Description
Total cost management (TCM) is the name given by AACE International to a process for applying the skills and knowledge of cost engineering. It is also the first integrated process or methodology for portfolio, program and project management.
Total Cost Management for Competitiveness
In the 70s, an American automobile manufacturer took a group of Japanese industrialists around his automated warehouse, of which he was very proud. When he wanted to know what they thought about it, the reaction was “Why do you store what you cannot sell?” During the same time, in Japan, a supplier’s truck was halted at the gates of Toyota for no other reason but that they were earlier than their delivery schedule, which was against the concept of ‘Just in Time’. This is just a glimpse of the impending competition that was waiting to happen. Today, with global competition on the one hand, and highly demanding customers and dwindling life cycles of products on the other, organisations are finding themselves in the midst of a revolutionary transformation. “Market determines the price, Cost determines the profitability” In this market-oriented economy, organisations are striving to offer customers maximum value at minimum possible price. Since they have more control over cost than price, the obvious option is to turn towards cost management to address the seemingly paradoxical situation of offering more value at lesser price and still maintain profitability. This call on cost management required an integrated approach, involving both strategic and operational areas, a system that pervaded through the organisation, horizontally as well as vertically. Total Cost Management (TCM) rose to this call. What is TCM? Total Cost Management is a company-wide systematic and structured approach, which provides a holistic framework to control, reduce and eliminate costs, throughout the value chain. This process of managing the financial outcome of activities encompasses all operations, internal and external. For these reasons, TCM is one of the most powerful tools that corporations can wield in their quest for competitive advantage. Issues addressed by TCM Does your existing system provide reliable information to answer the following — • Which are your profitable customer segments? • What are your product costs and their profitability? • How well informed are your sourcing decisions? • Do your cost go up despite cost cutting efforts? • Can you reduce your price and yet increase customer value? If not, turn to TCM. “If you cannot measure it, you cannot manage it” With the environment becoming more competitive, inefficiency of one is becoming an opportunity for the other. Most of this inefficiency is in terms of the
November 2002
Communique
A Journal of the Confederation of Indian Industry
11
non-value–adding activity present in the system. To identify and gauge the progress and to eliminate the inefficiency, measurement is the key. In measurements, it is better to be approximately right, than to be precisely wrong. This calls for a structural change in the measurement systems for undistorted reliable information. Activity based costing evolved to serve this need. Some Tools and Techniques of TCM
These activities consume resources in terms of men, machines, materials, methods and means. Activity Based Costing (ABC) is a method of measuring the performance of the activities, according to their consumption of the resources, in terms of cost and apportions these to the products. This brings about changes in costing systems enabling organisation to allocate overheads to products, more accurately. This change in the system is so dynamic, that product profitability and profitability of a segment of customer or customer becomes feasible.
Activity based costing is a method that measures cost of a product/ service, based on the activities performed to produce the product/service. The underlying assumption is that activities drive the cost, which are driven by the product or customer. This radically differs from the conventional costing systems, which is built on the assumption that product drives the cost directly. Product Profitability Professor Robert Kaplan, international guru in TCM, surveying a list of American companies using Activity Based
Traditional product costing simplistically allocates costs. ABC traces costs based on cause and effect.
Traditional Product Costing Costs Activity-Based Costing Costs Consumed By Activities Consumed By Products
• Activity based costing • Activity based management • Target costing • Supply chain management • Strategic cost management The areas of focus for cost reduction also include: • Finance management • Chemical / material cost reduction • Energy cost management • Process improvement • Inventory management Activity Based Costing For an organisation to create, produce, sell or deliver, it needs to perform a list of activities.
