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Cost Management and Control – Steps and Strategies

Cost Management and Control – Steps and Strategies

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472



FINANCIAL MANAGEMENT: THEORY AND PRACTICE



INTRODUCTION

Total cost management and control, like the quality control, is of great importance and essence in the area of

strategic financial management and control. It would, therefore, augur well for all the business organizations

to understand and appreciate the various steps and strategies involved in the effective and efficient total cost

management and control.



COST CONTROL DRIVERS

We should understand and identify the various drivers (causal factors) of cost – both structural and executional,

as has well been bifurcated by the cost management guru, Daniel Riley.



Structural vs Executional Cost Drivers

According to Riley, the structural drivers of cost emanate from the scale of operation (the volume of production

and sales), the scope of operation, i.e. the extent of vertical integration, the extent of employment of technology,

and the variety of products and services offered by the company, by way of its strategic policy decisions.

The executional cost drivers, however, pertain to the effectiveness and efficiency of production and performance

of the company, by virtue of the involvement of the labourers and workers, supervisors and officers, total quality

management (TQM) and control, fuller capacity utilization, efficiency of the layout of the plants and machinery,

configuration of products, and the value chain linkages and management.



VALUE CHAIN

The cost control strategy must pay attention to the value chain in its entirety, and not just in parts and segments

of the business activities of the organization. With a view to saving the costs, the organization must work hand

in hand with both the suppliers and the customers. They should be treated as a part of the organization, and

not apart from it. As John K Shank and Vijay Govindarajan, in their book: ‘Strategic Cost Management’ argue

convincingly that a firm’s competitive edge critically depends upon its ability to manage its entire value chain

in comparison to that of its competitors.



TOTAL COST MANAGEMENT (TCM) AND BUSINESS PROCESS RE-ENGINEERING (BPR)

As James Champy and Michael Hammer put it, Business Process Re-engineering (BPR) is ‘the fundamental

rethinking and radical redesign of business to achieve dramatic improvements in contemporary measures

of performance such as cost, quality, service and speed’. BPR also logically pertains to the TCM (Total Cost

Management). Thus, BPR cannot succeed unless the TCM is already in place.



TCM AND TQM

‘The very essence of Total Quality Management is the process of getting it right the first time, every time,

by designing a quality chain that uses the customer’s needs to produce exactly what he/she needs at a price

that he/she is willing to pay, and in a way that enables the company to do this without rejection, rework and

redundancy’, as Nanda Mazumdar and Rakhi Mazumdar put it. True. If a job is done right the very first time,

all the time, the incidence of rejection and rework, scrap and wastages, cost of inspection for quality, and

customers’ dissatisfaction and the resultant loss of market reputation, will be minimal. Thus, the end-result

will naturally be cost savings and the higher profitability that goes therewith.



COST CONTROL

It has been empirically established that around 80 per cent of the costs are incurred at the designing and

developmental stages itself. Further, these costs are in the nature of hidden costs, which no customer is ready



COST MANAGEMENT AND CONTROL – STEPS AND STRATEGIES







473



to pay for. That is why, at the Daewoo Anchor Electronics, all the products are developed as per the customers’

needs, and the superfluous frills, involving avoidable costs, are eliminated. It would, therefore, augur well if

the companies prefer to invest sufficient funds to have a market survey conducted, and the consumers’ needs

and preferences identified, preferably through personal interviews, well before designing and developing any

new product.



VALUING THE VENDORS

‘The heart of supply chain management is the supplier-vendor relationship. The closer and more dependent

they are on each other, the better is the outcome. Despite the apprehension, single vendor relationships have

proved fruitful’, so says SV Subramanian. Maruti Udyog Limited, understandably, has made enough efforts

to train their vendors in the area of management of costs, so that they can supply the items at a cheaper rate

and, thereby, drastically bring down the cost of the final product (components of the car), so as to sustain the

recent stiff competition in the car segment.



