Cost Management and Value Creation - The Missing Link - CJ McNair

Costmanagementandvaluecreation:themissinglinkC.J.McNairandLidijaPolutnikBabsonCollegeRiccardoSilviUniversityofBolognaABSTRACT

Understandingoftherelationshipbetweenthecostsofthe󰁉rmandthevaluethe󰁉rmprovidestoitscustomersisthekeytotheabilityofthe󰁉rmtoreachitspro󰁉tpotential.Fromthisperspectivethe󰁉rmneedstohaveathoroughunderstandingofitsactivities,theircostsandtheirrelationtomarketprices.Advancedcostmanagementstudiesandpracticessuggestavarietyofdifferenttoolsthathelpusunderstandtherelationshipbetweenvalueandcost.However,mostofthesestudiesprovideuswithqualitativetoolsonly.Anexceptionisstudiesrelatedtoproductcostplanning,asinthecaseoftargetcostingorvalueanalysis=valueengineering.

Thispaper,whilebeingapartofemergingliteratureonstrategiccostmanagement,extendstheexistingknowledgeoftherelationshipbetweencostsandvaluebyintroducingthevaluecreationmodel(VCM).Inparticular,theVCMmodelde󰁉nesthe󰁉rms’coststructureintermsofvalueadded,non-valueaddedbutrequiredactivities,aswellasofwaste.A󰁉rm’scoststructureisalignedwithvalueattributesembeddedinproductsandservices.TheVCMmodelseekstounderstandthetrade-offbetweenwhatthecustomeriswillingtopayforaproduct=servicebundle(value)andthecostthe󰁉rmbearstoprovidewhatthecustomerdesires.Basedonthesetrade-offs,VCMde󰁉nesvaluemultipliers,whichhelpthe󰁉rmdeterminewhichactivitiesthe󰁉rmshouldfocusoninordertodevelopacompetitiveadvantage.

1.INTRODUCTION

Understandingvalue,asde󰁉nedbythecustomer,isthebasisforcreatinganeffectivecompetitivestrategy.Valueiscreatedforcustomerswhenevera󰁉rmprovidesproductsandservicesthatmeetcurrentmarketdemand.Themarketpricerepresentstheproxyforthepresenteconomicvaluederivedbythecustomerfromtheproductorservicepurchased.Companiesthatfailtounderstandtherelationshipbetweencustomervalue,priceandcostarelikelytoexperienceapro󰁉tdisadvantageinacompetitivemarketplace.

Addressforcorrespondence

RiccardoSilvi,UniversityofBologna,DepartmentofManagementStudies,47100Forl1`,Italy.E-mail:rsilvi@sun1.spfo.unibo.itCopyright#2001EuropeanAccountingAssociation

ISSN0963-8180print=1468-4497onlineDOI:10.1080=0963810020025321PublishedbyRoutledgeJournals,Taylor&FrancisLtdonbehalfoftheEAA

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Thechallengeofrelatingcustomervalue,priceandcosthasbeenaddressedbymanyattemptsintheliteratureandpracticetoimplement‘new’costmanagementtechniques.Thesetechniquesweredesignedtoimprovecostallocationandimproveproductmixdecisions(ABC),increaseproductor󰁉rmpro󰁉tabilitythroughcostreduction(e.g.ABM,targetcosting,TQM),improvequality(TQM)anddevelopacompetitivestrategyalongthevaluechainbyusingcostinforma-tion(SCM).

Whilethesetechniqueshavebeenadvocatedasameansofproviding‘value’tothecustomer,theyhavelargelyignoredtheconceptofvaluefromthecustomer’sperspective.Forexample,activity-basedmanagementapproaches(KaplanandCooper,1998;Morrow,1992)areusedtodividetheactivitiesandcostsofthe󰁉rmintovalue-addedornon-value-addedcategories,butitremainsunclearwhetherandhowcustomers’perspectiveisembeddedintotheseapproaches.Strategiccostmanagement(ShankandGovindarajan,1993)showsthedistribu-tionof‘value’alongthevaluechain,butitignoresthenatureoftherelationshipsbetweencostsandmarketvaluechanges.Eventhoughtargetcosting(AnsariandBell,1997;Cooper,1995;Horva´th,1993;Yoshikawaetal.,1993)relatescosttoproductattributes(BromwichandBhimani,1994)itsprimaryaimremainsincostminimizationandvalueasproxiedbymarketpriceisusedonlytode󰁉neallowablecosts.Infact,contributionoftargetcostingtotheoverallcostmanagementina󰁉rmremainsofverylimitedvalue(EwertandErnst,1999).Insummary,these‘new’costmanagementtechniquesdonotenableanidenti-󰁉cationofwhichactivitiesshouldbeemphasizedandprovidenoassessmentofspeci󰁉clinkagesbetweeninternalcoststructureandexternallyde󰁉nedvalue.Furthermore,themostimportantlimitationofthesenewtechniquesremainstobetheirlimitedandmostlyinternallydrivenperspectiveof‘value’.

McNair(1994)introducesthepro󰁉tpotentialconcept,whichusescustomerperceptionsofvalueasthebasisforidentifyingandmeasuringvalue-addedcosts.Focusingonthedifferencebetweenrevenueandcustomer-de󰁉nedvalue-addedcosts,thismodelgoesontoarguethat󰁉rmpro󰁉tabilitycanbeimprovedifthepercentageofvalue-addeddollarsisincreased.Whilethisworkrepresentsanimportantstepinadvancingtheunderstandingoftherelationshipbetweenvalueandcost,thisrelationshipisonlyqualitativelyde󰁉nedandnotsupportedbyanyevidence.

