Strategic Profit Management- ABC, ABB, ABM.pptx

It provides a comprehensive insight into profitability analysis, cost management, and performance measurement strategies. It covers essential topics such as Porter’s Generic Strategy Theory, the growth, price recovery, and productivity components in strategic profit analysis, and advanced methodologies like Activity-Based Costing (ABC), Activity-Based Management (ABM), and Activity-Based Budgeting (ABB). The presentation explores key financial decision-making tools, including customer profitability analysis, benchmarking, Pareto analysis, and strategic cost reduction techniques. Real-world applications and case studies from industries such as retail, manufacturing, and logistics illustrate the importance of optimizing business activities to achieve financial sustainability and competitive advantage.

1. Strategic Profit Management Dr. Ankita Chaturvedi

2. Strategic Profit & Performance Management - Overview Why is Strategic Profit Management Important? Helps businesses maximize profitability while maintaining competitive advantage. Ensures long-term sustainability through cost management strategies. Enables accurate performance measurement using financial metrics. Key Concept: Porter’s Generic Strategy Theory suggests firms should either: Be cost leaders (lowest cost producer). Offer differentiated products (unique value to customers).

3. A. Profitability Analysis - An Introduction What is Profitability Analysis? It measures how well a firm is generating profit from its operations. Helps identify critical success factors for better decision-making. Key Elements of Profitability Analysis: * Growth Component – Effect of increased sales volume. * Price Recovery Component – Changes in selling prices and costs. * Productivity Component – Efficiency improvements affecting profits.

4. Components of Strategic Profit Analysis Component What it Measures Formula & Impact 1 Growth Component Change in revenue and costs due to higher sales volume. Revenue Effect of Growth = (Current Year Units - Last Year Units) × Last Year’s Selling Price 2 Price Recovery Component Change in revenue and costs due to price fluctuations. Revenue Effect of Price Recovery = (Selling Price This Year - Last Year) × Units Sold This Year 3 Productivity Component Cost reductions due to efficiency improvements. Cost Effect of Productivity = Actual Input Cost - Standard Cost

5. 1.1 Growth Component - Revenue Effect How Does Growth Affect Revenue? When more units are sold, revenue increases. Growth is measured by comparing current vs. previous year’s sales . Formula : Revenue Effect of Growth = (Actual Units Sold This Year - Last Year) × Selling Price in Last Year Example: If last year 100,000 units were sold at ₹50 each , and this year 110,000 units were sold: Growth Revenue Effect = (110,000 - 100,000) × ₹50 = ₹500,000 increase

6. 1.2 Growth Component - Cost Effect How Does Growth Affect Costs? Variable Costs : Increase proportionally with production. Fixed Costs : May remain constant or increase at a slower rate. Formula for Variable Cost Effect: Cost Effect of Growth (Variable) = (Required Inputs for Current Year - Last Year) × Input Price in Last Year Formula for Fixed Cost Effect: Cost Effect of Growth (Fixed) = (Capacity Used This Year - Last Year) × Cost Per Unit of Capacity .

7. 2.1 Price Recovery Component - Revenue Effect How Does Price Recovery Impact Revenue? If a firm increases selling prices, revenue rises. Price Recovery ensures businesses maintain profitability despite inflation . Formula : Revenue Effect of Price Recovery = (Selling Price This Year - Last Year) × Units Sold Example : If last year’s price was ₹50 and this year it is ₹55, and 100,000 units were sold: Price Recovery Revenue Effect = (₹55 - ₹50) × 100,000 = ₹500,000 increase

8. 2.2 Price Recovery Component - Cost Effect How Does Price Recovery Affect Costs? Price increases in raw materials, wages, and energy lead to higher costs. Formula for Variable Costs: Cost Effect of Price Recovery (Variable) = (Input Price This Year - Last Year) × Inputs Used Formula for Fixed Costs: Cost Effect of Price Recovery (Fixed) = (Cost Per Unit of Capacity This Year - Last Year) × Capacity Used Example : If raw material prices increase by ₹5 per kg , total cost effect must be adjusted accordingly.

