THE INSTITUTE OF COST AND WORKS ACCOUNTANTS OF INDIA

Regional Cost Convention30TH November, 2007

Strategic Management Accounting for Value Creation

P. Thiruvengadam Deloitte, India

Strategic Management Accounting

Strategic Management Accounting provides information and analysis for planning, control

and decision making from a strategic perspective

Strategic Decisions and Value

Decisions create options

Good decisions create valuable future options

Poor decisions limit future options,

The more good decisions management makes, the more valuable options a company will have

Management should seek to maximize the number of good decisions it makes each year

Insights Decisions Performance

Strategy Execution Strategy Development

Strategy Development – taking great information, ideas and insight and turning them into great strategy:

• Where to compete?• How to compete?

Strategy Execution – taking great decisions and strategy and turning them into great performance:

• What needs to be done?• How will it be accomplished?

Which is the bigger challenge in driving superior performance – strategy development or strategy execution – and how should companies best meet this challenge?

Superior Strategy Development + Superior Execution = Superior Performance

The Strategy-to-Performance Gap

What drives superior strategy execution? There is a significant gap between the performance most companies could deliver – were they to choose the right strategy and execute it in the right way – and the

results they actually produce over time

Two Underlying Causes

1. Agenda management is undisciplined and unfocused

2. Strategic planning produces too few good decisions

3. Strategy execution is poor

Three Contributing Factors

1. Decision-making• Quality • Quantity• Magnitude

2. Execution• Information• Process• People

Two broad sets of processes are involved in turning strategy into performance – planning and performance monitoring

Performance Monitoring

What Are Execution Processes?

Performance monitoring tracks actual performance relative to plan

Planning delineates the resources required to get us from here to there and the associated financial implications

PlanningStrategy Development

Strategy development determines “where we intend to go” and describes (at a high level) “how we intend to get there”

Closing the Decision-making Gap

1. Deal with operations separately from strategy

1. Focus on decisions, not discussions

2. Measure the real value of every item on the agenda

3. Get issues off of the agenda as quickly as possible

4. Put real choices on the table

5. Adopt common decision-making processes and standards

7. Make decision-making consequential

Disciplined Strategic Management

• Value-based compensation• Align with short and long term delivery• Instill enterprise-wide leadership

• Establish performance dialogues• Simple value driver dashboards• Use financial, strategic and

operating KPIs to trigger intervention

• Work on quality of forecasting over the cycle & track performance over time

• Communicate clear management guidance and/or constraints• Track resource deployment as a leading indicator• Link to team and individual targets and operating plans

• Use value goals to create new ambition for strategy• Measure performance vs. peer set• Cascade value goals to each BU

• Develop clear line-of-sight into the sources and drivers of value

• Create a single strategic agenda – priorities based on value-at-stake

• Use common standards for participation and competitive strategies

• Formulation and evaluation of strategy alternatives to drive decision-making

• Ensure strategies translated into concrete and synchronized action and operating plans

1. Ambitious & Stretching

Goals

2. Value-based Facts &

Priorities

3. Strategic Choices &

Commitments

4. Targets & Resource Allocation

5. Effective Performance Management

6. Performance-based Rewards

Value = Common

Currency

Performance Measurement

Performance Measurement is the process of collecting, analyzing,evaluating, and communicating information relative to an organization's performance and results.

Effective Performance Measurement provides information for the planning and control of organizations, and is a means of ensuring that the direction, efforts

and results of an organization are in alignment.

Performance Measurement is the process of collecting, analyzing,evaluating, and communicating information relative to an organization's performance and results.

Effective Performance Measurement provides information for the planning and control of organizations, and is a means of ensuring that the direction, efforts

and results of an organization are in alignment.

Performance Management is the integration of the results of performance measurement into management processes so that the results can influence the decisions made by the organization.

Performance Management is the integration of the results of performance measurement into management processes so that the results can influence the decisions made by the organization.

STRATEGIC

DIRECTION

BUSINESSPLANNING

PERFORMANCEMEASUREMENT

PERFORMANCEMANAGEMENT

INFORMATION FORDECISION MAKING

AND TAKING ACTION

Activity Based Management Priority Setting Impact Analysis

Performance Management

Why Performance Management?

