Title III: Modern Business Practices

Strategic Cost Management

• Application of Management techniques to achieve cost leadership, improving the firm’s strategic
positioning. It involves the recognition and management of important cost relationships along
the value chain.
Product Lifecycle Costing or Super Absorption Costing
Under this cost regime, production cost is not determined in the short-term sense of the production of
one unit. A company takes a longer view to the cost of production and attempts to allocate all the
available resources along a product’s life cycle or value-chain (from R&D to Customer Support, and
everything in between)
• Super Absorption is done to attribute a product’s performance over its life cycle since:
o Capital Investments were placed into its inception
o Returns need to be monitored
• Hence, product life-cycle costs are used for Capital Budgeting, Customer and Product Evaluation,
and Strategic Variance Analysis.
The Value-chain (by Michael Porter) begins with Upstream Costs, then follows Manufacturing Costs,
and finally Downstream Costs (Both Upstream and Downstream Costs are conceptually expensed under
GAAP. For Internal Reporting, these will be costs that have to be recovered.)
• Upstream Costs – Before Production – Research and Development, Design
• Downstream Costs – After Production – Selling, Advertising, Servicing and Warranties
Firm Infrastructure (Administration & Governance)
Human Resource Management
Support

Technology, Research and Development

Margin
Procurement
Post-
Inbound Outbound Sales and
Primary

Operations Sales or
Logistics Logistics Marketing
Servicing
Stages in the Product Lifecycle
• Introduction Stage – Slow sales growth, lack of profits (high R&D, High Advertising)
• Growth Stage – High Production Volume and High Demand, fixed costs are absorbed
• Maturity Stage – Sales growth declines, new competitors enter the market
• Decline Stage – Price Cutting, narrowing product line, reduction in promotion budgets\
High Investment Cost Improving Product Cost Production Costs are Cost Inefficiency
Introduction

Growth

Decline
Maturity

Budding Competition minimized Competition is Very

High Operations Cost
Premium Pricing and Capacity is Maximized Strong
Low Competition
Bundling are common Variable Cost-based Significant Disruption
Inelastic Price pricing is common Elastic Price
Strong Competion

During the Decline Phase, a company may choose

to:
• Restart the Life Cycle and remarket the good
• Harvest the Product line and Close-out prices
• Discontinue the product naturally and Divest
Total Quality Management
• Aims to improve Product Quality by Reducing and eliminating errors, streamlining activities, and
continuously improving productions. The Cost of Quality is Emphasized in this system.
• Cost of Quality – based on the philosophy that failures have an underlying cause, prevention is
cheaper than failures, and cost of quality performance can be measured. (Includes good and
bad quality costs)
• Quality of Design – A fairly accurate impression
of what the customer requires of the supplier
• Elements:

Participative Management – a deemphasis of top-down

management
Continuous Improvement/Kaizen
Teamwork
Emphasizing Delivering Value to Customers
Reducing Waste and Defects

Prevention Cost Appraisal Cost Internal Failure Cost External Failure Cost
Quality Engineering Testing and Inspection of Scrap Cost of Field Servicing
incoming materials
Quality Training Testing and Inspection of Spoilage Handling Complaints
in-process goods
Quality Circles Final Product Testing and Rework Product Recalls
Inspection
Statistical Process Supervision of Testing and Rework Labor and Warranties Expense
Control Inspection Activities Overhead
Supervision of Depreciation of Test Retesting Reworked Lost Sales from
Prevention Activities Equipment Products reputation and quality
Quality Data Maintenance of Test Reinspection of Reworked Non-value adding
Gathering, Analysis, Equipment Products Activities/Wastage
and Reporting (Not necessarily Failure Cost)

Quality Improvement Plant Utilities in the Disposal of Defective • Transport

Projects Inspection Area Goods • Inventory
Technical Support Field Testing and Appraisal Downtime caused by • Operator Motion
provided to Suppliers at the Customer Site Quality Problems • Idle time
Audits on effectiveness Analysis of cause of
• Overproduction
of Quality System Quality Problems
Reentering Data because • Overprocessing
of Keying Errors • Defects
Debugging Software Errors

Six-Sigma Quality
A statistical measure expressing how close a
product approaches its quality goal. One-sigma
means that 68% of products are acceptable; three-
sigma means 99.7%; Six-sigma is 99.999977%
perfect. In other words, 3.4 defects per 1 million
parts of products (Sigma denotes the standard
deviation from the mean in a normally distributed
population)

