MANAGEMENT

Cost Management Cost Management SummarySummary

Strategy – Long-Term Planning?Strategy – Long-Term Planning?

Often people think of strategy as simply Often people think of strategy as simply planning, or “long term” planning. In the planning, or “long term” planning. In the broadest sense, this is correct, though the broadest sense, this is correct, though the planning in strategy formulation and planning in strategy formulation and execution is somewhat more complex, execution is somewhat more complex, including developing an understanding of including developing an understanding of the business environment in which the the business environment in which the firm operates and of the resources firm operates and of the resources available within and outside the firm to available within and outside the firm to help it compete effectively.help it compete effectively.

Strategic Decision-MakingStrategic Decision-Making Strategic decision making involves Strategic decision making involves

obtaining and using resources to meet an obtaining and using resources to meet an organization’s goals by exploiting its organization’s goals by exploiting its competitive advantages. Competitive competitive advantages. Competitive advantages may be from lower cost advantages may be from lower cost operations, higher customer value, and operations, higher customer value, and ability to innovate. Examples of strategic ability to innovate. Examples of strategic decisions include a) outsourcing support decisions include a) outsourcing support services to gain a cost advantage, b) services to gain a cost advantage, b) adding product features that customers adding product features that customers value at low cost, and c) focusing value at low cost, and c) focusing resources on development or acquisition resources on development or acquisition of new technology.of new technology.

Strategic Cost ManagerStrategic Cost Manager

A strategic cost manager is not focused on A strategic cost manager is not focused on or limited to financial information only, as or limited to financial information only, as in the traditional view of cost and in the traditional view of cost and management accounting. In contrast, a management accounting. In contrast, a strategic cost manager includes a strategic cost manager includes a consideration of the firm’s critical success consideration of the firm’s critical success factors, which might include such non-factors, which might include such non-financial information as delivery speed and financial information as delivery speed and customer satisfaction.customer satisfaction.

Cost Management TechniquesCost Management Techniques– Cost management techniques include:Cost management techniques include:

Comparing performance over time and against competitorsComparing performance over time and against competitors Benefit-cost analysis of plans and decision alternativesBenefit-cost analysis of plans and decision alternatives Value-chain analysis of alternative resource arrangements and Value-chain analysis of alternative resource arrangements and

processesprocesses Learning and educating others about the organization, its Learning and educating others about the organization, its

competitors, and its environmentcompetitors, and its environment Measuring the expected efficiency of acquiring and using Measuring the expected efficiency of acquiring and using

resources in alternative operationsresources in alternative operations Identifying opportunities for improving the value and cost of Identifying opportunities for improving the value and cost of

new or existing products and servicesnew or existing products and services Leading organizational changeLeading organizational change Measuring actual outcomes of activities, products, and servicesMeasuring actual outcomes of activities, products, and services

Developing measures and methods for motivating and Developing measures and methods for motivating and evaluating personnelevaluating personnel

Communicating the results of cost management activities Communicating the results of cost management activities effectivelyeffectively

Explaining and interpreting differences between actual Explaining and interpreting differences between actual outcomes and plans or expectationsoutcomes and plans or expectations

Management Decisions in Cost Management Decisions in Cost ManagementManagement

Matches of cost management Matches of cost management techniques and management techniques and management decisions are:decisions are:

Learning about how operations work Learning about how operations work ___ The design of incentive bonuses of ___ The design of incentive bonuses of

up to 12% of salary by Electricity up to 12% of salary by Electricity Corporation (ECNZ) for middle Corporation (ECNZ) for middle managers based on meeting difficult managers based on meeting difficult profit goalsprofit goals


Organizing resources into efficient Organizing resources into efficient activities and operations __ The use of activities and operations __ The use of seminars called “What if I owned the seminars called “What if I owned the business?” by Television Corporation business?” by Television Corporation (TVNZ) to introduce staff to issues of (TVNZ) to introduce staff to issues of competitioncompetition

Measuring actual and expected costs of Measuring actual and expected costs of activities, products, and services __ activities, products, and services __ ECNZ’s decision to restructure into four ECNZ’s decision to restructure into four major operating divisions: Production, major operating divisions: Production, Marketing, Power Transmission, and Marketing, Power Transmission, and ConstructionConstruction


Identifying profitable products, services, Identifying profitable products, services, customers, and distribution___ The customers, and distribution___ The decision by Coal Corporation (CoalCorp) to decision by Coal Corporation (CoalCorp) to evaluate every job currently performed by evaluate every job currently performed by employees to determine which jobs were employees to determine which jobs were essential to the goal of profitabilityessential to the goal of profitability

Identifying opportunities for Identifying opportunities for improvements in the value of products improvements in the value of products and services___ TVNZ’s new focus on and services___ TVNZ’s new focus on estimating the costs of television estimating the costs of television programming and productionprogramming and production


Communicating effectively__ The Communicating effectively__ The decision by Public Works decision by Public Works Corporation’s (WORKS) to sell its Corporation’s (WORKS) to sell its poorly performing Property and poorly performing Property and Computing Services divisionsComputing Services divisions

Motivating and evaluating Motivating and evaluating personnel___ TVNZ’s analysis of personnel___ TVNZ’s analysis of TV3’s programming and advertising TV3’s programming and advertising practices, its new commercial rivalpractices, its new commercial rival

Short-term and long-term Short-term and long-term Performance MeasuresPerformance Measures

Short-term performance measures are those Short-term performance measures are those based on periods less than a year, such as based on periods less than a year, such as accounting earnings or total sales. These accounting earnings or total sales. These measures are used to assess the achievement of measures are used to assess the achievement of an employee or business unit for a given short an employee or business unit for a given short period of time. In contrast, long-term period of time. In contrast, long-term performance measures, while quantified in terms performance measures, while quantified in terms of current achievement, are used to assess both of current achievement, are used to assess both the current and potential performance of the the current and potential performance of the employee or unit. Examples of long-term employee or unit. Examples of long-term measures include customer satisfaction, product measures include customer satisfaction, product quality, manufacturing cycle time, and quality, manufacturing cycle time, and productivity.productivity.

Critical Success Factors (CSFs)Critical Success Factors (CSFs)

Critical success factors are strategic Critical success factors are strategic financial and non-financial measures of financial and non-financial measures of success.success.

Critical success factors are used to define Critical success factors are used to define and measure the means by which a firm and measure the means by which a firm achieves a competitive advantage. achieves a competitive advantage. Strategic cost management involves the Strategic cost management involves the development, understanding, and use of development, understanding, and use of critical success factors to manage critical success factors to manage business firms and other organizations.business firms and other organizations.

