5-1 value chain analysis and activity-based management c hapter 5 prepared by douglas cloud...

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Value Chain Value Chain Analysis and Analysis and

Activity-Based Activity-Based ManagementManagement

Value Chain Value Chain Analysis and Analysis and

Activity-Based Activity-Based ManagementManagement

CChaptehapterr

55

Prepared by Douglas Cloud

Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

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1. Describe strategic cost management.2. Discuss the importance of the value chain approach

to analyzing decision alternatives.3. Analyze an organization’s internal value chain,

dividing it into process and activities.4. Explain how process management can help improve

organizational performance.5. Determine the costs of individual activities and the

activity costs associated with various cost objectives.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

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Strategic Cost ManagementStrategic Cost ManagementStrategic Cost ManagementStrategic Cost Management

Strategic cost management is defined as making decisions concerning specific cost

drivers within the context of an organization’s business strategy, its internal value chain, and its place in a larger value chain stretching from the development and

use of resources to the final consumers.

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Elements of a Value-Chain for a Beverage-Packaging Plant

First level: Business entities

Timber Farm

PulpMill

Paperboard Manufacturer

Paperboard Converter

Beverage Company

Grocery Store

Final Customer

to second level

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Second level: Processes

Procurement Storage Display

from first level

Sell to customer

Third level: Activities

Preparing purchase

order

Receiving order

Inspecting delivery

Moving to

Storage

Paying invoice

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Usefulness of the Value Usefulness of the Value Chain PerspectiveChain Perspective

Usefulness of the Value Usefulness of the Value Chain PerspectiveChain Perspective

The goal of maximizing final customer value while

minimizing final customer cost leads organizations to

examine internal and external links in the value chain.

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The Value Chain Perspective The Value Chain Perspective Fosters Supplier-Buyer Fosters Supplier-Buyer

PartnershipsPartnerships

The Value Chain Perspective The Value Chain Perspective Fosters Supplier-Buyer Fosters Supplier-Buyer

PartnershipsPartnerships

Value Chain Perspective Focuses Value Chain Perspective Focuses on Processes, Not Departmentson Processes, Not Departments

Value Chain Perspective Focuses Value Chain Perspective Focuses on Processes, Not Departmentson Processes, Not Departments

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The Value-Chain PerspectiveThe Value-Chain Perspective

Comprehensive

Focused on the final customers

Strategic

Basic for partnerships between vendors and customers

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Structural Cost DriversStructural Cost DriversStructural Cost DriversStructural Cost Drivers

Structural Cost Drivers

Organizational Cost Drivers

Activity Cost Drivers

Making fundamental choices about the size and scope of operations

and technologies involved.

Making choices concerning the organization of

processes and activities

Performing specific units of work (activities) to serve

customer needs.

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GoalsLocationScaleScopeTechnologyComplexity

Structural cost drivers include decisions affecting--

Structural Cost DriversStructural Cost Drivers

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Organization of processes Layout efficiency Product configuration Exploitation of linkages in

the value chain Work force involvement Attitudes toward total

quality management

Organizational cost drivers include decisions affecting--

Structural Cost DriversStructural Cost Drivers

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Measures of ActivityMeasures of ActivityMeasures of ActivityMeasures of Activity

Preparing purchase

order

Receiving delivery

Inspecting delivery

Moving to

storage

Paying invoice

Number of orders

Number of orders

Number of units in order

Units in order

Number of orders

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Generic Internal ProcessesGeneric Internal Processes

OperationsInbound Logistics

Outbound Logistics

Marketing and Sales Service

Source: The basic idea for this exhibit is based on concepts contained in Michael E. Porter, Competitive Advantage (New York: The Free Press, 1985), p. 37.

Supporting Processes: Accounting, Design, Finance, Supporting Processes: Accounting, Design, Finance, Human Resources, Maintenance, and so forth.in Human Resources, Maintenance, and so forth.in

Supporting Processes: Accounting, Design, Finance, Supporting Processes: Accounting, Design, Finance, Human Resources, Maintenance, and so forth.in Human Resources, Maintenance, and so forth.in

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Representative ActivitiesRepresentative ActivitiesRepresentative ActivitiesRepresentative Activities

• Processing employee paychecks

• Developing budgets

• Determining activity costs

• Verifying the existence of recorded assets

AccountingAccounting

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• Developing specifications for products or services delivered to customers

Developing specifications for procedures to produce products or services

DesignDesign

Representative ActivitiesRepresentative ActivitiesRepresentative ActivitiesRepresentative Activities

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• Signing checks

• Obtaining financial resources

FinanceFinance

Representative ActivitiesRepresentative ActivitiesRepresentative ActivitiesRepresentative Activities

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Human Resources

•Hiring employees•Training employees

•Repairing equipment•Cleaning buildings

Representative ActivitiesRepresentative ActivitiesRepresentative ActivitiesRepresentative Activities

Maintenance

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Process MapProcess MapProcess MapProcess Map

It is a schematic overview of all the activities within a

process.

