Strategic Cost Analysis

Strategic Cost Analysis

Strategic cost analysis focuses on a firm’s cost position relative to its rivals. It involves comparing a company’s cost position relative to key competitors, activity by activity, from raw materials purchase to the price paid by ultimate consumers.

A company must know how its costs compare with rivals’ costs. Usually, disparities in cost among rival producers stem from differences in –

  • prices of raw materials and other inputs
  • basic technology
  • internal operating costs due to economies of scale, different wage rates and productivity levels, different overhead costs, etc.
  • marketing costs, sales, promotion expenses, and advertising expenses
  • Inbound transportation costs and outbound shipping costs.
  • Costs & markups of intermediaries (i.e., distribution costs).

The primary analytical tool of strategic cost analysis is a value chain. It shows values from raw materials supply to the price paid by the ultimate customer.

The chain goes beyond the company’s internal cost structure to cover all the stages in the industry chain: raw materials supply, manufacturing, wholesale distribution, and retailing.

Value chain/ activity-cost chain reveals much about a firm’s cost competitiveness. The total industry value chain or activity-cost chain includes;

  1. supplier-related activities (such as purchased inputs and inbound logistics),
  2. manufacturing-related activities (such as production and operations, marketing and selling, customer service and outbound logistics, in-house staff support activities, and general and administrative activities), and
  3. distribution-related activities (such as distributor/wholesaler and retailer activities).

Examining the firm’s chain and comparing it to that of the competitors indicate who has how much of a cost advantage/disadvantage and which cost components are responsible.

Such information is vital in formulating strategies to create a cost advantage or eliminate a cost disadvantage.

Developing the Data for Strategic Cost Analysis

Once the major elements of the value chain are identified, the next step in strategic cost analysis involves breaking down a firm’s departmental cost accounting data into the costs of performing specific activities.

A good guideline is to develop separate cost estimates for activities with different economies and activities representing a significant proportion of the cost.

Unlike traditional accounting, activity-based costing entails defining expense categories based on specific activities and assigning costs to the appropriate activity responsible for creating the cost.

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