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Supply Chain Management:

From Vision to Implementation

Chapter 8: Strategic Supply Chain Cost

Management

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Chapter 8: Learning Objectives

1. Explain what strategic cost management is a

port in the company and SC success.

2. Apply the three elements of strategic costmanagement to an analysis within your

organization.

3. Explain the relationship between process

mapping in strategic cost management.

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Chapter 8: Learning Objectives

4. Describe the various types of price and cost

analysis strategies applied today.

5. Select the right type of cost analysis tool tobest support a particular SC design situation.

6. Develop and explain the total cost of

ownership analysis.

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Profit Leverage Effect

Measurable cost savings that dont hurt sales

have a tremendous impact on the bottom line.

Profit impact of cost reduction is muchgreater than the impact of increased sales.

The lower the average profit margin, the

greater the impact.

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Strategic Cost Management Principles

Strategic cost management uses cost management

techniques to reduce the organizations costs

and improve profit while supporting its value

proposition.

Three elements of strategic cost management:

1. Supply Chain Analysis

2. Value Proposition Analysis

3. Cost Driver Analysis

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Supply Chain Analysis

Supply chain analysis is the examination of the

management of the flow of information,

inventory, processes, and cash flows from the

earliest supplier to the ultimate consumer,

including the final disposal process.

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Value Proposition Analysis

Value proposition analysis is the essence of a

corporation strategy, determining how an

organization chooses to compete in its

markets.

Generic value propositions include:

Cost leadership

Differentiation strategies

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Value Proposition

Intel is putting the people and resources in place

to sharpen our focus on the development of

platforms that meet the demands of our

customers and provide innovative and exciting

new technologies for the marketplace.

Paul Otellini, Intel CEO

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Value Proposition

To use the Internet to transform e-commerce

shopping into the fastest, easiest, and most

enjoyable shopping experience possible.

-Amazon.Com

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Value Proposition Analysis

New approaches for achieving competitive advantageinclude:

First to market provider: This was a very popular strategy inthe late 1990s and continues to be an important approach to

doing business today. Service/solution provider: This has become one of the key

ways for organizations to compete in this decade. Being a full-service solution provider requires a high level of understanding

of customer needs and flexibility and willingness to meet thosecustomer needs.

Technology Leader: This is a focused innovation approach,whereby the organization competes by providing the latest andgreatest technology to its customers.

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Value Proposition Analysis

Companies may choose a combination of

value propositions.

Different strategic business units within the

same company may choose different value

propositions.

Value propositions may change over the

product life cycle.

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Cost Driver Analysis

Cost driver analysis identifies processes,

activities, and decisions that actually create

cost for the supply chain.

Cost drivers vary over time and among

different products and services.

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Generic Cost Drivers

Level of outsourcing within a company. Companies thatoutsource may experience higher costs for additional servicesthan if it had internal operations. Overall costs may be lowerwhen demand is erratic.

Use of nonstandard materials, components and parts. Customitems are more costly because of low economies of scale. Custom

parts may have better performance or lower operating costs. Scale of operations. Very large manufacturing operations must

have high stable volume. Small manufacturing operations may beunprofitable at high-volumes due to overtime costs, inefficiency

in operations, machine breakdowns and maintenance issues. High level of finished goods product mix. The more options the

organization offers its customers, the more inventory it may haveto carry, and the more flexible it production operations must be.

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Cost Driver Analysis

Cost drivers are not inherently good or bad.

Cost reduction strategies must analyze cost

drivers in relation to their impact on the value

proposition.

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Cost-Reduction Considerations

For each product or service, how do you become aware of thevalue proposition in your organization at any point in time?

What is the value proposition for your organization, product,service?

Does the value proposition vary among business units andproducts or services? If so, are you certain you have identified the right value

proposition? Does the value proposition vary over time?

If so, are you certain you have identified the current or future value proposition? Will current/proposed activities be transparent to the customer?

If not, what in what way will they be visible? Are these areas that the customer values? Will the impact be positive, negative or neutral?

