Will your ABC system have what it takes? While the activity-based costing concept is rather simple and straightforward, implementing a system that actually works and delivers the exected benefits is not.
In the Winter 2004 issue of Management Accounting Quarterly, DeWayne Searcy discussed Temp Employment Company's (TEC) implementation of ABC to calculate the profits generated on a customer-level basis. Increasing revenues, yet stagnant profits caused the CFO of TEC to use ABC in assessing the company's profitability picture. Prior to the ABC implementation, this information was not available.
The results of the ABC analysis revealed that TEC's largest customer generated losses equal to almost 200% of the company's total profits and that more than 70% of TEC's customers were generating losses. In other words, ABC brought into focus the company's profitability picture--or lack thereof. You would think the information from the analysis would have profound effects on how TEC's management executed its business strategy. You would be wrong. Just two years removed from the initial analysis, the company abandoned ABC and the analysis from its implementation. This article explores what went wrong and offers some guidance on how to avoid the same outcome.
How could the management of TEC abandon activity-based costing after the stark picture it painted regarding the company's profitability? Why do we keep hearing stories of companies deciding against implementing ABC when publications are replete with stories touting its benefits? We think the answer lies in a company's failure to integrate ABC with its other information systems, especially the decision-support system (DSS). Instead, ABC maintains its status as an accounting tool kept in the accounting office, which is especially true for small to midsize organizations.
While ABC is not a panacea, organizations can reap significant benefits from it if they approach it correctly. We believe the paradox is remedied through the system-wide integration of ABC information. The best practices in this area have cost systems that are integrated with an organization's other systems where the ABC information is used outside the accounting function for decision making and performance measurements. (1) For example, the supermarket/grocery industry considers ABC a key enabler for implementing its Efficient Consumer Response (ECR) initiative. To receive the highest score on the cost/profit measurement section of the ECR Global Scorecard (www.globalscorecard.net), ABC information must be incorporated throughout a supermarket/ grocery-related company's information system. Organizations can increase the value of ABC and avoid the pitfalls TEC encountered by integrating ABC throughout their information system.
MOVE ABC BEYOND THE ACCOUNTING OFFICE
As in many companies, TEC's management thought of ABC as merely a cost-reporting information system, which was the heart of the problem. The objective of an information system is to collect, record, store, and report information. Although these activities are necessary, they add little value in and of themselves because value comes from leveraging the information available. By approaching ABC as just another information system responsible for identifying, recording, storing, and presenting cost data, companies are setting themselves up to fall short of realizing all the benefits a true ABC system can offer. Instead, it must be approached as a dynamic, integrated system to support the varied needs of decision makers.
In addition, companies should recognize a common, yet dangerous snare--untimely and disconnected data. They should be wary of the approach where ABC cost data is fed into a stand-alone application, such as a spreadsheet, to develop static cost models. This is exactly what occurred at TEC. While the static ABC model shed light on the company's historical profitability picture, the company updated the model infrequently and eventually forgot about it. For this reason, the use of ABC information for decision making was infrequent. Originally, TEC planned on using the ABC information for bidding purposes, but the marketing function simply ignored the analysis since the ABC system was not easily accessible to those individuals.
It is here where companies must approach ABC as a DSS to help bring about the needed change. Decision-support systems differ from traditional information systems in key ways. Whereas an information system is concerned with collecting, recording, storing, and reporting information, a DSS focuses on analyzing data and assisting decision makers.
Decision-support systems vary in the amount of support they provide decision makers, ranging from data-oriented to model-oriented (analytical). (2) At one extreme, a data-oriented DSS merely retrieves items of information. It can categorize and retrieve pieces of data, so think of it as file drawers. As a DSS becomes more analytical, it progresses to higher levels of support: providing a mechanism for ad hoc data analysis, providing pre-specified aggregations of data, estimating the consequences of proposed actions, proposing decisions, and even making decisions. The deficiency of a data-oriented DSS is that relevant information might not be utilized in the decision-making process. The decision maker is relied upon to gather all relevant information and process it optimally (i.e., it is user-dependent). A data-oriented DSS depends heavily on the decision makers' judgments, but because of information processing limitations, decision makers can easily become overloaded with information and fail to fully incorporate relevant information.
An analytical DSS helps overcome these limitations by incorporating all relevant data and using algorithms and decision rules to provide better and more consistent decision solutions. For example, in production planning and scheduling, a data-oriented DSS would retrieve and present a variety of decision inputs, but the decision maker would be left to choose and combine the appropriate inputs and formulate an optimal plan. In contrast, an analytical DSS would not only retrieve the necessary data but would assist in determining the relevance and weighting of various inputs, identify potential missing inputs, and formulate an optimal plan, all with little to no human involvement needed.
Ask yourself the following questions to determine if your ABC system is integrated with a DSS: u Does your system include data external to your company?
* Does your system include nonfinancial information?
* Does your system contain up-to-date information in a single location?
* Does your system have analytical tools available?
* Does your system allow you to generate custom reports quickly and easily?
* Is your system user-friendly?
Does your system include data external to your company?
As decisions are made based on more than just cost data, a company's ABC decision-support system should have more than just the traditional cost data as an input and incorporate all relevant data. For many situations this requires both internal and external data beyond the cost data. For example, a company's pricing decisions are not based solely on product cost and other internal data but on external market factors also.
