Strategic management accounting

Back in 1981, Ken Simmonds, probably the pioneer writer on the subject, developed the above definition. He saw it as the collection of management accounting information about a business and its competitors for use in developing and monitoring the business strategy. The emphasis was placed upon relative levels and trends in real costs and prices, volume, market share, cashflow and stewardship of the resources available to the business.

More recently (1994) Professor Bromwich pointed out that adding the strategic perspective to traditional management accounting required the role of accounting to extend in two directions. First, costs need to be integrated into strategy through strategic cost analysis, and thus align costs with strategy. Secondly, to ascertain, albeit in a fairly general way, the cost structure of competitors and to monitor the changes over time. In achieving this, Bromwich also sees two distinct approaches:

• costing product attributes provided by the company’s products;
• cost the functions in the value chain which are perceived as giving value to the customer.

Traditional management accounting is perceived as inadequate since it:

• concentrates on the manufacturing and neglects the high cost post-conversion activities;
• ignores the impact of other activities;
• fails to assess the relative cost positions of competitors;
• over-reliance on existing accounting systems;

By contrast, strategic management accounting purports to place emphasis on:

• the relative cost position;
• the ways in which a company may secure a sustainable cost advantage;
• costs of differentiation i.e., what makes their product different and hence more attractive.

This article will take two approaches. First we will look at how Strategic Management Accounting adopts a different emphasis. Secondly, we will look at areas that need to be the focus of a management accounting view.

1 Strategic management accounting
One of the main exponents of Strategic Management Accounting is the American M.E. Porter. As you progress in your studies at final level, you will become very familiar with that name. His 1985 text on strategic management is regarded as a corner-stone. Porter takes a two pronged approach.

First he assesses different industries in terms of their long-term profitability. He sees five competitive forces that will contribute to a strategic equation.

(a) The threat of new entrants into the market

While it is influenced by the cost of entry into a market and perhaps the opportunity to make a profit, this threat remains. In principle, the larger the organisation and the more investment required, the less likelihood of any competition. However, students have only to look at the recent history of commercial aviation, where deregulation has allowed small airlines to enter the market and compete successfully, while the UK telecommunications industry has seen a monopoly situation turned into one of fierce competition.

New entrants can have another implication. They can expand the number of competitors without expanding the market. Entrants into the UK supermarket business have this problem. In a country of less than 60 million people, who spend about 11% of their income on food, growth in the supermarkets business can only be at the expense of rivals and the ultimate destruction of the corner shop.

(b) The threat of substitute products or services

There was a time when communication was by letter, then the telephone entered the communications market. Now we have the Internet, where people can conduct business with all the advantages of letter writing, but down a telephone line. Telephones historically relied on land lines. Now there is a whole new area of competition from mobiles.

(c) Rivalry amongst existing organisations within the industry

Again within the UK, the student needs to look no further than his local supermarket. There is intense rivalry between Sainsbury’s, Tesco and ASDA for a bigger share of the grocery and food market. At the bottom end of the market, there are a number of smaller and possibly cheaper players, while at the top, the food departments of Marks & Spencer compete against Waitrose.

On the world scale, the volume automotive industry provides a classic example. Historically, they were somewhat nationalistic and fought each other for a share of the home market. Now, as major multinationals, Ford, Volkswagen, FIAT, Toyota and GM compete on a world stage. A few smaller companies, such as Jaguar and Volvo, are gradually being swallowed up by the major players.

(d) The bargaining power of suppliers

(e) The bargaining power of consumers

These two forces have been put together because they demonstrate the impact upon corporate profitability. In each of the five forces are the constituents of profitability, prices, costs and investment. Prices are influenced by the bargaining power of consumers and the threat of substitutes. Costs are influenced by the bargaining power of suppliers and the rivalry between competitors.

R.M.S. Wilson, in his review of strategic management accounting, illustrates how these forces work both to the benefit and detriment of various industries. The forces work very favourably for the pharmaceutical, soft drinks and database publishing industries. As a result, they presently earn very attractive returns. By contrast, some of the more basic industries, rubber and steel for example, as well as some of the high value-added industries, such as video games, are under such intense competitive pressure that they are unable to generate high returns.

You should also be aware that the relative strengths of individual forces can change with time. For example, look very closely at the pharmaceutical industry. Once it was able to operate a jealously-guarded price maintenance system. The argument was always based upon the high cost of R&D and the long lead time because of testing and the need for government approval. This view is now being challenged, especially in the patent and over the counter section of the market, by the supermarkets.

