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50 Modern Plastics & Polymers ● August-September 2005

Cost management has been defined as any cost improvement that creates and sustains value for the customer better than the competitor. Put it simply,

cost improvement is not cost reduction. Rather, it is value creation. Cost improvement can be achieved by either keeping costs constant & increasing value, or by reducing cost & keeping value constant, or increasing cost a bit & increasing value more, reducing cost & increasing value, or reducing cost more & reducing value a little. Further, the customer is at the heart of cost management and organisations have found ways to create more value for the customer at lesser cost.

Steps of cost managementMost organisations create customer value at

two levels: internal and external. The internal level comprises three activities: R&D and engineering cycle, operations and delivery cycle and post-sales service cycle. The external activity includes buyer supplier interface.

Internal levelInternal activities are the links in a chain

that create and sustain customer value. In

many industries, a part of these activities are performed outside the firm. However, these should not be viewed as silos but as links of a chain. Otherwise, one could end up improving the links and fail to address the linkages. The three internal stages address specific customer values (Figure 1). For example, the mould cost and processing cost that will be incurred at the operations and delivery cycle greatly depends upon the kind of plastics decided at the time of R&D and engineering cycle.

R&D and engineering cycle: Metals, wood, glass and polymers compete with each other. Each of them offers different value propositions to the customer. Polymers compete on many of the value parameters. However, there are difficulties to provide cost effective replacement where extreme strength, odour, etc, become critical.

For example, in the Indian context, tractors are not only used for farming but also as a medium for transporation. Imagine half a dozen heavily built farmers travelling on fenders made of plastics. Additionally, offensive odours emitted by plastic products have long been a deterrent. This problem becomes quite acute in the case of recycled plastics.

Cost management

The focusThe first article of our series on cost management explored the perspective of cost management with respect to the

plastics and polymers industry. The second article of this series focusses on the various stages of cost management

and unravels its focus. Read on…

M Hariharan

Figure 1: Customer value creation through the three stages

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Modern Plastics & Polymers ● August-September 2005 51

Customer value creation at the R&D and engineering stage, thus, becomes critical. R&D efforts to increase the strength of the polymer without compromising on the cost can go a long way in ensuring the desired customer value. Similarly for odour, plastic resin compounders try to overcome odour by replacing unpleasant smelling additives with low-odour substitutes, minimising levels of monomers in plastics, adding odour absorbers to plastics and using antimicrobial agents to prevent formation of musty odours by bacteria and fungi.

Continuous innovation leads to sustaining customer value throughout the lifecycle of the product. Innovations are critical in enhancing plastic’s performance, which include properties like better thermal behaviour, better low-temperature behaviour, ease of processing leading to lighter and cheaper packaging and, shorter cycles, innovative processes and materials to enhance shelf-life and recycling.

Electronic components are sensitive to static discharge. So, it becomes dangerous to use insulated materials such as polymers in the vicinity of sensitive components. It is therefore imperative for design engineers to understand their options well. This will help them to manufacture static safe polymers from insulated polymers.

Thus, introduction of new products in the market, reduced time to market and efforts at the design stage to plan the future cost, create phenomenal value for the customer.

Operations and delivery cycle: What is planned at the design stage is fulfilled at the operations and delivery stage. Besides, having a focus on process technology to enhance process capability, reducing the delivery cycle time and efforts to control/reduce the current cost, ensure customer value creation and sustenance.

For example, for reduction of lingering odours in the case of recycled plastics, solvent extraction and degassing during processing can help.

In the case of manufacturing containers of different colours, colour changes cause wastage of process efforts and materials. Efforts to reduce this wastage can greatly improve the flexibility of the plant to adapt to the customer’s needs of varying colours.

Biodegradable polymers are generally

considered to be costly for processing and less robust physically, when compared to conventional plastics. However, innovations at processing stage are bringing down the costs of these plastics. Sophisticated polymerisation and blending techniques are making such materials stronger and more durable. Thanks to eco-consciousness, these plastics are gaining ground these days.

The use of plastic containers - compared to glass - lead to tremendous energy savings, handling, transport and end-use wastes. Plastics requires blow moulding and thus provides flexibility of volume and variety.

Post-sales service cycle: There is a difference between the cost incurred in acquiring the product and total cost of ownership (TCO) (ie, total cost of acquiring, using and disposing the product). Many a times, one tends to look only at the purchasing cost and fails to recognise the TCO.