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Example Southwest Airlines

Utilize secondary airports wherever possible in major cities, for lowercost as well as reduced traffic and congestion to improve on-timereliability.

Standardize on one type of equipment (Boeing 737) to improve theefficiency of pilots and crew, maintenance, flight turn around andequipment substitution, when necessary.

Implement performance enhancing upgrades to the equipment to lowerfuel costs, maintenance costs, noise level and improve range, contributingto lower cost and improved customer satisfaction.

Do not use pre-assigned seating, different classes of service or mealservice in order to lower cost and speed turn around of airplanes.

Careful hiring and cross training of associates so that employees supportthe mission of friendliness and customer service, and are flexible to meetthe needs of whatever job is required, within reason.

Customer self-ticketing, early adoption of ticketless travel and no use oftravel agencies to reduce costs and promote efficiency.

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Responsibility for Strategic Cost Management

Historically accounting and finance had

responsibility for reporting and managing costs.

SCM requires a broader cost perspective.

Corporate Response:

Intel - accounting and finance develop tools, supply

managers are responsible for delivering cost savings

SBC - internal consulting groups attack complex

problems

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Strategic Cost Management Tools

Cost analysis: including should-cost analysis orzero-based pricing, as well as analysis of service

provider cost elements. Price analysis: understanding the prices available in

the competitive marketplace. Total cost of ownership: analyzing the true cost of

acquisition, use, maintenance and disposal of a good,service, capital equipment, or process.

Target costing: determining what the market willbear and working backwards to see how much youcan afford to produce the product or service for, andstill make a profit.

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Decision Classification

Once the process has been mapped and agood understanding of the system has beenachieved, a decision matrix can be used to

determine the appropriate cost managementtool.

The decision matrix classifies decisionsaccording to: Nature of the Buy

Relationship with Supplier

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Nature of the Buy

Is the cost of the item or service important, perhaps due to highvolume?

Is the technology used by the supplier critical to the productsimage, performance or quality?

Does the supplier have a critical brand name or image that youcan use to generate sales? Is the technology used by the supplier critical to future products,

line extensions, or the next generations of products? Is the item critical to getting leverage with supplier for other

buys? Could the item create environmental or safety concerns? Are there limited good sources available? Is the item purchase ongoing? Other issues that complicate the buying situation for your

organization at this time?

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Supplier Relationships Sought

How long would we like to continue to do business with thissupplier?

If we desire an on-going relationship, would we like thissupplier to be aware of our intentions?

Would we like to share information related to the buy withthe supplier?

Would we like the supplier to become involved in ourproduct or service development?

Would we like the supplier to locate one or more of itsemployees at our facility?

Other issues that affect the nature of the desired relationshipwith this supplier at this time?

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Classifying Suppliers/Purchases

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Classifications of Decisions

Low Impact low-cost commodity items;focus is on price analysis/comparison

Leverage large purchases of items in

competitive markets; focus is on cost analysis Strategic Item large purchases from

important suppliers; focus is on continuous

improvement Critical Projects large dollar volume

infrequent purchase; focus is on life cycle cost

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Tool Selection

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Commodity Classifications

Item Classification Rationale

Company Fleet Leverage Large volume, many suppliers, notcritical to our product

Copiers Critical Project One time buy with long-term costimplications, many suppliers available

Desktop Computers Leverage Large volume, relatively undifferentiated,very competitive market

Facilities Management Leverage Large volume, many suppliers, notcritical to our product

Furniture Leverage Large volume, many suppliers, notcritical to our product

Office Supplies Low Impact Relatively unimportant, easy to switch,many suppliers

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Commodity Classifications

Item Classification Rationale

Latest High-SpeedMicroprocessors

Strategic Large spend, affects productperformance, few suppliers available,maybe critical to our leading edge image

Outsourced Copy Center Leverage Large volume, many competitivesuppliers

Production Equipment Critical Project One time buy with ongoing impact

Telemarketing Center Leverage Large volume, many comparablecompanies

Technical Support Call Center Leverage/strategic Large volume, limited qualified suppliers,may be critical to our firms image and

customer service

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Activity-Based Cost Management

Traditional cost accounting systems are used

for internal reporting costs.

