LECTURE: DEVELOPING A COMPETITIVE STRATEGY; CONTEMPORARY COST

MANAGEMENT TECHNIQUES

DEVELOPING A COMPETITIVE STRATEGY

A strategy is a set of policies, procedures and approaches to business that produce long-term success.

Finding a strategy begins with determining the purpose and long-range direction or in other words, the
mission of the company. The mission is developed into specific performance objectives which are then
implemented by specific corporate or company's strategies, that is, specific actions to achieve the objectives
that will fulfill the mission. A firm succeeds by implementing a strategy.

Strategy specifies how an organization matches its own capabilities with the opportunities in the market
place to accomplish its objectives. In other words, strategy describes how a company will compete and the
opportunities its employees should seek and pursue. Companies follow one of two broad strategies. Some
companies such as Jollibee, Pure Gold and Cebu Pacific Airline compete on the basis of providing a quality
product or service at low prices. This is also known as “Cost Leadership” strategy. Other companies such as
Rustan’s Department Store and BGC Shangri-La Hotel compete on their ability to offer unique products or
services that are often priced higher than the products or services of competitors. This is known as the
“Product Differentiation” strategy.

Deciding between these strategies is a big part of what managers do. Management accountants work closely
with managers in formulating strategy by providing information about the sources of competitive advantage
– for example, the cost, productivity, or efficiency advantage of their company relative to competitors or the
premium prices a company can charge relative to the costs of adding features that make its products or
services distinctive. The management accountant also helps formulate a strategy by answering questions
such as:
●​ Who are our most important customers?
●​ How sensitive are their purchases to price, quality, and service?
●​ Who are our most important suppliers?
●​ What substitute products exist in the marketplace, and how do they differ from our product in terms of
price and quality?
●​ Is the industry demand growing or shrinking?
●​ Is there overcapacity?

Strategic cost management is often used to describe Cost Management that specifically focuses on strategic
issues such as these.

STRATEGIC MEASURES OF SUCCESS

Firms use cost management to support their strategic goals. The strategic cost management system develops
strategic information, including both financial and non-financial information.

Financial performance measures include among others

a.​ growth in sales and earnings
 b.​ Cash flows
c.​ stock price

They show the impact of the firm's policies and procedures in the firm's current financial position and
therefore, its current return to the shareholders.

Non-financial measures of operation include among others

a.​ market share
b.​ product quality
c.​ customer satisfaction
d.​ growth opportunities

The nonfinancial factors show the firm's current and potential competitive position as measured from three
additional perspective, namely:
1.​ the customer
2.​ The internal business and process
3.​ innovation and learning

Strategic financial and nonfinancial measures of success are also commonly called: Critical Success Factors
(CSFs)

COMPETITIVE STRATEGIES
For a firm to sustain a competitive position, it must purposefully or as result of market forces arrive at one of
the two competitive strategies, namely Cost Leadership and Product Differentiation

Cost Leadership
This is a competitive strategy in which a firm succeeds in producing products or services at the lowest cost in
the industry. A firm that is a cost leader makes sustainable profits at lower prices, thereby limiting the growth
of competitions in the industry through its success in price wars and undermining the profitability of
competitors which must meet the firm's low price.

Product Differentiation
The differentiation strategy is implemented by creating a perception among consumers that the product or
service is unique in some important way, usually by being of higher quality, features or innovation. This
perception allows the firm to charge higher prices and outperform the competition in profits without
reducing cost significantly. Most industries, including automobile, consumer electronics, and industrial
equipment, have differentiated firms. The appeal of differentiation is especially strong for product lines
which the perception of quality and image is important, as in cosmetics, jewelry and automobiles. Tiffany,
Rolex, Ferrari and BMW are good examples of firms that emphasize differentiation.

