The Hindu : Business : Towards a strategic costing system

Online edition of India's National Newspaper
Monday, Jun 21, 2004

Business

Business

Towards a strategic costing system

IT WAS dinner time after a seminar on `Strategic Cost Management' organised by a leading industry forum. The new perspectives emerging seemed to fascinate the captains of industry. How could they use costing tools in the strategic issues they face in their business? Is it possible to use the costing system to trigger across-the-board decisions? Is it possible to assess the effectiveness of their costing systems vis-à-vis pricing, estimation, capacity utilisation and enhance process efficiencies?

A system that responds!

"Our costing system is more of an extended accounting system,'' observed the head of an auto major. Cost management decisions are not triggered by it". A banking industry senior echoed the collective thoughts when he said aiming for such sweep and depth would mean a huge challenge to the fundamental design of the costing system — especially in the service industry with customer profitability as the key focus. Can it be done? "For this, the organisational thinking must go far beyond the implementation of an automated costing system,'' observed a systems consulting veteran. "Sophisticated technology is not an end in itself. It should be used optimally for strategic inputs. The trick is to set up a mechanism for the costing system to continuously learn and respond to the business challenges.''

Catch-22?

Cost management is an art that needs constant honing. It is driven by the fundamental purpose and the environment in which the costing system operates. At the same time, it should ideally determine and influence the environment rather than itself being influenced by the environmental factors. It has to impact the system by which it is impacted — a la Catch-22?!

Organisations have responded to the dynamic business environment in varied fashions. Here we are talking of an integrated cost management that sets goals, monitors and controls the business impact. Cost leadership and organisational cost culture make the system contribute proactively rather than respond reactively. The common thread of cost focus can be easily identified if the scope of costing and cost management is extended from mere accounting (number-crunching) to evolving a suitable mechanism to integrate it with the operational activities. There are specific techniques aimed at addressing concerns encompassing strategic, tactical and operational issues. Organisations have successfully applied process related initiatives like Six-Sigma programs across the functions of manufacturing, marketing and logistics.

What is cost culture?

Costs are hard facts that need to be understood in the most relevant perspective for a costing system to be effective. Costing is not cocooned within the boundaries of cost reduction and cost rationalisation; rather, it includes strategic issues including capacity planning and utilisation, and investment decisions in specific geographies/or technologies.

Cost culture is the way an organisation's costing system influences its reaction to the business dynamics and challenges. It reflects core organisational issues such as cost ownership, investment related decision-making capabilities, responsibility ownership, and alignment of strategic goals with operational efficiency.

A study of the cost culture can reveal whether the top management's cost related targets have permeated to the shop floor. Cost culture echoes the extent of the permeation of cost consciousness across the organisation.

Among the various factors that drive business leadership, cost leadership is the most significant one. The model presented here can act as a mirror for the effectiveness of its cost culture. The model is a representation of the evolution of the costing systems across an organisation, but can be adopted for specific business units too.

The leadership ladder

Each of the levels from basic to globally competitive would need to be defined in terms of measures or the parameters based on which a fair judgment can be made about the appropriate level. For each of these measures a quantifiable determinant needs to be identified which again will be subject to the popular Plan-Do-Check-Act (PDCA) cycle. The extent to which cost management has traversed from the finance/accounting domain to that of the line/operational executives will be a key factor in determining an appropriate level. An Activity Based Management (ABM) programme will indicate the activity costs and areas where the process inefficiencies occur.

Using an analysis of cost drivers, ABM helps catalyse the organisation's march towards cost leadership.

The success of cost leadership was demonstrated in an engineering company that implemented an activity based costing system with the focus of identifying process inefficiencies. When a cost rationalisation programme was initiated to set cost reduction targets, the ABC model was extended to prepare an Activity Based Budget which provided a more rational approach to budgeting than the traditional "across the board" reductions in cost budgets.

Key success factor

A key measure in the effectiveness of cost culture would be the integration of organisational initiatives with the costing system. A real world example is TCS' own story of transforming the organisation's performance and compensation model through the integrated costing systems. Another initiative was the formulating of Six-Sigma programme, using activity costs as indicators of its existing processes as well as for setting targets for cost reduction.

It is a daunting task for an organisation to take stock of the strength of its costing system since the latter itself would have been moulded over a sufficiently long period by the various business factors.

A strong information technology infrastructure would ideally identify and address fundamental costing issues through a mechanism for monitoring the costing system rather than reacting to specific factors. The smart use of technology for strategic impact could be your key differentiator in successful business.

S. Mahalingam, Chief Financial Officer, TCS K. Shyam Sundar,Consultant, Activity based management,

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