ABC and SCM

ABC and SCM - Transcript

Strategic cost management an activity based management approach
John M Trussel Pennsylvania State University Harrisburg Pennsylvania USA Larry N Bitner Hood College Frederick Maryland USA

The design and implementation of new strategic management initiatives such as reengineering have been common since the publication of Hammer and Champy s 1993 popular book on reengineering In the process of designing and implementing these new initiatives however managers have virtually ignored the cost management system Activitybased management ABM is a system that incorporates many of the concepts of strategic management reengineering and applies them to cost management ABM consists of two viewpoints a cost view and a process view ABM is both an accurate cost accounting system the cost view and a performance evaluation tool the process view This paper presents the ten steps to design and implement an ABM system and offers an actual application

Many organizations are designing and implementing new strategic management initiatives such as reengineering Hammer and Stanton 1994 Reengineering and other strategic management initiatives have become popular since the publication of Hammer and Champy s 1993 Reengineering the Corporation A Manifesto for Business Revolution However the cost management system has been almost completely ignored from the discussion Activity based management ABM is a modern cost accounting and management model that is consistent with the concepts of strategic management and reengineering ABM is both an accurate cost accounting system and a performance improvement tool Turney 1991 Like reengineering ABM focuses on business processes which are collections of activities or work that result in valuable output The purpose of this paper is to describe the design and implementation of an ABM system The design and implementation steps are applied to an actual organization

Overview of activity based management
Business process reengineering BPR is a management tool for redesigning business processes in order to obtain dramatic improvements in performance measures such as cost and quality The idea behind BPR is to funda mentally revise all aspects of performing activities from a revision of strategic goals and operating objectives to an alteration of work methods Under BPR work should be focused on processes and not functional tasks BPR begins with a clear mission statement and continues with a redesign of processes in line with the mission statement Activity based management ABM is similar in nature to BPR but adds the analysis of the cost management system ABM consists of two primary viewpoints a cost view and a process view Under the cost view ABM is a cost accounting system called activity based costing It is a system that is used to more accurately determine the full costs of services and products This system allows for the cost analysis of service activities such as payroll accounting and

duplicating costs of core activities such as production processes and costs of products services and other cost objects Under the process view ABM is used to develop nancial and non nancial performance indicators for the output of each activity center The two viewpoints of ABM are summarized in Figure 1 The goal of the cost view is to determine the cost of a product or service while the goal of the process view is to measure performance The attractiveness of ABM is that the same information system accomplishes both goals The principles of ABM can be used for budgeting performance evaluation and resource allocation decisions Like reengineering ABM is more concerned with planning and controlling the various activities or processes of a company rather than its functional tasks Under an ABM system a two stage process is utilized Resource costs are rst assigned to activities and then activity costs are assigned to cost objects see Figure 1 In the rst stage the ABM system is designed to trace costs to activities or processes i e activity centers All tasks or work performed that result in a valuable output are grouped together into an activity center Using ABM the costs of operating each activity center is determined and reported In the second stage the costs of activity centers are traced to cost objects i e products departments divisions customers or other de ned services In both stages cost drivers are utilized to assign costs The cost drivers have a causal relationship between the activity and the cost object

Designing and implementing the process of ABM
Implementation steps
The steps necessary for designing and implementing the process view of activity based management are outlined below The steps are based upon procedures espoused by Hammer and Champy 1993 and Cooper et al 1992 The steps follow 1 Develop a clear and succinct mission statement What is the organization s raison d tre

Management Decision 36 7 1998 441 447 MCB University Press ISSN 0025 1747

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John M Trussel and Larry N Bitner Strategic cost management an activity based management approach Management Decision 36 7 1998 441 447