Thepurposeofthispaperisto󰁉llthisgapintheliteraturebydevelopingavaluecreationmodel(VCM)thatalignscoststomarketvalueapproximatedbythecurrentmarketprice.Itcontributestotheexistingadvancedcostmanagementliteraturebysystematicallyandquantitativelyanalysingandde󰁉ningthelinkagesbetweeninternalcostsandmarketvalue,andusingtheselinkagestoprovideinsightsfora󰁉rm’sstrategyformulation.Themodelcommencesbyidentifyingbundlesofattributesdesiredbycustomers(Lancaster,1971;WaylandandCole,1997)aswellastheirrelativeimportancetothecustomers’purchasedecision.Onceattributeshavebeenidenti󰁉ed,󰁉rms’costs(de󰁉nedasvalueadded,businessvalueaddedandwaste)aretracedtothesevalueattributes.The

Costmanagementandvaluecreation:themissinglink35

identi󰁉edrelationshipbetweenrevenuepotentialandvalue-addedcostsisde󰁉nedbythemodelastherevenuemultiplier,whichisarguedtobearelativemeasureoftheeffectivenessofthe󰁉rms’valuestrategy.ThispaperteststheapplicabilityoftheVCMmodelinasmallItalian󰁉rm.

Thepaperisstructuredasfollows.Thefollowingsectiondevelopsthevaluecreationmodelbasedonthestrategiccostmanagement,valuecreationandrelevantmarketingliterature.Next,theresearchmethodtotesttheVCMmodelisdescribedindetail.The󰁉ndingsassociatedwiththeimplementationofthemodelareprovidednext,followedbyadiscussionandsomeconcludingremarks.

2.DEVELOPMENTOFTHEMODEL

Themanagementaccountingpracticeshaveoftenbeenchallengedinrecentyearsandthesechallengeshavebroughtaboutcontinuousimprovementandincreasedrelevanceofthe󰁉eld(BerlinerandBrimson,1988;Johnson,1992;JohnsonandKaplan,1987).Duringtheearlystagesofmanagementaccountingtransforma-tion,theemphasiswasplacedonimprovingtheaccuracyofproductcostingpractices(KaplanandCooper,1998;Turney,1991).Unbundlingoverheadandre-assigningittotheactivitiesandoutcomesthatweredeterminedtocausecosts,theseearlyactivity-basedcostmodelsmadethequestioningandchangeofmanagementaccountingpracticeslegitimate.

Activity-basedmanagement(KaplanandCooper,1998;Morrow,1992;Turney,1992),processvalueanalysis(OstrengaandProbst,1992)andbusinessprocessre-engineering(Davenport,1994;HammerandChampy,1995)approacheshaveallemergedtoprovideapotentialmethodologyforunder-standingwhereandhow󰁉rmscaninvesttheirresourcestoenhancetheirvaluedriversandbettercontroltheircostdrivers.Intheanalysisperformed,ABM=ABCadvanceourpreviousunderstandingofcostsbysplittingtheactivitiesintovalue-addedornon-value-addedcategories,andthenattempttocreatewaystoeliminateorcompressnon-value-addedorenhancethevalueprovidedbyef󰁉ciencyandeffectiveness.Whilevalue-addedissuesareempha-sized,ABM=ABCdonotbuildfromthemarketanddonotmatchtheseactivitycostswithcustomer-de󰁉nedpreferences.Theresultisthat󰁉rmscanhavehighratesofvalue-addedactivities,butatthesametimenotbepro󰁉table,simplybecausethevalueprovidedisnotthevaluethecustomerisfullywillingtopayfor.Giventhatvaluecreationisamarket-de󰁉ned,externallyevaluatedconstruct(ClelandandBruno,1996;WaylandandCole,1997),thisongoinginternalfocuslimitstheusefulnessofinformationprovidedbyactivity-basedapproachesforstrategicandtacticaldecision-making.Strategiccostmanagement(SCM;ShankandGovindarajan,1993)emergedtoaddresstheseshortcomings.

WhilethereexistvariousapproachesofSCM,themainunifyinggoalofSCMistousecostinformation,providedfromseveraloftenheterogeneoussources,tocreateacompetitiveadvantage(ShankandGovindarajan,1993).IntheSCMframework,keyissuesaddressedarewherethe󰁉rmshouldmoveinthevalue

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chain,whichactivitiesshouldbeperformedandhowcostcanbecompressedandvalueenhanced.Speci󰁉cally,ShankandGovindarajan(1993)arguethattocomprehenda󰁉rm’scoststructure,andsosupporteffectivecost-baseddeci-sion-making,managersshouldwidentheirperspectivetoincludetheir󰁉rm’sstrategicpositioning,valuechainandcostdrivers.Relatedtechniques,suchasstrategicvalue-chainanalysis(Porter,1985;Shanketal.,1998)andvalue-migrationconcepts(Slywotzky,1996;SlywotzkyandMorrison,1997)emphasizethedynamicnatureofvaluerelationshipsalongthevaluechain.Whiletheyidentifyareaswhereitmightbestrategicallyconvenienttofocuseffortsandinvestments,thenatureoftherelationshipsbetweencostandtheirvaluepotentialismostlyignoredorremainsatagenerallevelofanalysisonly.SCMassumesthatmanagerscanplacea‘value’onthechainofactivities.Itdoesnotattempttouseanexternalreferencetoassess‘value’.Assuch,SCMprovideslittleguidanceonhowtoimproveacompany’spro󰁉tability.

Customersbuyspeci󰁉cproductsorservices,notvaluechains.Infact,extensivemarketingliteratureprovidesevidencethatcustomersbuyabundleofproduct=serviceattributeswhenmakingachoiceinthemarket(GreenandSrinivasan,1990;WaylandandCole,1997).Thisisnotanewinsightintobusinesseconomicsormarketing,butthisproductattributeconceptdoesleadtoachangeinthenatureofmanagementaccountingpractices.Targetcostmanage-ment(TCM;AnsariandBell,1997;Cooper,1995;Horva´th,1993;Yoshikawaetal.,1993)andproductattributecosting(BromwichandBhimani,1994)haveemergedtomeettheneedforproduct-speci󰁉cvaluemeasurements.Re󰁊ectingparalleldevelopmentsinengineering(e.g.,qualityfunctiondeployment;valueengineering;valueanalysis),TCM-basedapproachesaredrivenbyexternal,customer-drivende󰁉nitionsofvalue.Thesemodelsbringtogetherthecostandrevenuecomponentsofaproduct=servicebundletohelpprioritizeandchooseamongabroadrangeofpotentialproductorservicedesigns.ThegoalofTCMistobuildpro󰁉tandperformancerequirementsfromthemarketbycontrollingtherelationshipbetweencostandrevenue.