9. 3.1 Productivity Component - Cost Effect How Productivity Improvements Impact Costs? If a company reduces waste or improves efficiency , costs decrease. Productivity gains allow businesses to maintain cost leadership strategies . Formula : Cost Effect of Productivity = Standard Cost of Input - Actual Cost of Input Example: If machine efficiency improves, reducing electricity usage, costs drop and profit increases.

10. Reconciliation of Operating Profit

11. Example Y Limited is a manufacturer of Cardboard boxes. An analysis of its operating income between 20 23and 2024 shows the following : Y Limited sold 4,00,000 boxes and 4,20,000 boxes in 2023 and 2024, respectively. During 2024, themarket for cardboard boxes grew 3% in terms of the number of units, and all other changes are dueto the company’s differentiation strategy and productivity . Required COMPUTE how much of the change in operating income from 2023 to 2024 is due to the industrymarket size factor, productivity, and product differentiation and also reconcile the profit of both yearsdue to these factors.

12. solution

13. B. Introduction to Activity-Based Costing (ABC) What is Activity-Based Costing (ABC)? ABC is a costing methodology that assigns costs to activities based on their actual consumption. Helps in accurate cost allocation to products, customers, or services. Why ABC is Important? Traditional costing allocates overheads arbitrarily , while ABC assigns costs based on cost drivers . Improves profitability analysis by linking costs to activities. Example: A manufacturing company can use ABC to determine which activities are consuming the most resources .

14. Components of ABC How ABC Works? ABC has four key components : Cost Objects – Products, customers, or services that consume activities. Activities – Processes that generate costs (e.g., material handling, machine setup ). Cost Pools – Grouping of costs based on similar activities. Cost Drivers – Factors that determine the cost of activities (e.g., machine hours, labor hours). Example: If the cost driver is machine hours , products using more machine time will be allocated higher costs.

15. Steps in Implementing ABC How to Apply ABC in an Organization? Step 1: Identify major activities (e.g., ordering materials, quality control). Step 2: Assign costs to activities using cost pools. Step 3: Determine cost drivers for each activity. Step 4: Allocate costs to products/services based on usage. Example: A hospital may use number of patient visits as a cost driver for administrative expenses.

16. Direct Product Profitability (DPP) in ABC What is Direct Product Profitability (DPP)? Measures the profitability of each product instead of overall company profit. Helps management focus on high-profit vs. low-profit products . Why is DPP Useful? Traditional costing spreads overheads evenly , but ABC allocates true costs to each product. Provides more accurate profit margins . Example: A retail company can analyze which products generate the highest net profit .

17. Direct Product Profitability - Cost Categories Types of Costs in DPP : Cost Type Description Example Overhead Cost Costs not linked to a specific product Rent, utilities Volume-Related Cost Costs based on space occupied Storage, transport Batch Cost Costs based on batch size Machine setup, labor time Inventory Cost Cost of tying up money in stock Interest on unsold goods Example: If warehousing space is expensive, products occupying more space will have higher storage costs .

18. ABC vs. Traditional Costing Factor Traditional Costing ABC Costing Overhead Allocation Based on labor/machine hours Based on actual activity usage Accuracy Less accurate More accurate Cost Drivers Few cost drivers Multiple cost drivers Application Suitable for simple businesses Best for complex organizations Example: Traditional costing may assign equal electricity costs to all products, while ABC assigns actual energy usage per product .

19. Advantages of ABC in Profitability Analysis Why Use ABC? Accurate Costing: Helps in better decision-making. Eliminates Waste: Identifies unnecessary cost-generating activities. Better Pricing Strategies: Ensures competitive pricing. Improved Resource Allocation: Focus on profitable activities. Example : ABC helped Amazon optimize its logistics and fulfillment costs by analyzing warehouse activities.