CSFs for Chemical ManufacturerCSFs for Chemical Manufacturer

Several potential critical success factors for an industrial Several potential critical success factors for an industrial chemical manufacturer might include:chemical manufacturer might include:

1. cost and price, since most chemicals are commodities 1. cost and price, since most chemicals are commodities which compete principally on pricewhich compete principally on price

2. speed of delivery, since many applications for these 2. speed of delivery, since many applications for these chemicals require prompt deliverychemicals require prompt delivery

3. quality of the chemicals, so that they meet the required 3. quality of the chemicals, so that they meet the required specifications of the customersspecifications of the customers

4. location and cost of storage, to enhance customer 4. location and cost of storage, to enhance customer service and reduce overall costsservice and reduce overall costs

5. modernization of production and processing facilities, to 5. modernization of production and processing facilities, to produce the highest quality chemicals at the lowest pricesproduce the highest quality chemicals at the lowest prices

6. research and development, to introduce new and 6. research and development, to introduce new and improved productsimproved products

CSFs for Savings & Loan InstitutionCSFs for Savings & Loan Institution

Several potential critical success factors for large Several potential critical success factors for large savings and loan institution might include:savings and loan institution might include:

1. Spread between the cost of funds and the 1. Spread between the cost of funds and the earnings on investments and loansearnings on investments and loans

2. Amount of total deposits, number of 2. Amount of total deposits, number of depositors, number of new offices, number of depositors, number of new offices, number of loansloans

3. Decrease in loan losses, number of bad loans, 3. Decrease in loan losses, number of bad loans, losses due to theft and fraudlosses due to theft and fraud

4. Training hours per employee, employee 4. Training hours per employee, employee turnover,turnover,

5. Customer satisfaction as measured by phone 5. Customer satisfaction as measured by phone survey or other meanssurvey or other means

CSFs for Small Chain of Retail CSFs for Small Chain of Retail Jewellery StoreJewellery Store

Several critical success factors for a small chain of retail Several critical success factors for a small chain of retail jewelry stores might include:jewelry stores might include:

1. Growth in sales, number of new customers, number of 1. Growth in sales, number of new customers, number of new products, number of branch storesnew products, number of branch stores

2. Operating costs, by category2. Operating costs, by category 3. Customer satisfaction as measured by phone survey or 3. Customer satisfaction as measured by phone survey or

mail surveymail survey 4. Identification and introduction of new products4. Identification and introduction of new products 5. Effective promotion and advertising using a variety of 5. Effective promotion and advertising using a variety of

mediamedia 6. Competitive service policies6. Competitive service policies 7. Identification of attractive store locations7. Identification of attractive store locations 8. Effective control of inventory to prevent fraud and theft8. Effective control of inventory to prevent fraud and theft

CSFs for a Large Retail Discount CSFs for a Large Retail Discount StoreStore

Several potential critical success factors for a large retail Several potential critical success factors for a large retail discount store might include:discount store might include:

1. Growth in sales, number of new branch stores1. Growth in sales, number of new branch stores 2. Operating costs, by category2. Operating costs, by category 3. Customer satisfaction, as measured by phone survey or 3. Customer satisfaction, as measured by phone survey or

mail surveymail survey 4. Identification and introduction of new products4. Identification and introduction of new products 5. Effective promotion and advertising using a variety of 5. Effective promotion and advertising using a variety of

mediamedia 6. Competitive service policies6. Competitive service policies 7. Identification of attractive store locations7. Identification of attractive store locations 8. Effective inventory management, both to reduce 8. Effective inventory management, both to reduce

employee theft and also to reduce waste, overstocking and employee theft and also to reduce waste, overstocking and excessive out-of-stock conditionsexcessive out-of-stock conditions

9. Choice of merchandise mix, to attract customers9. Choice of merchandise mix, to attract customers

CSFs for a Small Auto Repair ShopCSFs for a Small Auto Repair Shop

Several potential critical success factors for a Several potential critical success factors for a small auto-repair shop might include:small auto-repair shop might include:

1. reliability of service1. reliability of service 2. fair pricing2. fair pricing 3. warranty for service; and policies for satisfying 3. warranty for service; and policies for satisfying

customer complaints when they occurcustomer complaints when they occur 4. inventory management to reduce loss, waste 4. inventory management to reduce loss, waste

and to reduce the cost of carrying inventory of and to reduce the cost of carrying inventory of partsparts

5. proper location with sufficient parking and easy 5. proper location with sufficient parking and easy accessaccess

6. effective marketing using the appropriate 6. effective marketing using the appropriate mediamedia

Balanced Score CardBalanced Score Card The balanced scorecard is an accounting report that includes the The balanced scorecard is an accounting report that includes the

firm’s critical success factors in four areas: customer satisfaction, firm’s critical success factors in four areas: customer satisfaction, financial performance, internal business processes, and innovation financial performance, internal business processes, and innovation and learning (human resources). The primary objective of the and learning (human resources). The primary objective of the balanced scorecard is to serve as an action plan, a basis for balanced scorecard is to serve as an action plan, a basis for implementing the strategy expressed in the CSFs.implementing the strategy expressed in the CSFs.

The balanced scorecard is important to integrate both financial The balanced scorecard is important to integrate both financial and non-financial information into management reports. Financial and non-financial information into management reports. Financial measures reflect only a partial – and short-term -- measure of the measures reflect only a partial – and short-term -- measure of the firm's progress. Without strategic non-financial information, the firm's progress. Without strategic non-financial information, the firm is likely to stray from its competitive course and to make firm is likely to stray from its competitive course and to make strategically wrong product decisions -- to choose the wrong strategically wrong product decisions -- to choose the wrong products, the wrong customers. The balanced scorecard provides products, the wrong customers. The balanced scorecard provides a basis for a more complete analysis than is possible with financial a basis for a more complete analysis than is possible with financial data alone.data alone.

Qualitative and Quantitative Qualitative and Quantitative Information in Cost ManagementInformation in Cost Management

The principal implication of strategic analysis for cost The principal implication of strategic analysis for cost management is that new types of information must be management is that new types of information must be provided in addition to that provided in the traditional cost provided in addition to that provided in the traditional cost accounting system. The focus of cost management is now accounting system. The focus of cost management is now on critical success factors including the types of non-on critical success factors including the types of non-financial information not often associated with accounting financial information not often associated with accounting reports: product quality, customer satisfaction, information reports: product quality, customer satisfaction, information on plant operations, etc. Another implication of strategic on plant operations, etc. Another implication of strategic analysis is that cost management must become more analysis is that cost management must become more integrated with the other management functions: integrated with the other management functions: operations, finance, and marketing. Accounting reports operations, finance, and marketing. Accounting reports must facilitate cross-functional management decision must facilitate cross-functional management decision making, and thus must include information relevant to making, and thus must include information relevant to marketing, finance and operations managers. Accounting marketing, finance and operations managers. Accounting reports must extend beyond needs for the determination of reports must extend beyond needs for the determination of product costs and external financial reporting.product costs and external financial reporting.

