Cost Modeling in an SCM Framework

At the base of any comprehensive Strategic Cost Management Framework is solid governance and infrastructure. This infrastructure aligns stakeholder requirements with the resources and technology that creates a centralized integrated system for managing costs consistently. Once this type of infrastructure and governance is in place, it creates a foundation that can guide effective and efficient cost models. We assert that these models are one of the most critical elements of a best practice finance and without them, further cost management analysis will only result in inconsistent and inaccurate information for the organization in which to base its strategic decision making.

As you can see in our framework, Strategic Cost Modeling is essential. In order to begin to realize benefits, create plans and manage performance on a volume based approach, the organization must understand the true unit cost of each output or service it provides. A good cost model is the most effective way to do this. While it may seem obvious, generating reliable cost data is crucial in order to make strategic decisions and measure improvements. A detailed understanding about your organization’s costs provides a competitive advantage and empowers management with valuable information that can be used to implement process improvements throughout the organization.

Cost models force you to think about the drivers of your costs on a consumption basis and therefore help you to understand how costs are incurred by various organizations. In order to make intelligent decisions about managing your costs (either increasing or decreasing costs), management needs to fully comprehend how those changes will affect the ability of the organization to produce the products and services consumed by their customers. In the current economic environment, it becomes even more crucial to understand the strategic impacts of cutting costs. In an effort to reduce overall costs, many organizations will actually do harm by making cuts in strategic areas. A sound strategic cost model can help you avoid these mistakes.

Cost models also make efforts such as predictive analysis and customer profitability much simpler. Both of these undertakings depend on the ability to be able to identify the unit cost attributable to certain activities, outputs or products. Without an adequate cost model these processes are only carried out with estimates or allocations that do not reflect the true costs of resources, activities, and services. Read more about Strategic Cost Management.