20. Limitations of ABC Expensive to Implement – Requires detailed data collection. Time-Consuming – Complex calculations involved. Requires Employee Training – Not all employees understand ABC initially. Data Collection Challenges – Difficult to track all activities accurately. Example: Small businesses may find ABC too costly and complex to implement

21. Case Study – ABC in Retail Industry How Retailers Use ABC for Profitability Analysis? Retail Chains (e.g., Walmart): Uses ABC to allocate store maintenance costs based on foot traffic. Helps in determining the true cost of product placement . Online Retailers (e.g., Amazon, Flipkart): Analyzes storage costs, packaging costs, and delivery expenses . Uses ABC to optimize inventory management . Result: Retailers using ABC can reduce costs by eliminating unprofitable products

22. Case Study – ABC in Manufacturing How ABC is Used in a Manufacturing Firm? Company : Automotive Parts Manufacturer Issue : High overhead costs leading to inaccurate product pricing. Solution : Identified cost drivers ( machine setup, material handling, quality control ). Assigned actual costs to each car part based on activity usage. Adjusted pricing to reflect actual production costs. Result: Increased profit margins by 12% through better cost allocation .

23. C. Introduction to ABC, ABM, and ABB What are ABC, ABM, and ABB? Activity-Based Costing (ABC): A costing methodology that assigns costs to activities based on their actual consumption. Activity-Based Management (ABM): A management approach that uses ABC insights to improve efficiency and strategic decision-making. Activity-Based Budgeting (ABB): A budgeting approach that forecasts resource requirements based on expected activities. Why Are They Important? Help businesses optimize cost allocation, improve operational efficiency, and enhance financial planning . Widely used in manufacturing, services, and retail industries

24. ABC in Advanced Manufacturing Environment Why is ABC Needed in Modern Manufacturing? Traditional costing fails to capture indirect costs accurately in automated environments. ABC helps allocate costs based on activities rather than arbitrary volume-based measures . Key Benefits of ABC in Manufacturing: More accurate cost allocation for complex production processes. Better pricing and profitability analysis. Supports lean manufacturing and process improvement. Example : A car manufacturer uses ABC to allocate costs to production, quality control, and machine maintenance separately .

25. Activity-Based Cost Management (ABM) What is Activity-Based Management? A management approach that focuses on improving activities and reducing costs . Uses ABC data to enhance decision-making. Key Components of ABM: Operational ABM: Increases efficiency by reducing waste and non-value-added activities. Strategic ABM: Helps companies decide which activities to invest in or eliminate . Example: A logistics company uses ABM to optimize transportation routes and reduce fuel costs .

26. Cost Driver Analysis in ABM What is a Cost Driver? Any factor that influences the cost of an activity . Identifying cost drivers helps businesses manage and control expenses . Types of Cost Drivers: Transaction-Based: Number of orders processed. Duration-Based: Machine run time. Intensity-Based: Resources used per transaction. Example : A hospital tracks patient admissions as a cost driver for administrative costs .

27. Activity Analysis in ABM Why is Activity Analysis Important? Helps identify value-added vs. non-value-added activities . Enables businesses to streamline operations and eliminate waste . Steps in Activity Analysis : Identify all business activities. Categorize activities into value-added and non-value-added . Optimize or eliminate non-value-added activities. Example : A retail store analyzes checkout processes and removes redundant steps to speed up service .

28. Performance Analysis in ABM What is Performance Analysis? Evaluates how efficiently resources are used in key activities. Helps identify areas for cost reduction and process improvement . Key Performance Measures: Cost Efficiency: Comparing activity costs to industry benchmarks. Time Efficiency: Reducing process cycle times. Quality Metrics: Defect rates, customer satisfaction. Example : A manufacturing firm compares production cycle times with competitors to improve efficiency.

29. ABC vs. ABM – Key Differences Feature Activity-Based Costing (ABC) Activity-Based Management (ABM) Purpose Assigns costs to activities Uses ABC insights for decision-making Focus Cost allocation Process improvement Benefits Accurate cost data Efficiency and cost reduction Example Assigning overhead costs to production Eliminating non-value-added activities

30. Activity-Based Budgeting (ABB) What is ABB? A budgeting method that forecasts expenses based on expected activities . Unlike traditional budgeting, ABB links costs directly to business processes. Key Elements of ABB: Type of activities needed . Quantity of activities expected . Cost estimation for each activity . Example: A manufacturing firm forecasts machine maintenance costs based on expected production hours .