Value Chain AnalysisValue Chain Analysis Value-chain analysis is a strategic analysis tool used to Value-chain analysis is a strategic analysis tool used to

identify where value to customers can be increased or identify where value to customers can be increased or costs reduced, and to better understand the firm’s costs reduced, and to better understand the firm’s linkages with suppliers, customers, and other firms in the linkages with suppliers, customers, and other firms in the industry.industry.

The value chain is a way to describe relations The value chain is a way to describe relations among an organization's operations. The value among an organization's operations. The value chain describes how an organization assigns its chain describes how an organization assigns its resources to these operations and how one resources to these operations and how one operation affects other operations. It is important operation affects other operations. It is important for managers to understand the value chain for managers to understand the value chain because it can be the basis for competitive because it can be the basis for competitive advantages and is the starting point for making advantages and is the starting point for making improvements in the organization.improvements in the organization.

Examples of Firms Emphasizing Examples of Firms Emphasizing Cost ManagementCost Management

Firms Using Cost Management. Here are some examples; there Firms Using Cost Management. Here are some examples; there are manyare many

possible answers.possible answers. 1. Wal-Mart: to keep costs low by streamlining restocking and 1. Wal-Mart: to keep costs low by streamlining restocking and

salessales 2. COMPAQ: to keep costs low by improving manufacturing 2. COMPAQ: to keep costs low by improving manufacturing

performance and byperformance and by using target costing and other management techniquesusing target costing and other management techniques 3. Citicorp: to keep costs low by using activity analysis (see 3. Citicorp: to keep costs low by using activity analysis (see

problem 1-31) toproblem 1-31) to identify key operations and to find those that add little or no valueidentify key operations and to find those that add little or no value 4. A local school district or public agency: to keep costs low in 4. A local school district or public agency: to keep costs low in

order to provideorder to provide the best possible service given available fundsthe best possible service given available funds 5. Procter & Gamble: to assess the profitability of its different 5. Procter & Gamble: to assess the profitability of its different

productsproducts

Firms Emphasizing Cost Firms Emphasizing Cost ManagementManagement

6. Any other large, diversified manufacturer, 6. Any other large, diversified manufacturer, like Procter & Gamble: which needs to be able like Procter & Gamble: which needs to be able to analyze the relative profitability of its to analyze the relative profitability of its different products, using cost managementdifferent products, using cost management

7. A small machine shop: which needs cost 7. A small machine shop: which needs cost management to determine whether it should management to determine whether it should repair or replace a machinerepair or replace a machine

8. A dance studio: to analyze and choose 8. A dance studio: to analyze and choose between different compensation plans for its between different compensation plans for its teachers; and to determine whether it should teachers; and to determine whether it should open a new studioopen a new studio

Firms not expected to be significant users of cost management Firms not expected to be significant users of cost management information:information:

1. Microsoft: here the focus is on forming strategic alliances, innovation 1. Microsoft: here the focus is on forming strategic alliances, innovation andand

competition; cost management is more important for other firms in thecompetition; cost management is more important for other firms in the information technology business, such as COMPAQ, Hewlett Packard, and information technology business, such as COMPAQ, Hewlett Packard, and

IBMIBM that compete in part on innovation but also on pricethat compete in part on innovation but also on price 2. Versace: a high fashion firm competes on innovation and product 2. Versace: a high fashion firm competes on innovation and product

leadership;leadership; the development and communication of attractive new ideas is the key tothe development and communication of attractive new ideas is the key to competitive success rather than cost managementcompetitive success rather than cost management 3. Other firms in the fashion industry, such as Chanel, Givency, and 3. Other firms in the fashion industry, such as Chanel, Givency, and

Armani: forArmani: for reasons similar to Versacereasons similar to Versace 4. Major league sports: dependent primarily on the development of fan 4. Major league sports: dependent primarily on the development of fan

support,support, good coaching and player acquisitionFirms not expected to be significant good coaching and player acquisitionFirms not expected to be significant

users of cost management information:users of cost management information:

Factors affecting Business Factors affecting Business EnvironmentEnvironment

The factors in the contemporary business environment that affect business firmsThe factors in the contemporary business environment that affect business firms and cost management are:and cost management are: 1. Increased global competition, which means an increasingly competitive1. Increased global competition, which means an increasingly competitive environment for all firms and thus the need for cost management information toenvironment for all firms and thus the need for cost management information to become more competitive; the need for competitive non-financial information inbecome more competitive; the need for competitive non-financial information in addition to financial information in cost management reports;addition to financial information in cost management reports; 2. Changes in manufacturing and information technologies, and thus the need for2. Changes in manufacturing and information technologies, and thus the need for cost management information to facilitate the introduction of new manufacturingcost management information to facilitate the introduction of new manufacturing and product technologies (e.g., determining which technologies will mostand product technologies (e.g., determining which technologies will most contribute to profitability), and to incorporate in cost management reports thecontribute to profitability), and to incorporate in cost management reports the information needed to manage the new technologies effectively; the importanceinformation needed to manage the new technologies effectively; the importance of life cycle costing -- considering the total costs of the product or service over itsof life cycle costing -- considering the total costs of the product or service over its entire cost life cycle, from raw materials to sales and service;entire cost life cycle, from raw materials to sales and service;

Factors affecting Business Factors affecting Business EnvironmentEnvironment

3. A focus on the customer, which requires cost management reports to 3. A focus on the customer, which requires cost management reports to includeinclude

critical information about customer satisfaction, changing customer critical information about customer satisfaction, changing customer preferences,preferences,

etc.;etc.; 4. Changes in management organizations, new reporting practices to 4. Changes in management organizations, new reporting practices to

recognizerecognize the new focus on cross-functional teams in which employees from all areas the new focus on cross-functional teams in which employees from all areas

of theof the firm work together to make the firm successful;firm work together to make the firm successful; 5. Changes in the social, political, and cultural environment of business, 5. Changes in the social, political, and cultural environment of business,

whichwhich requires an expansion of cost management reporting to include critical requires an expansion of cost management reporting to include critical

successsuccess factors related to the expectations of those beyond the ownership of the factors related to the expectations of those beyond the ownership of the

firmfirm including employees, local government officials, and community leaders.including employees, local government officials, and community leaders.

