Strategic Cost and Value Management in the Supply Chain

Author(s):

Lisa M. Ellram, Ph.D., C.P.M., CPA, C.M.A.
Lisa M. Ellram, Ph.D., C.P.M., CPA, C.M.A., Professor of Supply Chain Management, Arizona State University College of Business, Department of Supply Chain Management, P.O. Box 874706, Tempe, AZ 85287-4706, 480/965-3231, Lisa.Ellram@asu.edu

86th Annual International Conference Proceedings - 2001 

Abstract. Strategic cost management in the supply chain is an extremely broad topic. It encompasses upstream cost management issues such as target costing, understanding supplier costs, and cost drivers. It also encompasses understanding and managing downstream costs such as finished goods inventory, logistics and costs of serving customers. It includes consideration of, and response to cost pressures by customers at all levels in the supply chain. In the broadest sense, strategic cost management takes a holistic, total cost perspective throughout the supply chain. This presentation uses a research approach that identifies the leading edge of current practice and applications. It focuses on exploring "best" practices in strategic cost management among leading-edge purchasing organizations today.

The Opportunity. There has been limited literature explicitly linking strategic cost management with supply chain management in general, and with the role of supply management in particular. While this research is in process at the time of this writing, it proposes to:

  1. Identify and study a number of "best practice" organizations across several industries
  2. Explore BOTH upstream and downstream strategic cost management issues and practices
  3. Synthesize these best practices
  4. Develop a prescriptive model for world class cost management in the supply chain

Objectives. The objective of this research is to develop an understanding of successful approaches to cost management that span the boundaries of the organization to include active cost management of the supply base, and well as understanding of and influencing the customer's costs, as appropriate.

Specifically, some of the key elements to explore include:

  • Purchasing and the wider organization's use of:
    • Total Cost of Ownership
    • Target Costing
    • Cost information sharing/monitoring internally and externally

  • Understanding of supplier's cost structure and how it relates to
    • Relationship/cost management
    • Influence on next tiers
    • Documentation/improvement strategies

  • Understanding of profitability of key customers, and how this effects strategic cost management in the supply chain

  • Cost monitoring and management systems, including key cost drivers

  • Cost management goals, expectations and the impact these have on the reward structure

Clearly, the objectives of this research are broad and far-reaching, going beyond the boundaries of supply management. As part of this project, the researchers are talking to individuals from a variety of functional areas, including supply management, logistics, finance, accounting, planning, manufacturing and others as appropriate.

Preliminary Findings. Early results from the case studies conducted to date indicate that target costing is the cornerstone of strategic cost management efforts within the firm as well as outside of the firm, in the upstream and downstream supply chain. The elements of Strategic cost management include:

  • Understanding and supporting the organization's value proposition
  • Understanding the key cost drivers of the organization's processes and supply chain
  • Understanding and leveraging the organization's supply chain.

Target costing addresses these elements as follows. First, part of the target costing process involves identifying the customer's current or potential needs and wants in the marketplace, and how the organization might fill these needs. This incorporates the organization's value proposition: what business are we in, and what unique value do we provide? This also incorporates the "voice of the customer," or downstream aspects of the supply chain. The target price represents the price the customer is willing to pay. Based on how much profit the organization requires, or its budget in a not-for-profit decision, a cross-functional team begins working on the project to determine whether it the product or service attractive to produce.

The target cost, which is the target price to customers, less desired profit, becomes a key vehicle for communicating the financial requirements of the project. But the cost in itself is not enough. The value proposition and goals for the product or service must be constantly in the front of the mind of those working on the project, so that they are not sacrificed to meet cost goals. As the organization begins to work to develop the product or service, other members of the supply chain are brought on-board. A key customer or customers may be involved in the business-to-business arena. Key suppliers are brought in to help understand the product/service cost drivers. The team works to determine the configuration of the supply chain, everything from what should be done internally versus outsourced, to the types of technology used to produce the product or service, to the type of distribution network that will deliver the product to the consumer. Target costing helps focus the design process on life cycle cost issues across the supply chain.

The research is uncovering the types of cost management tools that organizations use to work with their suppliers and customers, and when they best apply. In some cases, simple competitive bidding is an effective tool. In other cases, detailed "should cost" analysis involving both suppliers and customers is best. The presentation will provide some results from the case studies to give insights to those interested in expanding the use of strategic cost management in their supply chains.

REFERENCES
  • Ansari, Shahid L. and Jan E. Bell, Target Costing: The Next Frontier in Strategic Cost Management, Chicago, IL: Irwin Professional Publishing, 1997.
  • Cooper, Robin and Regine Slagmulder, Target Costing and Value Engineering, Portland,OR: Productivity Press, 1997.
  • Duffy, Roberta, "Strategic Cost Management: What's the Plan to Follow," Purchasing Today®, September, 2000, pp. 42-51.
  • Ellram, Lisa M., The Role of Supply Management in Target Costing, Tempe, AZ: Center for Advanced Purchasing Studies, 1999.
  • Ellram, Lisa M., Total Cost Modeling in Purchasing, Center for Advanced Purchasing Studies, Tempe, AZ., 1994.
  • Newman, Richard G. and K. Rhee, AA Case Study of NUMMI and its Suppliers, International Journal of Purchasing and Materials Management, vol. 26, no. 4,1990, pp. 15-20.
  • Shank, John K. and Vijay Govindarajan, Strategic Cost Management, New York: McMillian, Inc., 1993.

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