Cost efficiency for strategic capability of economy
Dr. D. Mukhopadhyay
India is attributed with a vast economy comprising of public sector and private sector manufacturing hubs. A commercial organisation’s ability to grow, survive and develop depends upon its strategic capability and cost efficiency is the pivot which ensures strategic capability to the concerned business organisation in particular and the whole economy in general. Cost management is the nucleus of cost efficiency philosophy. Cost efficiency is practiced on the foundation of efficient and judicious uses of factors of production which essentially includes land, labour, capital and entrepreneurial ability and it is the outcome of efficient management of the rewards payable to the contributors of the factors of production. The degree of cost efficiency depends on how effectively costs are managed or the ability of a firm to manage cost. The need and requirement of achieving cost efficiency is equally applicable to both the public sector and private sector organizations though the objectives of public sector organizations are different to certain extent from that of private sector organizations. Government of India is very serious in using cost and management accounting theory and philosophy of cost management and promoting cost culture in the country. In this context, the role played by the Institute of Cost Accountants of India (ICAI), formerly the Institute of Cost and Works Accountants of India (ICWAI) is vital. The name of ICWAI has been changed to ICAI and the Professional Designations of the Members of the Institute have been changed from AICWA (Associate Incorporated Cost and Works Accountant)/FICWA (Fellow Incorporated Cost and Works Accountant) to ACMA (Associate Cost and Management Accountant)/ FCMA (Fellow Cost and Management Accountant) respectively by dint of the Cost and Works Accountants (Amendment) Act, 2011 (Act No. 10 of 2012) passed by the Indian Parliament. It is evident from this that Cost & Works Accountants have been recognized by the Government as Cost and Management Accountants who remain engrossed in helping a firm to achieve the target of cost efficiency.
The seed of cost efficiency and cost management as a corporate managerial culture was sowed seventy two years ago by a group of Management Accountants by promoting the ICWAI in 1944 and the same emerged as a Body Corporate through enactment of the Cost and Works Accountants Act, 1959 by the Indian Parliament. Government of India is happy to acknowledge the role being played by ICAI in promotion of cost culture in the country. Any organization can hardly sustain the shock of intense competition in the globalised economy unless they practice cost management in order to achieve cost efficiency. Cost efficiency is the function of efficient utilisation of resources and ability to manage cost. The gulf between price and cost is the profit. Price of a product is determined by the market forces in competitive business environment and cost management is left in the hands of the producers of goods and services. It is to state that public sector organisations and private sector organisations are the twin constituents of the national economy. In public sector, cost efficiency is the political imperative in order to provide improved and affordable level of service while keeping the cost within the circumference of public finance. On the other end, i.e. at the end of the private sector organizations, cost efficiency enables the firm to offer the economic benefits at managed cost. Cost efficiency aims at building core competence of both the public and private sector firms. Profit earning capability of an economic entity is the litmus test of survival. Without cost efficiency through effective cost management, it is perhaps impossible to ensure perpetuity of a business under the business environment of competition. Customers are price sensitive and they as usual intend to trade off between the desirability of features of the products and consideration for purchase they are to sacrifice. In simplicity, the suppliers are to provide requisite value for money for the features of a particular product and customers would go elsewhere if the firms fail to do so.
