The Relationship Between Cost Management And Company ...



The Relationship Between Cost Management And Company Performance: The Slovenian Case

Metka Tekavcic, (E-mail: metka.tekavcic@uni-lj.si), University of Ljubljana, Slovenia

Darja Sink, (E-mail: darja.sink@uni-lj.si), University of Ljubljana, Slovenia

Abstract

Contemporary decision-making system must be able to predict long-term consequences of present company performance. Moreover, it must be able to support implementation of changes as regards existing ways of doing business. Cost management is a set of techniques and methods for planning, measuring, and reporting intended to improve a company’s products and processes. Its ultimate purpose is to provide information which companies need to provide the value that customers demand. The aim of the paper is to emphasize the relationship between cost management and company performance theoretically and empirically. The paper sets out to investigate first, how company performance is influenced by the use of particular cost management techniques and methods, and second, whether better performing companies are more inclined to implement a particular cost management technique or method, by providing final results of empirical research conducted in Slovenian companies.

Introduction

Business of the late 1990s is characterized by a rapid rate of change, evolutionary business practices, and intense competition. Present dynamic business environment demands a lot of flexibility and adaptability from companies. In such an environment timely and quality decision-making is of great importance. It enables efficient business performance and reaching predetermined objectives. Contemporary decision-making system must be able to predict long-term consequences of present company performance. Moreover, it must be able to support implementation of changes as regards existing ways of doing business. Companies wishing to compete in demanding markets must accept the challenge of achieving business excellence. Business excellence refers to cost efficient link-up of activities within all organizational units, continuous improvement of business processes as well as products and services designed to fulfill customer needs. Business excellence requires extremely flexible performance that enables companies to respond quickly to changes in the business environment and to adapt correctly to new customers’ needs.

Global competitive pressures have made companies focus increasingly on the cost management that has always been a basic component of any successful business strategy. Modern cost management still in its infancy, has roots in cost accounting and managerial accounting. Cost management assumes knowledge of both, although the purposes and methods of cost management differ in important ways from those of cost accounting and managerial accounting. Modern cost management helps a company improve its product and processes by reducing waste and other non-value-adding activities, because it assumes familiarity with all business processes. A great part of cost management deals with streamlining internal processes, integrating more tightly with suppliers and distributors, ensuring quality, etc. Cost management is a set of techniques and methods for planning, measuring, and reporting intended to improve a company’s products and processes. Its ultimate purpose is to provide information that companies need to provide the value that customer demand.

The purpose of the paper is to emphasize the relationship between cost management and company performance, theoretically and empirically. The aim of the paper is to investigate first, how company performance is influenced by the use of particular cost management techniques and methods, and second, whether better performing companies are more inclined to implement a particular cost management technique and method, by providing final results of empirical research conducted in Slovenian companies. The results presented in the paper can be applied to all companies trying to compete in the global environment.

Contemporary cost management concepts (CCMCs)

In today’s business environment companies focus increasingly on cost management. Modern cost management assumes knowledge of cost accounting and managerial accounting, although the purposes and methods of cost management differ in important ways from those of cost accounting and managerial accounting. The primary purpose of cost accounting has always been to calculate inventory and cost of goods sold for financial statement purposes. In other words, the focus of cost accounting is on external financial reporting. The primary concern of cost management, by contrast, refers to internal decision-making (Handbook of Cost Management, 2001, page xiii).

Although managerial accounting has always been intended to provide support for decision-making used internally by managers, its emphasis and methods have been attacked relentlessly since the mid-1980s. The criticisms point out that traditional systems fail to provide relevant and timely information for managerial decision making. Too often, traditional cost systems provide inaccurate and misleading product and customer cost information. They focus too narrowly on historical information. They also emphasize the firm as the unit of analysis, not considering the entire supply chain of which the firm is only a part. In short, they emphasize an outward-focused historical cost lens, rather than a customer-focused prospective cost lens. Traditional cost systems also contribute to dysfunctional behavior such as producing excess inventory to absorb overhead or buying substandard raw materials to meet price targets. By contrast, cost management emphasizes better full-stream product and customer information. Cost management helps a company improve its product and processes by reducing waste and other non-value-adding activities. Although modern cost management requires knowledge of cost accounting and managerial accounting, it also assumes intimate familiarity with all business processes, and with full stream supply chains. Cost managers cannot measure and manage what they do not understand (Handbook of Cost Management, 2001, page xiii).

Cost management is a set of techniques and methods for planning, measuring, and reporting intended to improve a company’s products and processes. Its ultimate purpose is to provide information that companies need to provide the value that customers demand. Most people would argue about the basic tools, techniques, and methods that, together, constitute cost management. These tools, techniques, and methods are directly or indirectly related to cost management. In the paper they are referred to as ‘contemporary cost management concepts’ and abbreviated as ‘CCMCs’. CCMCs comprise the set of business practices and methods used to support outward looking and strategically oriented companies. During recent years several CCMCs have been introduced in order to help companies improve their decision-making and performance in highly competitive business environment. CCMCs include several cost management tools, techniques, and methods, including activity-based costing (ABC), activity-based budgeting (ABB), activity-based management (ABM), life-cycle costing (LCC), target costing, theory of constraints (TOC), benchmarking, just-in time (JIT), total quality management (TQM), continuous improvement, business process reengineering (BPR), and balanced scorecard (BSC).1 In this paper, we do not intend to discuss particular concepts in detail. Further reference to particular concepts can be found in Tekavcic, Sink (2002).

