The Value Chain

• Research & Development
• Design
• Production and Purchasing
• Marketing
• Distribution
• Customer Service

Industrial value chain

• Linked set of value-creating activities from basic raw materials to the disposal of the finished product
• costs are interrelated with suppliers and other external entities

Value-chain framework linkages

• internal linkages: relationships among activities that are performed within a firm’s portion of the value chain.
• external linkages: value-chain activities that are performed with its suppliers and customers
  • Supplier linkages
  • Customer linkages

Responsibility Accounting

Types of Responsibility Centers

• Cost Center: only responsible for costs
• Revenue Center: only responsible for revenues
• Profit Center: responsible for both revenues and costs
• Investment Center: responsible for revenues, costs and investments

Measuring the Performance of Investment Centers

Return on investment (ROI) - the most common measure of performance for an investment center.

ROI

• Operating income/Average Operating Assets
• Operating income/sales x sales/average operating assets
• Operating income margin x Operating Asset Turnover

Margin: portion of sales available for interest, taxes and profit = Operating Income/Sales

Turnover: how productively assets are being used to generate sales = Sales/Average Operating Assets

Advantages of the ROI Measure

• helps managers focus on the relationship between sales, expenses and investment
• encourages cost efficiency
• discourages excessive investment in operating assets

Disadvantages of the ROI measure

• discourages managers from investing in projects decreasing divisional ROI but increasing profitability of the company overall
• encourages managers to focus on the short-term at the expense of the long-term

Residual income - the difference between operating income and the minimum dollar return required on a company’s operating assets.

Residual income = Operating Income - minimum return on operating assets

Transfer Pricing

Transfer prices are the prices charged for goods produced by one division and transferred to another.

The price charged affects the revenues of the transferring division and the costs of the receiving division.

A transfer pricing system should satisfy three objectives:

• Accurate performance evaluation
• Goal congruence
• Preservation on divisional autonomy

Commonly used policies

• Market price - Price in an outside, perfectly competitive, market
• Negotiated transfer prices - Agreed to only if the opportunity cost of the selling division is less than the opportunity cost of the buying division
• Cost-based transfer prices
  • Variable cost
  • Full (absorption cost)

IRS Code §482

• Requires arms’-length transactions
• Allowable pricing methods
  • Comparable uncontrolled price method
  • Resale price method
  • Cost-plus method
  • Negotiated between the company and the IRS

Strategic Cost Management: Basic Concepts

Three general strategies have been identified:

• Cost leadership - To provide the same or better value to customers at a lower cost than offered by competitors.
• Product differentiation - Strives to increase customer value by increasing what the customer receives (customer realization).
• Focusing - A firm selects or emphasizes a market or customer segment in which to compete.

Process Value Analysis

• Driver Analysis is the effort expended to identify the factors that are the root causes of activity costs
• Activity Analysis in the process of identifying, describing and evaluating the activities an organization performs.

• Activity Analysis should produce four outcomes

  • what activities are performed
  • how many people perform the activities
  • the time and resources required to perform the activities
  • assessment of the value of the activities to the organization

• Value Added Activities

  • necessary to remain in business
  • by mandate (sec reporting requirements, e.g.)
  • may contain nonessential actions that create unnecessary cost
• Non-Value-Added Activities
  • All activities other than those essential to remain in business

Financial Measures of Activity Efficiency

• Benchmarking - uses best practices as the standard for evaluating activity performance
• Internal Benchmarking - against the best internal performance
• External Benchmarking - comparison with others outside the organization

The relationship of Activity-Based Costing and Activity -Based Management

Activity-based management (ABM) is a:

• Systemwide, integrated approach
• Focuses management’s attention on activities with the objectives of improving
  • Customer value
  • The profit achieved by providing this value

ABC is the major source of information for activity-based management.

Steps in ABM

• define focal department/process and accumulate costs
• determine process the focal department performs
• identify inputs that trigger the process or its costs
• define outputs that result from the process
• define activities involved with each process
• identify resources required to support the process
• develop output measures and cost expectations
• measure performance
• brainstorm improvements

Why ABM implementations fail

• lack of support from higher-level management
• failure to maintain support from higher-level management
• resistance to change