1- To improve the breath of performance reporting (continued)...

MANAGEMENTNEEDS

INFORMATIONTHAT IS:

• High Level

• Broad Scope• Strategic

• Long-term• Top-Down

MANAGEMENTNEEDS

INFORMATIONTHAT IS:

• High Level

• Broad Scope• Strategic

• Long-term• Top-Down

TRADITIONALMEASUREMENT

SYSTEMS PROVIDE LITTLE SUPPORT TO MEET

THESE NEEDS:

• Too Detailed

• Limited Scope• Tactical Information

• Short-term• Bottom-Up

• Financials not linked to operational data

• Report only on the past

TRADITIONALMEASUREMENT

SYSTEMS PROVIDE LITTLE SUPPORT TO MEET

THESE NEEDS:

• Too Detailed

• Limited Scope• Tactical Information

• Short-term• Bottom-Up

• Financials not linked to operational data

• Report only on the past

Why Performance Management?

2- To counter-act the phenomenon of “Strategy Dilution”:

Strategy Dilution is the gradual erosion of understanding of strategy and direction the lower in an organization you go. Measures link process performance directly to strategy. Developing a measurement framework which cascades down through the organization and allows results to be pyramided-up builds organization understanding and reduces "dilution".

Why Performance Management?

3- To establish accountability for results throughout the organization - At the Corporate level At the Business line level At the Product level At the Process level At the Functional level At the Team level At the Individual level Linkages at all levels allow individuals to

understand their role and expected contribution to the achievement of corporate objectives and goals.

Why Performance Management?

4- Used as a dashboard, the use of a Performance Management framework also allows management:

To assess strengths and weaknesses of business processes

To monitor performance of major improvements efforts

To better understand root cause performance

To make strategic decisions To more effectively manage the

business

Management Dashboard

A new framework is required that encompasses three types of measures: Business Performance Measures, Management

Accounting Measures, and Diagnostic and Control Measures

Value Creation

Business Performance Measures

Management Accounting Measures

Diagnostic & Control Measures

Business Model Strategy Investment Operational

New Performance Measurement Framework

Benefits : MAC and Customer / Product Profitability

-10

-5

0

5

10

15

%

A B C D E

sector 1

sector 2

sector 3

sector 4

Business Sustaining

%

Consistent comparisons gives interesting results! High margin business is not always the most profitable!

Only 30% of customers make a positive contribution!! Product profitability identifies it’s own challenges

Product Profitability

Compare individual customersSector contribution by business

CumulativeNet Margin

Number of Customers,Ranked by Contribution

Marginal or NoReturn Customers

Negative MarginCustomers

The “Whale Curve”

CumulativeNet Margin

Number of Customers,Ranked by Contribution

Marginal or NoReturn Customers

Negative MarginCustomers

The “Whale Curve”

-15

-10

-5

0

5

10

15

20

25

30

GM%

ABM - ROT%

Servicerationalization

Cost reductionopportunities

Possible productredesign opportunities

Targets forincreased salesopportunities

-1,750

-1,200-1,000 -850

-250 -100 -50 -40

100 250 350 400750

1,000

1,7502,000

-2,000

-1,000

0

1,000

2,000

3,000

Servicerationalization

Cost reductionopportunities

Possible productredesign opportunities

Targets forincreased salesopportunities

-1,750

-1,200-1,000 -850

-250 -100 -50 -40

100 250 350 400750

1,000

1,7502,000

-2,000

-1,000

0

1,000

2,000

3,000

Value added / Non-value added

0 500 1000 1500 2000 2500

Collect Cash

Deliver Product

Manage Stock

Replenish Stock

Process Sales Orders

Manage & Source Prods

Manage Customers

£000s Costs

VANVA

Benefits : MAC Process Analysis - Invaluable Management Information

Cost to win and retain

Co

st

Time

Cost to Manufacture

Cost to sell & serve

Customer Lifetime ValuePositive lifetime value

Reven

ue

0

5

10

15

20

25

A B C D E

Manage the business

Manage finances

Deliver product

Store product

Purchase product

Process sales orders

Manage Customers

Market the business

Benchmarking - Business cost profiles

The focus is on what an organisation does, not just £’s Comparison of process costs by business = Challenge

