The first theme, is that products are desired for the attributes that they provide
(Lancaster, 1979), and, thus, accountants have a role to play in costing various product attributes and monitoring the performance of such attributes over time. “Attribute costing” would require accountants to embrace strategic information as well as cost information. This would entail costing the attributes or characteristics provided by goods and monitoring and reporting these costs regularly. However, information about the demand and cost factors associated with those attributes must be relative to those of current and future competitors. To survive, a firm must continue to offer the cheapest way for consumers to obtain the desired bundle of attributes. Bromwich stated that this may require some organizational restructuring to enable the accounting and finance functions to be situated closer to the function that require and work with this new information. In a later work, Bromwich explained that attribute costing was quite distinct from ABC and ABM: ABC/ABM costs the functions in the value chain that provide value to the customers, whereas under attribute costing it is the attributes provided by a product that customers desire which are costed (Bromwich and Bhimani,
1994, p. 128).
The second theme draws on the theory of contestable markets, which suggests that
a company needs to maintain its cost advantage over current and potential competitors
to have a sustainable strategy (Baumol, 1982; Baumol et al., 1988). This will involve
reporting on the cost structures of competitors and potential rivals, to survive in a
competitive market that is horizontally differentiated. The costs of barriers to entry
and sunk costs related to those cost barriers, requires accountants to adopt a more
external focus to cost analysis (Bain, 1965).
In their books, Management Accounting: Evolution not Revolution and Pathways to
Progress, Bromwich and Bhimani (1989, 1994) provide a commentary on the US
“relevance” debate and the state of SMA on both sides of the Atlantic, as at that time.
There are several aspects of these books that are relevant for this paper.
- Strategic cost accounting
Value chain analysis
According to Porter (1985), one important purpose of strategic cost analysis is to better manage linkages with buyers and suppliers in the value chain. A value chain is defined as “the linked set of value-creating activities all the way from basic raw material sources for component suppliers through the ultimate end-use product delivered into the final customers’ hands” (Shank, 1989, p. 50). In a value chain different types of relationships or ‘linkages’ can be distinguished: relationships between activities, relationships between Business Units of the firm, and relationships between the firm and its buyers and suppliers (Porter, 1985). This last type of relationship, referred to as ‘vertical linkages’ in the supply chain, concerns how a firm’s internal value chain is related to those of its buyers and suppliers. A linkage expresses the relationship between the performance of one activity and its effects on the performance of another activity. In other words, a linkage exists when there is a certain degree of interdependence between activities (Shank and Govindarajan, 1992). This interdependence needs to be managed by coordination mechanisms, in order to achieve efficient and effective outcomes (Thompson, 1967)
How to analyse value chain? A VCA explicitly takes account of the interdependence between activities of buyers and suppliers. In the analysis the value chain is decomposed into strategically relevant activities, and costs, revenues and assets are assigned to these ‘value activities’. For each activity the cost drivers are identified that cause its economic behavior. These steps enable the firm to analyze the behavior of costs and the sources of differentiation. When the analysis includes multiple firms across the value chain, insight is gained into how buyers’ and suppliers’ activities are interrelated in terms of cost and differentiation. To develop a sustainable competitive advantage, the last step is to use the outcomes of the analysis to control cost drivers better than competitors do or to reconfigure the value chain. In principle, Shank and Govindarajan argue, competitive advantage can be achieved either by reducing costs, while keeping value constant, or by increasing value, while keeping costs constant.
Target cost
Definition
When consider producing competitive advantage products, the LEGO should understand the customers’ preferences including assess the price they are willing to pay combine with competitors’ reaction and ensuring that the product generates the desired return to shareholders.
As we know almost 80% of a product’s costs are committed during the product design stage. Therefore the best time for LEGO to exercise effective cost control is when the bricks’ planning and design phase. Target control is a cost management tool that cross-functional team use it to design the products with core attributes customer preferences at the same time control the cost in an acceptable level. It’s customer-oriented determines the process which manager first set the competitive price then determine cost finally design product. By processing like this the frim can make sure that the product has competitive advantage as well as they can earn sustainable profit at the first time so that avoid the risk of failure.
The company uses target costing to establish concrete and highly visible cot target for their new product. To maximize cost control and enhance profit improvement, most companies set relatively aggressive target. Frequently a gap exists between the target cost and cost projects for the new product based on current designs and manufacturing capabilities. Closing the gap through cost reduction is central to the target costing process.