31. ABC vs. ABB – Key Differences Feature Activity-Based Costing (ABC) Activity-Based Budgeting (ABB) Purpose Assigns costs based on activities Plans budgets based on activity levels Focus Historical cost data Future cost planning Benefits Accurate cost tracking Improved financial forecasting Example Allocating administrative costs Estimating next year’s HR expenses

32. Business Applications of ABM Why is Activity-Based Management (ABM) Important? Helps optimize resources and reduce costs . Supports continuous process improvement . Enhances decision-making through cost driver analysis . Key Business Applications: Cost Reduction – Identifies non-value-added activities and eliminates waste . Business Process Reengineering (BPR) – Redesigns workflows for efficiency . Benchmarking – Compares activities with industry standards to improve performance . Performance Measurement – Uses key performance indicators (KPIs) to track progress. Example: A manufacturing firm uses ABM to analyze the cost-effectiveness of different suppliers .

33. Business Process Reengineering (BPR) What is BPR? The fundamental rethinking and redesign of business processes to achieve dramatic improvements in performance . Steps in BPR : Identify processes that need improvement . Analyze existing workflows and bottlenecks . Redesign processes to remove inefficiencies . Implement changes and monitor progress . Example: A retail company automates inventory management to reduce stockouts and excess stock.

34. Benchmarking in Strategic Profit Management Why is Benchmarking Important? Helps businesses compare performance with best industry practices . Identifies gaps in efficiency and cost management . Encourages continuous improvement . Types of Benchmarking: Internal Benchmarking: Comparing different departments within the same company. Competitive Benchmarking: Comparing with industry peers. Functional Benchmarking: Comparing processes across industries. Example: Toyota benchmarks its lean manufacturing processes against global best practices.

35. Performance Measurement in ABM Key Performance Metrics for ABM: Cost Measures – Cost per unit, overhead allocation. Time Measures – Cycle time, process efficiency. Quality Measures – Defect rates, customer complaints. Innovation Measures – Number of new products launched. Why Performance Measurement is Crucial? Helps track operational efficiency . Ensures alignment with strategic goals . Improves customer satisfaction and profitability . Example: Amazon uses customer delivery times as a key performance metric

36. Strategic Cost Reduction Techniques Ways to Reduce Costs Strategically: Process Optimization – Eliminating redundant tasks . Technology Adoption – Implementing AI and automation. Supplier Negotiations – Reducing procurement costs. Lean Manufacturing – Minimizing waste in production. Example : A logistics company uses route optimization software to lower fuel expenses .

37. Customer Profitability Analysis What is Customer Profitability Analysis? Determines which customers generate the most profit. Helps businesses prioritize high-value customers . Key Factors Considered: Purchase volume. Cost to serve. Discounts and returns. Example: A telecom company analyzes customer profitability to offer targeted loyalty programs .

38. Pareto Analysis in Cost Management What is Pareto Analysis? The 80/20 rule , stating that 80% of results come from 20% of causes. Helps identify the most significant cost drivers . Applications in Cost Management: Identifying the top 20% of products generating 80% of revenue. Focusing on high-impact cost reduction areas. Improving customer segmentation. Example : A retailer finds that 20% of its inventory accounts for 80% of its sales

39. Pros of Pareto Analysis Why Use Pareto Analysis ? Breaks Down Complex Problems – Helps decompose large issues into manageable causes . Identifies Significant Causes – Highlights which factors have the greatest impact. Prioritization Tool – Focuses resources where they will have the most benefit . Optimizes Resource Allocation – Ensures the best use of time, money, and manpower . Acts as a Control Mechanism – Helps in monitoring and maintaining process efficiency . Example : A company finds that 20% of products contribute to 80% of sales , so it focuses marketing on those key products.

40. Cons of Pareto Analysis Limitations of Pareto Analysis Exclusion of Emerging Problems – Small issues today may grow over time and become major concerns. Incorrect Application – Misuse can lead to wrong identification of causes , leading to poor decision-making Data Dependency – The accuracy of Pareto Analysis depends entirely on the quality of data collected . Example : If customer complaints are misclassified , businesses might focus on the wrong issue, leading to wasted resources.