Does your system include nonfinancial information?
Information should not be limited to financial data but should also include relevant nonfinancial data. For example, product pricing and product mix decisions may require consideration of vendor and customer relationships in addition to cost data and market variables. By combining internal and external data, as well as financial and nonfinancial data, a company achieves a more complete picture of its organization. Just as the company does not operate in isolation, neither should it rely on isolated information.
Does your system contain up-to-date information in a single location?
Employees must have up-to-date information to make the best decisions. Information that is weeks, days, or even hours old may mean the difference between good and bad decisions, success and failure. A frequent cause of failed ABC implementations, or information system implementations in general, is untimely information. Often this is caused in part by a number of manual steps in the updating process. A company's objective should be to eliminate as many manual updating processes as possible and replace them with automatic procedures. Once the implementation team has identified the relevant data sources, system updates should be automatically fed from their sources, and updates should occur as frequently as possible.
Additionally, companies must make every attempt to integrate the various data sources into a single source. Having the information available is not enough. Users should not be forced to search extensively for the data they need nor be required to go to multiple sources to get it. As users are forced to search for and manually integrate data, the probability that users will select the first option that meets a given need, whether or not the first option is the optimal alternative, increases because of incomplete information. To maximize their chance of success, companies must make sure their system consolidates all relevant data in a central location with a single access point.
Does your system have analytical tools available?
Once a company has ensured that its system contains current, relevant data, the next big hurdle is to get its decision makers to take full advantage of what is there and to do so in an efficient and effective manner. The true value of a DSS is realized in data analysis. First, there is a company's cost model--the heart of its ABC decision-support system. It must make sure the model is dynamic and updated frequently. Just as system data feeds must be frequent and automated, there also must be a transparent coupling of the cost model with the rest of the system. Additionally, many decisions require analytical tools extending beyond the cost model. A company's system must allow users the ability to run simulations and perform what-if, goal-seeking, and optimization analyses. Without this functionality, the ability to make longer-term tactical and strategic decisions is greatly reduced. For example, in determining an optimal product mix, a company's decision process will include estimating outcomes under a wide variety of situations.
Does your system allow you to generate custom reports quickly and easily?
Perhaps the most important aspect of a company's ABC decision-support system is flexible reporting and querying capabilities. It is impossible to know beforehand every decision that employees will need to make, so a system needs the ability to build new reports quickly and easily. The ability for users to ask questions of the data as needs arise is critical to success. Static or limited querying ability can lead to incomplete analyses and suboptimal decision making. While data may be highly aggregated, users must have the ability to drill down to any level of detail. Given the data's multidimensional nature, users need the ability to slice and dice the data as the situation demands.
Is your system user-friendly?
A company can create a well-built system yet still fail if users do not know how to use the system or if it is difficult and frustrating to use. The interface between the system and the user can make or break the system, so companies should strive to make the interface as intuitive and user-friendly as possible (e.g., use of graphical user interfaces) because this increases user satisfaction. In turn, user satisfaction will be a significant factor in the success or failure of a company's system. Thus, the interface is a critical component of the DSS and one that should be given sufficient consideration. In fact, a company would be well-advised to consider involving users in the selection of the interface.
YOU CAN ACHIEVE THE BENEFITS
The most reliable and valid cost information must be available to decision makers for them to survive in today's highly competitive environment where margins are tight and cost is often a differentiating factor for consumers. While activity-based costing has its roots in manufacturing, it applies to a wide variety of cost-based businesses in an array of industries and sectors. ABC provides the necessary cost information, but measures must be taken to ensure that companies use the information.
Approaching activity-based costing as a decision-support system provides the mechanism for ABC information to be an integral part of the decision-making process. Companies need to focus on these key aspects: Include all relevant data, ensure frequent and automatic system updates, provide appropriate analytical tools and flexible reporting options, and provide a well-designed interface. Your ABC DSS must be flexible and easily adaptable to change and allow frequent, even continuous, cost/activity reporting to allow ongoing use of cost information in decision making. Ten years ago, these suggestions might have seemed out of reach for many organizations. Advances in technology, however, have paved the way for even small organizations to participate. With the correct approach, you can avoid the situation TEC experienced and achieve the expected benefits of ABC.
BY DEWAYNE L. SEARCY, PH. D. CMA, CPA, CIA, AND DOUG ROBERTS, PH. D., CPA
(1) See Kip Krumwiede, "The Implementation Stages of Activity-Based Costing and the Impact of Contextual and Organizational Factors," Journal of Management Accounting Research, Fall 1998, pp. 239-278; and James M. Reeve, "Projects, Models, and Systems --Where Is ABM Headed?" Journal of Cost Management, Summer 1996, pp. 5-16.
(2) Steven L. Alter, "A Taxonomy of Decision Support Systems," Sloan Management Review, Fall 1977, pp. 39-56.
DeWayne L. Searcy, Ph.D., CMA, CPA, CIA, is an assistant professor in the School of Accountancy at Auburn University in Auburn, Ala. His research interests are supply chain management, lean accounting, and continuous auditing. He can be reached at (334) 844-5827 or email@example.com.
Doug Roberts, Ph.D., CPA, is an assistant professor of accounting at Appalachian State University in Boone, N.C. He can be reached at (828) 262-6213 or firstname.lastname@example.org.