Strategic cost28th February 2021
Strategic Cost Analysis is a comparison of one entity’s cost position to another. Cost analysis compares everything from the price paid for raw materials right to the price customers pay for the finished product. The goal of the analysis is to determine whether or not one company’s costs are competitive with another’s.
No company can totally avoid the impact of increasing costs. And most managers have learned to adjust to the effect inflation has on current operating costs. But few have factored it into their competitive strategies. And most managers, particularly those in capital-intensive industries, have not paid enough attention to the way increasing capital requirements affect their ability to compete in the long run.
Strategic cost management is the process of reducing total costs while improving the strategic position of a business. This goal can be accomplished by having a thorough understanding of which costs support a company’s strategic position and which costs either weaken it or have no impact. Subsequent cost reduction initiatives should focus on those costs in the second category. Conversely, it may be useful to increase costs that support the strategic position of the business.
There are the following steps required in strategic cost analysis:
- Identify the appropriate value chain and assign costs and assets to it.
- Diagnose the costs drivers of each value activity and how they interact.
- Identify competitor value chains, and determine the relative cost of competitors and the sources of cost differences.
- Develop a strategy to lower relative cost position through controlling cost drivers or reconfiguring the value chain and/or downstream value.
- Ensure that cost reduction efforts do not erode differentiation, or make a conscious choice to do so.
- Test the cost reduction strategy for sustainability.
Strategic Cost Analysis helps companies identify, analyse, and use strategically important resources for continuing success and growth of the business.
This type of analysis may be used to review the overall direction of the company as the result of a merger, acquisition or take-over. It may be part of a strategic planning exercise or may simply be necessary as a major investment or divestment decision is to be made. It can also be used to provide consistent information for cost/benefit evaluations.
Activity-based Costing (ABC) can be used to provide the cost data required to focus attention on those factors that determine the expenditure on key projects or activities. It can help in the cost/benefit analysis of individual projects and hence assist the prioritisation of alternative projects, managing resources to maximise the return on investment in line with the strategic direction of the institution.
It can be used to determine when costs should be incurred (such as, when to diversify and move into a new business area). This will enable management to manage costs on the basis of spending (the investment in a new market or business activity) not consumption (the operation of the business).
An organisation creates a competitive advantage through the use of resources to provide products and services which meet customer needs. The resources consumed to create these attributes are not free, and the effective use of the resources is critical in any competitive environment. The value of a cost management system comes from the way management uses it to support decision making, including decisions about long-term strategy.