Figure 1 Activity based management
Resources Cost View

Inputs Process View

Processes Activities

Outputs

Cost Objects

2 Determine the core processes and the major cost objects What are the processes that are central to the mission of the organization What are the items to be ultimately costed 3 Determine the supporting processes What are the processes that sustain the core processes such as certain administrative activities 4 Form the process teams What teams should be in place to perform the core and supporting processes As espoused by reengineering theory the process teams essentially replace the old function oriented departments Each team consists of employees trained or to be trained to accomplish the activities within each process 5 De ne the strategic objectives of each process What are the long term strategies and goals of each process 6 Set the major operating objectives of each process How can the long term strategies and goals be achieved 7 Identify the main activities in each process What are the activities work to be performed that encompass each process In ABM terminology these are the activity centers 8 Develop key performance indicators for each process and activity How should performance for each process and activity center be measured The performance indicators may include both nancial and non nancial measures 9 De ne the cost drivers for each activity What is causing resources to be consumed by each activity and cost object 10 Take steps to ensure the acceptance of the new system Employees must be oriented and trained to implement the new system and understand its output

implementation strategies of ABM systems for eight companies ve manufacturing entities one distribution company one nancial services provider and one energy company however they did not include a college or university nor did they relate the design steps to reengineering Anotos 1992 discusses ABM for not for pro t organizations but is not speci cally related to higher education Hammer and Champy 1993 discuss the implementation of business process reengineering for several companies but they did not include a discussion of the accounting systems Hammer and Champy s reengineering concepts were applied to higher education by the National Association of College and University Business Officers 1994 However the cost accounting system was ignored in this publication During the summer of 1995 Hood College began to reengineer its work processes and to develop an activity based management system Hood College is a private institution of higher learning with undergraduate and graduate enrollments of approximately 1 100 and 900 respectively In July of 1995 an ABM team was formed consisting of four members from the faculty and three members from various supporting staff positions The main charge of this team was to diagnose the existing processes and oversee the redesign and implementation In preparation for this task a process inventory was conducted by the team This consisted of interviewing the head of every functional department on campus from administrative departments such as accounting to academic departments such as English and Communications This information was utilized to determine the reporting structures and work processes that were in place The results of the ten step design and implementation of the ABM system follow

Step 1 the mission statement
Hood College prepares students to excel in meeting the personal professional and global challenges of the future Hood is committed to the integration of the liberal arts and technology to the exploration of values and community and to the preparation of students for lives of responsibility and leadership

Step 2 the core processes and the cost objects
The ABM team determined which processes are central to achieving the mission of the college This determination was made using various sources of information such as a survey of the work processes benchmarking and individual interviews Viewing students as the focal point of the college the core processes are to attract enroll and keep the students the

Implementing the new system a case study
To illustrate the design and implementation procedures of an ABM system the results of an actual organization a small college are summarized Prior ABM research discusses other industries besides higher education For example Cooper et al 1992 discuss the

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John M Trussel and Larry N Bitner Strategic cost management an activity based management approach Management Decision 36 7 1998 441 447

enrollment management process to feed shelter and provide for the wellbeing of the students the student life process to educate the students the education process and to provide the students with a window to the outside world the external relations process The team also determined the cost objects In a manufacturing environment the cost objects are normally products or customers The analogy then is that the academic programs are the product and the students are the customers Thus there are two primary cost objects academic programs and students There are over 30 academic programs at Hood College including undergraduate graduate core and honors programs Each of these programs is considered a cost object There are six classi cations of students including traditional aged residential full time traditionalaged commuting part time traditional aged commuting full time non traditional aged commuting part time non traditional aged commuting and graduate students Each of these classi cations is considered a cost object

Step 5 the strategic objectives
Each of the process teams was charged with developing long term goals and objectives To illustrate the development of strategic objective one of the process teams is selected the physical facilities team The strategic goal of this team is to develop a long range forward thinking facilities plan to support the programs of the college The team is to formulate plans policies and procedures pertaining to facilities development allocation and use The team has four focal points space utilization and allocation capital improvements campus aesthetics and maintenance

Step 6 the operating objectives
The operating objectives de ne how the strategic objectives can be achieved Again the physical facilities team PFT is used to illustrate the implementation of this phase The team proceeded to achieve its strategic goals by using several operating objectives The rst operating objective was to determine the space capital and maintenance requirements of the college community The second was to develop an inventory of space utilization The third was to prioritize the space capital and maintenance needs of the college The last was to develop a facilities master plan The PFT accomplished these operating objectives by conducting a campuswide survey of needs interviewing key personnel inspecting the facilities and considering the budget implications

Step 3 the supporting processes
The ABM team concluded as to which processes are absolutely necessary to support the core processes That is the team determined what processes must be in place to operate the core processes With the core processes as the focal points the key supporting processes are to gather report and provide information the management information process attract hire maintain and release competent personnel the human resources process to nance the operations of the school the nancing process to provide adequate facilities i e the physical facilities process and to adequately plan and control the strategies and operations of the college the planning and control process