COMPARE AND COMPETE WITH THE BEST

It will augur well if the companies would undertake some inter-firm comparisons and would try to come up

to the high standards of the best performing companies, even in the area of cost reduction and control. Such

steps may facilitate them in assessing their own gaps and shortcomings, enforcing better discipline among the

work force, and exploring the areas of improvement, and finally, to achieve and reach the same high standards.



FLEXIBLE MANUFACTURING SYSTEM

In the current era of stiff global competition, it will augur well for the companies to switch over to the flexible

manufacturing, by developing suitable machineries, production process, workflows and worker skills, so as to

facilitate the processes of switching over from one product line to the other, with ease and speed, of course,

without disturbing or losing on the economies of scale. Such a strategy will definitely have a positive impact

and effect in the area of cost reduction and control. Similarly, by introducing the use of the standard make of

the components and parts, the company will also reduce cost, as these may be purchased outright at a much

lower cost, as compared to the in-house manufacturing or even outsourcing made-to-order items of non-standard

specifications.



Just in Time (JIT) vs Just in Case (JIC)

As we all know, inventory-carrying costs by themselves account for around 25 per cent of the total costs of the

raw materials and finished goods. Therefore, the basic principle of cost management and control of inventorycarrying costs is to hold the minimal stocks of the various items of inventories. That is, we should slowly but

steadily progress and march towards achieving the benchmark of just-in-time (JIT) technique of inventory

management that was first introduced in Japan by Taichi Okno. But then, the JIT system presupposes that

the suppliers of the various items and machine parts will supply the required items just-in-time, failing which

the whole excellent system may tend to collapse. But, in India we can hardly afford to take such a reckless risk,

when we know for sure that most of the venders and suppliers may not be serious enough about keeping their

promise of delivering the components and materials just on time.

We should, therefore, move towards the achievement of the full JIT system of inventory management in

the long run. In the meantime, we should effectively use the ABC technique of inventory management (of high

value, medium value, and low value items). This technique has been put to use most effectively by the Bajaj

Auto and Ashok Leyland, to their great advantage and substantial cost savings.

(A detailed discussion on the topic of ABC technique or VED technique appears in Chapter 13 of the book).



Brand Extension

Launching an altogether new brand is a very expensive proposition, though it may be expected to increase

the sales and facilitate the entry into the new market segments and also attract new customers. But, a surer



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FINANCIAL MANAGEMENT: THEORY AND PRACTICE



and rather cheaper alternative could be the expansion and extension of the already existing brands, whereby

we are able to encash on the existing brand equity of the parent company. Besides, it involves much lesser

advertisement and promotional activities and expenses. For example, the ‘classic light’ brand of usual Classic

cigarettes for ladies, or the Red and White Premium brand by way of an extension of the existing Red and

White label of Godfrey Phillips India. The same may be true of Horlicks or Boost Brands of biscuits, launched

by Glaxo Smithkline Beechem, or Vicks Vaporub, Vicks inhaler, Vicks cough drops, Vicks syrup, besides Dettol

soap and shaving cream, and so on.



Advertisement Expenses

In the present era, highlighted by the stiff global competition and the vast network of TV channels and the

media, the need for aggressive advertisement has been very high, and so is the heavy expenditure attached

therewith. Thus, a viable option could be to advertise one or two of the key products and thereafter to encash

on the well-received popular and household brand names. Yet another cost saving strategy could be to initially

screen a full sixty-second advertisement on the TV for a week or two, and thereafter, to thirty seconds or even

to ten to fifteen seconds, displaying only the key portion of the advertisement which contains the punch line.

Amir Khan’s advertisement on Coca cola like ‘Thanda Matlab Coca cola’, or ‘Panch Matlab Chhota Coke’, or

‘yeh dil mange more’ of Pepsi or just ‘Barhiyan Hai’ of Asian Paints, say it all.