Secondly, Porter poses the question about the enterprise’s relative position within its industry. The question of position is important because it influences the ability of a business to generate profits greater or less than the industry average. Above average returns may be achieved by sustainable competitive advantage. This is achieved by three basic generic strategies.

(i) Cost leadership

Here an enterprise aims at being the lowest cost producer in the industry. This is achieved by scale economies, capitalising on experience curve effects, tight cost control and cost minimisation in such areas as R&D, service, and advertising. The student should think very carefully about the latter two. Tight or over-excessive or over-zealous cost control could lead to penny wise, pound/dollar foolish decisions being made. Equally, while advertising may be an easy target for cost savings, well-directed R&D is a positive advantage. Corporations which concentrate on this strategy are Texas Instruments, Black and Decker and BIC.

(ii) Differentiation

Here an enterprise seeks to offer some different dimension in its products/services that is valued by its customers and may command a premium price. This can be achieved by image (e.g., Coca-Cola), superior customer service solutions (IBM and Dell), dealer network and support (e.g., Caterpillar), and product design (Hewlett Packard).

(iii)Focus

This has two variations — cost focus and differentiation focus. Strategies that are based upon focus i.e., the narrow segments to the exclusion of others. One obvious example was the review of the hotel portfolio held by THF when it was acquired by Granada. The basic focus strategy was to eliminate all five and two star and below hotels. These were sold off. Then the middle three and four star hotels were reviewed under the Post House and Heritage banners. Those not meeting the agreed criteria were also sold.

Porter identifies the value chain as the next approach in strategic management accounting. Value is what the customers are prepared to pay, and this is a function of the image of the product. You will see this most pronounced in the automotive industry. The volume car manufacturers Ford, GM, Rover, FIAT, Toyota, Nissan, Renault etc., have a ceiling beyond which the customer will not pay. It does not matter what refinements are fitted to a volume car, there comes a point where the customer will not pay because it is a volume car and he can move up into the next level. Market research found that this figure was about $40,000 (£24,000). At that price, a top of the range Ford with every imaginable extra could be acquired. However, $40,000 also buys an AUDI, a BMW or even a Mercedes. This is why, to move into the lucrative big luxury car market, Ford produce the Lincoln and have acquired Jaguar and Volvo, while Toyota produce the Lexus. Likewise, FIAT keep Alfa Romeo and Ferrari separate.

The value chain
This has nine elements, each with operating costs and allocated assets driven by one or more cost drivers. Some of these cost drivers may be controllable. The elements of the value chain are:

Support activities

1. firm infrastructure;
2. human resources management (and perhaps development);
3. technology development (and perhaps level);
4. procurement.

Primary activities

5. Inbound logistics;
6. Operations (or traditional production);
7. Outbound logistics;
8. marketing and sales;
9. services.

In making the analysis, attempts must be made to assess the impact of the cost drivers on each of the elements. Also, the cost of the nine elements must produce a satisfactory margin.

Once this exercise is complete, an attempt must be made to analyse one’s competitors in the same way. Strategic advantage will then be identified if the total cost of the elements is less than that of the competitors. Taking a more positive approach, assess if the margins are better than those of the competition. If they are not, then a strategy must be developed to achieve a lower cost position through controlling the cost drivers. This may mean cost savings by cost cuttings, or improving productivity.

To achieve this, the student could recall his studies of quality costs and TQM, a popular topic in recent examinations. The problem of increasing margin could be resolved by examining internal failure costs in the context of operations. Marketing, sales and service costs could be more productive if external failures were reduced. An obvious example might be the provision of an excellent customer support service provided by Volkswagen. If a Volkswagen breaks down while under warranty, a rescue vehicle comes out to it and fixes it. If it cannot be fixed, then a replacement is provided. This is very good, but very expensive, and begs the question would better investment in machinery, technology and education at the production operations level eliminate this expensive and image damaging cost?

There is always a danger with cost reduction. It just may be that the lower cost component may save money in the short term, but again create a serious failure which will damage the image of the product. Quick, efficient and courteous rectification is always impressive, but is it too late? Has irreparable damage been done to product image and customer confidence?

The Bromwich Ideal
The strategy of cost leadership tends, at best, to develop the well-worn traditions of cost accounting. Emphasis is placed upon:

This serious shortcoming is a direct result of the slavish adherence of cost accountants to what Johnson and Kaplan call in Relevance Lost (p195) "the financial accounting mentality." The excessive focus on production costs almost to the exclusion of non-conversion costs has proved disastrous. You should think carefully here. Traditional blue-collar labour costs have shrunk to around 10% of product cost. Costs of marketing, promoting, supporting the product or service must be brought into the equation for effective and meaningful strategic cost analysis.