All innovations in design and processing are put through the litmus test at the usage stage. Ultimately, the product’s failure at the users’ end, the response of the service provider and the product & service capability to reduce TCO, impact the customer value. Impact of plastics and polymers on TCO is both positive and negative.

For example, automotive industry incorporates methodologies to ease assembly, stock control, purchasing. There is tremendous proliferation of models. Plastics offers solutions to reduce the TCO with lower processing costs and lower end-user maintenance costs. Polymers

and composites allow integration of functionalities with a substantial reduction of part number. Thus, assembly costs are greatly brought down. Possibilities of bulk colouring and in-mould decoration contribute to the reduction of finishing costs. Tooling costs are lower than that of metal; hence, easier modifications of tools that allow frequent introduction of new variants of vehicles and extension of ranges are possible. At the customer’s end, use of polymers saves the weight and thereby leads to savings in fuel consumption.

On the negative side, there are environmental issues like chemical risks, pollution, recycling risks, etc.

Managing the TCO is critical for customer value and economic value creation. Hence, processing post-sales services should be viewed as a seamless chain providing cost management solutions. Various cost management methods are used at three internal stages of value creation (Figure 2).

Buyer supplier interface Firms do not compete any more. Rather,

it is supply chains that compete. So one has to look beyond the firm to understand where and how value is created. One also has to identify and fulfill value-creating opportunities through three stages and across the value chain (starting from suppliers’ end to customers’ end). Interaction between the various players - from source suppliers to end customers - creates and sustains customer value and increases economic value. At this stage, cost management graduates from

Figure 2: Cost management methodologies

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52 Modern Plastics & Polymers ● August-September 2005

a firm level to inter-organisational cost management (IOCM) (Figure 3).

Focus of cost managementA common refrain from many CFOs is,

“Our guys in operations claim that the plant efficiency has improved by 60 per cent in the last five years; but on the contrary our ROCE has dipped from 17 per cent to 3 per cent. I wonder where all that ‘efficiency’ vanished!”

What one must understand here is that though there are systems and procedures in place - to plan & incur capital expenditure (capex), to control cost & to motivate people towards achieving their goal - these are however not an insurance against bad decisions. For example, we conducted a simple exercise in one of the companies to check whether their capex budgeting process was robust enough to validate good investments. Its operations were also quite energy intensive, and most of the capex proposals were for energy saving. Further, we added up investments made during the past three years with respect to energy savings and also added up all the ‘savings’ claimed by those investments. This process revealed that total energy savings were indeed 70 per cent of the total energy consumed by the plant. Subsequently, we suggested adding a few more capex so that by running the furnace one could ‘generate’ energy.

Causes that lead to the above include: In many organisations, ‘management

accountant tends to be an accountant

appointed by the management whose job is to justify the unjustifiable actions and rationalise irrational decisions.’ The decisions are taken and then they are justified

‘People behave in the way their performance is measured’. In many organisations, the reason for bad organisational performance is inappropriate performance measures. Many a times, managers are motivated to do the wrong things

The focus of cost management, however, addresses the first cause. One of the main purposes of cost information system is to support the decision making process. Cost information is normally required for three purposes: decision support, cost control/cost reduction and statutory requirement. The numbers required for these three purposes are different (Figure 3)

Costing is normally presumed to be an accounting function. It is run by a team of accountants, whose prime objective is ‘statutory compliance’. In the process, the cost information system (CIS) turns out to be a ‘cost accounting system’. Cost accounting systems are appropriate for meeting the statutory requirement and not for decision support and control/reduction. With its primary objective being compliance, the other two requirements lose out.

To be competitive, a company must know its sources of profit and understand its cost structure. Key decision makers must also be aware of how informed their decisions are. Further, they must be able to answer

the following questions, without much of a number crunching effort.

Customer/channel/segment decisions: How profitable are our

customers/segments? Which among them are the least

profitable and how can their profitability be improved?

Who generates the greatest profit contribution and how best can we protect them?

Which is the most profitable channel to reach our customer?

How does our competitor trigger our cost?

How cost-effective are our marketing and sales efforts?

What will be the impact of distributing to major customers via their channel rather than through our own network?

What is the implication of serving small accounts through third party logistics?

What are the maximum discount/ service packages we can afford in the next round of negotiations with our largest customers while still meeting our profit objectives?

What type of account should we focus our new business effort on, for maximum profitability?

Do our large accounts really make money? Under what conditions are we prepared to walk away from that volume and what will we have to do as a consequence?

Does this product contribute sufficiently to profitability to justify retaining it in the range?