Cost management and company performance

Installing a cost management tool will not, by itself, increase company performance. Although executives and managers usually talk about CCMCs as if they were an end in themselves, company should implement each of these projects only to improve its performance. There are several facts showing that the implementation of CCMCs is not always followed by improved company performance including (Van Der Linde, 2002):

• It is estimated that more than 75% of performance improvement projects do not produce targeted performance improvements.

• Stories abound of costly organizational change efforts that either have fizzled, or worse, exacerbated the situations they aimed at improving.

• The great majority of large-scale projects overrun both schedule and budget by very wide margins.

• The number of organizations with Balanced Scorecards—replete with metrics that no one understands how to use to improve performance—is approaching epidemic proportions.

The question is why so many well-intended performance-improvement efforts fail to succeed. Companies should approach the question of how to start a project with a statement of their needs - such as: ‘We want to implement Activity Based Costing across the organization. How do we start?’ Companies want to increase their performance (customer satisfaction, mission effectiveness, response to new customer needs). Performance problems are usually due to bad systems that give managers incorrect or inadequate information as managers make rational decisions based on the information they have at hand. Therefore, fixing a system problem to get better or faster information to managers will result in improved performance. Although this is easy to understand in theory, many problems may occur in practice.

The first problem is associated with the statement that managers make rational decisions, given the data available. There is an underlying assumption that all decision-makers in a company share the same understanding of how the business works, and, if you provide them with better information, they will make better decisions. It is hard to find a company where managers fully agree as to how the business really works, but they rather see it from their own individual perspective. Given the same data, one will make a decision that may not be considered rational by another. The second problem is associated with the statement that better information will lead to performance improvement. Above we mentioned the familiar statistic that 75% of performance improvement projects fail to produce the intended results. It is easy to put a great deal of good work into solving a problem that turns out to have little effect. An ABC system giving more accurate product cost information won’t impact financial performance until the decision rules in the company are changed. If salesforce continue to be compensated based on revenue, they will continue to sell unprofitable but easy-to-sell products no matter what management knows about product profitability (Van Der Linde, 2002).

An obvious caveat is always to keep the primary purpose of the project in mind. People tend to work to increase the performance of the company. The most powerful discovery is to find the high leverage projects and most effective project scope. Results flow from spending the effort at the start to get all members of the executive team to share an understanding of how the business works – not just as seen from their unique perspectives. The heart of the process is to clearly define the objective (performance improvement) and work back to find out how the organization actually works to produce its output. In other words, you cannot fix the problem until you understand it. Before improving the way your business works, you must first understand the way your business works.

Van Der Linde (2002) presents a good example of the company which decided to install an MRP system (a software system integrating the information flow for production scheduling, purchasing, and inventory management to solve the problem of late shipments to customers and declining profitability). A consultant insisted that computer software could (and therefore, should) control the purchasing, receiving and issuing of every item right down to nuts, bolts, screws, and washers. The purchasing manager and staff were inundated with paper when the system came on line. However, they could not tell from the computer output which page contained critical information which needed being dealt with, since all parts had the same priority. They worked back from the performance improvement issue. They stated that the cause of late shipments was that often some parts were missing at the time of scheduled start of production. They wanted all data on all parts in the computer system because the way to get production started had always been to expedite those missing parts. Consultants suggested that they manage tightly the parts that were difficult to manage and not have the others in the system at all, but manage them separately (as it is not expensive to have abundant supplies of very low-cost items), because this clears the material manager’s view of the parts that require close management.

It is important that a company starts with a clear statement of the problem – the problem nearest the customer. From there, the operation of the system – the whole system that works together to produce the product or service -must be understood. From a model of that system, the company should be able to find and explain the high leverage changes. At this point it is vital to coach the decision-makers how to make decisions that work with the changed system.

Choosing performance measures is a challenge, as performance measurement systems play a key role in developing strategy, evaluating the achievement of organizational objectives and compensating managers. Ittner and Larcker (2002) suggest that financial data have limitations as a measure of company performance. They note that other measures, such as quality, may be better at forecasting, but can be difficult to implement.

Performance measurement systems

Many managers feel traditional financially oriented systems no longer work adequately. A recent survey of US financial services companies found most were not satisfied with their measurement systems (Ittner, Larcker, 2002). They believed there was too much emphasis on financial measures such as earnings and accounting returns and little emphasis on drivers of value such as customer and employee satisfaction, innovation and quality. In response, companies are implementing new performance measurement systems. A third of financial services companies, for example, made a major change in their performance measurement system during the past two years and 39% plan a major change within two years. Inadequacies in financial performance measures have led to innovations ranging from nonfinancial indicators of intangible assets and intellectual capital to balanced scorecards of integrated financial and nonfinancial measures. Nonfinancial performance measures have advantages and disadvantages.

Advantages of nonfinancial performance measures

Nonfinancial measures offer four clear advantages over measurement systems based on financial data (Ittner, Larcker, 2002). The first advantage refers to a closer link to long-term organizational strategies. Financial evaluation systems generally focus on annual or short-term performance against accounting yardsticks. They do not deal with progress relative to customer requirements or competitors nor other nonfinancial objectives that may be important in achieving profitability, competitive strength and long-term strategic goals. For example, new product development or expanding organizational capabilities may be important strategic goals, but may hinder short-term accounting performance. By supplementing accounting measures with nonfinancial data about strategic performance and implementation of strategic plans, companies can communicate objectives and provide incentives for managers to address their long-term strategy.

Second, critics of traditional measures argue that success in many industries is enhanced by intangible assets such as intellectual capital and customer loyalty, rather than the hard assets listed in official balance sheets. Although it is difficult to quantify intangible assets in financial terms, nonfinancial data can provide indirect, quantitative indicators of a firm's intangible assets. One study examined the ability of nonfinancial indicators of intangible assets to explain differences in US companies' stock market values. It found that measures related to innovation, management capability, employee relations, quality and brand value explained a significant proportion of a company's value, even allowing for accounting assets and liabilities. By excluding these intangible assets, financially oriented measurement can encourage managers to make poor, even harmful, decisions.