Step 7 main activities in each process
Each process consists of a set of activities that provides a valuable output These activities are essential to each process Each team was given the task of de ning the main activities and redesigning them to provide a seamless process to the user of the service The activities are listed below Enrollment management team The main processes are marketing the offerings of the college communicating with prospective and existing students obtaining information regarding the prospective and existing students evaluating the applicants accepting or rejecting them pricing providing incentives to accept obtaining a commitment collecting funds assimilating the accepted students and retaining the students Student life team The main processes are providing for the wellbeing of the students providing them food and shelter and communicating with them Education team The main processes are instructing evaluating mentoring providing experiential opportunities certifying and providing for lifelong learning

Step 4 the process teams
One process team exists for each of the core and supporting processes thus there is an enrollment management team a student life team an education team an external relations team a human resources team a management information systems team a nance team a physical facilities team and a planning and control team Except for the planning and control team each team constitutes a stand alone team and includes a liaison member from each of the other teams The planning and control team consists of a representative of each core process team one member of a supporting process team and the president of the college Figure 2 summarizes the processes and the process teams

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John M Trussel and Larry N Bitner Strategic cost management an activity based management approach Management Decision 36 7 1998 441 447

External relations team The main processes are providing the students a window to the outside world continuing the commitment and communications with alumni continuing to provide lifelong learning and relating with the community Human resources team The main processes are attracting hiring maintaining training supporting and evaluating and in some cases releasing personnel Management information team The main processes are gathering and reporting information to various users including the core process teams and other supporting process teams Financing team The main processes are budgeting obtaining redeeming and controlling the nancing needs of the college Physical facilities team The main processes are scheduling maintaining and controlling the facilities of the college Planning and control team The main processes are strategic and operational planning and control of all major college activities

of new students and the retention rate of returning students

Step 9 cost drivers
As previously stated ABM is a two stage process rst resources are assigned to activity centers and second activity costs are traced to cost objects At Hood College rststage cost drivers are needed to assign costs from supporting processes to core processes and second stage cost drivers are utilized to trace core process costs to the various academic programs and student classi cations cost objects The rst stage and the secondstage cost drivers are included in Table I

Step 10 gaining acceptance of the new system
The members of the ABM team used a variety of methods to gain acceptance of the ABM system First the president of the college fully supported the project Second all constituencies of the college students faculty staff and administration were surveyed or interviewed on topics ranging from work processes and data availability to performance evaluations and communication Third the team discussed the entire process with key administrators Last members of the ABM team helped to facilitate the development of the process teams and acted as consultants to the teams

Step 8 the key performance indicators
Key performance indicators KPIs are nancial and non nancial indicators of the performance of the college a division a team or an individual KPIs should be tied to the team s major output or value added to the process Thus the KPIs will vary by the type of service being provided by the team For example some of the KPIs for the enrollment management team are the matriculation rate

Designing and implementing the cost view of ABM
Implementation steps
The steps necessary for designing and implementing the cost view of ABM follow Cooper et al 1992 The cost view of ABM is called activity based costing ABC 1 Determine the activity centers Activity centers were discussed in the process view step 7 2 Assign costs to the activity centers Using rst stage cost drivers costs are traced to the activity centers 3 De ne the cost objects The cost objects were discussed in the process view step 2 4 Link activity costs to the cost objects Using second stage cost drivers costs are assigned from the activity centers to the cost objects

Figure 2 Process teams
Hood College Planning and Control Team Supporting Systems Teams Process Teams

Enrollment Management Team

Student Life Team

Students

External Relations Team

Education Team

Implementing the new system a case study
The Hood College example from the process view is continued here Hood College has eight service activity centers four core activity centers and over 30 programs in 15 departments Since there are so many programs it is difficult to illustrate all of the mechanics of the activity based costing ABC system therefore only a portion of the activities and programs at a college are presented

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John M Trussel and Larry N Bitner Strategic cost management an activity based management approach Management Decision 36 7 1998 441 447