• In other words, it is a statistical measure of how a production process consistently achieves

quality standards in terms of its products (There are deviations in production that impair the
goods or even render them useless, requiring product recalls.)
Kaizen Costing
The Japanese term for Improvement; it is used to mean continuous improvement (slow, but constant)
incremental improvements made in all areas of business operations “Always looking to improve”
• For ABC Systems – improve quality and or reduce the cost of business processes
• For Target Costing – Determining IDEAL STANDARD COSTS, and how to achieve standard costs by
developing new manufacturing methods and techniques
• For Budgeting – Developing budgets on kaizen principles will result in decreasing costs of
production over the budget period
A company following the Kaizen Philosophy will typically have an actual income statement as shown:
Year 1 Year 2 Year 3 Standards
Sales P7M P7.1M P7.15M P9M
Cost of Sales (2.20M) (2.15 M) (2.00 M) (1.5M)
Gross Profit 4.30M 4.95 M 5.15 M 7.5M
R&D (1 M) (1.10 M) (1.20 M) (2.2M)
Selling Costs (0.5 M) (0.49 M) (0.48 M) (0.35M)
Admin Costs (0.22 M) (0.21 M) (0.20 M) (0.15M)
Net Income P2.58 M P2.15 M P3.27 P4.8M
Small Incremental changes can be observed in the amounts. It can be expected as well that the standards
encompassing all the years (throughout Years 1 to 3) that the Standards are so Ideal, and the variances
very significant.
A Kaizen Philosophy will also emphasize continuous learning and research in order to drive innovation
within the firm. What ultimately matters in the Kaizen Philosophy is that there is incremental progress
toward a goal, not necessarily the variances that would normally alert management to an issue.
Supply Chain and Operations Management
• Supply Chain Management is the management of the flow of goods, services, and information
that includes all processes that transform resources into outputs. It involves the active
streamlining of a business’ supply-side activities to maximize customer value and gain a
competitive advantage in the marketplace
Business Process Outsourcing and Shared Services
• Business Process Outsourcing (BPO) – the delegation of IT-intensive business processes to an
external provider that, in turn, owns, administrates, and manages the selected processes based
on defined and measurable performance metrics.
• Shared Service Centers – the creation of an autonomous business unit, based on-site, which
carries out these processes for multiple functions within an organization
• Global Business Services – an evolved form of shared services which incorporates international
considerations in cost centralization
• Offshoring – transferring activities or ownership of an end-to-end business process to a different
country from the countries where the company receiving the services is located; in other words,
it is a captive service center located abroad.
Regardless of the location, all the above have the same goal, which is to reduce cost and exploit
economies of scale and labor arbitrage in the Firm’s Support Activities in the Value-chain without
obsolescence risk. All of which have a varying degree (limitation) of Information Sharing, Reporting,
Employee Morale, and Performance Monitoring (thru Service Level Agreements or SLAs)
Enterprise Resource Planning
• ERPs are software enablers that organizations use to manage business operations such as
accounting, procurement, project management, risk management, compliance, and supply-chain
operations.
• These include all the transaction cycles that are compiled into a suite of modules designed to be
centralize business capabilities
• These are ideally comprised of different user-interfaces (or different users around the
organization), a centralized database or a data warehouse, a query engine (to retrieve data and
gather insights therefrom), and their corresponding internal controls.
Materials Resource Planning
• Materials Requirements Planning – a system for calculating the materials and components needed
to manufacture a product. It consists of the following steps:
o Take note of Inventory on Hand or Stock
o Identify how much more is needed (or how much need to be sold first)
o Schedule the production or purchase of the goods
• It considers complex scheduling algorithms based on codependent business modules (i.e.,
business operations that cannot be done without accomplishing the prerequisite first) to produce
a comprehensive production or procurement plan.
• Business Modules may either be Independent Demand or Dependent Demand
o Dependent Demand are the requirements internal to production, these are ingredients
so to speak; or in accounting parlance: Direct Materials, and WIP
o Independent Demands are the outputs available to be sold out, menu items so to speak;
or in accounting parlance: Finished Goods or Ending Inventory
• Cost-Push System – A department pushes the cost onto another without any regard for demand,
increasing unliquidated inventories.