Consumed By Products
12
November 2002
Communique
A Journal of the Confederation of Indian Industry
Planned sales price (Rs 400000)
Less
Target profit (Rs 80000)
Equals
Allowable cost (Rs 320000)
Current cost (Rs 350000)
Value Engineering / supplier integration
Planned sales price (Rs 400000)
Costing came out with the following inferences. Typically in a multi product organisation, of the their total profit of Rs 100 lakhs contributed by all the products (say 10 products), typically 50% (5) of the products contribute 250% (Rs 250 lakhs) of profit and the other 50% (5) of the products make Rs 150 lakhs of loss, thus reducing the overall profit to Rs 100 lakhs. The graph is popularly known as the whale curve and is equally applicable to customer profitability too. Based on the above approach, one major way of improving profitability is to get rid of the loss making products or reduce the losses in unprofitable products. The above concept looks obvious!! In reality, most of the companies with multiple products may not be aware, which products make profits and which ones make loss. Even if they claim that they know, the information based on traditional costing might be inaccurate leading to erroneous decisions. One might land up in promoting the loss making products. With
Activity Based Costing the cross subsidisation of products can be assessed more accurately, enabling the right decisions. Activity based management Using ABC to improve a business is called activity-based management (ABM). It draws on ABC as a major source of information. ABM is a management analysis tool that brings the full benefits of ABC to the organisation. This is a discipline that focuses on the management of activities as the route to continuously improving value received by the customers and the profit achieved by providing this value. Control tomorrow’s cost thorough today’s design Target costing is a structured approach to determine the life cycle cost at which the proposed product with specified functionality and quality must be produced to generate the desired level of profitability when sold at its anticipated selling price. It starts with understanding what price the customer will pay and
sets target costs based on this price. This is based on the premise that 90% of the cost of the product is embedded at the design stage itself. Conclusion Cost leadership is definitely a competitive advantage. Organisations focussing on differentiating their product for competitive advantage cannot ignore this either. Cost advantage is becoming an integral part of any corporate strategy and is an essential tool to improve the competitive edge. The tools and techniques of Total Cost Management work towards this objective. These will also provide the organisation with the conceptual framework for effective management of its costs. From our implementation experience, we have often found corporates adopting TCM gain about 5 to 10% in their cost saving or improvement of profitability by 5 to 10%.
CII – Total Cost Management Cell [email protected]
November 2002
Communique
A Journal of the Confederation of Indian Industry
13
doc_231974310.pdf
Total cost management (TCM) is the name given by AACE International to a process for applying the skills and knowledge of cost engineering. It is also the first integrated process or methodology for portfolio, program and project management.
Total Cost Management for Competitiveness
In the 70s, an American automobile manufacturer took a group of Japanese industrialists around his automated warehouse, of which he was very proud. When he wanted to know what they thought about it, the reaction was “Why do you store what you cannot sell?” During the same time, in Japan, a supplier’s truck was halted at the gates of Toyota for no other reason but that they were earlier than their delivery schedule, which was against the concept of ‘Just in Time’. This is just a glimpse of the impending competition that was waiting to happen. Today, with global competition on the one hand, and highly demanding customers and dwindling life cycles of products on the other, organisations are finding themselves in the midst of a revolutionary transformation. “Market determines the price, Cost determines the profitability” In this market-oriented economy, organisations are striving to offer customers maximum value at minimum possible price. Since they have more control over cost than price, the obvious option is to turn towards cost management to address the seemingly paradoxical situation of offering more value at lesser price and still maintain profitability. This call on cost management required an integrated approach, involving both strategic and operational areas, a system that pervaded through the organisation, horizontally as well as vertically. Total Cost Management (TCM) rose to this call. What is TCM? Total Cost Management is a company-wide systematic and structured approach, which provides a holistic framework to control, reduce and eliminate costs, throughout the value chain. This process of managing the financial outcome of activities encompasses all operations, internal and external. For these reasons, TCM is one of the most powerful tools that corporations can wield in their quest for competitive advantage. Issues addressed by TCM Does your existing system provide reliable information to answer the following — • Which are your profitable customer segments? • What are your product costs and their profitability? • How well informed are your sourcing decisions? • Do your cost go up despite cost cutting efforts? • Can you reduce your price and yet increase customer value? If not, turn to TCM. “If you cannot measure it, you cannot manage it” With the environment becoming more competitive, inefficiency of one is becoming an opportunity for the other. Most of this inefficiency is in terms of the
November 2002
Communique
A Journal of the Confederation of Indian Industry
11
non-value–adding activity present in the system. To identify and gauge the progress and to eliminate the inefficiency, measurement is the key. In measurements, it is better to be approximately right, than to be precisely wrong. This calls for a structural change in the measurement systems for undistorted reliable information. Activity based costing evolved to serve this need. Some Tools and Techniques of TCM
These activities consume resources in terms of men, machines, materials, methods and means. Activity Based Costing (ABC) is a method of measuring the performance of the activities, according to their consumption of the resources, in terms of cost and apportions these to the products. This brings about changes in costing systems enabling organisation to allocate overheads to products, more accurately. This change in the system is so dynamic, that product profitability and profitability of a segment of customer or customer becomes feasible.