The steps illustrate the actual approach used to design the system at Hood College but the numbers and programs are disguised Assume that the college has two academic programs Program A is a low volume one i e it has a low student faculty ratio of 10 1 with 2 000 students and Program B is a highvolume one i e it has a high student faculty ratio of 20 1 with 4 000 students Costs for faculty salaries average 30 000 in each department and each department has 200 faculty members thus the total salary cost in each department is 6 000 000 30 000 200 The total overhead costs of providing these programs is 33 000 000 per year Although each program has the same number of faculty members and program B has more students program A requires more space for laboratories classrooms and the like as compared to program B The direct cost of operating each program is only the salaries of the faculty members The direct cost per student for program A is 3 000 per student i e 6 000 000 salaries 2 000 students and for program B is 1 500 i e 6 000 000 salaries 4 000 students If the college allocated indirect costs overhead to programs based on the number of students in each program i e a volume based costing method then the overhead application rate would be 5 500 per student i e 33 000 000 overhead 6 000 students Using this rate the cost per student of operating each program would be Program A Program B Salaries direct costs from above 3 000 1 500 Overhead rate indirect costs 5 500 5 500 Total costs per student 8 500 7 000

The problem with this volume based costing method is that it considers only the number of students and ignores the impact of other factors such as the space occupied or the number of computers used by the programs Since other factors are being ignored each program is assigned an equal amount of overhead costs per student While this method is simple to apply it is only relevant when other factors affecting overhead are not signi cant In institutions of higher education factors other than the number of students are signi cant in determining overhead costs for a particular program Owing to this problem with the volume based approach the college decided to design and implement an activitybased costing system With ABC costs that were once considered to be indirect costs overhead are now traced directly to cost objects programs

Step 1 activity centers
Assume that the college analyzed its operations and identi ed three core activity centers i e enrollment activities student support activities and academic activities and four service activities i e human resources computing duplicating and maintenance services

Step 2 cost assignment to activity centers
The determination of the costs per item for each of the activities is included in the Appendix For simplicity reciprocal services provided among activity centers such as duplicating services provided to human resources are ignored

Step 3 cost objects
As discussed in the process view cost objects for colleges are academic programs products or students customers In this simple example the cost objects are the two academic programs Program A and Program B

Table I Cost drivers First stage cost drivers Supporting activities Cost drivers Human resources Number of employees Payroll and other accounting Number of employees Management information systems Number of computers Utilities Square feet occupied Physical facilities Square feet occupied Duplicating Number of copies Security N A facility sustaining Other administration N A facility sustaining

Step 4 cost linkage from activity centers to cost objects
Costs are linked to cost objects using cost driver rates for each activity The cost driver rate for each activity is determined by dividing the total cost of each activity by the total expected activity of the cost driver The Appendix includes all of the cost driver rates

Analysis of ABC information
In the past the college has been charging 5 500 in overhead cost per student in either program whereas per Table I it should have been charging 6 845 in overhead cost to each student in program A and only 4 827 to each student in program B As a result of using the volume based costing method too little overhead has been charged to program A and too much has been charged to program B Through

Core activities Enrollment management Student life Education
External relations

Second stage cost drivers Cost drivers Number of new students by type Number of students by type Number of students by type and number of faculty Number of students by type and n a facility sustaining

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John M Trussel and Larry N Bitner Strategic cost management an activity based management approach Management Decision 36 7 1998 441 447

Table II Volume based versus activity based costing Volume based costing Program A Program B Tuition revenue Salaries Other costs Total costs Income loss Number of students Total income loss 9 000 3 000 5 500 8 500 500 2 000 1 000 000 9 000 1 500 5 500 7 000 2 000 4 000 8 000 000 Activity based costing Program A Program B 9 000 3 000 6 845 9 845 845 2 000 1 690 000 9 000 1 500 4 827 6 327 2 627 4 000 10 690 000