Third, nonfinancial measures can be better indicators of future financial performance. Even when the ultimate goal is maximizing financial performance, current financial measures may not capture long-term benefits from decisions made now. Consider, for example, investments in research and development or customer satisfaction programs. Under accounting rules (e.g., in Slovenia, USA), research and development expenditures and marketing costs must be charged for in the period they are incurred, thereby reducing profits. But successful research improves future profits if it can be brought to market. Similarly, investments in customer satisfaction can improve subsequent economic performance by increasing revenues and loyalty of existing customers, attracting new customers and reducing transaction costs. Nonfinancial data can provide the missing link between these beneficial activities and financial results by providing forward-looking information on accounting or stock performance. For example, interim research results or customer indices may offer an indication of future cash flows that would not be covered otherwise.

Finally, the choice of measures should be based on providing information about managerial actions and the level of ‘noise’ in the measures. Noise refers to changes in the performance measure that are beyond the control of the manager or organization, ranging from changes in the economy to luck (good or bad). Managers must be aware of how much success is due to their actions or they will not have the signals they need to maximize their effect on performance. As many nonfinancial measures are less susceptible to external noise than accounting measures, their use may improve managers' performance by providing a more precise evaluation of their actions.

Disadvantages of nonfinancial performance measures

Although there are many advantages of nonfinancial performance measures, they are not without drawbacks. Research has identified five primary limitations (Ittner, Larcker, 2002). Time and cost has been a problem for some companies. They have found out that the costs of a system tracking a large number of financial and nonfinancial measures can be greater than the benefits. Development can require considerable time and expense, not to mention selling the system to sceptical employees who have learned to operate under existing rules. A greater number of diverse performance measures frequently requires significant investment in information systems to draw information from multiple and often incompatible databases. Evaluating performance by using multiple measures that can conflict in the short term may also be time-consuming. Bureaucracy may affect the measurement process and transform it into mechanistic exercises that add little to reaching strategic goals.2

The second drawback is that, unlike accounting measures, nonfinancial data are measured in many ways, there is no common denominator. Evaluating performance or making trade-offs between attributes is difficult when some are denominated in time, some in quantities or percentages and some in arbitrary ways. Many companies attempt to overcome this by rating each performance measure in terms of its strategic importance (e.g. from ‘not important’ to ‘extremely important’) and then evaluating overall performance based on a weighted average of the measures. Others assign arbitrary weightings to the various goals. However, like all subjective assessments, these methods can lead to considerable error.

The third downside refers to the lack of causal links. Many companies adopt nonfinancial measures without articulating the relations between the measures or verifying whether they have a bearing on accounting and stock price performance. Unknown or unverified causal links create two problems in evaluating performance: incorrect measures focus attention on the wrong objectives and improvements cannot be linked to later outcomes. Xerox, for example, spent millions of dollars on customer surveys, under the assumption that improvements in satisfaction translated into better financial performance. Later analysis found no such link. As a result, Xerox shifted to a customer loyalty measure that was found to be a leading indicator of financial performance. The lack of an explicit casual model of the relations between measures also contributes to difficulties in evaluating their relative importance. Without knowing the size and timing of associations among measures, companies find it difficult to make decisions or measure success based on them.

Fourth problem related to nonfinancial measures is the lack of statistical reliability - whether a measure actually represents what it purports to represent, rather than random measurement error. Many nonfinancial data such as satisfaction measures are based on surveys with a small number of respondents and questions. These measures generally have poor statistical reliability and fail to discriminate superior performance or predict future financial results.

Finally, although financial measures are unlikely to capture fully the many dimensions of organizational performance, implementing an evaluation system with too many measures can lead to measurement disintegration. This occurs when an overabundance of measures dilutes the effect of the measurement process. Managers may follow a variety of measures simultaneously, but fail to monitor the main drivers of success.

Suggestions for implementation of appropriate measures

Once managers have determined that the expected benefits from nonfinancial data outweigh the costs, three steps can be used to select and implement appropriate measures (Ittner, Larcker, 2002):

1) Understand Value Drivers

The starting point is understanding a company's value drivers, the factors that create stakeholder value. Once known, these factors determine which measures contribute to long-term success and how to translate corporate objectives into measures that guide managers' actions. While this seems intuitive, experience indicates that companies do a poor job determining and articulating these drivers. Managers tend to use one of three methods to identify value drivers, the most common being intuition. However, executives' rankings of value drivers may not reflect their true importance. For example, many executives rate environmental performance and quality as relatively unimportant drivers of long-term financial performance. In contrast, statistical analyses indicate these dimensions are strongly associated with a company's market value. A second method is to use standard classifications including financial, internal business process, customer, learning and growth categories. Whereas these may be appropriate, other nonfinancial dimensions may be more important, depending on the organization's strategy, competitive environment and objectives. Moreover, these categories do little to help determine weightings for each dimension. Perhaps the most sophisticated method of determining value drivers is statistical analysis of the leading and lagging indicators of financial performance. The resulting causal business model can help determine which measures predict future financial performance and can assist in assigning weightings to measures based on the strength of the statistical relation. Unfortunately, relatively few companies develop such causal business models when selecting their performance measures.