Alternatively, it may augur well if a cheaper mode and media could be engaged for the purpose. Further,

buying the media time from one single ad agency could facilitate better bargaining power and discount, resulting

in a substantial savings on the total advertisement cost.



DISTRIBUTION AND SERVICING CHANNEL

It has been estimated that around 40 per cent of the selling price of most of the consumer products comprises

the distribution cost itself. The review and analysis of such costs, therefore, has got to be undertaken from time

to time, and suitable cost-effective measures promptly taken, e.g.

• Choosing the cheapest distribution channel

• Minimizing the delivery time

• Streamlining the sales

• Customizing offerings

• Outsourcing their services



USE OF INFOTECH AND IT

According to Anjan Mukherjee ‘Organizations can use InfoTech to apply Total Cost Management across the

entire value chain’, in the current age of high-tech and advanced information technology (IT). These technologies

can be best used for process improvements and information-enriched transactions. With the present high speed

means of communication and electronic network, the interaction with the individual buyer, as also the supplier,

has become simpler and faster. This way, the supplies could be obtained at the cheapest possible rates, and the

sales could be given a boost too, and all these at a relatively lower cost.



CUTTING NON-MANUFACTURING OVERHEADS

While we have some tools and techniques in place for managing and controlling manufacturing costs, there has

been no such laid down norms pertaining to the non-manufacturing expenses, like rental of office premises,

travelling costs of top executives (including executive class airfare and deluxe five star hotel comforts) and the

various perks and frills.

It will augur well if the organizations would resort to some economy drives and cost-effectiveness programmes

to save on avoidable costs, and thereby increasing its profitability. Some such measures, just by way of illustrative

examples, are given as follows.



COST MANAGEMENT AND CONTROL – STEPS AND STRATEGIES























475



(i)Move the office premises away from the expensive market places in metropolis, to some comparatively

cheaper locations, in some well-connected cities and towns. Of late, such effective steps have already

been taken by some companies which have moved away from Mumbai to Navi Mumbai or even Pune, as

also from New Delhi to Gurgaon, Noida and Faridabad, and so on.

(ii)With a view to cutting on travel expenses, more and more use of video and audio conferencing can be

resorted to.

(iii)If travelling becomes necessary, the senior executives could be requested to fly by economy class and

stay in not-so-expensive super five star hotels.

(iv)Some high-expenses items like STD calls and air-conditioning could as well be controlled and curtailed.

(v)The culture of using car pools should be encouraged.

(vi)Extensive use of email could substantially cut the costs of paper and postages.



ADOPT SOME INNOVATIVE STRATEGIES

We will now discuss some innovative strategies to cut costs in various cases.

(i)Designing a product that can be manufactured at a much lower cost. For example, replacing copper wire

with strengthened aluminium wire, replacing costly iron components with sturdy plastic parts, replacing

custom-made parts and components by standard ones, available over the shelf in the open market.

(ii)Eliminating or containing the incidence and quantum of wastages (both of materials and man-hours), and

delays in the production process, e.g. rational location of different plants and machinery on a systemic

basis, after undertaking the time and motion study and value engineering study.

(iii)Wastages can as well be eliminated by changing the designing and cutting process. In a company, a huge

quantity of wastages of steel strips could be saved just by ordering for the strips of the specific length,

width and thickness, and by slightly changing the design and process of its cutting to the required size

and shape.

The simple but significant strategy may well be appreciated with the help of the two diagrams given

in Fig. 23.1.

Thus, we see that in the diagram (i) there is the shaded part representing the wastage, which could be

completely eliminated by getting the steel strip of the required length and cutting one (larger) piece into two,

whereby it could produce two pieces of the required size and shape with one single strip, resulting in tremendous

savings of materials as also man-hour.

a



c



(i)

d



(ii)



    



Extent of wastage

quantum of wastage

of the material

(iron strip)

has been represented

by the triangle abc.



