Finance departments are under considerable pressure to reduce expenditures due to the economic fallout from the COVID-19 pandemic. But simply cutting spending without a long-term view in mind can have damaging effects long term.
Instead of engaging in arbitrary cost-cutting to save money now, finance departments need to implement strategic cost management — or the application of techniques that improve the competitive position of a business while simultaneously reducing expenditure. Strategic cost management is therefore focused on cost optimisation — as opposed to mere cost-cutting — and enhancing the long-term competitive advantage without merely improving the bottom line of one financial year.
Several years ago, we conducted a case study of strategic cost management in the South African automotive industry. The participants of the study included professionally qualified accountants and managers.
While our research was on a specific industry and location, it provides lessons that can aid other management accountants as they try to navigate the financial imperatives brought on by the pandemic.
Our research has shown that for cost management to be effective, it must be strategic and aligned with company goals. It also revealed a need for the company to broaden the finance division’s ability to operate cross-functionally and to perform beyond the confines of accounting standards.
A little background
Motor vehicle manufacturers focus on relentless cost reductions to lower prices through efficiency improvements, improved productivity, and relocation of manufacturing closer to markets with high demand to avoid logistics expenses, trade barriers, and currency risks.
As in other industries, cost management, with specific emphasis on driving expenses down without compromising quality, remains a priority. Studies show that short-term cost-cutting (short-termism) often harms organisations across industries and can even — perversely — ultimately increase costs. Moreover, past research has shown that reactive cost-cutting and business restructuring proved to do little to reduce total expenses or improve the bottom line.
Our research found that many automotive manufacturers have failed to learn from the mistake of others in the industry by making cost-cutting their major goal. If it is instead managed with a strategic approach, it will result in considerable value for the company through reduced costs and competitive advantage.
This was demonstrated by Hyundai Automotive Group in 2006, when its chairman ordered a 30% reduction in costs. The company did not execute sweeping cuts across the board but instead chose to adopt a strategic approach by exempting value-adding activities from the trimming of expenditure.
This involved proactively supporting and agreeing to cost increases from suppliers involved in providing engineering, design, and quality improvements. The company also chose not to cut back on research and development expenditure, nor to curtail expansion programmes in key markets such as the US, China, and India. The successful implementation of cost reduction through productivity enhancements helped the company to enhance brand value globally and increase sales domestically.
However, cost-cutting in isolation has its limits, and sometimes strategic cost management is best approached in partnership with other firms. An example of this is the announcement in January 2019 by Ford and Volkswagen of a strategic alliance. This partnership has since expanded. Ford’s CEO, Jim Hackett, describes this alliance as a method to save money through shared engineering.
Strategic cost management must follow corporate strategy, as evidenced by the Ford-Volkswagen alliance. If the corporate strategy within this alliance fails to maintain its pace and momentum, the financial results can be expected to lose steam as well.
Key actions for integrating strategy and strategic cost management
The finance function requires effective, decisive, and inspirational leadership to create a strong link between strategy and strategic cost management.
The head of the finance function should drive corporate governance and compliance in strategic cost management. Finance personnel should incorporate “strategic thinking” when addressing cost management using the following steps:
- Communication. Strategy and its integration with strategic cost management should be clearly articulated, concise, and easy to understand.
- Cost differentiation. Differentiate between costs that are relevant to strategy and have a long-term, sustainable impact in the achievement of relevant organisational objectives versus costs that are irrelevant, add no value, and therefore are irrelevant in any form of decision-making to support corporate objectives.
- Change management. Adopt an effective change management strategy that will align strategy and strategic cost management activities. This will ensure that the finance team embraces the new strategy to associate and integrate it with cost management. It is imperative that change management embeds the objectives of job rotation and multiskilling, ensuring finance professionals work in specific business functions with a strategic focus to develop skills in understanding and developing strategies.
- Technology. Using systems and processes that integrate strategy with strategic cost management is crucial in achieving a strategic focus on cost management. Technology should be an enabler for creativity and innovation in the finance function to further enhance the integration of strategy with strategic cost management.
Techniques to consider
Several contemporary strategic cost management techniques have been successfully deployed by the automotive industry that management accountants can adapt to other industries. They include:
World-class manufacturing is a model linked to the principles of the Toyota Production System, just-in-time and total quality control. Another example can be found at Fiat, which created a strategic cost advantage by reinventing the concept of world-class manufacturing (WCM). Adopting a WCM strategy contributed to an aggressive impact on cost reduction, which led to a stronger strategic position for Fiat. However, a limitation of WCM is that cost reduction is restricted within the boundaries of the factory; this means that other core operations such as sales and marketing do not benefit from cost reduction associated with WCM.
Product teardown analysis is a method of comparative analysis in which disassembled products, systems, components, and data are visually compared and their functions determined, analysed, and evaluated to improve the value-adding characteristics of the project under study. General Motors (GM) introduced the static teardown method to Isuzu in the early 1970s. Isuzu further developed the teardown process into a more extensive version than the original one offered by GM and incorporated it into its value-analysis and value-engineering processes.