2) Review Consistencies

Most companies track hundreds, if not thousands, of nonfinancial measures in their day-to-day operations. To avoid reinventing the wheel, an inventory of currently used measures should be made. Once measures have been listed, their value for performance measurement can be assessed. The issue at this stage is the extent to which current measures are aligned with the company's strategies and value drivers. A method for assessing this alignment is gap analysis. It requires managers to rank performance measures on at least two dimensions: their impact on strategic objectives and their currently perceived importance. The survey of 148 US financial services companies — a joint research project sponsored by the Cap Gemini Ernst & Young Center for Business Innovation and the Wharton Research Program on Value Creation in Organizations – found significant measurement gaps for many nonfinancial measures. For example, 72% of companies said customer-related performance was an extremely important driver of long-term success, against 31% who chose short-term financial performance. However, the quality of short-term financial measurement is considerably better than measurement of customer satisfaction. Similar disparities exist in nonfinancial measures related to employee performance, operational results, quality, alliances, supplier relations, innovation, community and the environment. More importantly, stock market and long-term accounting performance are both higher when these measurement gaps are smaller.

3) Integrate Measures

Finally, after measures are chosen, they must become an integral part of reporting and performance evaluation if they are to affect employee behavior and organizational performance, which is not easy. Since the choice of performance measures has a substantial impact on employees' careers and pay, controversy is bound to emerge no matter how appropriate the measures. Many companies have failed to benefit from nonfinancial performance measures through being reluctant to take this step.

One of the most successful efforts to integrate multiple perspectives in performance assessment has been that of Kaplan and Norton (1992, 1993, 1996, 1999, 1999a). Their balanced scorecard approach incorporates four perspectives on performance:

• The financial perspective (How do we look to shareholders?);

• The customer perspective (How do customers see us?);

• The internal business perspective (What must we excel at?);

• The innovation and learning perspective (Can we continue to improve and create value?).

These four perspectives provide a balance between external internal measures of performance for a company and help translate a company’s strategic objectives into a coherent set of performance measures. Below are the most common Key Performance Indicators used across most companies which have implemented a performance measurement system ). They are divided into four major groups: financial indicators, process indicators, customer indicators and learning and growth indicators. The most frequently used financial indicators are Total assets or Total assets per employee, Revenues per employee, Revenues from new products / customers, Return-on-assets (Profits (Net Income) / Total assets), Return-on-equity (Profits (Net Income) / Equity) Profits per employee, Profit margin, and Cash flow. Most frequently mentioned customer indicators are[pic] Number of customers, Market share, Annual sales per customer, Average time spent on customer relations, Sales closed vs. sales contracts, Customer loyalty index or Satisfied customer index. Learning and growth indicators are Leadership index, Employee turnover, Time in training, Average absenteeism, Per capita annual cost of training, and Satisfied employee index.

Companies claim to have been using the scorecard for a variety of purposes, namely, to clarify and update strategy, to communicate strategy throughout the company, to align unit and individual goals with the strategy, to link strategic objectives to long-term targets and annual budgets, to identify and align strategic initiatives, and to conduct periodic performance reviews to learn about and to improve strategy (Kaplan and Norton, 1996). However, an important apparent measurement problem of the balanced scorecard is its incomparability across firms. Kaplan and Norton (1993, page 135) noted: “The balanced scorecard is not a template that can be applied to businesses in general or even industry-wide. Different market situations, product strategies, and competitive environments require different scorecards. Business units devise customized scorecards to fit their mission, strategy, technology, and culture.” This quote underscores the fundamental purpose of the balanced scorecard. The methodology is intended to assist companies in improving their performance measurement and performance management processes. It may not be very helpful as a tool for comparison across the board.

Theoretical implications suggest that companies using CCMCs should have better performance, especially when faced with highly competitive and complex business environment. Performance can be measured by financial and / or nonfinancial measures (performance indicators). Key performance indicators in a company provide a mechanism to measure the critical success factors. They are mostly quantifiable measures that the organization uses to evaluate and communicate performance against expected results. It is important that key performance indicators are strategically linked and integrated throughout the company, controllable, measurable, simple, limited in number, and credible. Further, they should present a balanced view of the organization. The concept of balance requires that all key dimensions of performance, as defined by the critical success factors, are measured and reported in such a manner that managers can understand the trade-offs and interrelationships among the different areas.

In the following chapter we are presenting the results based on an extensive research conducted in Slovenian companies. Our basic objective is to investigate how company performance is influenced by the use of a particular CCMC, and whether better performing companies are more inclined to implement a particular CCMC.

Empirical research: The Slovenian case

Business environment in Slovenia

Slovenia is a small transition economy with a population of about 2 million. It was founded in June 1991. It is a small country with a land area of 20,296 square km, neighboring Italy in the West, Austria in the North, Hungary in the East and Croatia in the South. It has been a constitutional part of former socialist republic Yugoslavia in the period 1945-1991. The business environment in Slovenia has changed radically in the last decade. Slovenia has been faced with the triple transition process: the transition to an independent state, the reorientation from former Yugoslavian to the Western developed markets and the transition to the market economy.

When Slovenia became an independent state in 1991, it lost a rather large Yugoslav market. Companies’ markets began to change radically. Slovenian industry has succeeded in finding substitute markets. National economy had some advantages due to the positive legacy of its Yugoslav past that gave Slovenian companies a sizeable head start over the rest of the Central-Eastern European (CEE) region when it came into transition. Slovenian companies had been exposed to the market economy for decades and had had traditional trade links with Western European companies. Slovenia has remained one of the most successful economies in Central and East Europe. This fact is proven by the high GDP per capita at around € 10,500 which exceeds 70 percent of the EU average. In the beginning of transition period state-owned (i.e. socially-owned) companies encountered a radically different business environment. Companies were facing privatization and changes in top management, companies’ strategic and tactical planning, operations, etc.

