CMA Final · Strategic Cost Management
Introduction to Strategic Cost Management: formula sheet
Key formulas
- Three stages of the process
- Strategic planning → Strategy formulation → Strategy implementation (with control and feedback)
- Write the stages in this order. Add a feedback arrow back to planning.
- Target cost (strategic link)
- Target cost = Target selling price − Target profit
- Shows how market price and required return drive the cost the firm may incur.
- Cost variance for control
- Variance = Actual cost − Standard (or budgeted) cost
- Adverse if actual cost exceeds standard for a cost item. Used in the implementation and control stage.
- Generic strategies
- Cost leadership | Differentiation | Focus
- Each needs different cost information: lowest cost, cost of added features, cost of serving a niche.
- Target cost
- Target cost = Target selling price − Target profit
- Price is fixed by the market. Cost is the variable you must manage.
- Cost reduction gap
- Cost gap = Current estimated cost − Target cost
- A positive gap means the product is not yet viable. Close it through design changes.
- Target profit from margin
- Target profit = Target selling price × Required margin %
- Use this when profit is given as a percentage of selling price, not of cost.
- Kaizen cost reduction
- Kaizen target cost = Previous period cost × (1 − Reduction %)
- Applied each period on the previous period's actual cost.
- Life cycle cost
- Life cycle cost = Pre-production cost + Production cost + Post-production cost (distribution, service, disposal)
- Add all costs over the life, not only manufacturing cost.
- Margin in the value chain
- Margin = Total value to customer − Total cost of value activities
- Value is usually measured by the price customers are willing to pay. Advantage comes from widening this margin.
- Differentiation test
- Differentiation pays if Price premium > Extra cost of differentiating
- Compare per unit, and include extra marketing and service cost.
- Cost leadership test
- Cost advantage = Rival's unit cost − Own unit cost (at comparable quality)
- Advantage is real only if quality and features are comparable.
- Primary activities
- Inbound logistics → Operations → Outbound logistics → Marketing and sales → Service
- Remember them in flow order.
- Support activities
- Firm infrastructure, HR management, Technology development, Procurement
- They support all primary activities.
- Cost driver classes
- Structural: scale, scope, experience, technology, complexity. Executional: workforce involvement, TQM, capacity utilisation, plant layout, product configuration, linkages
- Structural are strategic and long-term. Executional are operational and ongoing.
- Generic strategic positions
- Cost leadership | Differentiation | Focus
- Focus can be cost focus or differentiation focus. State which one in your answer.
- Structural cost drivers
- Scale, Scope, Experience, Technology, Complexity
- Long-term, strategic choices made before operations. Hard to reverse.
- Executional cost drivers
- Workforce commitment, Quality management, Capacity utilisation, Plant layout, Product design, Supplier and customer linkages
- Operational capabilities used to run the chosen structure. Judge them by how well the firm performs them.
- Differentiation test
- Price premium earned > Extra cost of differentiation
- Differentiation adds value only if this holds, ideally after considering volume effects.
- Cost leadership test
- Firm's unit cost < Competitors' unit cost at comparable acceptable quality
- A low price without a low cost only reduces margin.
Quick revision
- SCM uses cost information to support strategy and competitive advantage, not only to control cost.
- Traditional costing is mostly internal and short-term; SCM looks at the external environment, competitors and the long term.
- Strategic management process: set direction, analyse, formulate strategy, implement, review and control.
- Two broad generic strategies: cost leadership and differentiation.
- Value chain splits a firm's activities into primary and support activities.
- Value chain analysis finds where value is created and where cost can be cut or differentiation built.
- Linkages between activities, inside and across the firm, can cut cost or add value.
- Cost drivers are the factors that cause costs to change.
- Structural cost drivers relate to long-term strategic choices such as scale and technology; executional ones relate to how well operations run.
- Strategic positioning is choosing how the firm competes and aligning its cost structure to that choice.
- In application answers, always link the tool to the firm's strategy and end with a clear recommendation.
Common mistakes
- Saying SCM is just cost reduction. Fix: State that SCM aligns costs with strategy. A differentiator may rightly spend more on quality or service.
- Treating SCM as a replacement for costing systems. Fix: Say SCM builds on and uses cost data, with a wider and more forward-looking purpose.
- Treating strategy formulation and implementation as the same thing. Fix: Formulation is choosing the strategy. Implementation is putting it into action through budgets, structure and control.
- Describing cost management only as cost reduction. Fix: Say it also covers cost analysis, cost avoidance, cost-based positioning and supporting decisions on price, mix and investment.
- Treating target costing and Kaizen costing as the same thing. Fix: Remember the stage and starting point. Target costing is at design and begins from market price. Kaizen is in production and begins from current cost with small, continuous cuts.
- Calculating target cost as cost plus profit. Fix: Always start from selling price and deduct profit. The formula is price − profit = target cost.
- Treating the value chain as a list of departments or cost centres. Fix: Define activities by what creates value, not by department. One activity may cut across departments.
- Mixing up structural and executional drivers, for example calling capacity utilisation structural. Fix: Structural means a long-term choice of scale, scope, experience, technology or complexity. Utilisation, TQM and workforce involvement are executional.
- Treating volume as the only cost driver. Fix: In strategic analysis, name structural and executional drivers, and state that costs are shaped by long-term choices and operating capability, not volume alone.
- Mixing up structural and executional drivers. Fix: Remember the test: structural is a strategic choice made beforehand and is hard to reverse. Executional is how well the firm performs given that choice.
Exam tips
- For 'distinguish' questions, always present a comparison with at least five bases.
- Use the words strategy, value chain, cost drivers and competitive advantage in every answer. They signal the right framework.
- In a case MCQ, first identify the strategy. Most options can be eliminated once you know it.
- Do not write that SCM ignores traditional costing. It uses cost data as an input.
- Add one short Indian example where possible. It turns a recall answer into an application answer.
- In theory questions, structure the answer by the three stages and add one cost tool per stage. Examiners reward structure.
- In case-based MCQs, first decide which stage the facts describe. The wrong options often belong to another stage.
- Always use names, figures and context from the case. Generic answers lose marks in application questions.