% ROI = 10%-20%
Using Accounting Data • Using larger ROI as an indication of greater power and value, we can reconfigure the business by moving up and down the value chain. • Different combinations of activities allow companies to differentiate their goods or services to create more value. • In the pizza example, the objective was to capture the more profitable garbage disposal activity. • Different combinations of activities allow companies to differentiate their goods or services. • A larger ROI indicates greater economic power. • By absorbing sequential activities, efficiency can be created by combining core competencies and reducing redundant activities. • By focusing on our value chain, we can identify potential ways to increase value and decrease costs.
Part III The Need for Cost Management Analysis Using CVP analysis
Sales revenues $15 100% $150 Less: Variable costs 5 33% 50 Contribution margin $10 67% $100 Less: Batch costs Delivery 25 Return 25 Cleanup 10 Disposal 20 Total batch costs $ 80 Net Income $ 20 Break even point = 8 pizzas CVP Analysis for Pizza Delivery, Cleanup,and Disposal Cost-volume-profit analysis allows us to examine the projected costs and the benefits of moving into the clean-up and disposal business.
Analysis of Pizza Business • The target sales price per pizza is $15. • Unit costs for each pizza are the variable costs which include labor and materials of $5. • The contribution margin per pizza is $10. • The batch costs include delivery, return, clean-up, and disposal of $80. • Each pizza sale with clean-up loses $70! • However, by covering only the clean-up with orders of ten pizza’s or more, the contribution margin per batch order increases to at least $20. • The PARTY PIZZA CLEAN-UP BUSINESS is born.
Limitations on Value Chain Analysis • Truly comparable activities may be difficult to identify. • Information may be difficult to obtain. • ROI approximates profitability and power (accounting profitability is not necessarily economic value). • We need better measures that correlate better with firm value. • Successful differentiation and cost management will require detailed cost analysis.
Part IV Using value Chains to Manage Multree Homes
Sell houses Build houses Customer order-taking 1.1 Sales 1.2 Credit check (Finance) 1.3 Accounts receivable Materials acquisition (inbound) 2.1 Scheduling 2.2 Purchasing 2.3 Receiving, inspection, storage 2.4 Delivery to factory Where We Are on the Industry-Wide Value Chain Industry goods and services (Exhibit 2-3) Multree Homes value chain (Exhibit 2-5)
Build Houses Manufacturing 3.1 Lumber sawing 3.2 Wall assembly (framing) 3.3 Rough wiring 3.4 Rough plumbing 3.5 Wall finishing (all inclusive) 3.6 Roof construction 3.7 Finish carpentry 3.8 Top-off plumbing 3.9 Finish electric 3.10 Carpeting 3.11 Inspection Continued Value Chain
Build Houses Sell houses Customer service (warranty) Shipping (outbound logistics) 4.1 Packing 4.2 Shipping 4.3 Set up for dealer, customer Close sales 5.1 Customer inspection 5.2 Bill customer 5.3 Collect and deposit cash After sale customer services 6.1 Provide warranty work 6.2 Survey customer satisfaction 6.3 New product and service advertising Concluded Value Chain
Value Chain Discussion • A process is the set of activities required to provide goods and services. • Exhibit 10-4 list the 6 processes that Multree needs to manage. • For example, customer order-taking has three activities — sales, credit checks, and accounts receivable. • Each activity becomes the cost objective for management accounting. • Activities are significant costs. • Activities are assigned cost drivers. • Often activities or processes can be outsourced.
Core Competencies • Core competencies are activities or processes where companies excel. • They are the process that individual companies do better than their competitors. • Multree has identified six processes in Exhibit 10-4 illustrated previously. • Multree’s core competency is the management of activities in the Organization value chain. • Superior cost and earnings performance measures are ways to identify the relative advantage of core competencies. Multree’s advantage against a general contractor is in production costs — see Exhibit 10-6, p. 358.
Company Core competencies Products or services AT&T Technological leadership through Bell Labs Telecommunications products Honda Small engine production Motorcycles, snowmobiles, lawnmowers, snow blowers, chain saws IBM Research and development Experienced sales force Mainframe computers and software Microsoft/ Apple Imagination New ways to use information technology Proctor & Gamble Research and development Marketing and distribution Ivory, Tide , Folgers, Crisco, Pampers Xerox Information processing Developed icons, pull-down menus, mouse Core Competencies in Well-Known Companies
Part V Value Chain Approach to Vendor Management
Vendors • Vendors costs are usually a major product cost. • Improving costs is dependent on improving vendor efficiencies. • I.E., if 70% of a company’s unit costs are paid to vendors, a 50% improvement in internal processes would only reduce costs by 15%. • Therefore, vendor management is a significant management consideration.