Professor Bromwich offers an interesting potential solution. Table 1 is based upon a fast food supplier which provides prepared and partly processed products to its network of selling outlets.

The first thing that you should note is the emphasis on consumer benefits. Clearly the strategy has been to look at what the customer wants, what he looks for and then place emphasis on the costs of providing those benefits. It is these benefits that sell the product and provide the differentiation from rival products.

The categories in Table 1 may need some explanation, and clarification of illustrative costs.

Bromwich emphasises that all these costs can be collected and reported separately, doubtless in a very traditional way. You may well be relieved by this. Certainly allocation in the way Bromwich suggests would seem difficult. Even so, what is more important is that relative costs positions can be determined in the areas where the product competes, ways of ensuring a cost advantage can be readily identified, and the costs of differentiation can be highlighted and justified. This emphasises again the primary activities identified by Porter, particularly the operations, outbound logistics, (in the case of fast food — serving and presentation) and the full range of marketing.

2 Other areas of analysis
Having examined how Strategic Management Accounting differs from conventional or traditional management accounting, it is now necessary to explore further Ken Simmonds’ area of ideas. The first area must come under the general heading of competition.

The impact of competition

Before any of the analysis alluded to by Professor Bromwich can be meaningfully undertaken, it is essential to identify who or even what the competition is. Mistakes have been made in this area e.g., in the United States, Ford and GM fought each other and overlooked Toyota stealing their market, while in Europe they failed to tackle the real market leader — FIAT. In certain markets, the competition may not be another brand. Florists compete with chocolates in the social gift market, but also with wine stores and even restaurants. The tradition of taking mum out for Mother’s Day rather than giving flowers has seriously eroded one of the florist’s traditional markets.

Kotler’s analysis of competitors

Kotler in Marketing Management: Analysis, Planning and Control identifies four types of competitor:

Porter has also identified barriers to entry. Any review of competition must consider how easy it is to enter a particular market, and how lucrative and hence attractive a particular market might be. Analysis under this heading will cover:

(i) Economies of scale

Many industries such as the automotive industry, require large scale operations just to compete. The cost of establishing and equipping from scratch would be prohibitive. The Japanese achieved their success from a home-based critical mass that gave them the requisite scale economies to compete. You should also remember that scale economies are not just confined to production. The prohibitive costs of entry may be developing effective distribution and service channels. The Japanese automobile companies had to establish dealer networks, service confidence and parts availability. This was achieved by granting dealerships to disenchanted former British Leyland dealers. More recently, the Korean Daewoo, have resolved this problem by integrating distribution with their own brand name, and effectively owning the distribution and service network.

(ii) Brand loyalty

Many consumer brands have a high level of customer loyalty which would be extremely difficult to destroy. The cost of wooing loyal customers away from an established well- known brand is high. But it has been achieved, e.g., Canon has taken a substantial slice of the office copier market.

(iii) Capital requirements

This relates to economies of scale. Daewoo have broken into the volume car market backed by the other enterprises that the Daewoo Corporation is involved in. The Japanese had their home critical mass and hence economic base for moving into the world markets.

(iv) Switching costs

There is always the possibility that the customers cannot readily change. In the aerospace industry there is limited choice worldwide for major components. Certificates of airworthiness depend on aeroplanes being built of components that have been certified by the licensing authorities.

(v) Access to distribution channels

Any food product, to be successful, must get on the supermarket shelves. If the big three are prepared to add it to their array of existing products, then success is virtually assured. One obvious example is wine. Most large supermarkets provide a wide choice of wines selected from the traditional parts of Europe and on an increasing scale from Australia, New Zealand and South Africa, as well as parts of South America and California. However, wines from England are difficult to find, as are many wines from Eastern Europe and the former Soviet Union.

(vi) Non-scale disadvantages

Established companies may have advantages not readily available to new entrants. The English wine industry lacks image, it is inherently small, often forced to pool processing facilities, and has difficulty getting into major outlets.

(vii) Government regulation

Many governments are very protective. Japan has a highly complex distribution and legal system to deter competition in its own home market. France also has complicated procedures designed to keep out foreign competition.

Traditional management accounting has always ignored the impact of competition and the market. It was so involved in the introspective aspects of control that it had almost become a closed system within its own right. At strategic level the competition and the market must be considered.