The world’s best practise companies have four certain commonalities in supporting the target cost that are very effective organizational structures, responded to the “voice of the customer” streamlined their product development process, and actively engaged their supply chain to achieve target cost objective.
First the LEGO’s target costing should be supported by a matrix organizational structure where a vertical functional organization combines with horizontal cross-functional trams. In detail, LEGO has three teams of major series of products: LEGO city, DUPLO and LEGO star war. Each team is cross-functional and include members from design engineering, manufacturing engineering, purchasing, production and finance. The teams implement value engineering to increase the value of LEGO’s products like their internal developed LEGO City to customers through improved designs. Furthermore, improvement of manufacturing lead to cutting half of the selection of LEGO brick colours and the number of mini-figures available is reduced a lot. +reorganization of lego’s plastic injection molding machines. This help to save raw material costs.
Second the LEGO should respond to the voice of customer, in other words, they must examine whether or not their customers are willing to pay for the design attributes. If the cost of the innovation is greater than its value to the customer, the attributes should be abandoned. For instance, when a designer wants to create a new brick or select a rare colour, he or she had better assess whether the customer willing to pay for this additional attributes.
Third, LEGO should improve their product to the direction of minimizing unique customer requirement and incorporating changes that will provide value to a large customer base. The production of each individual LEGO brick shape helped identify and reduce expensive items. The designer use exist brick shapes compare to creating new mould and colours.
Finally, in addition to internal operations, LEGO could search cost saving opportunity from its supply chain to meet target cost. As LEGO is the biggest building bricks company, they may have high bargaining power to suppliers so that they can establish inter-company teams with suppliers to achieve cost reduction goals.
Costing for quality
Definition
(TQM) In order to improve quality, an organization operates total quality management, as a result, increase customer satisfaction and financial performance. To be successful, it must be top management-driven and focus on maximizing efficiency and effectiveness, and promoting market dominance through improving systems and processes, error prevention and aligning business objective and the customer needs. The main objective of TQM is to establish a management system and corporate culture to ensure that customer satisfaction is enhanced.
(Cost of quality) Most companies are spending 15% and 20% of sales revenue on quality-related cost. Cost for quality approach collects all cost currently incurs to prevent defects and fix them after they have occurred. The cost of non-conformance can be classified into four categories: prevention, appraisal, internal failure and external failure costs.
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Prevention costs: expenditure made to prevent poor quality products or services from being produced in the first place.
- Appraisal costs: expenditure made to identify non-conformities before a product or service reaches another activity or is delivered to the ultimate customer.
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Internal failure costs: expenditure associated with products or services that fail to meet quality standards and are identified and corrected ‘before’ being delivered to the external customer.
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External failure costs: expenditures incurred because poor quality products or services are delivered to external customers. Such costs are incurred when customers discover a defect.
BUT:
- Lack of data needed to measure aspects of COQ (for example cost of product design is not included as cost of quality)
- Interdependence of some components of quality improvements ( example: prevention costs and rework costs)
- Time lag between quality improvement and full effect
- Customer profitability analysis
Definition: customer profitability analysis is the allocation of revenues and costs to customer (segment or individual) so that the profitability of those customers can be calculated. According to Porter, 20% of firm’s customers generate 80% of profits, so that find profitable customers and retain the relationship has sustainable impact on the company’s financial performance. There are few steps LEGO needs to do when target profitable segments.
Customer satisfaction as the extent to which customers perceive that their needs are met by the particular good or service they have purchased and consumed. Accordingly, satisfaction is based on the customer’s perception of value relative to the value expected from transactions or relationships with competing vendors.