ABC overhead costs that are traceable to each program have been identi ed and thus cost data are more accurately determined Assuming that tuition revenue is 9 000 per student the unit costs and pro t loss per student and in total are presented in Table II for both volume based costing and ABC What looks like a pro table program under volume based costing program A actually incurs a loss of 845 per student or a 1 690 000 total loss The pattern of cost distortion under volumebased costing methods is quite common When an entity installs an ABC system overhead cost is often shifted from the high volume programs to the low volume programs resulting in a higher cost per student for the lowvolume programs The reason for this shift is due to the way overhead costs are treated Rather than treating overhead cost as a lump amount and spreading it uniformly over all students ABC attempts to trace costs to speci c programs Since low volume programs with low student faculty ratios often require the same amount of total support such as space and maintenance as highvolume programs they typically are responsible for the incurrence of a disproportionately large amount of overhead costs As this cost is traced to the low volume programs it drives their cost per student upwards

are non nancial indicators of performance as well as nancial For example how many new students does the enrollment activity center process How many copies does the academic activity center use Efficiency reports how efficient were the programs For example Program A at the college appears to cost much more per student than Program B Pricing tuition what should the college be charging for tuition With accurate cost of operating each program tuition can be set at an appropriate rate to obtain an adequate return When an organization is in the process of designing and implementing a strategic management initiative such as reengineering the cost management system cannot be ignored Using an ABM system the costs of operating the activity centers as well as the costs of the products and services can be determined The cost gures will not be exact but they will be approximately right Current cost management systems are very precise in their measurements but the problem is that their measurements are not relevant to decision making ABM is the cost management side of strategic management and should proceed in tandem

References
Anotos J 1992 Activity based management for service not for pro t and governmental organizations Journal of Cost Management Summer pp 13 23 Cooper R Kaplan R Maisel L Morrissey E and Oehm R 1992 Implementing ActivityBased Cost Management Moving from Analysis to Action Institute of Management Accountants Montvale Hammer M and Champy J 1993 Reengineering the Corporation A Manifesto for Business Revolution Harper Business New York NY National Association of College and University Business Officers 1994 Business Process Redesign for Higher Education Washington DC Turney P 1991 Common cents the ABC performance breakthrough Cost Technology Hillsboro OR

Uses of ABM information
The output from the ABM system can be utilized for many purposes The costs of all activities and all programs are more accurately determined As a result of having more accurate activity and program costs college administrators are in a position to make better decision relating to resource allocation program retention marketing strategies program returns and the like Some application questions on how the information from the ABM system is utilized follow Budgeting how many resources should be allocated to activities and programs Performance evaluation how well did the activity centers perform Note that there

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John M Trussel and Larry N Bitner Strategic cost management an activity based management approach Management Decision 36 7 1998 441 447

Appendix Activity based costing example
Table AI Basic data Estimated traceable costs 1 000 000 2 000 000 100 000 5 000 000 12 000 000 9 000 000 4 000 000 Total expected activity of cost driver 500 2 000 100 000 50 000 1 500 6 000 400 Expected activity Program A 250 1 200 40 000 30 000 500 2 000 200 Expected activity Program B 250 800 60 000 20 000 1 000 4 000 200

Activity center Human resources Computing Duplicating Maintenance Enrollment Student life Academics

Cost driver Employees Computers Copies Square feet New students Total students Faculty

Table AII Step 2 cost assignment to activity centers Estimated traceable costs 900 000 2 000 000 100 000 5 000 000 12 000 000 9 000 000 4 000 000 Total expected activity of cost driver 500 employees 2 000 computers 100 000 copies 50 000 sq ft 1 500 new students 6 000 students 400 faculty Cost driver rate cost per item 1 800 employee 1 000 computer 1 copy 100 sq ft 8 000 new student 1 500 student 10 000 faculty

Activity center Human resources Computing Duplicating Maintenance Enrollment Student life Academics

Table AIII Step 4 cost linkage to cost objects Activity center Human resources Computing Duplicating Maintenance Enrollment Student life Academics Total costs Number of students Cost per student Program A Expected activity Amount 250 1 200 40 000 30 000 500 2 000 200 450 000 1 200 000 40 000 3 000 000 4 000 000 3 000 000 2 000 000 13 690 000 2 000 6 845 Program B Expected activity Amount 250 800 60 000 20 000 1 000 4 000 200 450 000 800 000 60 000 2 000 000 8 000 000 6 000 000 2 000 000 19 310 000 4 000 4 827 50

Cost per item 1 800 employee 1 000 computer 1 copy 100 sq ft 8 000 new student 1 500 student 10 000 faculty

Application questions
1 If activity based costing is as effective as many authors claim it to be why do more people not use it 2 Is ABM the natural partner to a business process management approach

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