Distinctive Aspects of the Two Competitive Strategies

 Aspect Cost Leadership Differentiation

Strategic target Broad cross section of the Focused section of the

market market

Basis of competitive Lowest cost in the industry Unique product or service

advantage

Product line Limited selection Wide variety,

differentiating features

Production emphasis Lowest possible cost with Innovation in

high quality and essential differentiating products
product features

Markets emphasis Low price Premium price and

innovative, differentiating
features

Looking more closely at differentiated firms, the key CSFs and execution issues are in marketing and
product development - developing customer loyalty and brand recognition, emphasizing superior and unique
products, and developing and using detailed and timely information about customer needs and behavior. This
is where the marketing and product development within the firm provide leadership and the management
accountants support these efforts by gathering, analyzing, and reporting the relevant information.

Other Strategic Issues

A firm succeeds by adopting and effectively implementing one of the strategies explained earlier. Recognize
that although one strategy is generally dominant, a firm is most likely to work hard at process improvement
throughout the firm, whether cost leader or differentiator, and on occasion to employ both of the strategies at
the same time. However, a firm following both strategies is likely to succeed only if it achieves one of them
significantly. A firm that does not achieve at least one strategy is not likely to be successful. This situation is
what Michael calls "getting stuck in the middle”. A firm that is stuck in the middle is not able to sustain a
competitive advantage. For example, giant retailer Makati Supermarket been stuck in the middle between
trying to compete with Pure Gold on cost and price, and with style conscious target on differentiation.

CONTEMPORARY COST MANAGEMENT TECHNIQUES

Managers commonly use the following tools to implement the firm's broad strategy and to facilitate the
achievement of success on critical success factors: just-in-time (JIT), total quality management, process
reengineering, benchmarking, mass customization, balanced Scorecard, activity-based costing and
management, theory of constraints (TOC), life cycle costing, target costing, computer-aided design and
manufacturing, automation, e-commerce and the value chain and supply-chain analysis.
The basic concepts of these cost management techniques are discussed in the succeeding section:
A.​ Total Quality Management
To survive in an increasingly competitive environment, firms realize that they must produce
high-quality products. As a result, an increasing number of companies have instituted total quality
management programs to ensure that their products are of the highest quality and that production
processes are efficient.

Total quality management (TQM) is a technique in which management develops policies and
practices to ensure that the firm's products and services exceed customers' expectations.

Currently, there is no generally agreed upon "perfect way” to institute a TQM program. But most
companies with TQM develop a company that stresses listening to the needs of customers, making
products right the first time, reducing defective products that must be reworked, and encouraging
workers to continuously improve their production process. That is why some TQM programs are
referred to as continuous quality improvement programs.

TQM affects product costing by reducing the need to track the cost of scrap and rework related to
each job. If TQM is able to reduce these costs to a very low level, the benefit of tracking the costs is
unlikely to exceed the cost to the accounting system.

Total Quality Management (TQM) is a formal effort to improve quality throughout an

organization's value chain. The two major characteristics of TQM are
1.​ a focus on serving customers, and
2.​ systematic problem-solving using teams made up of front-line workers.

B.​ Just-In-Time (JIT)

Just-in-Time (JIT) is the philosophy that activities are undertaken only as needed or demanded. JIT
is a production system also known as pull-it-through approach, in which materials are purchased and
units are produced only as needed to meet actual customer demand. In a JIT system, inventories are
reduced to the minimum and in some cases, zero.

Just-in-Time (JIT) production is a system in which each component on a production line is produced
immediately as needed by the next step in the production line. In a JIT production line, manufacturing
activity at any particular workstation is prompted by the need for that station's output at the following
station. Demand triggers each step of the production process, starting with customer demand for a
finished product at one end of the process and working all the way back to the demand for direct
materials at the other end of the process. In this way, demand pulls a product through the production
line. The demand-pull feature of JIT production systems achieves close coordination among work
centers. It smoothens the flow of goods, despite low quantities of inventory.

Financial Benefits of JIT

JIT tends to focus broadly on the control of total manufacturing costs instead of individual costs such as
direct manufacturing labor. For example, idle time may rise because production lines are starved for
materials more frequently than before. Nevertheless, many manufacturing costs will decline. JIT can provide
many financial benefits, including

1.​ Lower investment in inventories.

