CMA Final · Strategic Cost Management

Introduction to Strategic Cost Management: formula sheet

Full chapter guide

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.