Activity-based costing and activity-based management have been demonstrated to successfully achieve the principles of strategic cost management in wholesale distribution companies. This well-known method of reporting and managing costs, however, is notoriously difficult to implement and expensive to maintain.
Target costing is primarily a technique to strategically manage a company’s future profits. It achieves this objective by determining the lifecycle cost at which a company must produce a proposed product with specified functionality and quality if the product is to be profitable at its anticipated selling price. By estimating the anticipated selling price of a proposed product and by subtracting the desired profit margin, a company can establish its target cost. The key is then to design the product so that it satisfies customers and can be manufactured at its target cost. Both Goodyear and Mercedes-Benz make use of this model.
Product lifecycle management is the business activity of effectively managing a company’s products across their lifecycles — from the idea for a product through to its retirement and disposal.
Benchmarking is used to gain information on philosophies, practices, and measures that will help your company take action to improve its performance.
Modular platforms were successfully deployed by the Volkswagen Group to rationalise vehicle manufacturing. Modular platforms allow car manufacturers to offer vehicles that share the same engineering (interior) and only have a different design (exterior). The technology personified key principles and benefits of strategic cost management in automotive manufacturing — namely, reduction in investment development and unit costs, higher scale and efficiency effects, increased production flexibility, greater product diversification, and reduced time to market.
Breakeven analysis provides vital information on the implementation of strategic cost management as it quantifies the business risk and exposure a company faces in economically strained periods.
Innovation is based on ideas. The generation of ideas is not only vital in managing costs, but also in the improving revenue and synergies. It is clear then that strategic cost management and corporate strategy are intertwined.
Our research demonstrates that it basically comes down to the management of knowledge in such a way that it does not get lost in the corridors of the corporate offices but is recorded centrally for review and utilisation.
If success stories are to be found, what is hindering the implementation of a more encompassing strategic cost management approach? We found a lack of connection between cost management and strategy exists within our researched organisation. We found the company was reactive to cost pressures and did not demonstrate a strong business transformation capability to realise its expense-reduction targets.
We also found that finance functions often face a lack of interest in understanding cost drivers. They also struggle with poorly defined roles and responsibilities, as well as considerable focus on reporting activities at the expense of driving strategic initiatives. Addressing these challenges lies at the root of allowing the finance function to add value to strategic cost management for any company.
Costs should be managed as part of a corporate strategy and cannot be seen or driven in isolation from revenue generation. Finance professionals must become business partners by actively participating in developing and implementing corporate strategy and strategic cost management, instead of focusing only on daily accounting record-keeping.
The key obstacles we found hindering the achievement of strategic cost management included:
- Poor key performance indicator development;
- Short-term focus at the expense of long-term planning, and limitations in analytical ability and decision-making;
- The finance function’s reluctance to become a strategic business partner;
- Limited management accountability; and
- Limited skills and capability to execute strategic cost management.
To overcome these challenges, a company should compile success stories and challenges of strategic cost management implementation in other companies and then develop its own overriding corporate plan. This plan should focus on developing comprehensive and effective strategic cost management initiatives tied in with revenue enhancement that will benefit the company. This will require a change in corporate mindset away from short-termism and the emphasis should be on following an integrated approach to strategic cost management and revenue enhancement.
The way forward
We recommend that current supply and value chains be optimised by, for example, holding less inventory, managing stock based on a demand pull rather than supply push strategy. Other recommendations include:
- Fast-tracking digitalisation to reduce labour-intensive costs and enhance innovation in the operational financial functions;
- Driving product innovation to reduce costs in the long term and improve competitiveness;
- Reprioritising strategies and activities to reduce costs in day-to-day operations and short- to medium-term plans;
- Identifying further opportunities for synergies within the business;
- Leveraging partnerships with stakeholders and the broader industry for operational synergies — similar to what Ford and Volkswagen did.
The role of the finance function within the company should be considerably enhanced to support the achievement of strategic cost management and revenue enhancement — ie, finance business partnering. From the outset, finance professionals need to be involved in the corporate process to ensure that cost management follows an approach that aligns with long-term goals. Firms should consider applying the Global Management Accounting Principles CIMA published in 2014.
— Ratheesh Pillai, ACMA, CGMA, is a financial controller employed in the private sector in South Africa; Alick Burger, ACMA, CGMA, is an associate professor at the Department of Accounting, Rhodes University, Grahamstown, South Africa; and Sanlie Middelberg, FCMA, CGMA, is a professor at the School of Accounting Sciences, North-West University, Potchefstroom, South Africa. To comment on this article or to suggest an idea for another article, contact Drew Adamek, an FM magazine senior editor, at Andrew.Adamek@aicpa-cima.com.