Speci󰁉cally,TCMstatesthatproductscanbelaunchedonlywhentheymeetde󰁉nedpro󰁉tabilitygoalsandtheirrelatedleveloftargetcosts.IntheTCMperspective,atargetpro󰁉tissubtractedfromthepriceoftheproductasde󰁉nedbythemarketinordertode󰁉netheallowableunitcostofaproduct.Whentheactualproductcostexceedsthetargetcost,thecostplanningprocessisusedtoquestionthereasonsforthepro󰁉tabilitygapandtoidentifywaystoeliminatethediscrepancy.Inthisprocess,valueanalysisandvalueengineeringarenecessarystepsinensuringtheproductortheservicedeliversormeetscustomers’valueexpectations,bothinternalorexternal(Horva´th,1993;Yoshikawaetal.,1994).Asaconsequence,costandvaluearealignedwithproductpro󰁉tabilitytoensurethatthecompanyjointlymeetscustomerandshareholderrequirements.WhileTCMreferstothemarkettodetermineacceptablecosttargets,itsobjectiveisprimarilyincostminimization.TCMdoesnotprovideinformationtoenablemanagerstomake‘value’=costtrade-offs.Infact,recentevidencesuggeststhat

Costmanagementandvaluecreation:themissinglink37

whenmore‘strategic’dimensionsareaddedtotheproblemsofcostmanagement,TCMcontributesverylittletothesuccessoflong-termcostmanagementinanorganization(EwertandErnst,1999).

Arelatedtechnique,productattributecostingisfrequentlyemployedincostplanningprocessandintargetcostingpractices.Thismanagementaccountingtoolarguesthattheproducthastobede󰁉nedaroundasetofusagefunctions(lifecycle,easyassembly,easymaintenance,innovativedesign,etc.).Foreachofthesefunctions,managementestimatestherelativecoststoprovidethemcomparedtotheirabilitytomeetcustomer-de󰁉nedfunctionalityrequirements.AsinTCM,anygapbetweencostandvalueissubjecttoanalysisandinterventionsinproductattributecostingtoensurethatdesiredcostandvaluerelationshipsareattained.

Inintroducingthepro®tpotentialconcept(revenueslessvalue-addedcosts)McNair(1994)andMcNairandVangermeersch(1998)measurethemagnitudeoftheexistingrelationshipsbetweencostandvaluebymatchingcurrentrevenueswiththeirassociatedamountofvalue-addedcosts.Citingevidencefromthe󰁉eldwherethevalue-addedcostsof󰁉rmsareabout25%oftotalcosts(McNairandVangermeersch,1998),theunderlyingmessageofthisworkisthateverydollarinvestedinvalue-addedactivitiesgenerallyproducesaminimumreturnoffourdollarsinrevenue.Therelationshipbetweenrevenueandvalue-addedcostisde󰁉nedasthevaluemultiplier.

Eventhoughthevaluemultiplierratiorepresentsamilestoneconceptintheliterature,itonlyhighlightsanaveragelevelofperformanceforthe󰁉rm.Inotherwords,aratiooffoursimplymeansthatthe󰁉rmperformedsetsofvalue-addedactivitiesthatwereleveragedtocreateroughlyfourtimestheirinitialresourceinvestmentinrevenueyields.Astheactivitiesrelatedwithspeci󰁉ccustomers’requirementsarenotinvestigatedbythemodel,thepro󰁉tpotentialconceptdoesnotofferactionableleveragepointsnordoesitidentifywhichactivitiesthe󰁉rmshouldemphasizeinitseffortstomeetcustomers’needsinapro󰁉tableway.Lookingattheissuesmentionedabove,eachtoolmentionedfailstofullyexplainthecomplexrelationshipbetweencostandvalue.Ourpapercontributestothisliteraturebyde󰁉ningthelinkagesbetweenthevaluecustomersplaceonproductattributesandthecostofactivitiesthe󰁉rmincursinordertoprovidethesevalueattributes.Linkingvaluetocostsenablesthemanagerstoevaluatemanychoicesonresourceuseinanorganizationinordertoimprovetheirpro󰁉tsandstrengthentheircompetitivepositioninthemarket.Itisthedevelopmentofthisdualapproachthatunderliestherestofthispaperanditsempiricalanalysis.

3.MODEL

Asconsumersseektomaximizeutility,theychoosebundlesofproductcharacteristicsorattributesembeddedingoodsandservices.Itcouldbearguedthatapro󰁉t-seeking󰁉rmshouldstrivetoofferasetofproductcharacteristicsthatiseithersimilartothoseofcompetitorsbutatalowerpriceorbetterthanthoseof

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competitorsatasimilarorhigherprice.Asuperiorcompetitivepositioniscreatedwhenthe󰁉rmcontinuestoofferauniquebundleofattributesnoteasilyreplicatedinthemarket.

IntheVCMmodel,priceisde󰁉nedasavalidapproximationofthevaluethatconsumersderivefromthebundleofcharacteristicsembeddedintheproduct.Cost,ontheotherhand,isthetotaleconomicvalueoftheresourcesdeployedtodeliverthisvaluetocustomers.Whilecostisunrelatedtoprice,itenablesustode󰁉nepro󰁉t.TheVCMmodelidenti󰁉esproductorservicevalueattributes,de󰁉nestheirrelationshiptothecostofdeliveringtheseattributesandtherebyde󰁉nespro󰁉tpotentialopportunitiesforthe󰁉rm.