Should we stay in this market? Product decisions:

How profitable are our products? Is it appropriate to launch the product in

this market at this price? Should we drop this product? Should we

withdraw the product from this market? Are our R&D efforts paying? Should we make or buy?

Process decisions: How cost effective are our processes? What is the cost of accommodating less

than our desired ‘batch’? Is it the right time to expand

our capacities? Are we sweating our capacities? Is our capacity excess or protective?

Figure 3: Cost management – stages and enablers

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Which material is appropriate for managing the overall cost of ownership?

If these questions can be answered with reasonable assurance with reference to their profit impact, then it can be presumed that the company’s CIS is quite supportive.

For every action there is a financial reaction

Had Sir Isaac Newton been in business, his third law would have been ‘for every action there is a financial reaction’. Whatever be the function we are in, so long as our firm is ‘for-profit’, the ultimate goal has to be the ‘bottomline’ (economic value). Cost management perspective has to be backed by the focus of cost management. Focus of cost management is to understand, articulate and communicate the ‘financial reaction’ of the firm’s actions.

Many a times accounting justification is done more as an afterthought. Or worse, accounting requirements create hurdles to cost management. What is missing in many firms is an integrated approach towards cost management with customer value creation as the perspective and the bottomline as the focus. Therefore, cost management calls for an organisational effort to integrate, and align financial analysis and customer focus.

Cost information system forms the edifice of cost management. It cannot be viewed as an extension of financial accounting system. To sustain the focus of cost management, we need a cost information system that

can articulate the financial reaction of the actions by addressing the resource consumption. (Figure 3)

Performance management system It is important to decide how you

will evaluate the effectiveness of your performance management system before you begin implementing it. What are the outcomes you want from the system and how will you measure them? Most organisations will initially focus on monitoring.

However much we plan, it all boils down to people. Firms attempt to align employee performance to the overall goal. But, inspite of this noble intention, we end up having conflicts between individual goals and firm goal; and conflict among individual goals. We end up creating conflicts, resolving conflicts and get ‘enlightened’.

No performance measurement and management system can be fully aligned ever. But, we cannot do away with them either. After all we cannot manage what we do not measure. Attempts are made by firms to have an aligned the performance measures to the business goals. (Figure 3). However, it goes out of sync more often than not.

There are two primary reasons for this: People behave in the way their

performance is measured. Individual players end up protecting their turf. Employee focus gets localised. In the process, the overall goal is lost

Performance metrics are to be aligned to the strategy of the firm. Strategy depends to a great extent, on changes in the environment. Strategy is for the future while performance metrics are for the present. There is always a time gap between changing environment and strategy alignment; and strategy alignment and alignment of performance measures

ConclusionThe perspective of cost management

is to create value for customers. And, this is achieved through three stages: design, process and usage. It is sustained through better buyer supplier interface. Further, different methods and tools are used at these three stages to ensure customer value creation.

The focus of cost management, on the other hand, is to create an economic value for the customer. A robust cost information system ensures that the financial reactions of the actions are reasonably articulated. Besides, various tools used at the stage of customer value creation also ensure economic value creation. To carry these efforts one should have a performance measurement and management system. Such a system should be aligned with the goal of the firm.

‘Cheshire puss,’ asked Alice, “Would you tell me, please, which way I ought to go from here?” “That depends a good deal on where you want to get to,” said the cat. “I don’t much care where…” said Alice. “Then it doesn’t matter which way you go,” said the cat.

M Hariharan is the

director of Savoir Faire

Management Services,

Mumbai. He has been

helping firms across sectors

in identifying their core

problem, aligning their

processes according to

customer needs and enable sustenance of

the efforts. He preaches what he practices and has

successfully trained more than 5,000 executives

on these aspects. He can be reached on

email: sfgroup@vsnl.com

Table 1: Cost information depends upon the purpose

Purpose Grammar Information need

Decision supportWhat will be the cost? (Future tense)

Incremental cost/Revenue Planned capacity utilisation differentiating between

protective capacity and excess capacity Type of cost information required for the hierarchy of

the decision maker Classification of cost based on cost drivers Classification of cost based on the cost object Customer/channel/segment/profitability, product

cost analysis / R&D, etc

Control/reduction

What should have been the cost or what should be the cost? (Present ‘p erfect’ tense)

Function wise cost Value stream cost Controllable and uncontrollable cost Cost driver analysis Based on the current capabilities/efficiencies

Statutory requirement

What was the cost? (Past tense)

As required by the specific external agency - company law, electricity regulator, cost audit, tax requirement, etc