Nil wastage



         Figure 23.1



CUT COST OF HUMAN CAPITAL

Too many wrong and redundant people also escalate costs. Downsizing, therefore, is being resorted to by many

companies in India also, especially in the private sector. Besides, sincere efforts must be made to identify the

skill-gaps and to appoint the right type of people for the right job. Accordingly, the activity of training people

on a regular basis could be considered as a gainful investment in the people (the human capital) so as to avoid

the expenses involved in hiring experts from outside.



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FINANCIAL MANAGEMENT: THEORY AND PRACTICE



Companies should also take timely initiative for succession planning, so that no vacuum may get created,

which may prove to be most detrimental to the organization.

In the recent past, when Dhirubhai Ambani was ill, it created a sort of panic in the stock market. But then,

the Reliance Industries group had taken special care to build and develop the two worthy sons of Dhirubhai,

Mukesh and Anil, with the result that, after the sad demise of the industrial tycoon, on 06 July, 2002, what

ensured was one of the smoother succession in the entire Reliance group. The recent dispute between the two

brothers has also been finally settled amicably.

Besides, ‘offering competitive remuneration packages, motivating people through empowerment, and linking

compensation to performance’, could be the right strategy towards managing and controlling costs, at all fronts

and functions.



ADOPT ACTIVITY-BASED COSTING (ABC)

It will augur well for the companies to adopt the activity-based costing technique most judicially, especially in

such units where the percentage of indirect costs (overheads) constitute a much larger percentage, as compared

to the direct materials and labour costs.

Finally, as Prasanna Chandra aptly puts it, ‘In today’s environment, marked by high indirect costs, greater

complexity in product offerings, and heightened competition, there is a strong case for switching to the activitybased costing, which is more refined and accurate than the traditional system of costing.’ But then, care should

be taken that hair-splitting of overheads (especially in-not-so complex and high-tech units, producing lesser

varieties of products), should be avoided at all times.



SOME KEY FACTORS FOR SUCCESS





(i)All the functionaries of the company, from top to bottom, must be alert at all times and conscious of

controlling and mitigating total costs in all the ways.

(ii)There must be some objective yardstick and method of measuring the total cost.

(iii)There must be a well-defined responsibility area and responsible person for controlling costs.

(iv)Above all, there must be a strong will on the part of the management and the employees towards the

total cost improvement and all-round cost effectiveness.

In fact, the main secret of success of Japanese goods the word over, lies in their successful efforts in minimizing

cost of production by way of the cost reduction techniques, like just-in-time (JIT), Total Quality Control (TQM),

Kaizen and Kanban. Thus, they could sell high quality goods at a much lower price than those of their Western

counterparts.



TOTAL COST MANAGEMENT IN INDIA

It is a matter of grave concern that in India this aspect of financial management and control does not seem to

have been given as much importance and attention as it richly deserves. This seems to have happened mainly

due to the following factors:

(i)Till recently, our economy had been largely protected and sheltered, whereby the inefficient units were

being given somewhat preferential treatment in the name of the role and importance of the small and

tiny sector units in our national economy.

(ii)The ‘cost plus’ pricing policy condition did not require any sincere effort on the part of the management,

to control cost, as in all the conditions, the ‘plus factor’ meant profit, and thereby, the inefficiency seemed

to be going at a premium.

*as quoted by Prasanna Chandra in his book Finance Sense, Tata McGraw-Hill, 2000, New Delhi.

*For a detailed discussion on ‘Activity Based Costing’ (ABC), readers may like to refer to Chapter 20 in the book Accounting

for Management, by Dr Satish B. Mathur, Tata McGraw Hill, 2010, New Delhi.



COST MANAGEMENT AND CONTROL – STEPS AND STRATEGIES







477



(iii)Besides, due to the rather excessive restrictions imposed on imports, there was almost no competition

in India worth the name, as it was almost insulated from the global competition.