2.​ Reductions in carrying and handling costs of inventories.
3.​ Reductions in risk of obsolescence of inventories.
4.​ Lower investment in plant space for inventories and production.
5.​ Reductions in setup costs and total manufacturing costs.
6.​ Reduction in costs of waste and spoilage as a result improves quality.
7.​ Higher revenues as a result of responding faster to customers.
8.​ Reductions in paperwork.

Major Features of JIT Production System

There are five main features in a JIT production system:
1.​ Production is organized in manufacturing cells, a grouping of all the different types of equipment used
to manufacture a given product.
2.​ Workers are trained to be multiskilled so that they are capable of performing a variety of operations
and tasks.
3.​ Total quality management is aggressively pursued to eliminate defects.
4.​ Emphasis is placed on reducing setup time, which is the time required to get equipment, tools and
materials ready to start the production of a component or product, and manufacturing lead time, which
is the time from when an order is ready to start on the production line to when it becomes a finished
good.
5.​ Suppliers are carefully selected to obtain delivery of quality-tested parts in a timely manner.

C.​ Process Reengineering

Reengineering is a process for creating competitive advantage in which a firm reorganizes its
operating and management functions, often with the result that jobs are modified, combined, or
eliminated. It has been defined as the “fundamental rethinking and radical redesign of business
processes to achieve dramatic improvements in critical, contemporary measures of performance, such
as cost, quality, service, and speed”.

Process reengineering, a more radical approach to improvement than TQM, is an approach where a
business process is diagrammed in detail, questioned and then completely redesigned in order to
eliminate unnecessary steps, to reduce opportunities for errors and to reduce costs. A business process
is any series of steps that are followed in order to carry out some task in a business.

The main objective of this approach is the simplification and elimination of wasted effort and the
central idea is that all activities that do not add value to product or service should be eliminated. In its
most simplified version, the steps used in process reengineering are
1.​ A business process is diagrammed in detail.
2.​ Every step in the business process must be analyzed and justified.
3.​ The process is redesigned to include only those steps that make the product or service more
 valuable.

This process can yield the following anticipated results:

1.​ Process is simplified,
2.​ Process is completed in less time,
3.​ Costs are reduced, and
4.​ Opportunities for errors are reduced.

Process reengineering has one basic recurrent problem, that is - employee resistance. As with other
improvement projects, employees fear 1oss of jobs which may lead to lost morale and failure to improve the
bottom line (i.e., profits). For the process to prosper and succeed, employees must be convinced that the end
result of the improvement will be more secure, rather than less secure jobs. They can be made to understand
that by improving the processes, the company can generate more business, produce a better product at lower
cost and will have the competitive strength to prosper.

D.​ Benchmarking
Benchmarking is a process by which a firm
●​ determines its critical success factors
●​ studies the best practices of other firms (or other units within a firm) for achieving these
critical success factors, and
●​ then implements improvements in the firm's processes to match or beat the performance of
those competitors.

Today benchmarking efforts are facilitated by cooperative networks of noncompeting firms that exchange
benchmarking information.

E.​ Mass Customization

Many manufacturing and service firm's increasingly find what customers need. And many firms have
been successful with a strategy that targets customer's unique needs.

Mass customization is a management technique in which marketing and production processes are
designed to handle the increased variety that results from delivering customized products and services
to customers.

The growth of mass customization is in effect another indication of the increased attention given to
satisfying the customer.

F.​ Balanced Scorecard

The balanced scorecard is an accounting report that includes the firm's critical success factors in four
areas
a.​ financial performance,
b.​ customer satisfaction,
c.​ internal business process, and
 d.​ innovation and learning.

The concept of balance captions the intent of broad coverage, financial and nonfinancial, and of all the
factors that contribute to the success of the firm in achieving its strategic goals. The use of the balanced
scorecard is thus a critical ingredient of the overall approach that firms take to become and remain
competitive.