Slovenia is not the only CEE country facing transition period difficulties. Apart from Yugoslavia, some other countries also split up (Czechoslovakia, the Soviet Union). Firms in these countries lost a significant part of their domestic markets while their traditional export markets also disappeared. Companies in transitional economies were entering an open competitive environment. They had to face the deregulated and liberalized business environment. The problem was that many of CEE companies were neither flexible nor customer oriented. That is the reason why they had to rethink and / or change basic management tools they were using in order to survive in turbulent business environment. Moreover, some companies began to use these tools for the first time. Due to its successful transition process, Slovenia may be considered as a "benchmark" for the majority of transitional economies in the region. It is currently in the process of integration into the European Union. Companies are therefore faced with the intensive processes of deregulation and liberalization of the foreign trade regime. They are being exposed to increasing foreign competition. The major changes in the business environment described above strongly influenced the introduction of CCMCs in proactive and outward oriented companies. Practically all CEE countries were in some sort of transition period during the last decade. Despite many remaining imperfections, these countries now have functioning market economies. This is the reason why our research findings and main conclusions regarding Slovenian companies can be applied to all countries facing transition period difficulties and operating in turbulent environments.

Method

The aim of the research was to develop a better understanding of contemporary cost management concepts (CCMCs) presence in Slovenian companies. In particular, we sought to explore whether the use of CCMCs affect the performance of Slovenian companies. The purpose of our research was to find out the current situation as regards the number, size, and performance of Slovenian companies familiar and unfamiliar with CCMCs, especially those implementing or using these concepts. Reasons why particular types of companies use or fail to use CCMCs will be defined in greater detail in our further research.

The main source of data is the survey ‘Cost management in Slovenian companies’ conducted during the winter of 2000/2001. The empirical research is based on an extensive questionnaire. After a careful consideration, it was decided to conduct personal interviews with top managers or middle managers (responsible for the cost monitoring and analysing). A fully structured interview with pre-coded responses was prepared. We chose personal interviews because we believe that they provide more complete and precise information than mail, telephone or e-mail questionnaires, taking account of the length of questionnaires. Personal interviews provided the opportunity for feedback in clarifying any questions a respondent has about the instructions or questions. Other advantages of personal interviews are moderate to fast speed of data collection, excellent respondent cooperation, low number of unanswered questions, and lowest possibility for respondent misunderstanding (Zikmund, 2000, page 212). We conducted personal interviews with 100 specially trained interviewers.3 Each interviewer questioned 2-3 companies. Slovenia is a relatively small country (20,296 square km, 2 million inhabitants), so we could cover all geographical areas at a relatively low cost, which is usually not the case when using personal interviews (Zikmund 2000, page 212).

This study is based on the research sample of 264 companies. When choosing companies to be included in the sample we had no intent to exclude any company. That is why we believe our selection has many attributes of random selection. Moreover, the sample is relatively big and offers a good representation of the whole population, as regards the size of companies, their geographical position and industry (branch) they belong to. The sample consists of 33% small, 23% middle, and 44% large companies. Companies are classified according to Slovenian legislation as follows. ‘Small company’ fulfills two of the following criteria: average number of employees does not exceed 50, annual revenues are less than SIT 280 million (around € 1.25 million), average assets at the beginning and at the end of the financial year do not exceed SIT 140 million (around € 625,000). ‘Medium company’ is a company fulfilling two of the following criteria: average number of employees does not exceed 250, annual revenues account for less than SIT 1,100 million (around € 5 million), average assets at the beginning and at the end of business year do not exceed SIT 550 million (around € 2.5 million). Other companies were classified as ‘large companies’.

Research results

During our research we investigated the relationship between cost management and company performance. We attempted to answer the following question: Does the use of CCMCs affect the performance of Slovenian companies? Theoretical implications suggest that companies using CCMCs should have better performance, especially when faced with highly competitive and complex business environment. Performance can be measured by financial and / or nonfinancial measures. For an easier comparison among different companies, we selected financial measures. Some companies participating in our research do not use nonfinancial measures at all; the ones using them don’t use the same nonfinancial measures of performance. For this reason, it would be impossible to compare all companies according to nonfinancial measures. We compared different companies (who know CCMCs) using the following financial measures of performance: net income (loss), ROA, ROE, and profit margin.

Table 1 presents final results as to what kind of companies have the highest performance measures on average. There was no company implementing or using TOC. That made TOC incomparable to other concepts and was thus not included in the analysis. Companies are classified in two types: A - Companies implementing or using a particular concept, and B - Companies thinking it is wise to implement a concept or are planning to implement it. The findings can be classified as follows: (1) The best results as regards financial performance measures on average are achieved by those companies which are implementing or using JIT, TQM, and continuous improvement. In the case of these concepts companies fall predominantly into group A. (2) Companies thinking it is wise to implement a particular concept or are planning to implement it are frequently having the best results according to financial performance measures, especially as regards ROA and profit margin. This implies that successful companies are on average more inclined to implement CCMCs. The implementation of CCMCs is connected with high initial investments. On the other hand, positive financial results can be expected in a few years time. Thus, it would be appropriate to repeat the survey among the same sample units (including only those implementing or using CCMCs) in a sequence of at least 5 years to test the influence of CCMCs’ on the company performance.

Table 1: Types of company with highest average performance measures

|Concept |Net Income |ROA |ROE |Profit Margin |

|ABC |A |B |A |B |

|ABB |A |B |A |B |

|ABM |A |B |A |B |

|Life-cycle costing |A |B |A |B |

|Target costing |A |B |B |A |

|Benchmarking |A |B |B |B |

|JIT |A |A |A |A |

|TQM |A |A |B |A |

|Continuous improvement |A |A |B |A |

|BPR |A |B |A |B |

|Balanced scorecard |A |B |B |A |

A - Companies implementing or using the concept;

B - Companies thinking it is wise to implement the concept or are planning to implement it;

Source: Research ‘Cost management in Slovenian companies’, winter 2000/2001.