Decisions Regarding Vendors and Value Chains • Strategic partnering with selected vendors can result in significant competitive advantage. • By working with a small number of vendors, Multree has more influence over them. • Long-term relationships allow differentiated products to be developed to eliminate redundant activities and complement core activities.
Let’s Look at Multree • Multree builds a standard 26-foot roof. • They bid for the standard 10-foot bundles of plywood on the open market to obtain the best price. • Each span requires three sheets. • Four feet must be cut off every third sheet and thrown away. • Using three sheets leaves two seams that must be sealed and forms weak points for leaks.
Multree’s Solution • By strategic partnering with the plywood mill, Multree can eliminate redundant activities between it and the mill. • Multree pays for an additional setup on the plywood saw to cut 13-foot sheets. • Exhibit 10-7a, p.362 and 7b, p. 363, summarize the costs before and after the process redesign. • Multree reduces it’s cost per roof by 35% or $141.38.
Let’s Analyze Multree’s Solution • Multree’s core competency is manufacturing. • By strategic partnering it’s non-core activities in purchasing, shipping, and preparation, Multree can eliminate some less efficient activities and reduce unit costs. • Value-chain thinking leads to a shift in value creation focus from separate cost centers to maximizing the efficiency of the entire value chain. • The virtual company they formed can maximize its competitiveness by combining the core competencies of several organizations.
Part VI Value Based Vendor Performance Measures
The Vendor Performance Index (VPI) • VPI measures the cost of purchasing goods from a vendor. • The costs to work with a vendor are not limited to the invoice costs that are measured by GAAP. • Rather, the non-value added activities caused by the vendor’s produce and performance need to be considered. VPI = Purchase Cost + Non-Value Added Costs Purchase Cost
Inspection 10 $100 Processing paperwork 2 20 Returning bad materials 3 30 Waiting for late deliveries 5 50 Totals 20 $200 Materials purchase cost $1,000 VPI Calculations Labor hours Labor cost at $10/hr Nonvalue added activities Materials purchase cost Nonvalue added costs + VPI = Materials purchase cost $1,000 + $200 $1,000 VPI = VPI = 1.2
VPI Components • On-Time Delivery — measures of delivery are useful when VPI is unavailable. On-time measures are easy, cheap, and meaningful to the shop floor. • Complete Order Filling — is an example of a quality of service measure.
Part VII Managing Value Chain Relationships with Customers
Exhibit 10-10 Analysis • The snake chart allows companies to monitor their product as viewed by the customer. • Customers identify and rank these attributes on a 1 (lease important) to 10 (most important) scale for their importance and the perceived quality Multree provides. • To improve value • Multree needs to improve where it is under performing (warranty service) — a 9 in importance and a 4 in performance. • They also may need to consider reducing the variety of homes (2 in importance vs. an 8 in performance). • These are non-financial measures and do not score on value. Further cost analysis is needed before decisions are made.
Activity Analysis of Customer Delivery Costs • First, review and analyze Exhibit 10-11, p. 370. • A firm can develop competitive advantage by matching their core competency to their customers. • Activity analysis of customer delivery activities allows companies to focus on customers with which they have a core competency advantage. • Different support resources have unique cost drivers. • Customers consume resources differently.
Part VIII Product Line Strategic Cost Management
Target Costing TARGET COST = REVENUE – DESIRED PROFIT • First, calculate the value of products to customers, then subtract the desired profit. • Customers set the cost standard that the company must reach.
Simultaneous Engineering Using QFD Analysis • There is a high cost of independent, functional specializations like design, manufacturing and sales. • Significant costs are locked in at the design stage. • These costs cannot be changed significantly after production begins. • Concurrent or simultaneous design means the design team needs to include members of, and cost data from, each activity in the life-cycle of the product. • Quality function deployment (QFD) starts with characteristics that the customer desires.
Purchase glass $500 $600 Purchase framing materials 50 50 Cut frame lumber 100 100 Package glass for shipping 25 25 Special installation labor 75 100 Extra sealing materials 0 25 Warranty work 250 0 Budgeted cost $1,000 $900 Target costing allowance $900 $900 Drift ($100) None Note: The chalet home is a purchased kit (package) assembled at the site. ABC Quality Function Deployment (QFD) Analysis Original ABC analysis Revised ABC analysis Picture Window Activities