According to the case, LEGO has three strongest-selling product lines: they are LEGO Star Wars, LEGO City, and LEGO DUPLO. Before analysis we assume all three products lines or segments are earning same revenues. Because there are no detail data to support the active based cost, so we can discuss the service components or attributes which they different from each other to tell the cost differences. Analysing their cost of service components, we can conclude that their production cost, distribution chain and the sale retail are almost the same and the only difference is the production of LEGO Star war and some series of DUPLO need costly licenses agreement. As a result, the customers who purchase LEGO City and most series of DUPLO are defined as the profitable segments and the customers who purchase license bricks such as LEGO Star War and a few series of DUPLO are defined as less profitability segment. For the profitable customer segments, LEGO could use Integral Award Scheme which they could provide gifts like special tailed mini-figures to customers who accumulate over a thousand LGEO bricks to build customers loyalty and facilitate company profit performances. To the less profitable customer segments in which customer prefer licenses products like Star War, Spiderman and Harry porter, LEGO could reengineering them to profitable ones by using cross selling strategy, which introduce the company’s high profit rate products to the customers in this segments. What’s more LEGO could increase the price of license products to achieve the sustain profits because the customers who crazy to cartoon characters are less price sensitive. In addition, the firm could provide new different products which combine bricks with special attributes--professional sports like LEGO NBA Basketball and LEGO soccer to take place of original costly licenses. Even though, the firm fail to reengineer the less profitable segments, the large volume of customers still absorb large amount of fixed costs.
- Performance management
There are seven frameworks for performance measurement and management.
First, value based management is a return to economic values in assessing the performance of the firm and places the concerns of shareholders above others. Ultimately, it maintains that an organisation’s strategy should be tested, based on whether it adds value for its shareholders.
Second, activity-based costing and activity-based management create a new way to manage cost. ABC focuses on the activities and processes within an organisation and is based on the principle that by controlling the activities that consume resources, costs can be controlled by source.
Third, balanced scorecard is a tool to articulate, execute and monitor strategy using a mix of financial and non-financial measures. It is designed to translate vision and strategy into objectives and measures across four balanced perspectives: financial, customers, internal business processes and learning and growth. Therefore, it focuses on all the activities that generate financial results, rather than financial side alone. Balance scorecard can act as both a control system and a management tool- in other words, it can be used for monitoring performance as well as for strategic planning.
Forth, Quality Management is prepared by companies to indicate the total cost incurred to maintain quality. The framework drives continuous quality improvement which access the costs incurred in relation to inspection of raw materials, testing equipment, rework, returns and quality training.
Fifth, benchmarking is a way of identifying potential improvements in effectiveness and efficiency, in current operations and also in considering future strategy, by looking at how the organisation’s performance compares with others. The organisation needs to look objectively at its current internal operations and then look at best practice in those areas in the organisations or other industry sectors.
Sixth, Strategic enterprise management is adopting a dynamic management activity that allows organisations to sustain competitive advantage through superior strategic management. A key driver of improved corporate performance through a SEM approach is faster and better decision-making at various levels of the organisation. This requires the capacity of capturing information from within the firm and from the external environment in which it operates, and better business performance monitoring capability.
Seventh, Six sigma is a management tool designed to cut waste and make better, cheaper or faster products or services. It does this by selecting an objective or a goal, measuring how well the company is doing against it in terms of variation and then making changes in order to achieve the Six sigma standard.
Financial measurement …..
As the LEGO company is in a growing market segment and the competitors it faced are still small (MEGA) or new entrant (Hasbro), the firm should focus to maintain its market share and reduce cost by the economies of scale and learning effort. I recommend LEGO to use balanced scorecard because it is a tool to articulate, execute and monitor strategy by using a mix of financial and non-financial measures. It is designed to translate vision and strategy into objectives and measures across four balanced perspectives: financial, customers, internal business processes and learning and growth. Therefore, it focuses on all the activities that generate financial results, rather than financial side alone. Balance scorecard can act as both a control system and a management tool. In other words, it can be used for monitoring performance as well as for strategic planning. The use of scorecard ensures that strategy and performance measurement is closely aligned. Each factor has its own objectives and accordingly measure mechanism. First, financial perspective, the objective of LEGO is maintain existing large market share at the same time earn higher profit premium. Management could use EVA which is obtained by subtracting a capital charge for the average investment in the division from divisional net income to measure LEGO’s financial performance. Second, from customer perspective, LEGO has objectives to produce high quality products in order to attract retailers and new customers, as well as cultivate customer loyalty so that retain customers. Internal process perspective refers to increase whole efficiency and eliminate waste. By Learning and growth perspective refer to produce more innovation bricks because a large amount of annual revenue of LEGO comes from launching new products. What’s more evolving manufactory process also help firm to reduce cost and increase efficiency.
Fifth, benchmarking is a way of identifying potential improvements in effectiveness and efficiency, in current operations and also in considering future strategy, by looking at how the organisation’s performance compares with others. The organisation needs to look objectively at its current internal operations and then look at best practice in those areas in the organisations or other industry sectors.
