Management Accounting 101: Strategic Cost Management - Value Chain Analysis, Porter's Value Chain Cost Drivers Linkages

What This Is

Value Chain Analysis (VCA) is a strategic management tool developed by Michael Porter that helps organizations understand the activities that create value for their customers and eliminate non-value-added activities. By analyzing the value chain, managers can identify opportunities to improve efficiency, reduce costs, and increase profitability. For example, Toyota, a leader in the automotive industry, has used VCA to streamline its manufacturing process, reducing production costs and increasing quality.

Key Frameworks & Metrics

• Porter's Value Chain: A framework that identifies primary and support activities within an organization, such as inbound logistics, operations, and marketing and sales. Managers use VCA to understand which activities create value and which can be eliminated or improved.
• Cost Drivers: Factors that affect the cost of an activity, such as volume, complexity, or technology. Identifying cost drivers helps managers understand the root causes of costs and make informed decisions.
• Linkages: Relationships between activities within the value chain, such as the impact of marketing and sales on customer satisfaction. Analyzing linkages helps managers understand how changes in one activity can affect others.
• Value Chain Analysis (VCA) Matrix: A tool used to evaluate the potential impact of changes to activities within the value chain. Managers use the VCA matrix to prioritize initiatives and allocate resources.
• Activity-Based Costing (ABC): A costing method that assigns costs to activities and then to products or services based on their consumption of those activities. ABC helps managers understand the true cost of products and services.
• Value-Added Analysis (VAA): A method used to identify and measure the value-added activities within an organization. VAA helps managers understand which activities create value for customers.
• Cost of Quality (COQ): The cost of ensuring quality in products and services, including prevention, appraisal, and failure costs. Managers use COQ to understand the cost of quality and make informed decisions.
• Six Sigma: A methodology used to improve quality and reduce defects in products and services. Six Sigma helps managers understand the root causes of defects and implement solutions.
• Total Quality Management (TQM): A management approach that focuses on continuous improvement and customer satisfaction. TQM helps managers understand the importance of quality and implement processes to achieve it.

Step-by-Step Process

1. Identify the Value Chain: Determine the primary and support activities within the organization, such as inbound logistics, operations, and marketing and sales.
2. Analyze Cost Drivers: Identify the factors that affect the cost of each activity, such as volume, complexity, or technology.
3. Evaluate Linkages: Analyze the relationships between activities within the value chain, such as the impact of marketing and sales on customer satisfaction.
4. Prioritize Initiatives: Use the VCA matrix to evaluate the potential impact of changes to activities within the value chain and prioritize initiatives.
5. Implement Changes: Allocate resources and implement changes to activities within the value chain based on the priorities identified.
6. Monitor and Evaluate: Continuously monitor and evaluate the impact of changes to activities within the value chain and make adjustments as needed.

Common Mistakes

• Mistake: Treating all costs as relevant when using ABC.
• Correction: Only consider costs that are directly related to the activity being analyzed.
• Mistake: Ignoring qualitative factors in make-or-buy decisions.
• Correction: Consider both quantitative and qualitative factors, such as strategic fit and supplier reliability.
• Mistake: Using ROI alone without considering residual income or EVA.
• Correction: Use a combination of metrics to evaluate investment opportunities and make informed decisions.

Decision-Making Tips

• When faced with a make-or-buy decision, always isolate avoidable costs and consider strategic, not just quantitative, factors.
• When evaluating investment opportunities, use a combination of metrics, such as ROI, residual income, and EVA, to make informed decisions.
• When analyzing the value chain, consider both primary and support activities, as well as the relationships between them.

Quick Practice Scenario

A company uses ABC to calculate the per-unit cost of a product that consumes 10 setups and 5 design changes. If the total cost of setups is $100,000 and the total cost of design changes is $50,000, what is the per-unit cost of the product?

Answer: $15 per unit (=$100,000 / 6,667 units + $50,000 / 6,667 units)

Explanation: The company uses ABC to calculate the per-unit cost of the product by dividing the total cost of setups and design changes by the number of units produced.

Last-Minute Cram Sheet

• Porter's Value Chain: Identifies primary and support activities within an organization.
• Cost Drivers: Factors that affect the cost of an activity.
• Linkages: Relationships between activities within the value chain.
• VCA Matrix: Evaluates the potential impact of changes to activities within the value chain.
• ABC: Assigns costs to activities and then to products or services based on their consumption of those activities.
• VAA: Identifies and measures the value-added activities within an organization.
• COQ: The cost of ensuring quality in products and services.
• Six Sigma: A methodology used to improve quality and reduce defects in products and services.
• TQM: A management approach that focuses on continuous improvement and customer satisfaction.
• Fixed costs are only fixed in the short run within a relevant range – outside that range, they can change.
• Avoidable costs are costs that can be eliminated or reduced by changing a decision or activity.
• Residual income is the profit earned by an investment after charging for the cost of capital.
• EVA measures true economic profit after charging for the cost of capital.