AssuggestedinFigure1,pricecanbeseenasanouterboundaryofwhata󰁉rmcanchargecustomersforaspeci󰁉cproductorservicegiventheirobjectiveofpro󰁉tmaximization.Thispricecanbefurtherbrokendownintovalueattributesembeddedintheproductorservicedesiredbytheconsumer.Thecostsofresourcesnecessarytoproducetheproductorserviceaswellasthepro󰁉trepresenttheinnercirclesinFigure1.Totalrevenueslessallofthecostsyieldthebefore-taxincome(pro󰁉t)ofthe󰁉rm.Thecostcirclesarefurtherbrokendownintovalue-addedcost,businessvalue-addedcosts(currentandfuture),adminis-trativeornon-value-addedcostandwaste.Onlyvalue-addedcost,orthedollars

Figure1Thevaluecreationmodel

Costmanagementandvaluecreation:themissinglink39

spenttodirectlysatisfyacustomer-de󰁉nedvalueattribute,yieldsrevenueandconsequentlypro󰁉tforthe󰁉rm.Theremainingelementsofcostcreatenovaluedirectlyand,therefore,norevenue.1Forthepurposeofthisresearchpaperthecostswillbedividedintovalueadded,non-valueaddedandwaste.

Asweevaluateperformanceofany󰁉rm,therelationshipbetweenthepercentageofcustomer-de󰁉nedvalue-addedcostandrevenuesisacriticalissue.Wede󰁉nethisrelationshipwithavaluemultiplier.Itenablesustoevaluatehowmuchofthe󰁉rm’scostisfocusedonimprovingthe󰁉rm’spro󰁉tandpro󰁉t-makingpotential.Itfurtherenablesustode󰁉nehowmuchvalue(revenue)iscreatedforeachdollarofvalue-addedcost.

Theproposedmodelisparticularlyusefulinanalysingdifferentiatedproductmarkets,inwhichproductsthataresubstitutesforeachotheraredistinguishedbytheirembodimentofaspeci󰁉csetofattributesvaluedbydifferentgroupsofconsumers.

4.RESEARCHMETHODOLOGY

Theory-buildingefforts(Dubin,1978),suchasthatunderlyingthevaluecreationmodel,beginwiththecollectionandanalysisof󰁉elddatathateithercorrobo-rates,ordisproves,suggestedrelationships.Differingmarkedlyfromtheorytesting,theorybuildingseekstodevelopamodeloftherealworldbycomparingdiversesituationsandevents.Byde󰁉nitionboundtothe󰁉eld,theorybuildingisatonceacreative,yetdisciplined,initiativeguidedbytheinsightsandshort-comingsoftheresearcher(s).Itisbyde󰁉nitionanchoredintheinterpretiveparadigm.

Havingplacedthisresearchwithinitsepistemologicalframework,theempiri-calmethodologybecomesevident.Theory-buildingeffortsareintricatelytiedtocase,or󰁉eld,research(LincolnandGuba,1985).Whilemanydifferentapproachescanbeusedtogathercasedata,themethodologydevelopedbyYin(1984)providesthegreatestcontrolovertheresearchendeavour.TheheartofYin’sapproachisdocumentation,before,duringandafterthesitevisit.Builtfromawell-de󰁉nedsetofprotocols,questionsandissues,case-basedresearchusingYin’smodelcanprovidereliable,veri󰁉able󰁉ndings.

Thestudypresentedherewasconductedinseveralstages.First,theprimaryfocusofthisresearchwasbasedonawell-articulatednotioninthemarketingliteraturethatcustomer-de󰁉nedvalueattributescanbeidenti󰁉edandthattheir‘weights’intheutilityfunctioncanbedetermined.Further,borrowingfromthemarketingliterature,WaylandandCole(1997)andothershavesuggestedthatwhencustomersegmentscanbede󰁉nedtheyre󰁊ectsigni󰁉cantdifferencesincustomerpreferences,andthereforeintheirwillingnesstopay,forabundleofproductattributes.However,theprimaryresearchquestionexploredbytheauthor(s)inthisstudyfocusedonidenti󰁉cationofarelationshipbetweencostandaproduct’svalueattributes.Thepreliminaryreviewandanalysisofrelatedliteraturesuggestedthatcustomer-de󰁉nedvalueattributescouldbemappedto

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internalactivitiesinthecompany.Whatremainedtobeseenwaswhetherthisinformationcouldbeelicitedjointlyduringa󰁉eldstudy,andonceobtainedwhethermanagementwouldvalidatethe󰁉ndingsand=or󰁉ndtheminformative.Thespeci󰁉csassociatedwiththedesignofthisstudyareasfollows:

Theunitofanalysisisastrategicbusinessunit(SBU).

Customervalueattributedataarecollectedbyasurveyofanunbiasedsampleofcustomers.Proxiesforvalueattributeswerealsoobtainedfrommanagementinordertoevaluatedifferencesinperceptionofvaluebetweenthemarketandthemanagement.

Valueattributesareweightedusingstatisticalanalysis(forexample,conjointanalysis)orbyaskingcustomersdirectlytoallocate100pointsacrossamostpreferredbundleofattributes.Valueattributesandtheirweightsarede󰁉nedforeachmarketsegment.

SBU’scostsarede󰁉nedasvalueadded,non-valueaddedandwastewithaninternal,individuallyde󰁉nedassessmentprotocol.2

Activityanalysisforcostsisconductedspeci󰁉callyfortheprojectbyinterviewingappropriatedepartmentmanagers.ActivitiesperformedforallfunctionalareasoftheSBUarede󰁉nedandalljobdescriptionsareincluded.Inactivityanalysisofcostsinterviewedindividualsareaskedtode󰁉nevalue-addedactivitiesfromthepointofviewoftheconsumers’willingnesstopayforthem.