Changing Business EnvironmentChanging Business Environment

Changing Business EnvironmentChanging Business Environment

Cost Management TechniquesCost Management Techniques The eleven contemporary management techniques are:The eleven contemporary management techniques are: 1. Benchmarking, a process by which a firm identifies its critical success factors,1. Benchmarking, a process by which a firm identifies its critical success factors, studies the best practices of other firms (or other units within a firm) for thesestudies the best practices of other firms (or other units within a firm) for these critical success factors, and then implements improvements in the firm'scritical success factors, and then implements improvements in the firm's processes to match or beat the performance of its competitors.processes to match or beat the performance of its competitors. 2.Total Quality Management, a technique in which management develops2.Total Quality Management, a technique in which management develops policies and practices to ensure that the firm's products and services exceed thepolicies and practices to ensure that the firm's products and services exceed the customer's expectations.customer's expectations. 3. Business Process Improvement, a management technique in which managers3. Business Process Improvement, a management technique in which managers and workers commit to a program of continuous improvement in quality and otherand workers commit to a program of continuous improvement in quality and other critical success factors.critical success factors. 4.Activity-based Costing and Management: Activity-based costing is used to4.Activity-based Costing and Management: Activity-based costing is used to improve the tracing of manufacturing costs to products and therefore theimprove the tracing of manufacturing costs to products and therefore the accuracy of product costs. Activity-based management (ABM) uses activityaccuracy of product costs. Activity-based management (ABM) uses activity analysis to help managers improve the value of products and services and toanalysis to help managers improve the value of products and services and to increase the firm’s competitiveness.increase the firm’s competitiveness.

Cost Management TechniquesCost Management Techniques 5. Reengineering, a process for creating competitive advantage in which a 5. Reengineering, a process for creating competitive advantage in which a

firmfirm reorganizes its operating and management functions, often with the result reorganizes its operating and management functions, often with the result

thatthat jobs are modified, combined, or eliminated.jobs are modified, combined, or eliminated. 6. The Theory of Constraints, a strategic technique to help firms to 6. The Theory of Constraints, a strategic technique to help firms to

effectivelyeffectively improve the rate at which raw materials are converted to finished product.improve the rate at which raw materials are converted to finished product. 7. Mass Customization, a management technique in which marketing and7. Mass Customization, a management technique in which marketing and production processes are designed to handle the increased variety of production processes are designed to handle the increased variety of

deliveringdelivering customized products and services to customers.customized products and services to customers. 8. Target Costing, a management technique that determines the desired 8. Target Costing, a management technique that determines the desired

cost forcost for a product upon the basis of a given competitive price, such that the a product upon the basis of a given competitive price, such that the

product will earn a desired profit.product will earn a desired profit.

Cost Management TechniquesCost Management Techniques 9. Life-Cycle Costing, a management technique 9. Life-Cycle Costing, a management technique

used to monitor the costs of a product throughout used to monitor the costs of a product throughout its life cycle.its life cycle.

10. Value-Chain Analysis, a too that hels the firm 10. Value-Chain Analysis, a too that hels the firm identify the specific steps required to provide a identify the specific steps required to provide a product or service.product or service.

11. The Balanced Scorecard, an accounting report 11. The Balanced Scorecard, an accounting report that includes the firm’s critical success factors in that includes the firm’s critical success factors in four areas: customer satisfaction, financial four areas: customer satisfaction, financial performance, internal business processes, and performance, internal business processes, and innovation and learning (human resources).innovation and learning (human resources).

Theory of Constraints (TOC)Theory of Constraints (TOC) The concept of throughput in the theory of constraints The concept of throughput in the theory of constraints

(TOC) is central to TOC to reduce the time and waste in (TOC) is central to TOC to reduce the time and waste in producing the product or service. The concept also applies producing the product or service. The concept also applies to the service context as well as to manufacturing. In to the service context as well as to manufacturing. In service firms, TOC is used to identify bottleneck operations service firms, TOC is used to identify bottleneck operations in the set of steps and operations that are needed to in the set of steps and operations that are needed to provide the service. For example, in banking, the provide the service. For example, in banking, the bottleneck might be the movement of cash and transaction bottleneck might be the movement of cash and transaction forms between the branches and to the central bank forms between the branches and to the central bank processing point. Similarly, in providing a professional processing point. Similarly, in providing a professional service such as accounting, legal or medical, the bottleneck service such as accounting, legal or medical, the bottleneck might be the scheduling of specialized professionals to a might be the scheduling of specialized professionals to a given client or patient. In a hospital, the bottleneck might given client or patient. In a hospital, the bottleneck might be the admitting process. In each case, the proper design be the admitting process. In each case, the proper design of systems to speed the service to the customer is the of systems to speed the service to the customer is the objective of the TOC analysis. This is done by an activity objective of the TOC analysis. This is done by an activity analysis of the operations necessary to provide the service.analysis of the operations necessary to provide the service.

TOC for Service and Manufacturing TOC for Service and Manufacturing FirmsFirms

A difference between service and manufacturing firms is A difference between service and manufacturing firms is the presence of inventory in the manufacturing setting. An the presence of inventory in the manufacturing setting. An objective of TOC for a manufacturer is to reduce inventory objective of TOC for a manufacturer is to reduce inventory levels; the presence of large quantities of inventory is levels; the presence of large quantities of inventory is evidence of bottlenecks for a manufacturer. In contrast, evidence of bottlenecks for a manufacturer. In contrast, inventory is not an important matter in the service firm. inventory is not an important matter in the service firm. Rather, it is important to identify people/processes where Rather, it is important to identify people/processes where the delivery of the service to the customer is “stalled,” that the delivery of the service to the customer is “stalled,” that is, the bottleneck. This might be a stack of forms waiting to is, the bottleneck. This might be a stack of forms waiting to be processed by a clerk, a waiting room of patients waiting be processed by a clerk, a waiting room of patients waiting to be seen by a doctor, etc. The application of the concept to be seen by a doctor, etc. The application of the concept of TOC is however, the same. That is, how to get the service of TOC is however, the same. That is, how to get the service to the customer as quickly and with as little waste as to the customer as quickly and with as little waste as possible. Retail and auto repair businesses are among the possible. Retail and auto repair businesses are among the good examples.good examples.

TOC at different firmsTOC at different firms

At Wal-Mart, or any other retail firm, TOC At Wal-Mart, or any other retail firm, TOC can be applied to speed the product to the can be applied to speed the product to the customer, that is quick re-stocking of customer, that is quick re-stocking of items in the stores, quick introduction of items in the stores, quick introduction of new products into the stores, and fast new products into the stores, and fast customer check out. In an auto repair customer check out. In an auto repair business, TOC is applied to determine business, TOC is applied to determine ways to serve the customer more quickly, ways to serve the customer more quickly, with less wasted time during and between with less wasted time during and between jobs.jobs.

