A Costing Approach for Virtual Organizations - Example

Virtual Organizations Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Name Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Course Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Lecture Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Date Introduction In order for organizations to remain competitive in today’s business environment where the forces of globalization, technological change, functional competitiveness play a greater role in determining the strategic direction of organization business have to be managed and operated differently and the boundaries of product sourcing redefined. Nowadays, the world is characterized by evolving business models. Evolution of business model is one of the ways businesses are adapting to changing business and technological environment. One of the most profound changes in the business world is the concept of outsourcing. Businesses may outsource various components of their operation, but for the purpose of this paper we will concentrate on product outsourcing. Virtual organization is an emerging business model where the organization conducts its business entirely on electronic media (Tapscott and Williams 2006). One of the most successful virtual organizations is Amazon.com, which operates a retail book selling service without having a physical bookstore (Mahadevan 2000). According to Gunasekaran, Williams and McGaughey (2005), Virtual organizations outsource their entire production operations therefore avoiding the cost of production. Other than organizations that sell physical products, the rise of virtual organizations that sell services has been on the increase as well. Virtual businesses now provide graphic design services, administration, and research among a host of other services. Notably, Virtual organizations act as a link between the producer of a service and a good and the final consumer. According to Mahadevan (2000), one of the factors underlying the success of virtual organization is their ability to rapidly respond to changes in the market. Virtual organization adapt quickly to customer needs, evolving cost structures and the forces of globalization. Outsourcing enables virtual organizations change their product offering almost instantly in line with changes in the market. Virtual organizations have been described as possessing the following characteristics: Low cost, high utilization of information technology, non-bureaucratic, high response to customer requirements and effective utilization of resources. Outsourcing as used by a virtual organization refers to the practice of obtaining products offered to consumer from outside vendors rather than engaging in the production of the product (Tapscott and Williams 2006). Outsourcing for most companies including Virtual ones aimed at minimizing the operating cost of a company. According to Fill and Visser (2000) where an organization obtains its entire product offering from outside vendors, issues of understanding the product cost drivers are unimportant. According to Kotabe, Mol and Murray (2008) organizations can gain competitive advantage by letting external suppliers carry out the non-core functions of the organization. The concept of outsourcing assumes, external suppliers are more effective and efficient and in the case of virtual organizations can produce the product in question at a lesser cost. Outsourcing of product operation offers a virtual organization a number of advantages including transfer of knowledge management (both tacit and codified) as the supplier is responsible for the physical business function. Once a virtual organization receives a product all the product cost drivers are incorporated into the product by the supplier. Essentially, Virtual organization is unaware of the forces that influence the cost of the product they're dealing with. According to Barthelemy (2001) letting the cost allocations of a product be determined by the market pricing mechanism may lead to situations where the product cost does not reflect the actual cost of producing the product. This paper presents the argument that virtual organization needs to be concerned with product costing even though they outsource their entire production operations. Discussion Product costing traditionally has been done to provide management with information that will enable them to determine the price to offer for a product. Product costing is purposely done to map and record the production of goods and services. Product costing provides knowledge that informs managerial decisions such as capital budgeting, production and pricing. On the other hand, outsourcing is concerned with keeping the cost of production low. According to Embleton and Wright (1998), the three primary reasons for outsourcing are: (i) reduction on labour costs (ii) “transfer of demand uncertainty to vendor” (iii) access to higher quality products that the company may not be able to produce. McIvor (2000) believes that by virtue of the fact that the vendor organizations have economies of scale outsourced production operations will be inherently cheaper. In conclusion, the argument for outsourcing produces a myth that outsourced products are cheaper therefore undercutting the need for costing operations for virtual organization that outsource their entire production operations. However, Fill and Visser (2000) notes that outsourced product operations do not always bring about cost saving, therefore costing should remain as important in virtual organization as in actual brick and mortal companies. According to Chalos (1995) the price quoted by an outside vendor to a virtual organization bears little relationship to the actual cost of producing the product. Rarely does the cost of the production define the price quoted by outside vendors. Outside vendors quote their products by reference to the price the market can bear and therefore they quote a price whose main aim at maximizing their own profits rather than reflect