Uponcompletionofcustomersurveyandactivityanalysisforcosts,thedataarelinkedtogetherandthefollowinganalysisismadepossible:

1Acustomervaluepro󰁉leiscreatedforeachde󰁉nedmarketsegment.Thispro󰁉leincludesthevalueattributesandtheirrespectivevaluesona100-pointrankingsystem.Fortheanalysisofthisstudytheaveragecustomervaluepro󰁉leforeachmarketsegmentisused.

2Revenueproxiesarecreatedforeachsegmentbymultiplyingtherankingofthevalueattributebythecurrenttotalrevenuesgeneratedbythatsegment.3Theactivityanalysisforcostsresultsinthreeseparablecostentities:valueadded,non-valueaddedbutrequired,andwastecosts.Theunderlyingcoststructureofthe󰁉rmisanalysed.

4Activitiesde󰁉nedasvalueaddedarelinkedandmatchedwiththevalueattributetheysupported.

5Multipliersaredevelopedbydividingattributerevenueproxiesbythetotalvalue-addedactivitycoststracedtoeachattribute.6Multiplierrelationshipsareanalysed.

Followingthestudydesignasoutlinedabove,ameetingwasheldwithsitemanagerstodiscusstheimplicationsoftheresultsandassesswhetherandhowusefulwasthenewinformationintermsofin󰁊uencingmanagementthinkingandgeneralorientationofthe󰁉rm.Overall,themethodologydescribedhereisa󰁉rstattemptde󰁉nedtotesttheimplementationofthevaluecreationmodelasanew

Costmanagementandvaluecreation:themissinglink41

managementtoolwithinacompany.Doneonanexperimentalbasis,thisstudywasundertakentodeterminewhetheritispossibletodeveloplinkagesbetweenvalueattributesandcost,andevaluatetheusefulnessoftheselinkagesformanagersandtheirthinkingoflong-term󰁉rmperformance.

5.EVIDENCEFROMTHEFIELD:CASEOFCELLISPA

CelliSPAisanItalian󰁉rm,whichhasbeenproducingagriculturalmachines(rotarytillers,spadingmachines,harrows,etc.),since1955andemployseightypeople.Thecompanywasfacingacriticalmomentin1998,duetoadecliningdemandintheagriculturalmachines’industry.Celliexperiencedadeclineinrevenuesafterasteadygrowth.Revenuesin1997amountedtoapproximately28billionItalianlire,andpro󰁉tabilityintermsofROSwasabout4%comparedto6%in1995.ShankandSilvi(1999)studiedCelli’svaluechainandfoundoutthat80%ofthevaluecreatedalongthepipelinefromthesuppliersofcomponentstotheenduserswascapturedbythedistributorsandagreatpartofthevaluewascreatedbythoseactivitiesvaluedmostbythecustomers.TheyindicatedthatCelliwascompetinginafragmentedindustrywherebothlow-costanddifferentiationstrategiesco-exist.Matureindustry,fragmentedcompetition,highcustomers’bargainingpowerandexcesscapacitywereperceivedtoconstrainCelli’spro󰁉t-ability.

WeapplytheVCMmodeltoCelliSPAtode󰁉neandanalyserelationshipsbetweenvalueandcostandtheirpossibleimplicationsforpro󰁉tabilityofthe󰁉rm.TheVCMmodelwasappliedtotheagriculturalmanufacturingequipmentbusinessunitonly.3

TheVCM®ndings4

Thecustomervalueperspective

VCMsuggeststhatcustomervalueattributeproxiesshouldbeestimatedbyanunbiasedsampleofcustomers.WeemployedasurveytocollectdataaboutattributesmostimportanttoCelli’scustomers.Questionnairesaimingtoidentifyvalueattributesweresentto100ofCelli’sbestItaliancustomers,andtheirreturnratewas43%.5Informationaboutvalueattributesandtheiroverallimportancewerealsoobtainedfrommanagementinordertoassessdifferencesinimportanceofdifferenttypesofattributesbetweenthemarketandthemanagement.6Table1showstheresultsofthesurveycombinedwiththeattributeweightingsofthemanagement.

OurcustomersurveydataindicatedthatCelli’scustomersvaluedthefollowingattributesthemost:technicalreliability,price,servicereliability,lifecycle(productduration),customerassistanceandtechnicalperformance.7Servicereliabilitywasde󰁉nedason-timedelivery,orderconformityandcompleteness.

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Table1Valueattributes,relativeweightsandcustomersatisfactionValueattributesManagementweight(%)153015201010100Marketweight(%)211919151412100Market(std.dev.)9.07.710.87.06.67.7Customersatisfaction(%)747858807280Customersatisfaction(std.dev.)0.90.81.00.81.10.8TechnicalreliabilityPriceServicereliabilityaLifecycleCustomerassistancebTechnicalperformanceNotes:a

Servicereliabilitywasde󰁉nedason-timedelivery,orderconformityandcompleteness.b

Customerassistancewasde󰁉nedasafter-salesservice.

Theseattributeswereconsistentwiththeattributesde󰁉nedasmostimportantbymanagers.

Table1alsopresentstherelativeweightsofthecustomerattributes.InthecaseofCelli,marketandmanagementweightsoftherelativeimportanceofattributesdiffersigni󰁉cantly.Inparticular,customersrankedtechnicalandservicerelia-bilityasthetwomostimportantattributes.Ontheotherhand,managersrankedpriceandlifecycleasthetwomostimportantvalueattributes.Thisdifferenceintheassessmentofrelativeattributes’importancecouldleadmanagerstowronglevelsofspendinginproducingforthemarket.This󰁉ndinghelpedverifythatpreviousconcernsaboutthereliabilityofinternallyde󰁉nedvalueassessmentswerewellplaced.Managementdidnothave,atleastinthissituation,accurateknowledgeofcustomervaluepreferences.8

Costdatacollection

Next,company’svaluechainanddepartmentmapswerede󰁉ned.Foreachdepartmentwecarefullyidenti󰁉edactivitiesperformedwiththehelpofdepart-mentmanagers.Relativecostswereattributedtotheseactivities,andactivitiesweresortedintermsofvalueadded(bothforthecurrentcustomersandforthebusiness),non-valueaddedbutrequired,andwastebyinterviewing20%ofCelli’semployees.