G.​ Activity-based Costing and Management

Activity analysis is used to develop a detailed description of the specific activities performed in the
operation of the firm. Many firms have found that they can improve planning, product costing,
operational control, and management control by using activity analysis to develop a detailed
description of the specific activities performed in the firm's operations. The activity analysis provides
the basis for activity-based costing and activity-based management.

Activity-based costing (ABC) is used to improve the accuracy of cost analysis by improving the
tracing of costs to products or to individual customers. Activity-based management (ABM) uses
activity analysis to improve operational control and management control. ABC and ABM are key
strategic tools for many firms, especially those with complex operations, or great diversity of
products.

H.​ Theory of Constraints (TOC)

The Theory of Constraints is a sequential process of identifying and removing constraints in a system.

The Theory of Constraints emphasizes the importance of managing the organization's constraints or
barriers that hinder or impede progress toward an objective. Since the constraint is whatever is
holding back the organization, improvement efforts usually must be focused on the constraint to be
really effective.

The basic sequential steps followed in applying TOC are

1.​ Analyze all the factors of production (materials, labor, facilities, methods, etc.) required in the
production chain.
2.​ Identify the weakest link, which is the constraint.
3.​ Focus improvement efforts on strengthening the weakest link.
4.​ If improvement efforts are successful, eventually the weakest link will improve to the point
where it is no longer the weakest link.
5.​ At this point, a new weakest link (new constraint) must be identified and improvement efforts
must be shifted over that link.

The Theory of Constraints approach is a perfect complement to Total Quality Management and Process
Reengineering - it focuses improvement efforts where they are likely to be most effective.

I.​ Life Cycle Costing

Life-cycle costing is a management technique to identify and monitor the costs of a product
 throughout its lifecycle. It consists of all steps from product design and purchase of raw material to
delivery of and service of the finished product. The steps include
1.​ research and development
2.​ product design, including prototyping, target costing and testing
3.​ manufacturing, inspecting, packaging and warehousing
4.​ marketing, promotion and distribution
5.​ sales and service.

Cost management traditionally has focused only on costs incurred up to the third step manufacturing.
Management accountants now strategically manage the product's full life cycle of costs, including upstream
and downstream costs as well as manufacturing costs.

J.​ Target Costing

Target costing involves the determination of the desired cost for a product or the basis of a given
competitive price so that the product will earn a desired profit. The basic relationship that is observed
in this approach is
Target cost = Market determined price - Desired profit

The entity using target costing must often adopt strict cost-reduction measures to meet the market price and
remain profitable. This is a common strategic approach used by intensely competitive industries where even
small price differences attract consumers to the lower-priced product.

K.​ Computer-Aided Design and Manufacturing

More companies are using computer-aided design (CAD) and computer-aided manufacturing (CAM)
to respond to changing consumer tastes more quickly. These innovations allow companies to
significantly reduce the time necessary to bring their products from the design process to the
distribution stage.

Computer-aided design (CAD) is the use of computers in product development, analysis, and design
modification to improve the quality and performance of the product. Computer-aided
manufacturing (CAM) is the use of computers to plan, implement, and control production.

L.​ Automation
Automation involves and requires a relatively large investment in computers, computer programming,
machines, and equipment. Many firms add automation gradually, one process at a time. To improve
efficiency and effectiveness continuously, firms must integrate people and equipment into the
smoothly operating teams that have become a vital part of manufacturing strategy. Flexible
manufacturing systems (FMS) and computer-integrated manufacturing (CIM) are two integration
approaches.

A flexible manufacturing system (FMS) is a computerized network of automated equipment that

produces one or more groups of parts or variations of a product in a flexible manner. It uses robots
and computer-controlled materials-handling systems to link several stand-alone, computer-controlled
 machines in switching from one production run to another.

Computer-integrated manufacturing (CIM) is a manufacturing system that totally integrates all

office and factory functions within a company via a computer-based information network to allow
hour-by-hour manufacturing management.