As we can see in Table 1, research results suggest that companies differ according to performance measures. This finding was also tested with statistical methods. We used One-Way ANOVA procedure to test the dependence of performance of companies on the use of a particular concept. The One-Way ANOVA procedure produces a one-way analysis of variance for a quantitative dependent variable (in our case particular financial performance measures) by a single factor (independent) variable. Factor variable values are integers from 1 to 4, as the research was set up involving four types (groups) of companies: (1) Companies unfamiliar with the concept, (2) Companies familiar with the concept, but do not use it or think that using it is not sensible, (3) Companies thinking it is wise to implement the concept or are planning to implement it, and (4) Companies implementing or using the concept. Analysis of variance is used to test the hypothesis that several means are equal. One of the assumptions underlying the One-Way ANOVA procedure is that the groups should come from populations with equal variances. To test this assumption, we used Levene’s homogeneity-of-variance test. According to this test, we found out that the assumption regarding equality of variances is not valid for profit margin for all concepts. That is why in final findings we do not refer to profit margin and other performance measures, for which the assumption regarding equality of variances is invalid. The final results are presented in Table 2.

Table 2: F-test values and significance levels for each concept

|Concept |Financial Measure |F-test |Significance |

|ABC |Net income |11.601 |0.000 |

| |ROA |5.840 |0.001 |

| |ROE |5.703 |0.001 |

|ABB |Net income |7.142 |0.000 |

| |ROA |4.518 |0.004 |

| |ROE |6.175 |0,000 |

|ABM |Net income |2.104 |0.101 |

| |ROA |3.085 |0.028 |

| |ROE |5.178 |0.002 |

|LCC |Net income |6.510 |0.000 |

| |ROA |3.438 |0.018 |

| |ROE |5.423 |0.001 |

|Target Costing |Net income |4.680 |0.003 |

| |ROA |4.207 |0.006 |

| |ROE |4.354 |0.005 |

|Benchmarking |Net income |6.336 |0.000 |

| |ROA |3.067 |0.029 |

| |ROE |4.155 |0.007 |

|JIT |ROA |4.359 |0.005 |

|TQM |Net income |10.116 |0.000 |

| |ROA |1.472 |0.223 |

|Continuous Improvement |Net income |6.140 |0.001 |

| |ROE |4.937 |0.003 |

Source: Research ‘Cost management in Slovenian companies’, winter 2000/2001.

First, we found out that on the average net income is dependent on the use of the following concepts: ABC, ABB, life cycle costing, target costing, benchmarking, TQM, continuous improvement, BPR, and balanced scorecard. Second, we found out that on the average ROA depends on the use of the following concepts: ABC, ABB, ABM, life cycle costing, target costing, benchmarking, JIT, BPR, and balanced scorecard. Third, we found out that on the average ROE is dependent on the use of the following concepts: ABC, ABB, ABM, life cycle costing, target costing, benchmarking, BPR, and balanced scorecard.

As we have already explained, in today’s business environment key performance indicators should present a balanced view of the company. One would therefore expect that companies using nonfinancial performance measures perform better as they know more dimensions of their company than companies which are tracing financial performance measures only. Research results (see Table 3) suggest that Slovenian companies differ according to average performance measures.

Table 3: Average performance measures according to using vs. not using nonfinancial performance measures

|Group |Net Income |ROA |ROE |Profit Margin |

|Group 1 - Using nonfinancial performance measures |€ 960,700 |5.7% |15.6% |5% |

|Group 2 – Not using nonfinancial performance |€ 471,600 |3.8% |5.1% |4.5% |

|measures | | | | |

Source: Research “Cost management in Slovenian companies”, Winter 2000/2001.

This finding was also tested with statistical methods. We used Independent Samples T-test to test the dependence of performance of companies on the use of nonfinancial performance measures. All companies in the sample were split into two groups. Companies using nonfinancial performance measures were placed into group 1. Companies not using nonfinancial performance measures were placed into group 2. We expected, that companies from group 1 on average perform better than companies from group 2. Results are presented in Table 4. In order to generalize the conclusion, the t-test for independent samples was used. We tested the following hypothesis (Curchill, 1995):

H0: (1 = (2

H1: (1 ( (2

Table 4: Analysis of the relationship between the use of nonfinancial performance measures

and company performance

| |Net income |ROE |ROA |Profit margin |

|t-test for comparison of two means |-0.644 |-4.354 |-0.841 |-0.237 |

|Confidence level (2-tail) |0.520 |0.001 |0.401 |0.813 |

Source: Research ‘Cost management in Slovenian companies’, winter 2000/2001.

The data allow us to reject null hypothesis (H0) and accept alternative hypothesis (H1) only for ROE. There are statistically significant relationships between the use nonfinancial performance measures and ROE. On the basis of these results we can not conclude on the whole that Slovenian companies using nonfinancial performance measures are performing better than those companies which do not use nonfinancial performance measures in their decision-making. Further research will be needed to investigate this research question further.

Although Slovenian companies are tracking nonfinancial measures, only 6.5% of Slovenian companies actually implement or use formally modelled balanced scorecard. Nevertheless, a lot of companies (91.3%) track at least several nonfinancial measures. What is more, they find nonfinancial measures very important and indispensable when measuring and managing company’s performance. In general, companies track the following nonfinancial measures:

• Satisfaction of customers (66.3%),

• Quality (56.8%),

• Market share (48.5%),

• Employees’ capabilities (34.5%),

• Flexibility (32.2%),

• The number of new products / services (24.2%),

• Activities’ running time (23.1%), and

• The number of innovations per employee (12.9%).