• MRP is a Push System or a Make-to-Stock end-to-end process
Just-in-Time Production System (JIT)
• Aims to reduce carrying costs by eliminating inventories and increasing delivers made by
suppliers. Shipments of raw materials are received JUST IN TIME to be incorporated in the
manufacturing process. It stresses primarily Preventive Controls over Inventory Quality; so that
the responsibility for quality is shouldered by the Supplier instead of the firm (Suppliers are
chosen very carefully)
• Purchase just at the right time & quantity to fill-in customer orders, minimizing inventories
• A JIT Production Environment adopts specific plant layouts informed by Industrial Engineering to
streamline productions. Arranged by manufacturing cells instead of functional departments.
• Demand-Pull JIT System – There is no production without demand (Customer order)
• It is used in tandem with the Economic Order Quantity Model, and the Reorder Point Model
• JIT is a Pull System based on system-built triggers
• JIT also incorporates Kanban Systems which emphasize process transparency and goals
monitoring for production environments
• Scrum is an Agile Project Management Methodology that seeks to approach tasks in solution
sprints to deliver results quickly, allowing an in-development product to be released while
creating test environments for continuous improvements or refinements until a final and
complete version is rolled-out.
• Kanban is a way to visualize Scrum Methodology, hence the tool Kanban Boards
Lean Methodology
• Lean Methodology aims to minimize inputs for maximum output; in other words, eliminate waste.
• It is based on a horizontal design or results-oriented system rather than a vertical one or ‘business
unit system’ that incorporates a process realignment toward Total Quality Management
• Lean Manufacturing – Achieving the shortest possible cycle time by eliminating waste, reducing
non-incidental work thereby decreasing the time between a customer order and shipment;
designed to improve profitability, customer satisfaction, throughput time, and employee morale
Theory of Constraints and Throughput Costing
It is the methodology for identifying a constraining factor that slows down or impedes production
processes and managing the same by improving any aspect of the business process.
Constraint – A constraint is a limitation that a firm has no other choice but to be subject to whilst needing
to meet existing goals.
• The constraint is called the Bottleneck (the Labor & Overhead are applied in the Process).
• Under this method, Throughput Contribution Margin is used (only Sales less Direct
Materials), Opportunity Costs committed to productions are also considered, and finally the
costs of all operations are measured.
The theory of constraints, JIT, and Lean all consider non-productivity as an illness, specifically idle
inventory. This is because Inventory has tied-up costs that need to be minimized, as such:
Merchandize Inventory is not Quality Declines as Inventory If we choose to reduce decline in
considered an Asset, unless it is stays in stock due to wear and quality, we incur costs to
immediately considered sold tear, exposure to elements, etc. maintain that quality which are
from the time it is available. also costly, if not, more.
In as much as Quality should be managed, its costs should technically still be minimized.
As such constraints are eliminated or minimized as much as possible
Constraints can come from:
Internal Process Internal Policy External Material External Market
The Theory of Constraints identifies 4-constraints to minimize waste and maximize output quality
Drum Buffer Rope
The scheduling System or Limits what is fed into the Bottleneck The Rope pulls the output in
the Order Feed to minimize waste and to prevent the through the bottleneck at a
bottleneck or constraint from constrained speed, it is also to
overloading the entire process prevent overloading bottlenecks.
Limits Downstream Limits Downstream Limits Upstream
Sets the velocity or Prevents the bottleneck from Allows the bottleneck to deliver
pacing of the system, starving or being idle; it is a just enough input to prevent idle
which is why it is the deliberate delay or stock-in to keep capacity. It is the buffer’s signal to
slowest sub-process, inventory flowing at pace, thereby release the material from the
which is called Takt Time avoiding variably changing lead times buffer which encapsulates the ‘pull
(minimizing waste & stock-out cost) system’ in Lean.
• Determining the bottleneck includes acknowledging the fact that any changes to it may change
the overall throughput of the system as a whole
This requires determining a common input measure such as time, units needed, etc. and determining the
relative throughput margin per resource. The constraint can be identified relative to the total available
common resource. For example, if in a week a department takes 2,500 hours, then all products can only