It is a schematic overview of all the activities within a

process.

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Accept shipmentyes

no

Process MapProcess MapProcess MapProcess Map

Is there anexisting order

Reject shipment

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Process MapProcess MapProcess MapProcess Map

Activity: Placing a Purchase Order

Go to file

cabinet

Open drawer containing blank purchase orders

Remove one purchase

order

Close drawer

Return to desk

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In cIn continuous improvementontinuous improvement, an , an organization’s employees organization’s employees

constantly evaluate products, constantly evaluate products, services, and processes seeking services, and processes seeking

ways to do better.ways to do better.

In cIn continuous improvementontinuous improvement, an , an organization’s employees organization’s employees

constantly evaluate products, constantly evaluate products, services, and processes seeking services, and processes seeking

ways to do better.ways to do better.wawa

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Activity-based costing (ABC) involves determining the cost of activities and tracing their

costs to cost objectives on the basis of the cost objectives utilization of units of activity.

Activity-based costing (ABC) involves determining the cost of activities and tracing their

costs to cost objectives on the basis of the cost objectives utilization of units of activity.

Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing

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Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing

Activity-based costing is used to develop cost information for the following (and other) purposes in which management might be interested:

The cost of processing a purchase order to assist in continuous improvement.

The cost of a product or service to determine the profitability of the product or service.

The cost of alternative long-distance telephone carriers to identify the carrier with the best combination of quality, service, and cost.

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Activities performed to fill customer needs consume resources that cost money.

Customer Activitiesserved by

Resources

consume

Costshave cost

money

Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing

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The cost of resources consumed by activities should be assigned to cost objectives.

Costs Resourcesassigned

to

Activities Pools

assigned to

Cost Objectives

Reassigned to

Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing

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1. Identifying activities.2. Assigning costs to activities.3. Determining the basis (activity cost driver) for

assigning the cost of activities to cost objectives.4. Determining the cost per unit of activity.5. Reassigning costs from the activity to the cost

objective in the basis of the cost objective’s volume of consumption of activities.

Operationalizing the two-stage model requires the following:

Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing

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Detroit Metal Shop produces custom metal parts in response to customer job orders. Inbound logistics

and operations for the firm is as follows:

Place Place purchase purchase

orderorder

Receive Receive materialsmaterials

Setup Setup each jobeach job

Perform Perform activitiesactivities

Inbound Logistics

Purchasing Department

Operations

Machining Department

ContinuedContinued

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PolishPolish

Operations

Finishing Department

PackPack

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Monthly Costs: Purchasing Dept.Monthly Costs: Purchasing Dept.Monthly Costs: Purchasing Dept.Monthly Costs: Purchasing Dept.

Placing Purchase Receiving Orders Materials

Purchasing agent salaries ($4,000 x 3) $12,000

Receiving room employees ($3,000 x 5) $15,000

Supervisor:($6,000 x .38 time with purchasing agent) 2,250($6,000 x .63 of time with receiving agent) 3,750

Other costs:($12,000 x 0.15 purchasing space) 1,800($12,000 x 0.85 receiving space) 10,200

Total $16,050 $28,950

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Refining into Three ActivitiesRefining into Three ActivitiesRefining into Three ActivitiesRefining into Three Activities Placing Verifying Unloading/ Purchase Purchase Unpacking Orders Orders Inspecting

Purchasing agent salaries ($4,000 x 3) $12,000

Receiving room employees: ($3,000 x 5 x 0.20 verifying time) $ 3,000($3,000 x 5 x 0.80 unloading/ unpacking/inspect time) $12,000

ContinuedContinuedContinuedContinued

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Placing Verifying Unloading/ Purchase Purchase Unpacking Orders Orders Inspecting

Carried forward $12,000 $ 3,000 $12,000Supervisor:

($6,000 x .38 of time with purchasing agents) 2,250($6,000 x .63 of time with receiving employees x 0.20 employees’ verifying time) 750($6,000 x .63 of time with receiving employees x 0.80 employees’ unloading/ unpacking/inspecting time) 3,000

ContinuedContinuedContinuedContinued

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Carried forward $14,250 $ 3,750 $15,000Other costs*:

($12,000 x 0.15 purchasing space) 1,800($12,000 x 0.85 receiving space) 10,200

Total $16,050 $ 3,750 $25,200

* Because the purchase order is verified before delivery trucks are unloaded, the space devoted to this activity is assumed to be insignificant.