But then, with our changed economic policy since the mid 1990s, and the opening of our market to the

international players in various industrial and service sectors, the extent of competition has gone up drastically.

Thus, under such changed economic conditions, the cost factor has become a question of life and death, phenomena

of the survival of the fittest, of the cheapest and the best.



SUMMARY

Effective Total Cost Management (TCM), like the Total Quality Management (TQM) is of essence to

optimize proficiency, profitability and prospects. There are various drivers (causal factors) of cost – both

structural and executional – given as follows:

(i)The structural drivers of cost emanate from the scale of operation (the volume of production and

sales), the scope of operation (that is, the extent of vertical integration), the extent of employment of

technology, and the variety of products and services offered by the company, by way of its strategic

policy decisions.

(ii)The executional cost drivers, however, pertain to the effectiveness and efficiency of production and

performance of the company, by virtue of the involvement of the labourers and workers, supervisors  and

officers, total quality management (TQM) and control, fuller capacity utilization, efficiency of the layout

of the plants and machinery, configuration of products, and the value chain linkages and management.

Organizations must practise effective value chain management, and therefore, must work in close

coordination with the suppliers and customers. We must train our vendors in management of costs, even at

our own costs, so that they could supply us the items/parts at a cheaper rate, resulting in reduced overall

costs, and higher sales and profitability.

Business Process Re-engineering (BPR), which involves the fundamental rethinking and radical redesign

of business to achieve dramatic improvements in costs, quality, and service and speed, can succeed only

if the Total Cost Management (TCM) is in place.

Besides, we should ensure the process of getting it right the first time and every time, by designing a

quality chain that uses the customers’ needs to produce exactly what they need at a price they are willing

to pay, and in a way that enables the company to do this without rejection, rework and redundancy.

Superfluous frills, involving avoidable costs, must be eliminated. A market survey should identify the

consumers’ needs and preferences, preferably through personal interviews, well before designing and

developing any new product.

Further, inter-firm comparisons may help to meet the high standards of the best performing companies,

even in the area of cost reduction and control.

Companies should better switch over to flexible manufacturing, by developing suitable machineries,  production

process, workflows, and worker skills, so as to facilitate the processes of switching over from one product

line to the other, with ease and speed, without disturbing or losing on the economies of scale. Similarly,

the introduction of the use of the standard makes of the components and parts will also reduce costs.

We should hold the minimal stocks of the various items of inventories and must achieve the benchmark of

just-in-time (JIT) technique, which also includes just-in-time supply. We should effectively use the ABC

or VED technique of inventory management.

As the launching of an altogether new brand is expensive, the expansion and extension of the already

existing brands may encash on the existing brand equity. To reduce advertisement cost on TV, a viable

option could be to advertise one or two of the key products and thereafter to encash on the well received

popular and household brand names. Moreover, after initially putting a full sixty-second advertisement

piece on the TV for a week or two, it could be shortened to thirty seconds or even to ten to fifteen seconds,

displaying only the key portion of the advertisement. Further, buying the media time from one single ad

agency could facilitate better bargaining power and discount.



478

































FINANCIAL MANAGEMENT: THEORY AND PRACTICE



A periodical review and analysis of distribution cost may suggest some suitable cost-effective measures for

cheap distribution channels, minimizing the delivery time, streamlining the sales, customizing offerings

and outsourcing their services. Companies could use Info-Tech to apply TCM across the entire value chain,

for process improvements and information-enriched transactions.

To cut down non-manufacturing overheads, like rental charges of office premises, travelling costs

of top executives (including executive class airfare and deluxe five-star hotel comforts) and the various

perks and frills, we should resort to some economy drives, like the following:

(i)Move the office premises away from the costly posh markets in metro cities, to some comparatively

cheaper locations in some well-connected cities and towns.

(ii)More and more use of video and audio conferencing could be resorted to.