Review of Non Value Added activities can be fruitful Supporting a review of overall customer value

The Traditional ViewCosts

Salary and wages

Social costs – general

Social costs – specific

Travel – car

Other personnel costs

Hotel & overnight

Entertainment

External services – training

External services – other

Premises costs allocation

15 further cost elements

Total

1,151

372

173

89

38

63

8

4

474

117

61

2,550

The Activity Analysis ViewActivity

Develop policy and strategy

Manage provisioning system

Manage the supply chain

Store equipment

Refurbish equipment

Dispose equipment

Issue equipment on priority basis

Maintain storage assets

Issue equipment on non-priority basis

Perform modifications and upgrades

Provide post design services

Plan the maintenance of equipment

Manage employees

Total

75

414

671

105

115

110

218

235

321

40

65

85

99

2,550

Integrating with Performance Management

Performance Management is growing in importance as companies seek to align their reward systems with their strategic imperatives. The balanced scorecard is the most common vehicle for accomplishing this goal. This typically measures an organisation’s key strategies and core processes such as customer satisfaction, innovation, operations, employee satisfaction, financial performance and value.

The strategic nature of performance measures and related targets can focus ABM measures and analysis. Then ABM can be a powerful enabler to generate cost-based, process and/or profitability performance measures which are part of a scorecard.

For example, accurate activity costs can be computed using ABM techniques and rates can be input into the Performance Management process to facilitate accurate reporting of performance measures at the operating level. Furthermore, costs and capital can be allocated directly to objects., which can then be included in value metrics.

Accountability for measures can be identified at the detailed activity level as well as the higher cost attachment point level (i.e., product, customer, channel, etc.). This is consistent with the need for measures to be cascaded throughout the organisation to be most effective.

Performance Measures

Management

Integration Aspects

Value Driver Modelling and Strategic Measurement Focus

Cost and Profitability Goals

“What If” Scenarios for simulation

Cost Driver Definitions, Measures and Volumes (Actual & Budget)

Revenue, Cost and Profitability Results

Integrating with Profit Improvement

Strategic Profit Improvement efforts are strategically focused on improving cost structures to increase shareholder value.

Activity Based Management (ABM) plays a significant role in assessing the cost of both activities and processes in identifying those processes with high impact improvement opportunities. The ability to cost the effect of asset and technology utilisation can assist in the optimisation process of asset and technology usage.

The role of ABM is extended during the implementation and embedding process of improvement opportunities. Advanced Cost Management is viewed as a core competence to realise the benefits of Enterprise Wide Cost Reduction initiatives.

ABM and performance measurement becomes an integral part of the continuous process of valuing products, processes and services.

Opportunity Identification

Embedding Improvements

Products & Services

Org

an

isati

on

al

Un

its

Pro

cesses

Performance Measures

Shareholder Value Analysis

ABM Process Costing

Portfolio AnalysisValue Drivers

Shareholder Value

Mg. A/C Principles provide asolid foundation to support:

Understanding Profitability- Understand product & customer profitability,

what to focus on / manage?- Understand differing channel costs- Understand customer cost base, i.e. cost to serve

and cost to retain- Profile the profitability of scare resource e.g.

space utilisation, FTEs etc- Understand brand costs and profitability profiles- Underpin sales and marketing campaigns by

providing customer segmental analysis e.g. socio-

economic splits, method of payment etc

Performance Management- Provide multidimensional views of the business

giving improved ways of measuring and managing

performance- Provide key KPIs to support performance reporting

e.g. Balanced Score Card- Highlight best areas for investment e.g. brand

support, internet strategy- Give transparency of costing and pricing

mechanisms on a consistent basis to provide robust

analysis to regulators- Provide internal benchmarking of processes and

activities to measure performance gaps of similar

areas

Cost Reduction- Identify high cost, low value processes to focus cost reduction effort on- Provide insights into when businesses are able to work with suppliers and customers to share costs, mutually increase profits and share benefits- Understand causality and the variability of the cost base as business changes

Shared Services / Outsourcing- Provide service menu pricing- Support process analysis and ongoing management through KPIs- Resource requirements planning through Activity Based Budgeting- Support decisions on process off-shoring / outsourcing

THANK YOU