the cost of production. Suppliers will try to make prices appear as low as possible to keep in line with pricing aspects that are easily benchmarked, but in actual sense trying to settle at a price that is as profitable as possible. Gunasekaran, Williams and McGaughey (2005) various illustrations of how vendors maintain high prices for products supplied are available all over the business world. One of the most commonly used strategies to maintain higher profit levels by supplier is the use of a fixed markup despite variations on the volume of products supplied or manufactured. It is well known that it cost less to produce higher volumes of products and therefore suppliers who are able to charge fixed markup on higher volumes gain higher profits. Outside vendors are also known to initially set prices low, but once they secure supplier contracts they increase the prices of their supplies. In summary, price negotiations may take priority over cost of production in determining cost of products in outsourced product operations. Virtual organization must therefore be able to distinguish between inflated prices and actual cost of production. It is important for virtual organization to understand the cost drivers of the product they deal in to avoid being duped by unscrupulous outside vendors. Secondly, in those companies that have never engaged in production operations and do not understand the cost of production, they fail to account for internal cost associated with productions. According to Velmurugan (2010) these organizations take the price of the supplier as the product standard cost and fail to account for other costs of the product. It is inevitable that even virtual organizations will incur internal costs such as product planning, quality management and supplier relationship management costs. By using the supplier price as the primary metric the other cost of production remains ignored. According to Chalos (1995) some virtual organization fail to take note of their own internal costs but instead focus on getting a lower price from external suppliers. It must be noted that virtual organizations operate in a very competitive business environment. According to Walter (2002), a virtual organization must be perceived to be delivering more value to its customers than its competitors to effectively compete on costs and value. It must also make the switching cost from its value proposition higher than that of competitors. Where a Virtual organization lets it external suppliers set the price of product regardless of cost of production, the value preposition of the company may be affected negatively. A Costing Approach for Virtual organizations As it has been discussed above, Virtual organization also needs to offer a perceived higher value than its competitors to customers. One way that Virtual organization can optimize the cost of production associated with their internal overhead costs is using an appropriate accounting model. According to Gunasekaran, Williams and McGaughey 2005), (), the Activity based costing is one of the methods virtual organizations can use to identify and assign costs to their various business activities. Through activity based costing, Virtual organizations can be able to track costs associated with production processes such as planning and maintenance of supplier relationship. According to Ingram et al (2001), Activity based costing will complement the value chain of virtual organization as it accounts for value added in each production activity. According to Walters (2002) activity based costing is a valid method for use by organizations that have a disintegrated value chain in their financial planning activities. Alternatively, the grid accounting model can be considered as an appropriate costing model for virtual organization. According to Foster, Kesselman and Tuecke (2001), the grid accounting model can assists virtual organizations optimize their cost-benefit ratio. By tracking costing information using the grid costing model, virtual organization are able to charge their customers prices that are closer to the cost of the product than other competitors. Conclusion Although, outsourcing provides a viable option for businesses to reduce the cost producing their services or product, engaging in outsourcing does not always result in cost saving. It is not in doubt that when properly managed, outsourcing enable Virtual organization concentrate on their core competencies and thus gain competitive advantage in the market. In contrast, to the views of most supporters of outsourcing, cost saving is not an inherent characteristic of outsourcing, but rather one that is gained through careful management of outsourcing relationships. In this paper several compelling arguments why virtual organizations that have completely outsourced their production operations are presented. First, outside vendors will always strive to make the highest profit as possible from the goods supplied to the Virtual Organization. The paper shows instances where outsourced suppliers distort the cost of the product through such practices as maintaining a fixed markup even when the cost of production goes down. Secondly, despite getting a product where most costs of production have been factored into, Virtual organization still incur other overhead costs that they need to incorporate into the production cost of the products. Such expenses include planning, consumer relationship and communication costs. Finally, Virtual organizations operate in a competitive environment where they need to deliver higher perceived value in their products than competitors. Through costing virtual organizations can be able to optimize their cost-benefit ration to deliver higher value prepositions to their customers than competitors. It can be concluded that Virtual organizations just like ordinary organizations need to be involved in costing although they might have outsourced their entire production operations. 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