Analysis of Strategic Management Accounting - Assignment Example

Strategic Management Accounting (SMA) extends Traditional Management Accounting’s internal focus on financial information to include external information about competitors and customers. In using SMA, the firm’s main aim is to gain competitive advantage by reducing costs to below that of competitors and differentiating its products. Davis Ltd, a computer software development company, operates in a highly competitive market. Therefore, implementing SMA could be beneficial in giving Davis Ltd a competitive advantage.

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Currently, the firm wishes to improve its competitive position through an improved reputation, increased quality of work and more motivated workers. To achieve this, they enquire if SMA could help, and if so; whether or not it is feasible to utilise SMA as a measure of performance. SMA can be split into four main sections: customer profitability, competitor analysis, strategic cost management and the balanced scorecard. The content of this report will examine these four sections, relating them to Davis Ltd and identifying whether or not implementing these strategies will help the company to meet its objectives.

The first aspect of SMA is the customer profitability analysis. This identifies customer groups and shows how profits vary between them. This is done by assigning costs and revenues to major customers or customer groups rather than to units or products. This information can be used to achieve profit maximisation by eliminating the less profitable customers. This approach could be beneficial to Davis Ltd as the cost of each customer project varies significantly and it could identify if resources are disproportionally distributed.

However, Robert Kaplan (1992)1 suggested there are 3 customer types that should be retained even in the absence of profits; this is because they can provide non-financial benefits to a company. These customer types are: new customers that promise profitable business in the future, customers providing qualitative rather than financial benefits and customers with a status that can enhance the reputation of the supplier. An advantage of this method is that Steve can carry out a detailed analysis on the customers and their associated costs.

This information can be used to improve profits by eliminating less profitable customers and therefore reduce costs. Steve can also identify which customers fit with Kaplan’s idea. For example, if a customer is found to have high status in the market, Davis Ltd’s reputation can be improved through association with this customer. Also, this method requires employees to predict the costs accurately to produce a detailed analysis. This could help overcome the problem of ‘corner cutting’ as employees do not have an unrealistic budget they must keep. However, as each project is unique, every customer has different costs and requirements.

This may mean there aren’t distinct customers or customer groups that can be identified and used for future cost prediction. Another disadvantage is due to the apportionment of fixed costs across projects. If an unprofitable customer is identified and eliminated it increases the fixed costs apportioned to other projects and could ultimately cause them to be less profitable. This could be a major problem in Davis Ltd as 30% of costs are associated with fixed assets. Finally, as it is difficult to predict the costs of projects in advance this method of SMA may be inappropriate for Davis Ltd.

Another method of implementing SMA is through a competitor analysis. Simmonds (1981)2 suggests that accounting should be more outward looking, for Davis Ltd this means looking at cost structures and strategies of competitors. SMA realises the importance of competitor analysis and how analysing competitor data can help a company develop a strategy to gain competitive advantage. Steve does not mention competitors at all, however he does realise the need for a focus on high quality products to help gain market share. He realises that customers will be comparing his services with those of competitors and therefore, needs to be doing the same.

Competitor analysis can give Steve advanced warning to market movements, so that his strategy is better prepared to deal with change. By having a higher awareness of competitors he can match or even improve on his competitor’s prices and product quality. However, the major downside to competitor analysis is that it is timely to collect data that is relevant to the companies needs. By analysing competitor’s activities, Steve will be able to adopt a strategy that will give him a competitive edge. Davis Ltd can only develop and maintain a competitive position if they know where their position currently is.

Often, competitor analysis already exists within companies; however the data is often used inappropriately. Knowing what your competitors are doing can lead to understanding how to be more appealing to potential customers and by understanding how competitors operate, Steve may be able to implement a new cost structure in the company. SMA also incorporates a new approach to managing costs called strategic cost management. Traditionally, cost management mainly concentrated on cutting costs without consulting the business’s strategy.

This often caused demotivation of staff, loss of product quality and inefficiencies; which are all elements that Davis Ltd does not want to incorporate in his business. The idea of strategic cost management is to achieve the opposite of traditional cost management, with the principle of only cutting costs if it does not undermine the business strategy. It is necessary to understand how resources are aligned with activities and understand key cost drivers before establishing ways of reducing costs. Strategic cost management includes cost driver analysis (CDA) and target cost management.

The process of CDA is to identify the main cost drivers behind the activities/processes in the business, and attempt to reduce areas of highest cost without affecting business strategy. The cost drivers may be identified using value chain analysis; an Activity-Based Costing approach, which is especially beneficial when implemented for companies with unique products such as those of Davis’. Identifying value added processes enables the company to identify whether other companies in the same market operate differently, enabling them to eliminate unnecessary processes.