Firm Characteristics using Target Firm Characteristics using Target CostingCosting

The types of firms which would demand Target The types of firms which would demand Target Costing would be firms that are in very Costing would be firms that are in very competitive industries, where cost/price competitive industries, where cost/price competition is critical, such as consumer competition is critical, such as consumer products. Examples of firms that might use target products. Examples of firms that might use target costing also include those that have short product costing also include those that have short product life cycles (the time from introduction of the life cycles (the time from introduction of the product into the market until its withdrawal from product into the market until its withdrawal from the market). The firm must be very deliberate in the market). The firm must be very deliberate in planning about costs when there are short life planning about costs when there are short life cycles, since there is a short time to recover the cycles, since there is a short time to recover the development costs -- the product must be careful development costs -- the product must be careful designed, using target costing, so that it is designed, using target costing, so that it is profitable in its short life cycle.profitable in its short life cycle.

Firm Characteristics using Life Firm Characteristics using Life Cycle CostingCycle Costing

Appropriate firms that would use Life Cycle Costing would Appropriate firms that would use Life Cycle Costing would be the same types of firms as for target costing. Intense be the same types of firms as for target costing. Intense competition on price/cost and short product life cycles are competition on price/cost and short product life cycles are indicators of firms that are likely to use life-cycle costing. indicators of firms that are likely to use life-cycle costing. The reason is that in both cases, the focus is on the The reason is that in both cases, the focus is on the management of design and therefore the management of management of design and therefore the management of downstream costs, so as to achieve profitability for the downstream costs, so as to achieve profitability for the product over its life cycle. product over its life cycle.

Some Japanese firms, for example, will introduce a product Some Japanese firms, for example, will introduce a product that is not profitable at the first phase of its life cycle, but that is not profitable at the first phase of its life cycle, but as costs are expected to come down in the manufacturing as costs are expected to come down in the manufacturing process through continuous improvement efforts, the process through continuous improvement efforts, the product will become profitable later in its life cycle.product will become profitable later in its life cycle.

Cost Management and Profitability Cost Management and Profitability Analysis Analysis

Budget cutbacks, increased customer (taxpayer) demands, increased Budget cutbacks, increased customer (taxpayer) demands, increased operational complexity— many of today’s managers have to deal with operational complexity— many of today’s managers have to deal with these challenges. Every organization, be it public or private, operates in an these challenges. Every organization, be it public or private, operates in an environment that is going through fundamental and ongoing changes. It is environment that is going through fundamental and ongoing changes. It is vital, therefore, that these organizations equip themselves with the vital, therefore, that these organizations equip themselves with the management tools that will allow them to progress at the same rapid pace. management tools that will allow them to progress at the same rapid pace.

Knowing how your costs break down and especially how they behave Knowing how your costs break down and especially how they behave depending on a variety of different situations and decisions are two depending on a variety of different situations and decisions are two elements vital to sound organizational management. Knowing how fast elements vital to sound organizational management. Knowing how fast things change today is yet one more reason to deploy a strategic cost things change today is yet one more reason to deploy a strategic cost management enabling you to react quickly.management enabling you to react quickly.

In the public sectorIn the public sector, taxpayers demand more services while requiring , taxpayers demand more services while requiring the use of technology and new distribution means such as the internet. The the use of technology and new distribution means such as the internet. The rapid transformation of the government sector has had a major impact on rapid transformation of the government sector has had a major impact on its cost structure. For the federal government, “knowing your costs is part its cost structure. For the federal government, “knowing your costs is part of knowing your business”. Departments with external user fees are of knowing your business”. Departments with external user fees are required to know their costs and report on them. Cost management is part required to know their costs and report on them. Cost management is part of a sound governance process and leads to an accountable environment.of a sound governance process and leads to an accountable environment.

Nature of Costs in Private SectorNature of Costs in Private Sector

In the private sectorIn the private sector, managers have to deal with , managers have to deal with exchange rate fluctuations, aggressive and increasingly exchange rate fluctuations, aggressive and increasingly numerous competitors in an ever-expanding global market. numerous competitors in an ever-expanding global market. As company equipment ages, managers wonder how they As company equipment ages, managers wonder how they can modernize it without negatively affecting customer can modernize it without negatively affecting customer service and productivity. The ability to determine the service and productivity. The ability to determine the consequences of such decisions in advance is thus not only consequences of such decisions in advance is thus not only a vital component of managerial decision-making but also a vital component of managerial decision-making but also confers a strategic competitive advantage.confers a strategic competitive advantage.

Indirect costs continue to climb as a result of the Indirect costs continue to climb as a result of the company’s increasing focus on improving the way it company’s increasing focus on improving the way it manages both itself and its relationships with external manages both itself and its relationships with external partners. All these elements combine to modify your partners. All these elements combine to modify your company’s cost structure and behavior. All too often, the company’s cost structure and behavior. All too often, the limitations of conventional cost models prevent the limitations of conventional cost models prevent the company from seeing the complete cost mix picture. company from seeing the complete cost mix picture.

Profitability AnalysisProfitability Analysis Profitability AnalysisProfitability Analysis The Pareto Principle states that 20% of a company’s customers The Pareto Principle states that 20% of a company’s customers

generate 80% of its sales. This law has been part of our lives for generate 80% of its sales. This law has been part of our lives for quite some time already, and our guess is that it will be around for quite some time already, and our guess is that it will be around for a long time. a long time.

For example, for most manufacturers, Walmart usually represents For example, for most manufacturers, Walmart usually represents a huge customer (in top dollars) and is most definitely part of the a huge customer (in top dollars) and is most definitely part of the top quadrant of the 80-20 rule. But where does profitability fit into top quadrant of the 80-20 rule. But where does profitability fit into that law? Is Walmart a profitable customer? Is your best customer that law? Is Walmart a profitable customer? Is your best customer always in the top most profitable quadrant? always in the top most profitable quadrant?

In these times of budget cutbacks and rigorous cost management, In these times of budget cutbacks and rigorous cost management, managers have a tendency to look solely at costs and possible managers have a tendency to look solely at costs and possible ways of reducing them. However, it is now more than ever ways of reducing them. However, it is now more than ever necessary to know the mix of elements that makes up your necessary to know the mix of elements that makes up your profitability. How would you answer the following questions?profitability. How would you answer the following questions?

Exactly how much profit does each of your customers generate? Exactly how much profit does each of your customers generate? Which are the most, which are the least profitable, and why? Which are the most, which are the least profitable, and why?

Pareto Analysis in Profitability Pareto Analysis in Profitability StudiesStudies

Some studies show that a mere 20% of your Some studies show that a mere 20% of your clientele generate anywhere from 150 to 300% of clientele generate anywhere from 150 to 300% of your profits, while as few as 10% reduce your your profits, while as few as 10% reduce your profits by 50 to 200%. The following figure shows profits by 50 to 200%. The following figure shows the results of one study in table form.the results of one study in table form.

Thus, if you had made $1 million in profit by year-Thus, if you had made $1 million in profit by year-

end, 10% of your customers would have end, 10% of your customers would have generated losses of between $500,000 and $2 generated losses of between $500,000 and $2 million. It would seem logical to try and identify million. It would seem logical to try and identify those particular customers. This brings us to those particular customers. This brings us to another question:another question:

Client ProfitabilityClient Profitability

Loyal Customers – Profitable Loyal Customers – Profitable Customers?Customers?

