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Cost Management-final                                                                                                       12


Few firms have information systems that can identify and analyse these subtle relationships, For example, profitability and return on assets are key measures of competitive advantage throughout an industry's value chain. It can be extremely difficult to obtain pertinent information for these measures, including operating costs, revenues and assets for each process throughout the industry's value chain. However, this information is necessary to calculate a rate of return on assets for each value chain process.

Obtaining the replacement or current cost of physical assets used by a value-creating activity necessary but often-complex undertaking. Historical or book values usually provide equate measures of current investment. Plant engineers, equipment vendors and independent appraisal professionals may be consulted to help establish current asset values. Likewise, establishing prices for transferring goods and services along value chain processes requires an understanding of market or competitive-based rates. If at least one firm competes in each: of value creation, then competitive market prices are available. If not, then a company must use judgement in determining a transfer price that incorporates a normal profit margin of full costs. For long-term strategic decision-making, companies should use full cost under conditions of full capacity for the value activity. While several measures of capacity exist, the measure should represent the long-term utilisation of the value activity's assets (sometimes called "practical capacity").

Publicly available financial reports produced by firms throughout the industry value chain can provide key financial information. Typically, this information is neither in the proper format nor disaggregated enough to accommodate vertical linkage analysis. Significant analysis, data manipulation and judgement may be necessary to obtain the appropriate information for each value chain process.

For intermediate transfers between processes, competitive market prices, if available, should be substituted for the internal transfer prices. For example, competitive market prices for a e link in the value chain may be obtained from individual firms that operate only in that if the chain. For long-term cost estimation, full costs should be used rather than marginal variable or incremental costs.

2. Diagnose the cost drivers for each value-creating process: Traditional management or cost accounting systems often assign costs by using a single output measure of operating activity, such as output volume. For vertical linkage analysis, a single measure is inadequate to capture the underlying cost categories. Direct labour-based measures may be appropriate for labour-intensive activities; operating hours may be appropriate for machine-based activities.

3. Evaluate the opportunities for sustainable competitive advantage : By nature, competitive advantage is relative. In an ideal world, a firm can gauge its competitive position by knowing its competitor's value chains and the rates of return on each, in reality, however, this may be rather difficult; the competitor's internal cost, revenue and asset data for its process are generally unavailable. Sufficient qualitative information usually exists on a firm's major value-creating processes and the strategies for each. By understanding how other companies compete in each process of the industry value chain, a firm can use the qualitative analysis to seek out competitive niches even if financial data are unavailable.

Value chains for three competitors in the rapidly changing telecommunications industry -AT&T, NYNEX and IBM — are listed in Exhibit 4, along with the strategic differences for each firm (Hax and Majluf, 1991). The strategic differences reflect varying structural an executional cost drivers. In marketing, for instance, AT&T started with no organisation but with significant name recognition. The regional marketing scale of NYNEX and the work wide marketing scale of IBM are important cost advantages.

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