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Strategic Cost Analysis _at_ Capacity Decisions
Fedor Durnev
Sergey Kolmagorov

• Paint it Right!

Fabrizio Malinconico
Giorgio Ronca
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Strategic means Necessary
Strategic decisions are fundamental. They impact
on the way a company rules its business, its
activities and its operations
Managerial level
Key question
Applied to accounting
WHAT?
STRATEGY
HOW TO USE RESOURCES?
HOW TO ALLOCATE COSTS?
HOW?
TACTICS
WHAT INFORMATION TO GATHER AND HOW TO DO THAT?
WHAT AND HOW?
OPERATIONS
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and what is Strategic Cost Analysis (SCA)?

• Its the process of developing cost information

to help managers making strategic choices
Today
MAX (use of strategic resources)
Tomorrow
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So, what SCA does ?

• SCA examines the basic relationship between

the cost of providing a product or a service
The value delivered
And how? by understanding properly the
underlying causes of costs
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What does SCA take into account?

• Two main types of cost drivers
• Structural
• Capacity, set of resources and business model
  serve as variables, but only with a fundamental
  decision
• Executional
• Range of decisions lie within existing capacity.
  Decisions about product and process design,
  quality control and capacity management

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Strategic cost analysis

• Strategic cost analysis helps managers to take
  strategic decisions basing on two main points
• - clear understanding of relationship between
  costs and value delivered
• - maximizing overall profitability of limited
  resources used

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Lets make it more interesting Considering a
practical example
?
AUTOSHINE
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AUTOSHINE
?
The colours of your life
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AUTOSHINE company profile
?

• Founded by Mr. Kolmagorov in 1991 in
  St.Petersburg
• Provides a set of different services in area of
  painting cars components
• Very customized services immense number of
  combinations of coatings and colors? job is very
  complex
• Four main variables of production process
  coating, color, shape and size

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A snapshot of the production process

• Painting

Conveyor speed f (colour shape coating size)
Defects?
N
Y
Finessing
Output
Eliminated
Defects?
Y
N
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AUTOSHINE present situation
?

• The company uses only one conveyor line for all
  the production and cannot be used by different
  activities at once
• Used to take all the orders offeredwithout
  undertaking a customer strategy
• And what if the demand increases dramatically?

Problem!
NO CONSTANT AND STABLE DEMAND!
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AUTOSHINE company profile
?

• Initially, the company used the absorption
  costing method ?short-term orientation
• In fact, many paint jobs were thought profitable
  under this absorption costing analysis but.
• ...with an ABC analysis the situation appeared
  very different.

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Strategic costing
Different profitability
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ABC Vs Absorption costing
In addition, some differences refer to products
representing a large percentage of the companys
sales
Then the problem of a correct analysis of
products profitability is really crucial for
AUTOSHINE !
?
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Lets move to an ABC analysis

• ABC is a better option to guide a longer-term
  decision making? AUTOSHINE moves to an ABC
  approach
• Anyway demand is bigger than the existing
  capacity of conveyor line? the management should
  decide what to produce

?
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Lets move to an ABC analysis

• ABC doesnt take into account opportunity costs
  occurred when using bottleneck by one extra unit
  of product
• Companys profitability was stagnating despite
  evident growth of demand
• Sergey invited two consultants from Graduate
  School of Management Fabrizio Malinconico and
  Fedor Durnev.

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Capacity management key issue

• ABC-analysis does relate costs of resources to
  profitability of activities, employing them
• But it doesnt take into account alternative
  costs of capacity used!

So, what might be done? What is the best solution
for AUTOSHINE?
?
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What consultants suggest

• Either
• To use conveyor in an efficient way, calculating
  a more precise product profitability
• Or
• To introduce new conveyor line in case of
  stability of demand growth

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Plan A in action

• Lets take some different products made (types of
  orders taken).
• Lets handle some formulas
• Yield Rate (YR) 1 percentage of defects
  occurred after process
• Recovery Rate (RR) percentage of defects
  eliminated while finessing job

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Variables

• Run factor involves both the latter ones
• RF 1/(YR RR)
• Complexity factor (CF) is negatively correlated
  with a required speed of conveyor for each
  particular product
• Demand Factor (DF) RFCF
• Demand per square foot (DSF) DF/ Square feet
  required by different products

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The result

• The two advisors suggest a new measure, PTU that
  stands for
• Adjusted Product Profit per Throughput unit
  profit per sq ft/Bottleneck demand per square
  foot
• PTU Profit per unit/(square feet per unitBDF)
• PTU is just the metrics of product profitability,
  taking into account alternative costs of using
  shared capacity.

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Improving the PTU

• The management can promote a specific product
  related to the shift of demand
• The ultimate goal is to find the optimal product
  mix ? the combination of products with the
  highest PTU
• BUT HOW?
• By working on each different variable that is
  directly related to PTU

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Plan B

• The two consultants gave also a different
  framework to be implemented
• If the demand is expected to grow steadily and
  constantly, why not invest in capacity?
• How?

Adding a new conveyor line!!!
More attention to accounting!!!
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To sum up
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• 2 scenarios for AUTOSHINE

Change in the demand mix
Constant increase in demand
Variations in the demand for different products

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• THANK YOU!!!GRAZIE!!!
• ???????!!!

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• Questions?