Manage cost strategically: Strategic cost management vs. traditional cost management

For your company to grow and effectively scale operations, you must have a plan addressing higher operating expenses. According to Intuit, 58% of growing businesses say rising costs are their greatest challenge. Strategic cost management is a tested method for companies to manage their finances and control rising business expenses. 

Learn how strategic cost management can benefit your company, and the tactics you can implement today to allocate resources more effectively and improve your firm's profitability. 

What is strategic cost management?

Strategic cost management aims to reduce costs while supporting a company’s long-term objectives. It thoroughly analyzes costs at every part of the supply chain to identify opportunities to reduce expenses and improve efficiencies. 

Unlike traditional cost-cutting approaches, strategic cost management carefully integrates into your business strategy. The goal? Reduce costs without negatively impacting business performance.

Traditional cost management vs. strategic cost management

Traditional cost management methods are reactive and short-term in nature, mostly useful to solve an immediate challenge. Because the traditional approach doesn't address long-term cost optimization goals or help reduce day-to-day cost-related challenges, it can compromise quality, employee morale, and customer satisfaction. 

Strategic cost management is a proactive, long-term approach to cost strategy. It focuses on aligning costs with long-term business objectives. The goal isn’t just to spend less—it’s to spend more wisely.

Why strategic cost management is important for your business

Strategic cost management is an important component for building and scaling operations. It helps companies align their spending with strategic goals, ensuring that the dollars a business spends more directly impact profitability. 

The business intelligence you gain from strategic cost management can help you make informed decisions about pricing, resource allocation, and product development. Greater efficiency in managing costs opens up resources that your company can put toward further growth and expansion of operations. 

Does strategic cost management compromise product quality?

Strategic cost management enables companies to reduce low-value spending without reducing product quality or strategic position. It aids companies in reinforcing their core value propositions by ensuring they spend money impactfully.

Main components of strategic cost management

When a company cuts costs, there is always the risk that the cuts will do more harm than good. If the company is not careful, quality can suffer, employees’ morale can deteriorate, and customer satisfaction can be lost. 

Rather than making indiscriminate cuts to business operations, the strategic cost management process focuses on reducing low-value costs without jeopardizing high-value activities. It consists of three primary types of analyses: strategic positioning, cost driver, and value chain.

1. Strategic positioning analysis

Strategic positioning analysis focuses on aligning a company’s spending with its competitive strategy. Companies should evaluate how they want to excel in the market. Once a business identifies its competitive advantages, spending should reinforce them. 

For example, a business that positions itself as a cost leader will emphasize efficiency and scale. This might mean investing in tools such as automation or robotics that reduce expenses and improve operational efficiencies. 

2. Cost driver analysis

Cost driver analysis involves examining operations more critically to determine which elements are the primary cost drivers. Common cost drivers include labor, raw materials, and machine hours. 

This analysis helps companies see what parts of their operations contribute the most to costs and how large their contribution margin is. Understanding the root causes of costs allows companies to address the structural causes that can lead to sustained lower expenses. 

3. Value chain analysis

Value chain analysis examines all activities involved in creating or delivering a finished product or service. It identifies how to reduce or eliminate low-value activities while investing more in high-value activities. 

When conducting a value chain analysis, companies will begin to see where they create value and where waste occurs. This is true for internal processes as well as their partnerships with external vendors and suppliers. 

The 5-step process for strategic cost management

How businesses use and implement strategic cost management will vary from firm to firm. That said, there are five fundamental steps that all companies will take when executing this analysis. 

Step 1: Plan strategies

Strategic cost management starts with critically reviewing current strategies, identifying gaps, and developing innovative changes to business operations. Proper planning is a crucial step that helps businesses establish a clear structure and consider the impact of all relevant business activities. 

Step 2: Communicate strategies

Every organization member must understand the “what” and “why” of the changes you plan to make. The surest way to get everyone on the same page is through clear and robust internal communication. Investing in communication strategies leads to better alignment and accelerated company development of the proposed changes. 

Step 3: Analyze strategy performance and change recommendations

Once businesses identify strategic cost reduction strategies, they should critically analyse the proposed change recommendations. Part of this process should involve internally consulting on the cost-reduction strategies. 

Techniques companies may see value in including ABC, driver analysis, and benchmarking. Business technology tools and software, such as Intuit Enterprise Suite, can supplement your analysis, allowing you and your firm to uncover deeper and more impactful insights.