(a)CoststructureTable2identi󰁉esactivitycostintermsofvalueadded,non-valueaddedandwasteforeachdepartment.About47%ofcostswerefoundtobeattributedtovalue-added(VA)activities(bothrelatedwiththecustomersandfuturebusinessissues),whiletherestcouldbeattributedtonon-value-added(NVA)activitiesandwaste.ThisresultwasimpressivefortheCEOand

Table2Firm’scoststructureValue-addedcostTotalVA9306600001,58858834840703,92747.5%100.02,54430.7%100.023.71.70.00.00.00.040.415.08.910.40.01936565025660328294332971347.60.222.019.722.20.012.91.117.011.75.3PercentVATotalNVAPercentNVANon-value-addedbutrequiredWasteTotalwaste2674955029560237803912301,80821.8%Percentwaste14.82.73.00.016.333.320.90.02.26.80.0100.0DepartmentTotalcostPercentcostMarketingSalesmanagementProductionschedulingAdministrationProcurementsMaterialhandlingManufacturingResearchanddevelopmentOutboundExecutivemanagementManagementcontrol1,3901211115028616022,29461782082713416.81.51.36.110.47.327.77.59.910.01.6Total8,279100.0%100.0Note:CostsareinmillionsofItalianlire.44TheEuropeanAccountingReview

chairperson,MrCelli,whofeltthatithighlightedsomeofthereasonsforhis󰁉rm’slowanddecliningpro󰁉tabilityverywell.Speci󰁉cally,thelargestVAcostoccurredinthemanufacturingdepartmentwhere81%oftotalVAcostsresultedfromactivitiesdedicatedtotheassemblyof󰁉nalproducts.Thisdepartment,however,alsohadahighpercentageofwastethatcanbeexplainedbyunusedcapacityinperformingthesesameactivities.Ontheotherhand,VAcostswerenon-existentinthedepartmentsofprocurementsandmaterialhandling,whilealmosthalfofthetotalwastewascreatedinthesetwodepartments.Uponcloserinvestigationofactivitiesinthesedepartmentswefoundoutthatthewasteresultedfromproductcon󰁉gurationandmisalignedprocesseswherematerialswereunnecessarilyhandledandcheckedmultipletimes.Inthemarketingdepartment,orderswerecheckedandre-enteredanumberoftimescontributingtoalargepercentageofwaste.Additionally,salespeopleinmarketingspentalargeproportionoftheirtimevisitingcustomersandhandlingtheircomplaints.Thelowlevelofpro󰁉tabilitywithinCelliwasevenmoreevidentwhenthepro󰁉tpotentialschemewasoutlined(seeTable3).Pro󰁉tpotentialwas20%,whileNVAcostandwastedecreasedpro󰁉tpotentialbyapproximately85%,leadingto3%operatingincome.The󰁉rmwasgeneratingabout26.2billionlirawithlessthan4billionliraworthofitsresources(e.g.,VAcosts).Inthe‘multiplierworld’thisresultmeantthatanItalianliraspentinVAactivitiesyieldedabout6.7(revenues=VAcost)liraofrevenues.Thismultiplierwasde󰁉nedfortheoveralllevelofactivitiesofthe󰁉rm.Furtheranalysisofactivitiesthatarevaluecreatingwasthereforenecessary.Identi󰁉cationofactivitieswhichcontributedabove-averageamountstovaluecreationhelpsthe󰁉rmbetterdirectitsresourcesinordertobeabletorealizeitspro󰁉tpotential.

(b)Valueattributesversus®rm’scoststructureTable4showstheactivitycostsCelliSPAincurredtodeliverthevalueattributesdesiredmostbytheircustomers.Themostsigni󰁉cantdifferencesbetweenthemarketweightingsofattributesandtotalexpendituresexistedforservicereliabilityandtechnicalperformance.

Table3Firm’spro󰁉tpotential

RevenuesinmillionsofItalianliraRevenuesPurchasingMarginbeforeactivitycostsValue-addedcostPro󰁉tpotentialNVAcostWasteOperatingincome26,20017,0309,1703,9275,2432,5441,808889Percentoftotalrevenues100653515201073Percentoftotalactivitycost473122Table4Firm’sattributecostaandcustomerandmanagementrequirementNVA(%)18194471201001,08725%1004,288100%100100253160405921651223153781511,0999571,3024644194726223011101211919151412WW(%)TotalTotalcost(%)MarketweightManagementweight153015201010100ValueattributesVAVA(%)NVATechnicalreliabilityPriceServicereliabilityLifecycleCustomerassistanceTechnicalperformance645579390293113353128191452201218507791410TotalAverage2,05548%1001,14627%Note:aTable4de󰁉nesthecostintermsofcustomerservicesrelatedtothecurrentproductonly,whileTable3includescoststhatarerelatedtothecurrentaswellasfutureproductde󰁉nition(forexample,trainingandR&D).46TheEuropeanAccountingReview

FurthercomparisonbetweenwhatCelli’scustomersarewillingtopayforandVAexpendituresrevealedthatCelliwasoverspendingforthedeliveryoftechnicalreliabilityandpriceatthetimeofthisstudy.Thissituationwasfurtherworsenedbytheamountofwasteinthesetwoattributecategories.CelliwasunderspendingfortechnicalassistanceandtechnicalperformanceandVAexpendituresinthesecategorieswereseverelymisalignedwithcorrespondingmarketweights.