Under the general heading of ‘competition’ a business should:

• establish a basis for competitive strengths,
• identify the major competitors,
• compare with the major competitors,
• identify potential new competitors.

In analysing the competition, every employee should consider himself involved. A simple example might be R. C. Townsend’s famous ‘Call Yourself Up’ technique. To test Avis’ response to potential customers, he used to call himself. The response was then compared with that of the competition i.e., Hertz.

On a grander scale, certain industries have league tables — the automobile industry monitors who has the top ten model sales each month in a manner not dissimilar to the popular music charts. The media is able to monitor listener and viewer ratings.

At the lower end of the business scale, the local convenience store owner can see how the competition has attacked him. Back in the 1960s and 1970s one of the main advantages of these stores was that they were ‘open all hours’.

Three things have threatened these businesses. First, the major supermarkets, themselves fighting for more and more of the share of a largely static food market, have started to ‘open all hours’ — some even 24 hours. The major advantage of the convenience store has been eroded. Secondly, the petrol companies, and in some cases the supermarkets, have turned petrol stations into convenience stores. Again, they are open all hours. However, they also have the third prong of this attack. Many corner convenience stores have suffered from parking and waiting regulations, so the customer has been literally driven away. The supermarket, often with an out of town site, or the garage with its ready-made space, enables the mobile customer to stop.

Leaders, challengers and followers
The market leader is the company or product that is out in front. Leadership may be reinforced by brand strength. Such companies must be ever vigilant. Leadership is never permanent, the most recent casualty being Marks & Spencer, where complacency, deteriorating quality and boring products have cost it its position as the major High Street retailer. By contrast, the challenger attacks either the leader or other competitors. In the UK, this is most pronounced in the battle of the supermarkets, with Tesco and Sainsbury’s battling it out for both the top spot and a larger share of the market. While the ‘big two’ battle it out, threats from new entrants, both from continental Europe, new players at the bottom end and the threat of the American Wall Mart present other challenges. The follower may recognise his position, know he may never take the No.1 spot and remain content. The Avis success story is just such an example. They were never going to be the number 1 for size and volume, but by adopting their famous ‘We try harder’ slogan, they increased their share of the market and became a better performing company.

Progress measurement
Strategic management accounting focuses on a larger picture and a longer term than traditional budgeting. The rapidly changing economic world means that planning horizons have shortened, and even then, projections beyond perhaps twelve months are little more than best estimates written in pencil.

Conventional financial measures have a value and under budgetary control and Economic Value Added, may be reduced to a few, if not a single financial objective. Control might be through profit, cash generation or a measure of financial return.

The Balanced Scorecard approach may utilise multiple objectives, comprising of a mix of financial and  non-financial measures. To the traditional financial measures of profit, cash generation and return might be added tender success rate, reduction in rework, proportion of revenue from new business, market share and some objective attempt at quantifying customer satisfaction.

However, there is a popular trend to try and move away from strictly quantifiable and financial measures. Strategy may need to look at a wider series of objectives that "meet the needs of the present without compromising the ability of future generations." Such a view must go beyond any limit of traditional economics and accounting measures. By looking at a very recent (March 1999) article in the ACCA’s own Accounting & Business, you will see a possible way forward for measuring strategic performance. Six measures are illustrated, viz., Diversity, Added Value, Productivity, Integrity, Health, and Development. These are then considered under different dimensions, economic, social and environmental. Table 2 illustrates the theme of Diversity, defined as an enterprise’s mix and balance of activities and human, ecological and economic resources.

Conclusion
Having read this article, the student should now be able to:

• adequately and critically define strategic management accounting;
• be aware of the shortcomings at strategic level of traditional management accounting;
• be aware of the different emphasis;
• understand the importance of the value chain;
• be aware of the contribution of Professor Bromwich’s ideas;
• understand the impact of competition and the market;
• be aware of potential measures of progress towards the objective..

Finally, you should not be a stranger to the use of non-financial information. Concepts in management accounting stress that the accounting function has access to all the data within the entity so monitoring such information should not be difficult.

References and further reading

1. Adams Roger, (1999), "Performance Indicators for Sustainable Development" Accounting & Business, March pp 16 – 19.
2. Bromwich M., Bhimani A. I., (1994), Management Accounting — Pathways to Progress, London.
3. Simmonds K., (1981) The Fundamentals of Strategic Management Accounting, London.
4. Wilson R. M. S., (1995), Strategic Management Accounting, in Ashton et al (eds), Issues in Management Accounting, 2nd edition, PHI Englewood Cliffs (NJ).