The major characteristics of modern manufacturing companies that are adopting FMS and CIM are
production of high-quality products and services, low inventories, high degrees of automation, quick
cycle time, increased flexibility, and advanced information technology. These innovations shift the
focus from large production volumes necessary to absorb fixed overhead to a new emphasis on
marketing efforts, engineering, and product design.

M.​E-Commerce
A number of internet-based companies have emerged and been proven successful in the last decade.
This E-Commerce business model adopted by Amazon.com and eBay has also attracted many
investors to pursue the use of the Internet in conducting business. Established companies will
undoubtedly continue to expand into cyberspace - both for business-to-business transactions and for
retailing. The Internet has important advantages over more conventional marketplaces for some kinds
of transaction such as mortgage banking. It is also very likely that a blockbuster business may be built
around the concept of selling low-value, low-margin and bulky items like groceries over the Internet.

N.​ The Value Chain

Value chain refers to the sequence of business functions in which usefulness is added to the products
or services of a company. The term value refers to the increase in the usefulness of the product or
service and a result of its value to the customer.

The value chain is an analysis tool that firms use to identify the specific steps required to provide a
product or service to the customer. The key idea of this concept is that the firm studies each step in its
operation to determine how each activity contributes to the firm's competitiveness and profits.

Analyzing the firm's value chain helps management discover

●​ which steps or activities are not competitive
●​ where costs can be reduced, or
●​ which activity should be outsourced, and
●​ how to increase value for the customer at one or more of the steps of the value chain.

When properly implemented, these approaches can (a) enhance quality, (b) reduce cost, (c) increase output,
and (d) eliminate delays in responding to customers.

Internal value chain is the set of activities required to design, develop, produce and deliver products or
services to customers. If customer values are emphasized, managers are forced to determine which activities
in the value chain are important to customers. A management accounting system should track information
about a wide variety of activities than span the internal value chain.
Illustrative Case 4-1: Value Chain Analysis
Jack Reyes, a consultant for the Red Archer basketball team, has been asked to complete a value-chain
analysis of the franchise with a particular focus on comparison with a nearby competing team, the Roaring
Lions. Jack has been able to collect selected cost data, as shown below, for each of the six steps in the value
chain. Single-ticket prices range from P45.00 to P80 and average paying attendance is approximately 2,200
for Red Archers and 5,000 Roaring Lions.

Average Cost per Person and Scheduled Games

Red Steps in the Value Chain Roaring

Archer Lions

P.45 Advertising and general promotion expenses P.50

.28 Ticket sales: local sporting goods stores and at the .25
ballpark

.65 Ballpark operations .80

.23 Management compensation .18

.95 Players' salaries 1.05

.20 Game-day operations, special entertainment, and .65

game-day promotions

P2.76 Total cost P3.43

Required:
Develop an analysis of the value chain to help Jack better understand the nature of the competition between
the Archers and the Lions, and to identify opportunities for adding value and/or cost reduction at each step.

Illustrative Case 4-1 - Analysis of the Value Chain

The cost figures Jack has assembled suggest that the two team's operations are generally quite similar, as one
would expect in basketball. However, an important difference is the amount that the Lions team spends on
game-day operations - more than three times than that of the Red Archers. That difference has, in part, built a
loyal set of fans in Lions, where gate receipts average more than twice that of Archers (P285,000 versus
P123,500). It happens that the Lions have found an effective way to compete - by drawing attendance to
special game-day events and promotions.

To begin to compete more effectively and profitability, Archers might consider additional value-added
services, such as game-day activities similar to those offered in Lions. While Archers costs per person are
somewhat lower than Lion's, the cost savings are not enough to offset the loss in revenues.
On the cost side, the comparison with Lions shows little immediate promise for cost reduction; Archer
spends on the average less than Lions in every category except management compensation. Perhaps this is a
further indication that instead of reducing costs, Archer should spend more on fan development. The next
step in Jack's analysis might be a survey of Archer fans to determine the level of satisfaction and to identify
desired services that are not currently provided.