be produced within that timeframe. The process that consumes the most time is usually the bottleneck.
• Bottlenecks should ideally be busy and should be prioritized
To prioritize which aspect of the bottleneck needs to be addressed, the throughput margin must be
determined for the products. This is a straightforward process for a single production line; however, it
becomes a bit more complicated when multiple product lines are considered. Hence, a matrix
computation using linear algebra may be required to determine the optimum mix of production needed
to prioritize the bottleneck. (See Linear Programming)
• Eliminate Idle Time in the Bottleneck (the Buffer deliberately imposes minimal and optimized
idle time and the Rope generates the Reorder Point). To eliminate the idle time in the
bottleneck, buffers before or after the bottleneck must be set.
The buffers and ropes are placed to stock the inventory in a phase, enough to prevent it from both being
idle and overloading. The opportunity costs of keeping stock in buffers are determined and deducted
from the throughput margin determined in the bottleneck.
• Process only goods that increase throughputs, shift other goods that do not need bottlenecking
elsewhere, and repeat the process until satisfied. (Conduct Differential Analysis)
Example: A certain end-to-end process goes through the following steps A to E. The time taken by each
of the WIP goods go through each step is as follows (in minutes):
WIP A WIP B In any given week, 100 units of WIP A are required to satisfy demand,
A 18 16 while WIP B requires 150 units.
B 15 14 In a week, only 2,760 minutes are available for manufacturing.
C 17 15 WIP A sells for P67.00, B for P75.00;
D 12 11 DM costs for WIP A is P40.00, WIP B is for P52.00
E 10 9 Weekly DL and OH Costs P5,000.00
Total 72 65
Apply Theory of Constraints:
4. The bottleneck is Step A for WIP A & B
5. Throughput Margins are as follows:
WIP A WIP B
Margin P27.00 P23.00
6. Determine the Throughput Margin per Bottleneck Minute
Margin/Min P1.50/min P1.44/min
7. Determine the Profit Maximization Function (In this case, time is the constrained resource)
Max Profit = P1.50A + 1.44B where Max Profit is subject to time constraint as follows:
2,760 mins = 1,800 mins for A, and 960 mins for B.
8. Determine Income Impact and decide.
WIP A WIP B Total
Sales P6,700.00 P3,900.00 P10,600.00 (960/2,760)*150*P75.00
DM (4,000.00) (2,704.00) (6,704.00) The bottleneck is not recovering overall
Margin P2,700.00 P1,196.00 P3,896.00 costs. It must be reviewed for improvement.
OPEX (5,000.00)
Income (P1,104.00)
Business Transformation
It is a term that encompasses change all throughout an organization.
Business Process Management
• Views processes as strategic assets that must be understood, managed, and improved.
• It is necessary to understand how a Business Process is conceptualized before it is to be managed
and improved, hence its life cycle.
o Design – Identifying existing processes and creating design improvements
o Modelling – Simulating the process in a test environment and considering its possible
implications to the business environment
o Execution – Installing software, training personnel, & implementation of the new process
o Monitoring – Tracking processes with performance statistics
o Optimization – Retrieving performance statistics from modelling and monitoring to
identify bottlenecks or other problems; realizations for organizational structures such as
centralization and decentralization are discovered in this phase
Benchmarking
Benchmarking is concerned with determining best practices in other firms and comparing existing firm
performance and capabilities. It is not necessarily concerned with competitors and industry, but rather,
a mix of both to achieve a basis for improvement. It is composed of the following steps:
Document the Current
Select the Project and Identify and Research the Analyze Data and Identify
State and Conduct a Gaps Implementation
Team Target Improvement Points
Analysis
• Cost, Quality, Timeliness

Business Process Reengineering

• A fundamental rethinking and redesign of business processes to achieve improvements in critical
measures of performance such as cost, quality, service speed, and customer satisfaction. Its
scope includes anything from operations and production to administrative functions
• It is akin to Systems Analysis and Design
• It is a Radical Approach to Change compared to Kaizen which focuses on small increments over
time
• It often involves a large investment to implement, hence it is usually hounded with issues
surrounding retrenchment, employee motivation, and company culture
• Proper change management must be undertaken to avoid the issues as above mentioned
• It seeks to discard and replace inefficient, outdated, and redundant procedures in the business
o Reengineering looks at outcomes of the new process instead of the new tasks themselves
o It begins with the customer-level, not with the product
o Technology is not meant to add to old procedures, but rather to find new ways of working