Ideally, cost accounting would like to use

direct costing which determines cost based on

actual expenditures.

Overhead, a pool of indirect costs,

complicates direct costing.

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Traditional Cost Accounting

Traditional cost accounting aggregates all

indirect expenses into a classification called

overhead.

Overhead is then allocated to production

based on some benchmark activity.

Changes to the benchmark activity may

distort true cost performance.

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Traditional Cost Allocation System

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Activity-Based Cost Management

Activity-based accounting provides a more

accurate alternative to traditional cost

accounting.

Activity-based accounting attempts to match

indirect costs with the products or services

that generate them.

Activity-based accounting allocates indirect

costs based on the cost drivers that actually

create them.

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ABC Allocation

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Activity-Based Cost Management

Implementation of an ABC accounting system is

a non-trivial event. Organizations may have to

rethink:

Pricing strategy

Marketing strategy

Manufacturing strategy

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Total Cost of Ownership (TCO)

Total cost of ownership is defined as a

philosophy for understanding all relevant supply

chain related costs of doing business with a

particular supplier for a particular good/service,or the cost of the process, were particular supply

chain design.

Attempts to look at the big picture, consideringcost beyond that of the purchase price.

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Total Cost of Ownership Analysis

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Step 1: Identification of Benefits Sought

The first step in TCO analysis is to determine the benefits soughtfrom the analysis. Reasons to conduct TCO analysis include:

Performance measurement Framework for cost analysis Benchmarking performance

More informed decision making Communication of cost issues internally and with suppliers Encourages cross-functional interaction Support external teams with suppliers Better insight/understanding of cost drivers

Build a business case Support an outsourcing analysis Support continuous improvement Helps identify cost savings opportunities Prioritize/focus your time on high potential opportunities

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Good Candidates for TCO Analysis

Products and services that match the following criteriaare good candidates for TOC Analysis:

The firm spends a relatively large amount of money on the item

The firm purchases the item with some degree of regularity, in order to

provide some historical data, but more importantly, to allow opportunitiesto gather current cost information.

Purchasing believes the item has significant transaction costs associatedwith it that are not currently recognized.

Purchasing believes that one or more of the currently unrecognizedtransaction costs is individually significant.

Purchasing has the opportunity to have an impact on transactions costs,via negotiation, changing suppliers, or improving internal operations.

Those purchasing/using the item will cooperate in data gathering to learnmore about the items cost structure.

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Step 2: Form a TCO Team

Once a project has been identified, a TCO team shouldbe formed. Members should include purchasing, users,and any functional/technical experts.

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Step 3: Identify Cost Drivers

Begin the analysis by expressly identifying

potential costs by mapping the process flow

for all aspects of the project.

From the flowcharts, brainstorm key cost

drivers.

Gather cost data for all identified cost driver

for each alternative.

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Flowchart - Printer Example

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Flowchart - Printer Acquisition Example(2)

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Key Cost Drivers

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Gathering Cost Data

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Step 4: Fine Tune

Step 4 allows for fine tuning of the TCO

analysis including the use of sensitivity

analysis.

Sensitivity analysis allows for testing of what-if

scenarios.

Decisions that do not change based on changes to

assumptions of data are said to be robust. Managers can have more confidence in robust

decisions.

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Step 5: Present

Step 5 requires that the TCO analysis findings

be presented to the appropriate management

level.

Format for presentation should include:

Summary of TCO analysis results

Sensitivities

Non-Cost Issues

Recommendation

Presentation should also include soft costs

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A Return to the Opening Story

Based on what you have now read anddiscussed:

1. Why the companies engage in across-the-

board demands for cost-cutting rather thanusing a strategic cost management approach?

2. What is a good way to identify promising

initial project for strategic cost management?3. How do problems with current managementaccounting systems complicate the strategiccost management process?

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A Return to the Opening Story

4. How can a company reduce costs without

compromising quality or service?

5. Who needs to participate in strategic cost

management?

6. What tools can help the firm understand the

broad cost implications of its decisions?