Table4alsoalignsexpendituresforVA,NVAandwastebyattributes.Itshowsthatprovidingtechnicalandservicereliabilitycontains60%oftheoverallwaste.Asdiscussedpreviously,activitiesdevotedtoprovidingthesetwoattributesweremostlyconcentratedinthreedepartments:procurements,materialhandlingandmarketing.

(c)MultiplieranalysisAssuggestedbytheVCMmodel,spendingonavarietyofactivitiesisnotequallyeffectiveinin󰁊uencingpro󰁉tabilityofthe󰁉rm.Inthemodel,multipliersarede󰁉nedtomeasurethedegreeofalignmentbetweenthecostofproducingaspeci󰁉cattributeandarevenueequivalentofthatattribute.Themodelalsosuggeststhatbetteralignmentbetweencostandattributewouldleadtohighercustomersatisfactionandbetter󰁉nancialperformanceinthemarket.Acriticalissueinpro󰁉tpotentialandinadvancedcostmanagementanalysisistohaveabetterunderstandingofthevaluecreatedintheactivityperformedinordertoenhancetheeffectivenessofcompetitivestrategy.Table5showsthemultiplierscalculatedforCelli.

WhiletheaveragemultiplierforCelliisat12.7,revenuemultiplierspertainingtocustomerassistanceandtechnicalperformancearesigni󰁉cantlyhigherandrevenuemultipliersfortechnicalreliabilityandpricearesigni󰁉cantlylowerthantheaveragemultiplier.Giventheexploratorynatureofourstudy,thesediffer-encesinmultipliersdemandcarefulfurtheranalysisandinvestigationoftheirpotentialcauses.Forexample,Celli’shighmultipliersforcustomerassistanceandtechnicalperformancesuggestatleasttwopossibleanswers.Highmultipliercouldbearesultofinsuf󰁉cientexpendituresonanattributethatishighlyvaluedbythecustomer;inotherwords,theVCMmodelprovidesasignaloflowdegree

Table5Revenuemultipliersfora󰁉rm

Marketweight(%)TechnicalreliabilityPriceServicereliabilityLifecycleCustomerassistanceTechnicalperformanceTotal211919151412100RevenuesValue-addedcost645579390293113352,055Revenuemultipliers8.58.612.813.432.589.812.7Customersatisfaction(%)7478588072805,5024,9784,9783,9303,6683,14426,200Costmanagementandvaluecreation:themissinglink47

ofalignmentbetweenvalueandcosts.Second,ahighmultipliercouldalsosuggestacompetitiveadvantageforCelliindeliveringaparticularattributetothemarket.Therefore,themultiplieranalysissuggestsasigni󰁉cantpossibilityofimprovingitspro󰁉tpotential.AdditionallyinCelli’scase,technicalreliabilityandpriceexhibitbelow-averagemultipliers.Themultiplieranalysiswouldindicatethatthepro󰁉tpotentialcouldbeimprovedbyspendinglessondeliveringthesetwoattributes.ThelowmultipliercouldalsobeasignalthatthecompetitiverateofreturnontheseattributesislowbecauseoflowdegreeofdifferentiationofCelliinthemarketintheirprovision.

InordertoimproveCelli’svaluestrategy,thevaluecreationmodelsuggestsarealignmentofVAcoststocustomervalueattributes.Thisrealignmentwouldrequireafurthercarefulanalysisofallactivitieswithinthecompanyandtheirrespectivecostsaswellasassessingtheseagainstother󰁉rmsinthemarket.Asmentionedearlier,ourstudyalsosuggeststheneedtocomparetherevenuemultiplierstothecustomersatisfactiondata.Speci󰁉cally,highmultipliersmayresultfromthe󰁉rm’slackofsuf󰁉cientspendingonvalueattributesmostimportanttothecustomer.However,thisdoesnotseemtobethecaseforCelli,wherecustomersatisfactionrelatedtotechnicalperformanceisrelativelyhighandtherevenuemultiplieronthisattributeishighestoverallleadingustosuggestthesupportforthestrategicredesignofactivities.

Whileourstudycon󰁉rmsthatmultiplierscanbecalculated,theirinterpretationneedstobefurtherinvestigated.Speci󰁉cally,itisnecessarytofurtherclarifyhowmanagerscanusetheinformationprovidedbythemultiplierstoredirectspendingsothatitisbetteralignedwiththemarket.Furtherresearchinthisareashouldalsoaddresstheissueoflifecyclecostanditsin󰁊uenceonthecurrentlevelofmultipliers.Forexample,currentNVAexpendituresinresearchanddevelopmentareasmayleadtohigherfuturepro󰁉tpotentialinthemarket.Therefore,ourrevenuemultipliersshouldbeusedassignalsofvaluecreatedbyactivitiesdirectlyrelatedtoattributesandhowthisvaluecouldbechangedbyadifferentrelationship.

6.CONCLUSIONS

ThispaperextendstheunderstandingoflinkagesbetweencostsandmarketvaluebyintroducingtheVCMmodelandtherebycontributestotheexistingliteratureinthe󰁉eldofadvancedcostmanagement.TheVCMhelpsmanagersunderstandwhereandhowthe󰁉rmcreatesvalue.Ithighlightsthereasonscustomersbuyaproductandrecognizestherelationshipbetweenvalueandcost.Furthermore,VCMtracesthestructureofthecostsofthe󰁉rmasde󰁉nedbycustomervalueattributes.Italsomayservetocreateabetteralignmentbetweencostandvaluethrougheffectivemanagementofexpendituresonspeci󰁉ccomponentsofthevaluepro󰁉le.Thisalignmentmayhelpthe󰁉rmtargetareaswherecostscanbestbeleveragedtoimproveitsoverallpro󰁉tpotential.

