Changing product and market landscapes – effects on costs
Bromwich & Bhimani wrote a interesting short book in 2010 called “Management Accounting – retrospect and prospect” (see cimapublishing.com). In the book, they give a number of examples from modern business that makes us think about management accounting techniques. For example, what exactly does a company like Facebook or LinkedIn actually do? Do they offer products, services or what? Changing technologies, business markets and new ways of making/delivering products often causes changes to management accounting. For example recently I read that amazon.com now sells more e-books than paper books. Taking this e-book example, it is easy to visualise a shift in product costs. Arguably, an e-book has almost no variable costs. Instead the vast majority of costs are probably fixed – costs of running a data centre for example. This new way of doing business changes the information management accountants need and how that same information is collated and analysed. I have no idea what publishers or distributors like amazon.com do in their management accounting functions, but it is not too hard to think about how basic techniques like breakeven (CVP) analysis would change due to the changing cost structure.
Rising prices, holding prices – Primark holds retail prices steady
With some commodity prices on the rise, and continued economic woes, some businesses are holding retail prices and reducing margins. Associated British Foods, which includes the low price high-street retailer in Primark (UK/Ireland and some European countries) is an example. In late April 2011, the company reported it wished to absorb material price increases rather than pass them on to end-consumers. Increasing sugar and cotton prices reduce the company’s margins. However the CEO reported that the company did not want to relent it’s status as a low price retailer in the clothing sector.
Saving money by “greening” buildings.
According to an article in Time (April 18, 2011), a lot of money can be saved by retro-fitting old buildings. I have written a few posts already about this, but this article gives some really good examples of the kind of money that can be saved from some relatively simple initiatives. According to the article, older skyscrapers are one of the worst type of buildings in terms of energy efficiency. Some investment in lighting, heating and insulation can make a huge difference to costs and energy efficiency. For example, the Empire State building spent $13m in 2010 on a retrofit. The result is a 38% decrease in utility bills and a payback period of less than three years. Another example is a re-fit of a federal building in Cleveland, which saves $600,000 per annum. The city of Melbourne, Australia is also mentioned. The city’s Lord Mayor sums up well – “this is not some feel-good environmental initiative. It is a hard-headed economic business decision.
Australia plans to impose carbon tax
Many young Irish people (and other nations too of course) are making their way to Australia to seek employment and/or better their career prospects. The Australian economy seems to be booming based in its natural resources and its closeness to the Chinese markets – who consume huge quantities of these resources. This boom may be affected somewhat by the imposition of a carbon tax from 2012 on all firms emitting more than 25,000 tons of CO2 per annum. This will increase the output costs, which may affect consumer spending. To balance the affect, the Australian Prime Minister has promised some tax reductions. Read the full story here
Data centres costs – weather is a key factor
(Image from Economist.com)
A few weeks ago I was listening to the radio in the car. A news item came on about why Ireland is attractive to companies like Google and Microsoft to set up data centres. It wasn’t tax, or our educated workforce. Much to my surprise it was the Irish weather. Well, I suppose all three are important, but with an ambient average temperature well below 20 celsius, the cost of cooling the data centres falls considerably. Here’s a post I read earlier from Babbages’ blog on The Economist. It gives some great detail on the costs of running these data centres Data centres: Social desert | The Economist. I have to say, as a management accountant weather conditions would not be the first thing I’d consider in cost decisions – a good reason to talk to other people in the organisation to find out what’s going on.
Who makes what for the iPhone, and how much does it cost
As a management accountant, I’m always interested in what products cost to make. In today’s global manufacturing economy, it’s even more interesting as product components are sources from all over the world. Time [May 16, 2011] provides a great example, the iPhone. According to the article, the total cost of the iPhone 5 is $179. Of this amount, $61 goes to Japanese suppliers, $11 to US suppliers, $30 to Germany, $23 to South Korea, $7 to China [where the phone is assembled], and $48 goes to other unknown sources. Given that the selling price is around $500, this means that the loins share of the added value in an iPhone about, or $321, stays within the US company. I have to say I was surprised that China contributed so little to the final value.
Problems at Honda?
Following the earth quake and tsunami in Japan earlier this year, car manufacturers faced many problems. One I have wrote about previously, namely the fact that supplies of components dried-up after the disaster due to the close-knit just-in-time management systems used. The Economist provided another example from Honda recently. Honda launched their new Civic model in April/May this year. The problem of course was whether or not the company could actually deliver enough cars to meet demand, due to production disruption and supplier problems. Other car manufacturers, particularly US ones, would of course benefit. However, for Honda the short term seems still slightly troublesome
Problems at Honda?