Are your most loyal customers also your Are your most loyal customers also your most profitable ones, or are they merely most profitable ones, or are they merely profitable?profitable?

Here is what the authors of a study on this Here is what the authors of a study on this subject had to say about customer loyalty and subject had to say about customer loyalty and profitability:profitability:

"Specifically, we discovered little or no evidence "Specifically, we discovered little or no evidence to suggest that customers who purchase steadily to suggest that customers who purchase steadily from a company over time are necessarily from a company over time are necessarily cheaper to serve, less price sensitive, or cheaper to serve, less price sensitive, or particularly effective at bringing in new particularly effective at bringing in new business.” (1)business.” (1)

Find answers to the following questions:Find answers to the following questions:

Loyal Customers – Profitable Loyal Customers – Profitable Customers?Customers?

Which are my most profitable clients and, by the Which are my most profitable clients and, by the same token, my least profitable ones? same token, my least profitable ones?

Which are my most profitable products and Which are my most profitable products and services? services?

Which sources of information do I rely on to Which sources of information do I rely on to review my marketing strategy? review my marketing strategy?

How should I respond to my clients’ increasingly How should I respond to my clients’ increasingly complex demands? complex demands?

Would reviewing my production mix generate Would reviewing my production mix generate more profits? more profits?

How is it possible for my production costs to How is it possible for my production costs to remain steady while my profit margin steadily remain steady while my profit margin steadily decreases? decreases?

Commodity - DefinitionCommodity - Definition

A commodity is a product or service A commodity is a product or service that is difficult to differentiate from that is difficult to differentiate from competitors: gasoline, paper competitors: gasoline, paper products, are some examples. The products, are some examples. The crucial point for a commodity: is crucial point for a commodity: is there any reason you would pay there any reason you would pay more for this item? As such, more for this item? As such, commodities are natural cost commodities are natural cost leadership products or services.leadership products or services.

Differentiation vs Cost LeadershipDifferentiation vs Cost Leadership

Most people will argue that they chose Most people will argue that they chose their bank because of service and location, their bank because of service and location, thus differentiation. Others will say the thus differentiation. Others will say the rates are better, and then perhaps cost rates are better, and then perhaps cost leadership. It is useful to distinguish the leadership. It is useful to distinguish the banking needs of say, a student, versus a banking needs of say, a student, versus a small business like a car dealership which small business like a car dealership which will rely more heavily on a variety of will rely more heavily on a variety of customer services and will likely see banks customer services and will likely see banks as more differentiated entities.as more differentiated entities.

Industry Characteristics in Cost Industry Characteristics in Cost Leadership Leadership

The main point of the question is that the The main point of the question is that the cost leadership or differentiation cost leadership or differentiation classification applies across different types classification applies across different types of firms in different industries. There are of firms in different industries. There are some industries (particularly those with some industries (particularly those with commodities) which tend to be commodities) which tend to be characterized by cost leaders and others characterized by cost leaders and others (biotech,..) which tend to be characterized (biotech,..) which tend to be characterized by differentiators. Other industries may by differentiators. Other industries may have a mix of different types of have a mix of different types of competitors. Now consider the automobile competitors. Now consider the automobile industry and try to identify cost leaders industry and try to identify cost leaders and differentiators.and differentiators.

From Differentiation to Cost From Differentiation to Cost LeadershipLeadership

It is certainly likely that a new It is certainly likely that a new product, with technologically product, with technologically advanced features, may begin as a advanced features, may begin as a differentiator and then as the market differentiator and then as the market for the product matures and for the product matures and competitors enter the market for the competitors enter the market for the product, then the industry as a whole product, then the industry as a whole moves to more of a cost leadership moves to more of a cost leadership type of competition. Consider cell type of competition. Consider cell phones as an example.phones as an example.

Key Job Skills in the context of Key Job Skills in the context of Critical Success FactorsCritical Success Factors

Key Job Skills required these days:Key Job Skills required these days:

Business Knowledge/Understanding strategyBusiness Knowledge/Understanding strategy Has a good understanding of business fundamentals; cost andHas a good understanding of business fundamentals; cost and revenue drivers, the regulatory environment in banking, etc.revenue drivers, the regulatory environment in banking, etc. Understands the strategy and business environment of bankUnderstands the strategy and business environment of bank customers he or she works with.customers he or she works with. Customer FocusCustomer Focus Employee works well with customers and other employeesEmployee works well with customers and other employees Efforts are customer-focusedEfforts are customer-focused Creative Problem SolvingCreative Problem Solving Thinks creativelyThinks creatively Understand complexitiesUnderstand complexities

Key Job SkillsKey Job Skills PersuasivePersuasive Is able to present ideas concisely and clearlyIs able to present ideas concisely and clearly Understands who “owns” a problem, and who can solve itUnderstands who “owns” a problem, and who can solve it FlexibilityFlexibility Not easily disappointed; handles conflict wellNot easily disappointed; handles conflict well Is able to see multiple viewpoints while asserting a positionIs able to see multiple viewpoints while asserting a position Can be a business partner, customer advocate, as well as loyalCan be a business partner, customer advocate, as well as loyal employee and friendemployee and friend Embraces changeEmbraces change Good supervisorGood supervisor Creates a positive climateCreates a positive climate Provides opportunities for development, learning and promotionProvides opportunities for development, learning and promotion Can make tough personnel decisionsCan make tough personnel decisions Is able to delegate, and teaches others how to do the sameIs able to delegate, and teaches others how to do the same Looks for new ideas and rewards suggestionsLooks for new ideas and rewards suggestions Builds commitmentBuilds commitment

Key Job SkillsKey Job Skills PerformancePerformance Shows enthusiasmShows enthusiasm Has high standardsHas high standards Willing to work extra hours when necessaryWilling to work extra hours when necessary Is willing to take risksIs willing to take risks Keeps supervisors informedKeeps supervisors informed Works well on a teamWorks well on a team Effectively manages timeEffectively manages time Communication SkillsCommunication Skills Communication is clear and focusedCommunication is clear and focused Good sense of confidentiality where appropriateGood sense of confidentiality where appropriate