Although nonfinancial measures are increasingly important in decision-making and performance evaluation, companies should not simply copy measures used by others. The choice of measures must be linked to factors such as corporate strategy, value drivers, organizational objectives and the competitive environment. In addition, companies should remember that choice of performance measurement is a dynamic process - measures may be appropriate today, but the system needs to be continually reassessed as strategies and competitive environments evolve (Ittner, Larcker, 2002).

Discussion

Our research findings show that until recently, a relatively small number of Slovenian companies have undertaken implementation of CCMCs. TQM, continuous improvement, and JIT are best known among Slovenian companies (Tekavcic, Sink, 2002), but it should be stressed that almost a quarter of Slovenian companies are still unfamiliar with them, although since the early 1980s these concepts have been intensively used abroad. CCMCs are implemented and used mostly by large companies (Tekavcic, Sink, 2002). This is quite understandable, given that the implementation of these concepts is connected with relatively high requirements for knowledge, resources, and time. However, there is a considerable pay-off, as we found out that on average companies using CCMCs perform better than those which fail to do so. Larger firms tend to know CCMCs better and use them more frequently than smaller firms because larger companies possess more financial and managerial resources, have greater production capacity, and attain higher levels of economies of scale. Similarly, Krumwiede (1999) argues that according to a survey4 conducted by the Cost Management Group of the Institute of Management Accountants (IMA) ABC adopters tend to be somewhat larger on average than nonadopters. Possible reasons for the size difference include availability of resources (human and financial) and economies of scale in implementing ABC at multiple sites.

Research also indicated some reasons why Slovenian companies fail to implement CCMCs. First, the most important reason is lack of top management buy-in. Despite top management’s awareness of the potential benefits of the concepts, it is not willing to invest its own time or the funding needed to implement them. Top management buy-in is very important because management stimulates creativity, empowers employees, provides leadership, and establishes a framework for providing resources. Countless case studies have shown that top management’s commitment is crucial (Maguire, Putterill, 2000, page 601). For example, previously mentioned IMA survey’s results support the idea that ABC needs strong commitment from upper management. 58% of the usage-level companies had a very high level of top management support (versus 40% for the nonusage companies) (Krumwiede, 1999, page F1-4). Top managers must not only be committed, they must be seen to be committed. An effective way to do this is by being present at key gatherings, actively participating in them, and supporting the initiatives both in word and action.

Second, there tends to be a lack of clear objectives in Slovenian companies. Third, there is a lack of employee involvement. Employees are not involved in creating, implementing, and continuously improving CCMCs. Fourth, there is lack of funding. Companies (top management) are not prepared to invest great amounts of money into implementation of projects. As a counter argument we can say that according to a survey conducted by the Cost Management Group of the Institute of Management Accountants (IMA) 89% of companies using ABC said it was worth the implementation costs (Krumwiede, 1999, page F1-5).

Fifth, a lack of information technology support was also mentioned. It must be emphasized that a company operates in a predetermined direction only by the use of advanced information system that represents basic support to decision-making. Information has to be proper, accurate and timely, prepared in the most suitable way for those who use it. Under such circumstances, information supports good decision-making. It is extremely important that benefits derived from information exceed the costs incurred by collecting it. According to a survey conducted by the Cost Management Group of the Institute of Management Accountants (IMA), it appears that improvements to the information system often procede both ABC adoption and reaching the usage level. A high level of IT sophistication appears to be an important factor in getting to the usage stage for the majority of companies. Of the usage-stage companies, 61% received an above-average IT score, compared to only 46% of the nonusage stage firms.5 In general, companies will have an easier time implementing ABC if their IT system has the following characteristics: good subsystem for example, sales system, manufacturing system, and so on) integration, user-friendly query capability, available sales, cost, and performance data going back 12 months, and real-time updates of all these types of data (Krumwiede, 1999, page F1-4). Sixth, there is a lack of knowledge and training in companies as neither the implementation team nor the people using CCMCs' information are properly trained.

The aim of our research was to find out the current situation as regards the relationship between cost management and performance of large Slovenian companies. Reasons why particular types of companies use or fail to use CCMCs will be defined in greater detail in our further research focusing also on SMEs. It is noteworthy that there is a considerable difference between large companies and SMEs. On average SMEs do not posses the knowledge and resources of large companies, however, this is not an excuse to exclude concepts such as benchmarking and TQM, the use of which shouldn’t be constrained by the size of the company. They should be implemented in SMEs too, at least to some extend, especially in Slovenian and other CEE companies operating in transitional turbulent business environment facing severe global competition. TQM should be an integral part of the culture of every company committed to customer satisfaction through continuous improvement, which is facilitated through organizational learning which is supported by benchmarking. This culture tends to vary in different countries as well as in different industries. However, there are certain essential principles which can be implemented to secure greater market share, increased profits and reduced costs.

Although customer satisfaction has become a top priority for a lot of Slovenian companies today, many management control systems overemphasize throughput and short term cost control (e.g., reducing scrap and rework) within individual departments. These systems based on traditional accounting lead to goal-congruence and displacement problems. That is, maximizing or minimizing some measure in individual responsibility centers does not always lead to what is best for the company as a whole. Managers resort to managing the numbers instead of focusing on activities that would lead to higher quality and lower costs. These conditions cause losses in downstream processes and also losses to customer or society. This is obviously inconsistent with the goal of customer satisfaction, and it is also a poor strategy in a globally competitive environment.