Following the earth quake and tsunami in Japan earlier this year, car manufacturers faced many problems. One I have wrote about previously, namely the fact that supplies of components dried-up after the disaster due to the close-knit just-in-time management systems used. The Economist provided another example from Honda recently. Honda launched their new Civic model in April/May this year. The problem of course was whether or not the company could actually deliver enough cars to meet demand, due to production disruption and supplier problems. Other car manufacturers, particularly US ones, would of course benefit. However, for Honda the short term seems still slightly troublesome
Setting prices in small business
Setting a price for a small business can be a challenge. Cut the price too much and you loose money. Raise the price and you loose business. An article in the New York Times recounts the experience of some US small business. The basic message is that price is not everything. One business owner recounts how the quality customers gained outstrips those lost due to a perceived high price. Here’s one story
“About three years ago a computer error caused all of the prices on Headsets.com to be displayed at cost rather than retail. With the lower prices on display for a weekend, Mike Faith, the chief executive, expected sales to soar. Instead, the increase was marginal. “It was a big lesson for us,” Mr. Faith said.”
The basic lesson from this experience is that customers don’t think price is the be all and end all. The experience of a gluten free flour business showed that competitors prices may not matter as much as one thinks too. The company managed to raise its price by 20% in the first year in business by convincing customers that the product had more added value than competing flour. The most important lesson mentioned is that costs must be covered in the price charged. Seem so obvious, but I have written several pieces on this blog about breaking even.
New report on distribution of profits
The Guardian (May 1, 2011) reported on a new proposal put forward by the High Pay Commission recently. The proposal is a very simple addition to the annual financial statements. One though which is certainty aimed at stakeholders in the broadest sense, not just investors. The proposal comes about as a result of the many high salaries and bonuses of many banking and other executives which continued to be paid despite huge losses. The idea is simple. A company will have to report on how it has distributed its profit over each of the past three years. The distribution of profits as reinvestment, dividends or pay/bonuses is to be disclosed. Some of this is already in financial statements, but the latter certainty is not easy to decipher. A simple statement like that proposed would be really useful in my view, even helping people form a view on the longer term sustainability of the business. We’ll have to wait and see if this proposal becomes a reality.
Knowing breakeven is key for any start-up business
Anyone who has started a business from scratch knows how hard it is in the early months (or even years). Lots of businesses seem to fail too in these early times. Why? Well, there are many reasons from just bad timing, to poor marketing, poor quality and so on. There is also the possibility that the business simply did not understand its costs structure and how this relates to the volume of sales needed to make a profit.
The US Small Business Administration (and similar organisations world-wide) provide good advice for start-ups. One key concept on understanding costs and volumes is called breakeven. This simply means the output level at which your business neither makes a profit nor loss. To keep it simple, if a business knows its start-up costs and running costs for the first year, it can easily work out the level of sales required to breakeven – this output level is known as the breakeven point. To work out the breakeven point, you need to separate variable costs and fixed costs. Fixed costs remain the same regardless of how much your business sells (e.g. rent) and variable costs change as the output grows (e.g. labour costs , shipping cost, material costs). For breakeven, the sales value less the value of variable cost must be equal to fixed costs; any surplus is a profit, any deficit a loss. Doing this quick sum could save many businesses from going under. In fact, as a management accountant I would suggest a breakeven calculation is included in all business plans. I would say that, but why go into business to lose money? Or at least know when you will start to make money?
Perspectives on the meaning of “cost” – a quality management perspective
I recent read a research paper from the German “ControllerVerein” whcih I found quite interesting (controlling is the German word for management accounting by the way, and a controller is their nearest to the English term”management accounting” ). The paper is about business excellence and quality programmes. What I found interesting was the definition of “cost” from a quality perspective and well as a controlling (management accounting) perspective. I’ll do my best to translate them here.
According to the Deutsche Gesellschaft fuer Qulaitaet (DGQ or German Quality Assoc in English) costs are:
The value of physical and intangible materials, activities and other tasks which realise and subsequently recovery a product or service.
The above definition has some added notes too:
- These costs should include providing and maintaining the necessary capacity (of the product)
- Too many error and failure costs are indicators of a need for organisational and process improvement.