Key Job SkillsKey Job Skills

Technology SkillsTechnology Skills Fully versatile in using computer Fully versatile in using computer

applications that apply in theapplications that apply in the banking industrybanking industry Develops new skills where Develops new skills where

appropriateappropriate Professional EthicsProfessional Ethics Displays high standard for ethical Displays high standard for ethical

behaviorbehavior

ABC in Banks – Identifying ABC in Banks – Identifying ActivitiesActivities

Example activities might be to:Example activities might be to: process depositsprocess deposits process withdrawalsprocess withdrawals answer customer inquiriesanswer customer inquiries sell traveler checkssell traveler checks balance cash drawer (at the end of the day)balance cash drawer (at the end of the day) receive an installment loan applicationreceive an installment loan application process an installment loan applicationprocess an installment loan application provide advice regarding investments, including an explanation ofprovide advice regarding investments, including an explanation of investment services provided by the bankinvestment services provided by the bank receive a mortgage loan applicationreceive a mortgage loan application process a mortgage loan applicationprocess a mortgage loan application mail out monthly statements: checking customers, savings mail out monthly statements: checking customers, savings

customers,customers, loan customersloan customers

ABC in BanksABC in Banks

The activity analysis for processing The activity analysis for processing deposits, for example, would include adeposits, for example, would include a

detailed description of the number of detailed description of the number of different ways the activity is initiated anddifferent ways the activity is initiated and

performed, the time required, the skills performed, the time required, the skills required, resources required (e.g. labor,required, resources required (e.g. labor,

technology, facilities), etc.technology, facilities), etc.

Importance of Ethics in FirmsImportance of Ethics in Firms Even if the fault will occur in very rare and Even if the fault will occur in very rare and

unusual circumstances, if the consequence unusual circumstances, if the consequence could be some damage to a user, the firm could be some damage to a user, the firm should advise users of the fault and the should advise users of the fault and the potential implications. On the other hand, potential implications. On the other hand, there should be no need to advise users if there should be no need to advise users if the fault is not likely to have any the fault is not likely to have any noticeable consequence on the use of the noticeable consequence on the use of the chip, as for example, if the chip simply chip, as for example, if the chip simply takes much longer for a very rare type of takes much longer for a very rare type of processing, but returns the proper result. processing, but returns the proper result. The effect of the delay is not likely to have The effect of the delay is not likely to have a damaging effect on any known user.a damaging effect on any known user.

GM – Differentiation or Cost GM – Differentiation or Cost Leadership?Leadership?

The strategy adopted by GM is consistent with the The strategy adopted by GM is consistent with the differentiation strategy, a focus on quality, style, and differentiation strategy, a focus on quality, style, and innovation rather than price and cost. Unfortunately, the innovation rather than price and cost. Unfortunately, the dealers and some analysts were infuriated by GM’s move, dealers and some analysts were infuriated by GM’s move, believing that “the reality is this is a price-driven market” believing that “the reality is this is a price-driven market” (Merrill Lynch & Co auto analyst Nicholas Lobaccaro). GM’s (Merrill Lynch & Co auto analyst Nicholas Lobaccaro). GM’s response to the criticism was to state that brand value is response to the criticism was to state that brand value is what creates market share and profits, although it can take what creates market share and profits, although it can take time to do so. The incident shows that it can be difficult to time to do so. The incident shows that it can be difficult to determine the firm’s strategy, and experts can disagree. determine the firm’s strategy, and experts can disagree. How do you think GM competes?How do you think GM competes?

See: “GM Dealers Aren’t Buying It,” See: “GM Dealers Aren’t Buying It,” Business WeekBusiness Week, , February 8, 1999, pp 46-47.February 8, 1999, pp 46-47.

Calvin Klein – Differentiation Calvin Klein – Differentiation StrategyStrategy

Calvin Klein products are clearly differentiated on Calvin Klein products are clearly differentiated on the basis of high fashion and cost. What remains the basis of high fashion and cost. What remains at issue is whether some differentiated products at issue is whether some differentiated products can be sold in discount retail stores. Thinking that can be sold in discount retail stores. Thinking that the presence of so much of his products in the presence of so much of his products in discount retail stores could hurt his brand, Calvin discount retail stores could hurt his brand, Calvin Klein sued Warnaco to stop this practice. The suit Klein sued Warnaco to stop this practice. The suit was settled out of court in January 2001 and was settled out of court in January 2001 and Warnaco was allowed to retain the lucrative Warnaco was allowed to retain the lucrative Calvin Klein contract.Calvin Klein contract.

See: “Behind a Bitter Suit Filed by Calvin Klein See: “Behind a Bitter Suit Filed by Calvin Klein Lies Grit of Licensing,” Lies Grit of Licensing,” The Wall Street JournalThe Wall Street Journal, , June 1, 2000, p 1.June 1, 2000, p 1.

BMW – Differentiation StrategyBMW – Differentiation Strategy The critical question for BMW is how the use of another manufacturer The critical question for BMW is how the use of another manufacturer

might affect customers’ confidence in the BMW brand. Most would say that might affect customers’ confidence in the BMW brand. Most would say that BMW is a differentiated firm, and its customers expect quality and features BMW is a differentiated firm, and its customers expect quality and features over cost. The X3 has been a great success for BMW (both in sales and over cost. The X3 has been a great success for BMW (both in sales and reviews), so it is apparent that customers have accepted the contract reviews), so it is apparent that customers have accepted the contract manufacturing of the vehicle Perhaps more interesting is BMW’s plan to manufacturing of the vehicle Perhaps more interesting is BMW’s plan to “protect its brand by not entering the minivan market.” According to “protect its brand by not entering the minivan market.” According to BMW’s CEO, “We do not have a van because a van as it is in the market BMW’s CEO, “We do not have a van because a van as it is in the market today does not fulfill any of the BMW group brand values.” On balance, today does not fulfill any of the BMW group brand values.” On balance, BMW has succeeded in the luxury, high-end of the SUV market, but has BMW has succeeded in the luxury, high-end of the SUV market, but has determined that the luxury, high-end market currently has no place for a determined that the luxury, high-end market currently has no place for a minivan.minivan.

Source: “BMW;’s CEO Just Says No to Protect Brand,” Source: “BMW;’s CEO Just Says No to Protect Brand,” The Wall StreetThe Wall Street JournalJournal, November 26, 2003, p B1; “Ah, That Excellent German Engineering , November 26, 2003, p B1; “Ah, That Excellent German Engineering

–– Straight from Southern Austria,” Straight from Southern Austria,” The Wall Street JournalThe Wall Street Journal, September 10, , September 10,

2003, p2003, p B1B1

Innovation – Critical to Software Innovation – Critical to Software and Servicesand Services

1. The rate of innovation is higher in software and services, 1. The rate of innovation is higher in software and services, semiconductors, drugs, biotech, and technology hardware because the semiconductors, drugs, biotech, and technology hardware because the firms in these industries compete largely on innovation. For example, a firms in these industries compete largely on innovation. For example, a drug firm is successful to the extent it is able to develop new drugs; cost drug firm is successful to the extent it is able to develop new drugs; cost efficiency is not a key to its success, and it is unlikely to be a cost leader. efficiency is not a key to its success, and it is unlikely to be a cost leader. The only exception to this might be a manufacturer of generic drugs, The only exception to this might be a manufacturer of generic drugs, where quality as well as cost leadership would be important.where quality as well as cost leadership would be important.