Placing Verifying Unloading/ Purchase Purchase Unpacking Orders Orders Inspecting

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Cost per Unit of ActivityCost per Unit of ActivityCost per Unit of ActivityCost per Unit of Activity

Cost per unit of activity cost driver

Cost of activity

Units of cost driver=

Cost per unit of activity cost driver

$16,050

200=

Placing Purchasing Orders

Cost per unit of activity cost driver

$80.25 per order=

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Cost per unit of activity cost driver

Cost of activity

Units of cost driver=

Cost per unit of activity cost driver

$3,750

200=

Verifying Purchasing Orders

Cost per unit of activity cost driver

$18.75 per order=

Cost per Unit of ActivityCost per Unit of ActivityCost per Unit of ActivityCost per Unit of Activity

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Cost per unit of activity cost driver

Cost of activity

Units of cost driver=

Cost per unit of activity cost driver

$25,200

$800,000 (direct materials)

=

Unloading/Unpacking/Inspecting

Cost per unit of activity cost driver

0.0315 per dollar=

Cost per Unit of ActivityCost per Unit of ActivityCost per Unit of ActivityCost per Unit of Activity

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Assigning Activity CostsAssigning Activity CostsAssigning Activity CostsAssigning Activity Costs Purchase Purchase Order 1 Order 2 Total

Direct materials costs $5,000.00 $3,500.00 $8,500.00

Activity costs:

Placing purchase order $ 80.25 $ 80.25 $ 160.50

Verifying purchase order 18.75 18.75 37.50

Unloading/unpacking/inspecting ($5,000 x 0.0315) 157.50

($3,500 x 0.0315) 110.25 267.75

Total 256.50 209.25 465.75

Total costs assigned to costobjective $5,256.50 $3,709.25 $8,965.75

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Purchasing Department

$45,000

Resource Costs

Placing Placing purchase purchase

orders orders $16,050$16,050

VerifyingVerifyingpurchase purchase

orders orders $3,750$3,750

Unloading/Unloading/unpacking/ unpacking/ inspectinginspecting $25,200$25,200

Activity Cost Pool

Purchase Purchase Order 1 Order 1

$5,256.50$5,256.50

Cost Objectives

Purchase Purchase Order 2 Order 2

$3,709.25$3,709.25

Other Other purchase purchase

orders orders $36,034.25$36,034.25

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Detroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop Example

The following activity costs were determined in the Machining and Finishing Departments:

Machining Department:Setup

$ 250Conversion ($100 x 35MH)

3,500Finishing Department:

Polish ($50 x 20 labor hours)

1,000Pack ($5 x 450 kilograms)

2,250Total cost assigned to cost object

$7,000

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Machining Department

Finishing Department

SetupSetup ConversionConversion PolishPolish PackPack

Job102Job102 Other jobsOther jobs

Detroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop Example

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Detroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop ExampleDirect materials:

Order 1 $5,000.00

Order 2 3,500.00$ 8,500.00

Inbound logistics:Placing purchase order $ 160.50Verifying purchase order 37.50Unloading/unpacking/inspecting 267.75465.75

Operations:Setup $ 250.00Conversion 3,500.00Polish 1,000.00Pack 2,250.00 7,000.00

Total cost assigned to Job 102$15,965.75

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Two-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing Method

Direct Resource Costs

Costs of resources directly Costs of resources directly traceable to cost objectivestraceable to cost objectives

To Objective 1, 2, 3, through n costs

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Two-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing Method

Stage 1: Indirect resources costs are assigned to activity pools.

Cost of Resource 1

Cost of Resource 2

Cost of Resource 3

Cost of Resource n

Activity 1

Activity 2

Activity 3

Activity 4

Activity n

ContinuedContinuedContinuedContinued

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Stage 2: Activity costs are reassigned to cost objectives using an activity drivers.

Activity 1

Activity 2

Activity 3

Activity 4

Activity n

Two-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing Method

Objective nObjective 2 Objective 3Objective 1

from Direct Resource Costs

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Additional ConsiderationsAdditional ConsiderationsAdditional ConsiderationsAdditional Considerations

Because activity-based costing is not guided by financial accounting

requirements, there is wide variation in the components of ABC systems.

Because activity-based costing is not guided by financial accounting

requirements, there is wide variation in the components of ABC systems.

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Reducing Non-Value-Reducing Non-Value-Added ActivitiesAdded Activities

Reducing Non-Value-Reducing Non-Value-Added ActivitiesAdded Activities

• Movement

• Waiting

• Setup

• Inspection

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Continuous improvement and

process reengineering seek to minimize non-value-added activities.

Reducing Non-Value-Reducing Non-Value-Added ActivitiesAdded Activities

Reducing Non-Value-Reducing Non-Value-Added ActivitiesAdded Activities

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The ABC/ABM CrossThe ABC/ABM Cross

Process View (ABM)

Cost Assignment View (ABC)

Resources (What is used to do

work?)

Activities (Work)

Cost Objects (The object of

work)

Cost Drivers (Why is work

done?)

Performance Measures

(How well is work done?)

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CChapter

55

The The EndEndThe The EndEnd

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