Strategic Cost Management
What the paper tests
Strategic Cost Management moves beyond cost ascertainment to decision support: activity-based costing, target and life-cycle costing, the value chain, cost of quality, throughput and theory of constraints, transfer pricing and performance measurement.
Core rules
- ABC assigns overheads through activities and cost drivers such as setups, orders and inspections; it exposes cross-subsidy that volume-based absorption conceals.
- Target costing works backwards from the market: allowable cost = competitive price − desired profit. The cost gap is closed by value engineering, not by raising the price.
- Cost of quality: prevention and appraisal are conformance costs; internal and external failure are non-conformance, with external failure the most damaging.
- Theory of constraints: identify the bottleneck, exploit it, subordinate everything else, elevate it, then repeat. Throughput = sales − material cost.
- Transfer pricing: market price where available, cost-plus where not, dual pricing to protect the seller's margin while charging the buyer variable cost.
Worked example
Setup cost totals ₹6,00,000 over 500 setups, i.e. ₹1,200 per setup. Product A needs 300 setups for 10,000 units, so its setup cost is ₹36 per unit, against ₹15 charged under machine-hour absorption. A's cost was understated and B was subsidising it. Cutting A's batch frequency or repricing A restores the margin.
Traps
- Treating sunk costs or allocated fixed overhead as relevant to a special-order decision.
- Using full absorption cost as the transfer price, which makes the buying division reject orders that still earn group contribution.
- Classifying prevention spend as waste when it is the cheapest lever on failure costs.