2. Somewhat lower levels of innovation are seen in the food and beverage, 2. Somewhat lower levels of innovation are seen in the food and beverage, consumer goods, and household products, because a larger portion of consumer goods, and household products, because a larger portion of these products and firms will compete on cost leadership. These are the these products and firms will compete on cost leadership. These are the products we buy in Wal-Mart, Kmart, Best Buy and Home Depot, all cost-products we buy in Wal-Mart, Kmart, Best Buy and Home Depot, all cost-conscious retailers. The automobile industry has some firms that are more conscious retailers. The automobile industry has some firms that are more innovative than others, while others are less innovative. Note however, innovative than others, while others are less innovative. Note however, that William Ford, the CEO of Ford Motor has stressed in recent months the that William Ford, the CEO of Ford Motor has stressed in recent months the importance of innovation to that firm’s strategy going forward.importance of innovation to that firm’s strategy going forward.

Source: Peter Coy, “The Search for Tomorrow,” Source: Peter Coy, “The Search for Tomorrow,” Business WeekBusiness Week, October , October 11, 2004, pp 216-220.11, 2004, pp 216-220.

From Cost Leadership to From Cost Leadership to DifferentiationDifferentiation

SanDisk is apparently trying to move from SanDisk is apparently trying to move from a cost leadership strategy that fits well the a cost leadership strategy that fits well the commodity business it is in to a commodity business it is in to a differentiated strategy. This approach has differentiated strategy. This approach has been successful for other tech firms, such been successful for other tech firms, such as Intel, which has established itself as a as Intel, which has established itself as a differentiated brand in a commodity differentiated brand in a commodity market. The innovations described in the market. The innovations described in the article are significant and point to success, article are significant and point to success, but at the time of publication it is too early but at the time of publication it is too early to tell.to tell.

Differentiation in Tyre CompanyDifferentiation in Tyre Company

Michelin’s continued success at selling Michelin’s continued success at selling high-end tires at premium prices is high-end tires at premium prices is evidence that this firm is succeeding at evidence that this firm is succeeding at differentiation in an industry that is largely differentiation in an industry that is largely characterized as a commodity business characterized as a commodity business based on cost leadership. Michelin also based on cost leadership. Michelin also effectively markets the importance of the effectively markets the importance of the quality it provides in advertisements that quality it provides in advertisements that note the importance of safety in choosing note the importance of safety in choosing an auto tyre.an auto tyre.

Importance of Ethics in FirmsImportance of Ethics in Firms Even if the fault will occur in very rare and Even if the fault will occur in very rare and

unusual circumstances, if the consequence unusual circumstances, if the consequence could be some damage to a user, the firm could be some damage to a user, the firm should advise users of the fault and the should advise users of the fault and the potential implications. On the other hand, potential implications. On the other hand, there should be no need to advise users if there should be no need to advise users if the fault is not likely to have any the fault is not likely to have any noticeable consequence on the use of the noticeable consequence on the use of the chip, as for example, if the chip simply chip, as for example, if the chip simply takes much longer for a very rare type of takes much longer for a very rare type of processing, but returns the proper result. processing, but returns the proper result. The effect of the delay is not likely to have The effect of the delay is not likely to have a damaging effect on any known user.a damaging effect on any known user.

Ethics in WorldCom-MCIEthics in WorldCom-MCI The WorldCom scandal is one of the most The WorldCom scandal is one of the most

significant and extensive frauds in U.S. history. significant and extensive frauds in U.S. history. The important part of this story is that the The important part of this story is that the survivor organization, MCI, is doing well under survivor organization, MCI, is doing well under new leadership and has begun an ethical new leadership and has begun an ethical compliance program. The question is intended compliance program. The question is intended primarily as a basis for class discussion, and there primarily as a basis for class discussion, and there are likely to be a wide range of views. I begin by are likely to be a wide range of views. I begin by noting that the announcement of a Chief Ethics noting that the announcement of a Chief Ethics Officer is a good strategic move for MCI, given the Officer is a good strategic move for MCI, given the recent history of the company. It is important for recent history of the company. It is important for the firm to make a clear statement about the the firm to make a clear statement about the importance of ethical behavior in the years importance of ethical behavior in the years ahead.ahead.

Role of Ethics OfficerRole of Ethics Officer It is difficult to determine the precise role for an ethics It is difficult to determine the precise role for an ethics

officer; the concept is new and there is not much officer; the concept is new and there is not much experience to provide guidance. The functions set out in experience to provide guidance. The functions set out in the MCI announcement make sense – employee training, the MCI announcement make sense – employee training, hotline, pledge, and code of ethics. It is clear in the MCI hotline, pledge, and code of ethics. It is clear in the MCI case that the officer has the strong support of top case that the officer has the strong support of top management. So the role and responsibilities of the chief management. So the role and responsibilities of the chief ethics officer should be watched closely at the top ethics officer should be watched closely at the top management level -- both CEO and CFO. From the management level -- both CEO and CFO. From the experience with WorldCom and other frauds, where both experience with WorldCom and other frauds, where both the CEO and CFO were culpable, it is probably also the CEO and CFO were culpable, it is probably also important that the chief ethics officer report not only to the important that the chief ethics officer report not only to the CEO and CFO, but also to the firm’s audit committee (a CEO and CFO, but also to the firm’s audit committee (a subset of the firm’s board of directors with responsibility for subset of the firm’s board of directors with responsibility for managing the audit function and providing oversight of managing the audit function and providing oversight of internal control procedures within the firm).internal control procedures within the firm).

Green Acres and EthicsGreen Acres and Ethics Though Green Acres is benefiting financially from its Though Green Acres is benefiting financially from its

consumers’ misperception and has not purposely done consumers’ misperception and has not purposely done anything misleading (since it has never labeled its products anything misleading (since it has never labeled its products as “organic”), it cannot continue to allow consumers to as “organic”), it cannot continue to allow consumers to think its products are organic. As it knows that its think its products are organic. As it knows that its consumers perceive its products as “organic” and that consumers perceive its products as “organic” and that many consumers buy Green Acres products specifically for many consumers buy Green Acres products specifically for this reason, Green Acres has a moral obligation to inform this reason, Green Acres has a moral obligation to inform them about its true practices. Even if the health and them about its true practices. Even if the health and environmental consequences of genetically modified environmental consequences of genetically modified organisms are yet unknown, the potential for harm to the organisms are yet unknown, the potential for harm to the consumer necessitates that Green Acres advise consumers consumer necessitates that Green Acres advise consumers of its use of genetically modified crops and notify them that of its use of genetically modified crops and notify them that risks might potentially exist from consuming its products.risks might potentially exist from consuming its products.

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