Activity based costing is a method that measures cost of a product/ service, based on the activities performed to produce the product/service. The underlying assumption is that activities drive the cost, which are driven by the product or customer. This radically differs from the conventional costing systems, which is built on the assumption that product drives the cost directly. Product Profitability Professor Robert Kaplan, international guru in TCM, surveying a list of American companies using Activity Based
Traditional product costing simplistically allocates costs. ABC traces costs based on cause and effect.
Traditional Product Costing Costs Activity-Based Costing Costs Consumed By Activities Consumed By Products
• Activity based costing • Activity based management • Target costing • Supply chain management • Strategic cost management The areas of focus for cost reduction also include: • Finance management • Chemical / material cost reduction • Energy cost management • Process improvement • Inventory management Activity Based Costing For an organisation to create, produce, sell or deliver, it needs to perform a list of activities.
Consumed By Products
12
November 2002
Communique
A Journal of the Confederation of Indian Industry
Planned sales price (Rs 400000)
Less
Target profit (Rs 80000)
Equals
Allowable cost (Rs 320000)
Current cost (Rs 350000)
Value Engineering / supplier integration
Planned sales price (Rs 400000)
Costing came out with the following inferences. Typically in a multi product organisation, of the their total profit of Rs 100 lakhs contributed by all the products (say 10 products), typically 50% (5) of the products contribute 250% (Rs 250 lakhs) of profit and the other 50% (5) of the products make Rs 150 lakhs of loss, thus reducing the overall profit to Rs 100 lakhs. The graph is popularly known as the whale curve and is equally applicable to customer profitability too. Based on the above approach, one major way of improving profitability is to get rid of the loss making products or reduce the losses in unprofitable products. The above concept looks obvious!! In reality, most of the companies with multiple products may not be aware, which products make profits and which ones make loss. Even if they claim that they know, the information based on traditional costing might be inaccurate leading to erroneous decisions. One might land up in promoting the loss making products. With
Activity Based Costing the cross subsidisation of products can be assessed more accurately, enabling the right decisions. Activity based management Using ABC to improve a business is called activity-based management (ABM). It draws on ABC as a major source of information. ABM is a management analysis tool that brings the full benefits of ABC to the organisation. This is a discipline that focuses on the management of activities as the route to continuously improving value received by the customers and the profit achieved by providing this value. Control tomorrow’s cost thorough today’s design Target costing is a structured approach to determine the life cycle cost at which the proposed product with specified functionality and quality must be produced to generate the desired level of profitability when sold at its anticipated selling price. It starts with understanding what price the customer will pay and
sets target costs based on this price. This is based on the premise that 90% of the cost of the product is embedded at the design stage itself. Conclusion Cost leadership is definitely a competitive advantage. Organisations focussing on differentiating their product for competitive advantage cannot ignore this either. Cost advantage is becoming an integral part of any corporate strategy and is an essential tool to improve the competitive edge. The tools and techniques of Total Cost Management work towards this objective. These will also provide the organisation with the conceptual framework for effective management of its costs. From our implementation experience, we have often found corporates adopting TCM gain about 5 to 10% in their cost saving or improvement of profitability by 5 to 10%.
CII – Total Cost Management Cell [email protected]
November 2002
Communique
A Journal of the Confederation of Indian Industry
13
doc_231974310.pdf