Step 4: Establish the right tactics and methods to execute the planned strategies

After finalizing the cost management strategies, businesses must develop an implementation plan. This step should consider internal policies, procedures, and best practices and use these insights to create a step-by-step strategic financial plan to get stakeholder buy-in. 

In addition to an internal review, an external review of competitors’ best practices can increase the chances of successfully implementing change. Reviewing what your competitors do well helps to bolster your cost management strategies. 

Step 5: Implement and track strategy success 

Finally, once businesses complete all steps of the plan, they will implement the recommended strategic cost management techniques. Along with implementation, companies should monitor KPIs that track the impact and efficiencies of improvements made. Regularly reviewing and tracking performance is the best method to achieve desired results.

9 common strategic cost management tactics

There are several tactics companies commonly use in strategic cost management: 

1. Activity-based costing (ABC) technique

Activity-based costing (ABC) evaluates the specific costs tied directly to an activity within the production process. It is an effective method for allocating overhead and indirect costs more accurately than other costing methods. 

Whereas traditional cost accounting looks at the process as a whole, ABC accounting focuses on individual activities as cost drivers. This helps companies identify low-value processes to improve or remove. 

2. Total quality management technique

Total quality management seeks to improve the overall quality of products while reducing costs. This approach closely aligns with strategic cost management, aiming to create better products and services at reduced cost. 

Total quality management is a comprehensive approach that touches on every aspect of the organization. Businesses using total quality management should closely monitor core processes, improve work culture, and strive to deliver high-quality products and services at a lower cost. 

3. Target costing technique

Target costing is the process companies use to define the maximum amount they want to spend to create a product. Companies base the target cost on competitors’ pricing and desired profit margin. 

Target Cost = Selling Price - Desired Profit

Establishing a target price early aligns product development teams with a business’s profitability goals. A cost ceiling forces engineers, designers, and other product developers to create products and processes they can produce within those parameters.  

4. Benchmarking technique

Benchmarking involves comparing your company’s processes and performance to industry best practices and standards. Reviewing how key competitors and the industry operate can help identify effective tactics and areas of improvement. 

5. Business process re-engineering technique

Business process re-engineering (BPR) seeks to redesign core business processes completely. BPR gives businesses a clean slate to work with as they rebuild their end-to-end processes. 

Key elements of BPA include optimizing work and operational processes, integrating tech like ERP software to improve efficiencies, and identifying opportunities to improve the end products and services customers receive. All these actions can significantly improve productivity, cycle times, and quality. 

6. Break-even analysis technique

The break-even point is the number of sales a company must make to cover fixed costs. Sales volumes above the break-even point are profitable, while those below generate losses. 

Determining the required sales volume aids in the risk management process. During difficult economic periods, products with high break-even points may be hard for a company to meet. These products could become major drags on profitability during a recession. 

7. Product lifecycle management technique

Product lifecycle management reviews every stage of product creation. From initial product design to customer feedback, it helps companies control costs throughout every phase of the product’s lifecycle. 

Businesses can use these insights to create new product lines more cost-effectively. 

8. Product teardown analysis technique

Using the product teardown technique entails disassembling a product and analyzing its components. Businesses can compare individual components with competitors’ products, which can generate ideas for improving the performance and quality of their existing product lines. 

9. Theory of constraints

Every product and process has at least one variable constraining performance and volume. Labor, machinery, raw materials, and market demand all create a bottleneck in operations.

The theory of constraints says that addressing the most limiting factor to production will have the biggest impact on improving profitability. 

The five focusing steps of the theory of constraints:

1. Identify the constraint - What is the key bottleneck?
2. Exploit the constraint - Ensure the constraint is working at peak efficiency. 
3. Subordinate everything else - Align other processes to support the constraint.
4. Elevate the constraint - Increase the constraint’s capacity.
5. Repeat the process.

Boost productivity and enhance profitability

Reducing costs isn’t something that just helps improve margins. When implemented as part of a strategic cost management initiative, companies can lower input and overhead costs while maintaining or improving the product and service quality they deliver to customers. 

An integrated, powerful accounting solution like Intuit Enterprise Suite can assist with your company's strategic cost management initiatives. Our solution can integrate within your entire organization, giving you the information you need to make smarter, data-driven decisions.