Now here’s the definition of costs from the Internationler Controller Verein (a leading German management accounting body):
The value of goods and services used in the creation/delivery of business activities. The cost is calculated according to management needs. Different costs may be used according to the decision being made, the type of product or the organisational structure.
So what’s the difference between these two definitions? I think the most obvious one is the time focus of each. In management accounting, we are sometimes criticised for providing too much short-term information. For example, one criticism of traditional budgeting techniques is its short-term focus. Looking at the definition of cost from the DGQ above, it clearly perceives cost as a longer-term concept. Yes, management accounting does have techniques like “life-cycle costing” which makes us consider longer-term costs of product or services, but this is a more “specialised” technique and not normally within the armaments of the typical management accountant. Although having said that, nowadays the increased focus on longer-term sustainability has focused management accountants on much broader and longer-term concepts. However, I can’t help but think if the basic definition of cost were broadened to embrace longer term thinking, like how costs are perceived by quality professionals, it would be of great benefit to us.
Just in case or just-in-time?
Just-in-time is a management concept originating from Japan. The basic idea is that everything happens “just-in-time”; materials and supplies arrive just in time for production to start, and production finishes just in time for the customer to take it. With not much room of error, if a supplier fails to deliver goods on time production is disrupted and may even cease. Normally companies that use the just-in-time philosophy have close supplier relationships and tend not to run into supply problems. The savings from reduced inventory levels are obvious. Recent events in Japan however have raised issues about how tight things can get with just-in-time. A disastrous earthquake/tsunami in March this year left parts of Japan’s east cost in ruins. Factories were destroyed and power supplies disrupted for months. An article in The Economist (March 31, 2011) mentions how global firms are re-thinking how the manage production following events in Japan. According to the article, one company that controls 90% of the market for a resin is in smartphones had ceased production. Another company which supplies 70% of the global supply of a polymer used in iPod batteries is also out of action. And, car manufacturers in Japan and America have had to cut back on production as parts are in short supply. The events in Japan have prompted some commentators to say a “just-in-case” systems is also needed, according to the Economist.
Performance related pay – some food for thought BA v Banks
Image from slate.com
We’ve all heard the rumpus about bankers getting bonuses while the bank is still loss making. I can’t say I agree at all, as I can’t see a reason why someone should be substantially rewarded when losses are being made. While reading the news recently (April 1, 2011), I noted that British Airways CEO Willie Walsh, did not take a bonus for two years while the company was loss-making (see here). Contrast that to Royal Bank of Scotland. According to the Guardian, bonuses totalling £950m are to be paid out despite £1.1 billion in losses. Or out another way, the loss would be £150m if no bonuses were paid out. I am not getting into the personalities or the companies, but surely what the likes of BA have done is both logical and financially sound.
Opportunity costs of losing employees
If you have studied business or economics, you’ll know what an opportunity cost is. Just in case, an opportunity cost is the cost forgone by choosing one course of action over another. I often ask my students ” what is the opportunity cost of who sitting here listening to me? Can you put a money value on it?” Usually one or two of them realise that they could be out working, so they answer with the minimum wage rate, which is a reasonable answer.
Two things prompted me to write this post. First, someone I know was made redundant as a systems trainer a few years ago, due to the role being outsourced. Now, after much failures by the outsourcing company, that same person is back in the company as a contractor earning a tidy daily fee. Why? Well, the outsourcing/redundancy meant a huge body of knowledge was lost from the company, which to cut it short resulted in poor systems training. I wonder how much this mistake actually cost the company? WI had this thought in the back of my mind when I read a post on Marc Lepere’s Blog on the CIMAGlobal website. Marc talks about the opportunity costs of employees. It’s not something I have ever thought about, but I think he is right on the button. Marc’s company have devised too useful concepts called Cost of Replacing Talent® (CORT) and Cost of Loosing Talent®. Taking both together, you can imagine a substantial cost of losing valuable staff. In my example, the cost of loosing talent included a massive knowledge loss, which is a cost that might be hard to put a monetary value on but is a cost. Within the CORT is an estimate of the opportunity cost of replacing staff, which is something like the time in weeks it take the new staff to become effective. This could be up to 30 weeks for senior managers, according to the post. So be careful when putting too much pressure on your staff; losing the good ones costs more than you might think.
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