48TheEuropeanAccountingReview

Asalreadymentioned,multipliersmayindicateareaswhereincreasedeffortsmaygeneraterevenueimprovements.Whilethisisintuitiveinnature,thepotentialdegreeofrevenueincreasemustbecomparedwiththecompetitivedynamicsoftheindustryandthenwithitslifecycle,sizeandcompetitiontotrulyassessthisfeature.Overacertainthreshold,orinamaturingordecliningindustry,revenuescannotbeincreasedfurther.Inthiscontext,VCManditsmultipliersneedtobeusedasapotentialconceptforthedifferentiationofthemarket,notasaspeci󰁉cpro󰁉tpredictiontool.Highmultiplierscombinedwithhighcustomersatisfactioncandirect󰁉rmstofocusonspeci󰁉csegmentswherethe󰁉rmappearstohaveacompetitiveadvantage.

SinceVA,NVAandwasteactivitiesandcostareapparentlycloselyrelated,managersshouldnotignoretheserelationships.Leveragingrevenuemultiplierswithoutremovingthecauseofwaste,orcontainingNVAbutrequiredcosts,mayimprovethecompany’spro󰁉tabilityintheshortterm,butitwillnotcreateasustainableadvantage.Agrowthstrategyrequiresthata󰁉rmleveragesitsavailableresources,aswellasthosefreedupfromtheNVAandwastefulactivities,intospeci󰁉cvalueattributeswherethe󰁉rmprojectsahighreturntospends.

TheapplicationoftheVCMatCellihasveri󰁉edthattheapproachappearstoaltermanagement’smind-set.AsaresultofthisstudyCelli’sownerscloselyscrutinizedtheexistingrelationshipsbetweencustomers’requirements,activitiesperformedandpro󰁉tability.AccordingtoMrCelli,ownerandCEOofCelliSPA,thecommunicationbetweenthedepartmentsatCelliandtheeffectivenessofstrategyimplementationwasimprovedsigni󰁉cantly.TheVCMmodelhelpedtomakethecompanyownerscognizantofthecustomers’valuepro󰁉lesinadditiontofocusingoninternalproductionrequirements.AsaresultofthisstudyCelliintroducednewprocessesinproductplanning.

Unfortunately,VCManditsmultiplierinterpretationandapplicationarefairlycomplextounderstand.Forinstance,inaverysimpleinterpretationintangibleactivitiescouldbede󰁉nedtocreatemorevalue,whiletangibleactivitiescouldcreatelessvalue.Alsorelated,itwasfoundthathighmultipliersmightmeanseveralthings.Inanalysingothercases,forexample,wefoundthathighmultiplierstogetherwithhighcustomersatisfactionweresignsofeffectiveness.Conversely,whenhighmultiplierswerecombinedwithlowcustomersatisfaction,underspendingemergedasanexplanationofthisgap–openingthe󰁉rmtocompetitivethreats.Ourmodelsuggeststhatacarefulexaminationofnotonlyrevenuemultipliers,butalsothebusinessvalueaddedandwastecostsandtheirchangesovertimeareinorder.

Therefore,asuggestionforfutureresearchistoincorporatethetimedimensionofexpendituresintotheVCM.Managersneedtounderstandvalue,revenueandcostrelationshipsoverthelifecycleoftheproductorservice.ThiswouldbeparticularlyimportantforcompanieswhereR&Dandinnovationprovideastrategicadvantage.Forexample,itisquitepossiblethatahightechnicalperformancemultiplieratCelliisaresultofpastexpendituresonthisattribute.

Costmanagementandvaluecreation:themissinglink49

Multiplieranalysisalsoappearstosupportthemanagementofabusinessunitasaportfolioofinvestmentsinvariousproduct=servicevalueattributes.Inthefuture,thisresearchneedstofocusonbetterunderstandingthe󰁉rm’sstrategicenvironment,aswellasimprovingthemethodsofmarketdatacollectionandunderstandingthewaysinwhichthe󰁉rmcurrentlyattaches,implicitlyorexplicitly,resourcecosttothevalueattributes.

ACKNOWLEDGEMENTS

TheauthorsgratefullyacknowledgesupportreceivedthroughtheCenterforInnovationinManagementAccountingatBabsonCollege,Wellesley,MA.WethankMaggieAbernethyandthreeanonymousrefereesfortheirhelpfulcommentsandsuggestions.Allerrorsremainours.

NOTES

1However,futurebusinessvalue-addedcostsindirectlyleadtofuturerevenueandpro󰁉t.2Protocolsareavailableuponrequest.

3AgriculturalmanufacturingequipmentSBUaccountsforapproximately94%oftotalrevenuesofCelli.

4Costdatareferto1997.

5Sinceourdataarenotunbiased,ourresultspertaintoCelli’spresentcustomersonly.6Initiallyafocusgroupwiththetopmanagerswasconductedtoidentifyrelevantvalueattributes,supportedbyapreviousconsumers’studybyCelli.Atthisstagemanagersprovidedtheirownestimationoftheweightpereachattribute.

7InLancaster’s(1971)modelandeconomicsliteratureingeneral,consumersareassumedtomaximizeutilityfunctionconsistingofgoods=servicesor,inthecaseofLancaster’smodelattributes,subjecttothebudget=ef󰁉ciencyconstraint.Priceentersutilitymaximizationasalimitationonmaximumachievableutilityratherthanasanattribute.Atthisstageofourresearchourempiricaldataaremoreinlinewithmarketingresearchwhichallowsforpricetobede󰁉nedasanattribute.

8Furtheranalysisofconsumerpreferencescouldhelpthe󰁉rmidentifyspeci󰁉cvalue-basedsegmentsassuggestedbyWaylandandCole(1997).Thiscouldleadthe󰁉rmtoadoptuniquevalue-basedstrategies.InthecaseofCelli,treatingpossibledifferentgroupsofcustomersthesamecouldleadtosigni󰁉cantimpactsonpro󰁉tabilityofthe󰁉rm.

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