Slovenian companies should use a process management approach to improvement which requires defining each activity as part of a business process that can be continuously improved. Activities defined in this way can be based on various techniques to decrease time, improve quality, and reduce the cost of those activities. According to Brimson and Antos (2000), process management is crucial to excellence because high levels of performance are possible only when activities are carried out to the best possible standards, the unused capacity is minimal, the best practices are continually made better, and the activities are executed perfectly.6

Conclusion

Many companies are currently engaging in continuous improvement efforts that recognize the need to eliminate non-value-added activities so as to reduce lead time, make products or perform services with zero defects, reduce product costs on an on-going basis, and simplify products and processes. Present dynamic and uncertain business environment climate makes it hard for companies to meet stakeholder expectations. The proper use of CCMCs provide managers with the critical information they need to make proper business decisions related to costs and profitability, so companies can remain strong and efficient when faced with global competition.

Under normal conditions in the past, managers could often afford to be reactive. They could take actions that nested comfortably within their routine planning and control duties. But with a business moving into a turbulent business environment, demands for information and analysis become imperative and more challenging. For this reason it is important that companies learn about and start adopting CCMCs. The use of CCMCs in Slovenian companies for ensuring their effective performance is required due to the increasing complexity of economic processes and the system changes in Slovenian economy.

References

1. Brimson, J. A., Antos, J., (2000), ‘Activity-Based Budgeting’ in Barry J. Brinker (ed.), Guide to Cost Management, (New York: John Wiley & Sons).

2. Churchill, G. A. Jr., (1999), Marketing Research: Methodological Foundations, (Fort Worth: The Dryden Press).

3. Emerging Practices in Cost Management (1999), James B. Edwards (ed.), Boston: WG&L/RIA Group.

4. Emerging Practices in Cost Management: Strategic Cost Management (2000), James B. Edwards (ed.), Boston: WG&L/RIA Group.

5. Guide to Cost Management (2000), Barry J. Brinker (ed.), New York: John Wiley & Sons.

6. Handbook of Cost Management 2002 edition (2001), John K. Shank (ed.), USA: WG&L/RIA Group.

7. Ittner Christopher and Larcker David: Non-financial Performance Measures: What Works and What Doesn’t, , 22.8.2002.

8. - The Most Commonly Used Key Performance Indicators

9. Kaplan, R. S., Norton, D. P., (1992), ‘Balanced Scorecard – Measures That Drive Performance’, Harvard Business Review, 70(1): 71-79.

10. Kaplan, R. S., Norton, D. P., (1993), ‘Putting the Balanced scorecard to work’, Harvard Business Review, 70(5): 134-147.

11. Kaplan, R. S., Norton, D. P., (1996), The Balanced Scorecard – Translating Strategy into Action, (Boston: Harvard Business School Press).

12. Kaplan, R. S., Norton, D. P., (1999), ‘Why Does Business Need a Balanced Scorecard?’ in James B. Edwards (ed.), Emerging Practices in Cost Management, (Boston: WG&L/RIA Group).

13. Kaplan, R. S., Norton, D. P., (1999a), ‘Why Does Business Need a Balanced Scorecard? (Part 2)’ in James B. Edwards (ed.), Emerging Practices in Cost Management, (Boston: WG&L/RIA Group).

14. Krumwiede, K. R., (1999), ‘ABC: Why It's Tried and How It Succeeds’ in James B. Edwards (ed.), Emerging Practices in Cost Management, (Boston: WG&L/RIA Group).

15. Maguire, W., Putterill, M., (2000), ‘Continuous Improvement in Turbulent Times’ in Barry J. Brinker (ed.), Guide to Cost Management, (New York: John Wiley & Sons).

16. Oliver, L., (2000), The Cost Management Toolbox – A Manager’s Guide to Controlling Costs and Boosting Profits, (New York: AMACOM).

17. Rant M., Sink D., (2002), ‘An Integral Approach Towards Process-Based Thinking In Management’, International Journal of Business and Economics, 2(1): 172-178.

18. Tekavcic, M., Sink, D., (2002), ‘The Use of Cost management Tools for Global Competition: The Case of Slovenian Companies’ in S. Sharma and L. Galetic (eds.), An Enterprise Odyssey: Economics and Business in the New Millenium 2002 (CD), (Zagreb: University of Zagreb, Graduate School of Economics and Business).

19. Van Der Linde Bob: Performance Improvement: What Gets Results?, , 22.8.2002

20. Zikmund, W. G., (2000), Business Research Methods, (Fort Worth: The Dryden Press).

Endnotes

1 We selected those CCMCs, which are most frequently discussed in cost management literature, for example in Handbook of Cost Management, Guide to Cost Management, Emerging Practices in Cost Management, and Emerging Practices in Cost Management: Strategic Cost Management.

2 For example, shortly after becoming the first US company to win Japan's prestigious Deming Prize for quality improvement, Florida Power and Light found that employees believed the company's quality improvement process placed too much emphasis on reporting, presenting and discussing a myriad of quality indicators. They felt this deprived them of time that could be better spent serving customers. The company responded by eliminating most quality reviews, reducing the number of indicators tracked and minimizing reports and meetings (Ittner, Larcker, 2002).

3 Interviewers were properly trained because the research was part of their postgraduate course work.

4 The data cited in this paper come from two IMA surveys which were mailed in November 1995 and January 1996.

5 The ‘IT score’ was based on responses to questions relating to system characteristics such as subsystem integration, query capability, available data, and frequency of updates.

6 More on process thinking and management, also in Slovenian companies, see in Rant, Sink, 2002.

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