TOPIC-

INTRODUCTION of STRATEGIC COST MANAGEMENT

Traditional Cost Management System and its limitations;

1. Traditional Cost Management System largely focuses on cost control and cost reduction and also
involves allocation of costs and overheads to the production.
2. It involves comparing actual results with the standard expectations or we can say comparing
budgeted or standard costs and analyzing the differences.
3. A corrective action would be taken to ensure future outcomes are within the budgeted outcomes.
Limitations of Traditional Cost Management:

1. Excessive focus on cost control and reduction.

2. Short term outlook, for example – saving costs on an annual basis.
3. Reactive Approach.
4. Ignores the competition.
5. Ignores the market growth and customer requirements.
6. Less focus on analyzing and improvisation.
7. Traditional cost accounting relies on accounting data which can be misleading at times. It ignores
the dynamics of Marketing and Economics.
8. An extensive cost reduction could lead to inferior quality of products or services which might turn
back customers resulting in lower sales and profitability.

In the global business environment, it is not sufficient to control costs or reduction and thus, a business
must focus to manage cost as per business strategies. A strategy is a set of actions taken by managers of a
company to increase the company’s performance.

The businesses today operate in an environment with stiff competition, increasing consumer demands for
quality products and technology revolution. The ultimate objective of a business is to earn better profits and
create value for shareholders. This can be achieved by unique and high level performance as compared to the
competitors which results in different competitive advantages.
Strategic Cost Management System

Strategic cost management is a philosophy, an attitude, and a set of techniques to contribute in shaping the
future of the company!!

For example, company incurs extra costs to keep the obstructive production running for 24 hours on daily
basis.

What is Strategic Cost Management?

1. Strategic Cost Management (SCM) is the cost management technique that aims at reducing costs
while strengthening the position of the business.
2. It is a process of combining the decision-making structure with the cost information, in order to
strengthen the business strategy as a whole.
3. It measures and manages costs to align the same with the company’s business strategy.
4. Strategic cost management is the application of cost management techniques so that they improve
the strategic position (A firm’s decisions on how to serve customers and compete against rivals is
called strategic positioning) of a business along with controlling costs.
5. It is not limited to controlling costs but using cost information for management decision making.
6. The basic aim of Strategic Cost Management is to help the organization to achieve the sustainable
competitive advantage through product differentiation and cost leadership.

Sustainable competitive advantages are company assets, or abilities that are difficult to
duplicate or exceed; and provide a superior or favorable long term position over competitors.
It lays a greater focus on continuous improvement to deliver superior quality product to the customers..
For Example; 1.

The following is hypothetical information of a company producing products A & B. If the company stops
producing product B, the sale of A would fall down by 20%. Rs. lacs

Particulars A B
Revenue 80 45
Cost of Sales 45 35
Gross Profit 35 10
Overheads 5 12
Net Profit 30 -2

Analysis and the Conclusion

Under traditional cost management technique, the company might decide to stop production of B because
it has a very overhead cost and also results in a loss of Rs. 2 lacs. Hence they will close down the
production of B.

However, with additional information that sale of product A would fall down by 20% if B is sold then the
decision might change. The company would lose Rs. 6 lacs (20% of 30 lacs) because of reduced sales of A.
The net loss for the company if it decides to stop production of B is Rs.4 lacs (2 lacs of savings from B and 6
lacs of loss of profits from A). Hence the decision to stop of production B is not prudent.

For example: 2.

On a regular basis a manufacturing company, following the traditional approach, does not carry out
preventive maintenance of its machineries to save costs. Repair of machinery is carried out as and when the
machinery breaks down. Under this traditional approach focus is on cost reduction and cost saving. This is
a short- term approach to manage costs.

When machinery breaks down, the company loses more in terms of loss of production time and idle labour
time. Lack of regular preventive maintenance and planned shutdown time also reduces the life of the
machinery and has a long term impact. If the loss of production is remarkable or noteable then the
company might its lose market share to its competitors. Hence, it is important to look at cost management
with a strategic focus.
Let’s understand with one more Example; 3.

A telecom company closed down some of its customer service centres as a cost cutting measure. This led to
overcrowding of customers at other centres and longer waiting time for the customers. The volume of work
at other centres increased and it also impact the performance of employees. Due to this company’s decision
both the customers and employees, two of the key stakeholders, were not happy. This type of business
decision can impact the goodwill and brand image of the company and impact the sales and profitability
in the longer run.

Now let’s end it with comparing the two Cost Management Systems –

Traditional Cost vs. Strategic Cost Management

Traditional Cost
Strategic Cost Management
Management
Short term concept Long term concept
Focus Internally. Focus both internal and external.
Each value activity has a separate cost driver. So, not
Based on volume of the product. based on volume but on activities associated with the
manufacturing of the product.
Objective is COST CONTROL &
Its objective is cost leadership or product differentiation to
COST REDUCTION and
achieve SUSTAINABLE COMPETATIVE ADVANTAGE
VARIANCE REPORTING
Primary objective is cost control plus cost reduction and
Primary objective is cost reduction.
value improvement at the same time.
Increase cash flow for working
Increase cash flow for investment opportunities.
capital
Risk taking approach and ability to adapt itself with
Risk-averse approach
changing environment.