Every firm operating in competitive business environment is required to drive down the cost of products in order to offer value for sacrifice of the customers measured in monetary term through judicious practice of cost management. Cost and Management Accountants (CMAs) are the expert professionals who are rigorously educated and trained to manage cost of the products or services strategically. Cost management is an art of strategic business management and CMAs are business strategists who monitor commercial performance of the firms remaining engaged in production of economic goods and services. Cost and Management Accountancy Profession’s heart is cost management and generating cost efficiency which helps the business sustain the shock of intense competition that prevail under the influence of market economy by and large. The constituents of cost efficiency include economies of scale, design of products and processes, supply cost and experience. The effect of economies of scale reduces cost per unit as the scale of operation increases. The prices paid for factors of production do have linear effect on cost structure. Thirdly, business process and product design jointly becomes the source of cost efficiency. Productivity of labour, material yields and management of working capital are of prime importance in generating cost efficiency through cost management. Finally, experience i.e. learning curve helps in generating cost advantage mainly in repetitive processes. Michael Porter’s value chain on the other end does have a positive role in accruing cost efficiency. The CMAs analyse costs involving inbound logistics, operation, outbound logistics, marketing and sales and rendering services and measure earnings in terms of margin. The margin represents excess of consideration over cost paid to the firms for obtaining bundle of values added to the inputs through manufacturing operations. Cost incurred through various primary and secondary activities need proper monitoring and reporting to the strategic level management for appropriate action.
(To be continued)
Costs have greater influence on procurement, technology adoption, human resource management practices and infrastructure development. Value chain management by the CMAs ensures achieving cost efficiency and consequently developing strategic capability of a firm. It helps the firms in establishing those economic activities which provide the customers monetary value they want and this is possible with the managerial action advised by the CMAs. Moreover, the areas of weakness in the entire value chain are identified and placed before the management for appropriate action in order to take the firm to the desired level of prosperity. The purpose of value chain analysis is to ascertain how a firm creates value. A firm has to outperform its rivals in order to lengthen its stay in the market. The theory of Product Life Cycle (PLC) helps a lot in generating cost efficiency. PLC comprises of four stages and they are introduction, growth, maturity and decline. A product is attributed with different characteristics of revenue, cost profit and investment at each stage of its life cycle. Sales-revenue and profitability of a product are subject to change in each of the four stages of life cycle and cost management thorough cost analysis ensures cost efficiency for the concerned product. A product failing to be in the bracket of cost efficiency cannot sustain in the long run and more specifically it meets untimely death. During introduction stage, unit cost of a product is high because of low output and high promotional expenses. At the growth stage, high capital investment is felt to be necessary in order to meet the market demand which leads to low cash flow and it is even lower than profit and even sometimes a negative cash flow becomes a reality. During maturity stage, profit becomes healthier, investment becomes low and cash flow becomes certainly positive. Moreover, prices of the products start to decline since the firms face stiff competition. Decline stage in the PLC becomes very dangerous to any firm.
At this stage, sales decline considerably at high rate and there remains over capacity of production in the industry. Degree of competition is severe, profit falls and it compels some producers to leave the market. Therefore, cost management, profitability analysis and securing cost efficiency is the prerequisite at each and every stage of PLC and it is part and parcel of strategic management. The business undertakings should take into cognisance the importance of cost management as a tool for securing, survival, sustainability, growth and perpetuity of existence in the market. Cost management is strategic management tool and it is the cause whereas cost efficiency is the effect and it is difficult to think of one without the other and therefore cost management and cost efficiency can be used interchangeably. Cost management is the core function of the Cost and Management Accountants (ACMAs/FCMAs) in particular and it is the most valuable gift of Cost and Management Accountancy Profession in general. Strategy in simplicity stands for plan of action under different situations that prevail in dynamic economy. A business devoid of practice of cost efficiency philosophy can hardly reach its target and cost ineffective economy can hardly succeed in promoting wellbeing of the society. Therefore, every business should into consideration the role of cost management in achieving cost efficiency in order to minimise the risk of low profitability and consequently low return on investment. Cost management is science and it can deliver panacea for sustainability, growth and economic prosperity of the business. Cost efficient products can only rule the market thus it should be used as strategic management weapon in the hands of the management. Peter F. Drucker, the eminent management Scientists of the 20th Century advocated that customer is business and sales is the only window through which revenue enters into the business and all other are cost and cost efficiency is a must to retain the existing customers and cost efficiency is a must to have new customers whose presence and absence determine the rise and fall of a business.