(iii)Senior executives may fly by economy class and stay in not-so-expensive hotels.

(iv)STD calls and air-conditioning can be controlled.

(v)The culture of using car pools could be encouraged.

(vi)Extensive use of e-mail to cut down paper and postage charges can be implemented.

Design a product that can be manufactured at a much lower cost. For example,

(a)Replacing copper wire with strengthened aluminium wire, replacing costly iron components with

sturdy plastic parts, replacing custom-made parts and components by standard ones.

(b)Eliminating or containing the incidence and quantum of wastages and delays in the production process,

e.g. rational location of different plants and machinery, based on the time and motion study and value

engineering study.

(c)By changing the designing and cutting process.

The strategy of downsizing (or better call it ‘right-sizing’), and appointing right person for the right job

could be adopted. Further, we should identify the skill-gaps in the personnel at regular periodical intervals,

and train them suitably on a regular basis. Timely initiative for succession planning is a must, so that no

vacuum may get created to the detriment of the organization. Besides, offering competitive remuneration

packages, motivating people through empowerment, and linking compensation to performance, could be

the right strategies towards managing and controlling costs, on all fronts.

Adoption of the activity-based costing technique, most judicially, especially in such units where the

percentage of indirect costs (overheads) constitutes a much larger percentage (as compared to the direct

materials and labour costs), will result in valuable savings.

Some Key Factors for Success

(i)All functionaries must be always alert and conscious of controlling total costs.

(ii)There must be some objective yardstick and method of measuring the total cost.

(iii)Well-defined responsibility area and responsible person be in place for cost control.



(iv)Above all, there must be a strong will on the part of the management and the employees towards the

total cost improvement and all-round cost effectiveness.

Total Cost Management does not seem to have picked up in India, because of the following

factors:

(i)Our largely protected and sheltered economy, whereby inefficiency was at a premium.

(ii)The ‘cost plus’ pricing policy condition did not call for any effort to control cost.

(iii)Due to excessive restrictions imposed on imports, our economy was almost insulated from the global

competition.

But then, with our changed economic policy since the mid-1990s, and the opening of our market to

international players in various industrial and service sectors, the extent of competition has gone up

drastically, whereby the cost factor can no longer be overlooked.







COST MANAGEMENT AND CONTROL – STEPS AND STRATEGIES



479



REVIEW QUESTIONS





1. Discuss the various steps and strategies involved in the effective and efficient total cost management and

control.



2. Distinguish between ‘Structural’ and ‘Executional’ Cost Drivers with illustrative examples.

3. ‘We should treat the suppliers and customers as a part of the organization, and not apart from it.’ Discuss.

4. ‘Business Process Re-engineering (BPR) cannot succeed unless the Total Cost Management (TCM) is

already in place’. Discuss.

5. Write brief comments on the following statements:





















(i)We should compare and compete with the best.



(ii)It augurs well to have a flexible manufacturing system in place.

(iii)We should switch over from Just-in-Case (JIC) strategy to Just-in-Time (JIT) strategy; sooner the

better.

(iv)Expansion and extension of the already existing brands is preferable to the launching of an altogether

new brand.

(v)We should adopt suitable strategies to cut and control advertisement expenses.

(vi)Organizations should use Info-Tech to apply Total Cost Management across the entire value chain.

(vii)It is not enough to cut only the manufacturing costs; we should cut the non-manufacturing overheads,

too.

6. ‘It will augur well for the companies to adopt the activity based costing technique, most judicially’. Do you

agree? Give reasons for your answer.



7. (i)What are the key factors for the success of even the best cost control strategies? Give convincing

reasons for your answer.

(ii) ‘Total Cost Management in India is far from satisfactory.’ Do you agree? Give reasons for your answer,

and suggest some ways and means so as to improve upon the present position.



Part VII



PLANNING, BUDGETING AND CONTROL



PART PREVIEW

24. Corporate Planning, Budgeting and Control



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