It is therefore a way of measuring performance against competitors. This ties into competitor analysis; suggesting that the two could be implemented together to benefit the company in many ways. The last stage of CDA involves setting targets to monitor any changes, which, if done successfully, should motivate employees to reach for the goals. The second section of cost management is target cost management which is a Japanese approach involving working back from the market price and a given level of profitability to establish a given manufacturing cost, which becomes the target cost.

This is done on an ex ante basis which means cost reduction takes place at the design stage, rather than the traditional ex post method. If actual costs exceed this target cost, the business must achieve cost reduction through techniques such as total quality, just in time and quality circles. Having everyone involved in ensuring quality will help workers to motivate each other to strive for perfect quality and eliminate bugs in the software, which is one of the objectives that Davis Ltd wants to achieve. This, improved motivation can lead to an enhanced reputation through happier staff offering better quality service.

Davis’ would like to know if it is feasible to utilise SMA to measure performance and motivate staff. How successful strategic cost management is in measuring performance will depend on Davis’ definition of performance. If about profitability, cost management will help lower costs and, therefore, should increase profitability. If it is about efficiency, cost management should be useful in motivating staff to reduce errors in the processes of the business, and furthermore, by identifying all processes and comparing them with those of competitors, Davis Ltd will be able to eliminate any non efficient processes.

The last aspect of SMA is the balanced scorecard. It was introduced by Robert Kaplan and David Norton (1992) i?? as a performance measurement framework. The balanced scorecard is a strategic planning and management system that aligns activities to the vision and strategy of the organization, improves internal and external communications, and monitors organization performance against strategic goals. This management system enables organizations to clarify and translate their visions and strategies into actions.

It provides feedback around the internal business processes and external outcomes in order to continuously improve strategic performance. The system uses both financial and non-financial information to create short, medium and long-term targets to encourage focus on factors critical to achieving long run success. Advantages of implementing the balanced scorecard are that it provides a fully comprehensive framework for clarifying and translating a company’s strategic vision and objectives into a set of specific performance measures.

It introduces drivers of future financial performance whilst retaining financial measures of past performance. The balanced scorecard helps managers consider important operational measures and find a balanced set of perspectives so improvements in one area are not causing disadvantages to another. This enables the organisation to align and focus on implementing a long-term strategy to highlight the critical processes, and enable the firm to achieve a breakthrough performance.

The balanced scorecard accumulates four different perspectives into one single report showing the company’s performance relating to different elements of the organisation’s competitive agenda. It does this by improving quality and customer satisfaction in order to acquire and retain customers. Also to reduce new product launch times and reduce costs; it increases productivity and return on investment to eventually provide long-term growth and business improvement.

However, it has been criticized by Norreklit (2000)3 as being a poor strategic management tool because it is static not dynamic; there is no monitoring of technology enhancements or competitors actions so it cannot change quickly. It also ignores the stakeholder’s views. Furthermore, implementation issues could arise, as managers and employees may be resistant to changes in the organisational structure. The top-down structure means employees’ voices are often not heard. This is contradictory to Davis Ltd’s wishes of motivated personnel.

One main disadvantage of the scorecard is that the cause and effect relationship is too ambiguous. There is a lack of theoretical underpinning or empirical support, with studies showing lack of correlation between non-financial data and future financial performance. Also it does not take into account the impact on society or environment. The scores are not based on any proven economic or financial theory, and therefore have no basis in the decision sciences. The process is subjective and does not assess quantities such as risk and economic value.

Finally it does not provide a bottom line score or a unified view with clear recommendations of how to improve management. In conclusion, there are many aspects of SMA that could benefit Davis Ltd greatly in developing and maintaining their competitive position while still motivating staff. However, there are also aspects of SMA that may not be as helpful at obtaining goals. Nonetheless, we feel that implementation of SMA in the business would be advantageous and in the long run, benefits will outweigh the initial costs of set up and training.

Because SMA is so loose in its concept, not all parts of it need to be implemented. Guilding et al (2000)4 carried out a study of companies using SMA and found that there was wide variability in the application of the various techniques. Doing a simple SWOT analysis initially could help Davis Ltd assess their current position and thereby decide on their future strategic direction. After this we feel that the cost analysis part of SMA would be the most beneficial and that the Balanced Scorecard could help Steve see the company in a new light and help to realise the changes required.

Because no mention of competitors was given, we do not know how much competition Davis Ltd faces, even though a competitive advantage is their main goal. It seems that Davis Ltd’s main problem is controlling costs and cost estimation. SMA can help Davis Ltd to move away from unbeneficial traditional methods towards a more strategically focused system. SMA could help Steve to overcome the company’s issues and help Davis Ltd to improve its market position and maintain a high reputation.