How can IT help in implementing Activity Based Costing (Part 2 of 2)?
This week I got a chance to get a view from senior management of two companies on Activity Based Costing (ABC) for their organizations. Neither of these companies is using ABC, nor do they have any plans to go for it in a near future. In this part of the blog series - “How can IT help in implementing Activity Based Costing?”, let’s discuss the perspective of these two companies. Let’s also see how IT can make ABC viable for more and more organizations.
The first of these two companies is an India based Consumer Product Goods (CPG) company with revenue in tune of ~ 40 million USD. The manufacturing facility of this company is predominantly concentrated at a single location which is close to its predominant market. The CFO explains that the company doesn’t need ABC at the moment as its direct cost constitutes the majority of the cost. The CXO’s of this company feel that there are enough improvement opportunities available which should be taken up before an ABC program. I completely agree to this.
The second one is a fast growing global services company, headquartered in India. This company was using ABC till 6-7 years back. With the fast growth of the organization and frequent organizational restructure (every 3-5 years), this company found that ABC is too complex and inflexible to carry on. And it dumped its ABC system for simplicity and flexibility. There are many companies like the second one, which either implemented ABC or tried to implement or at least evaluated ABC, but dumped it on their way. This is not because they didn’t see value out of ABC but primarily because of complexity, inflexibility and cost.
In the part 1 of this blog, we agreed that IT has a definite role to play in adaption of ABC. It promises to make ABC simpler, flexible and cost-effective. One of the critical success factors in successful implementation of ABC is the selection of the right software. As there is no single tool that fits all, the evaluation has to be carried out on a case to case basis. The major evaluation criteria are:
- Transactional or Analytical ABC system: An ABC system can be part of transactional system (Eg.- ERP). This is best suited for management reporting, operational decision making, budgetary control, compliance like inventory valuation, COGS valuation etc. Another option is Analytical ABC system. This can fetch data from heterogeneous sources. These are more suited for tactical & strategic decision making and what-if simulations. Analytic systems also provide more modeling flexibility than transactional systems.
- Business Requirement Fitment: Organizations have different purposes and requirements for their ABC system. The software must be evaluated against those requirements.
- Integration with other IT systems: The software should easily integrate with the overall IT landscape
- Scalability, Flexibility and Performance
- Total Cost of Ownership (TCO): The TCO (license cost, implementation cost, training cost and maintenance cost over a period of time) should be lower. There may be tools which has higher upfront cost and still offer lower TCO because of intuitive user experience and business self support.
Let’s stop at the evaluation criteria for now. The subsequent blogs will focus on the tools available for analytical ABC system, implementation methodologies, analyst view and standing of SAP’s product in this area. Till then please send across your comments and feedback.
Comments
Vivek
The first case you have mentioned is seen in various organizations and across verticals. In Manufacturing, it is the material cost; in banking, it is the interest costs; in Oil and Gas, it is the oil cost etc. At a gross level the ROI of ABC comes from reduction of costs or improvement in profits. Actually people should look at the absolute amount of overheads or profits that can be improved. I have written a post http://activitybasedmgmt.blogspot.com/2009/03/activity-based-management-in-company.html to answer this.
The second example has been true from the inception of the concept. It depends on not only the software solution but also on the implementation partner. Another thing is, people are comparing ABC as a concept, ABC applications and use of ABC which was there some 20 years ago to their current problems. There has been a great amount of improvments in all these areas have happened. I read an article in latest 'Management Accountant' (ICWAI monthly), where two of the professors have written about Throughput Accounting and ABC. This article is talking about ABC that was something 20 years back. This is increasing the not-so-correct notions about the concept.
I am not too sure about the use of ABC in ERPs for compliance or inventory valuation. Have you seen organizations doing that?
The ETL tools have simplified the data upload in ABC solutions (for that matter any solution).
Today the tools are available which can calculate the profitability at subscription level inTelecom or Account level in Banking or SKU level in Retail.
Posted by: Rajendra Patil | February 28, 2010 2:01 AM
Dear Vivek
From the 3 large global programs in which we implemented SAP cost object controlling and OH mgt., I have got common answer from all CFOs.
" Cost of costing should not be more"
This is where ABC fails...
No one wants to generate huge data, which from decision making perspective is ir-relavant, as it is sunk cost / historical costs of fixed OHs. And even if you know minutest details, you can not change the fixed factors...only you can play with allocationns, with becomes a routine and non-value added job of a controller.
So, now a days the trend is not calculating line by line your costs, but bring the target costs to each product by going reverse back from Revenue --> Op. Mrgin reqd--> Direct cost--> Operations costs--> OHs.
So in this chain, OH controlling comes at last. So no one wants to build systems to take care of pinch of value chain.
This is reality across globe where ever Controlling functions were professionally managed.
Thanks
Dhiraj Deo
BE( Prod), FICWA, ACS
Infosys technologies
Switzerland.
Posted by: Dhiraj | March 18, 2010 9:36 AM
Profitability explained via detailed variance analysis. Every P&L item - Sales, Freight, Raw Materials, etc explained by a detailed analysis of variances between the actual and benchmark by cost and revenue driver. Actionable and insightful.
http://www.youtube.com/watch?v=JLihogMpZsk
Posted by: Valeri G | March 22, 2010 4:47 PM
Dear Rajendra,
Thanks a lot for reading the blog and taking out time to post your comment. Also thanks for sharing the link to your blog. I read the blog and found it very insightful. I would like to read the article you are referring to. Can you please send link to this?
About ABC in ERP for compliance, IFRS provides enormous opportunity for companies to relook at their existing processes and IT systems. For example - IAS 2 gives an opportunity to relook at the costing and inventory valuation process. Instead of making narrow-based changes just for IFRS compliance, companies can overhaul its costing process in the favor of ABC. This ABC should be part of transactional systems (like ERP) and not analytical system. IFRS has opened many such opportunities. There are few blogs on IFRS in http://www.infosysblogs.com/sap/2010/03/ifrs_adoption_or_convergence_g.html#more
As you rightly said the maturity of ETL tools can be seen as one of the big push for adoption of Analytical ABC system.
Thanks,
Vivek Madhav
Posted by: Vivek Madhav | March 29, 2010 1:37 PM
Hi
I have implemented ABC in several softwares such as SAP-CO-ABC, Oros plus(SAS ABM) in the past and currently in Prodacapo. The most important success factor for an ABC system is that it is not just a cost allocation engine, but should enable analysis of true cost and profitability. ERP system such as SAP-CO-ABC is largely an allocation engine and offers little scope for analysis. the system should be easy to do modeling so as to adapt to frequent changes in business processes and operational drivers. Special purpose ABC system will help not only to determine true cost and provide profitability analysis, it should also help in the ABM for process and performance improvement, besides supporting decision making and driver based planning.
Posted by: Sathish | June 23, 2010 8:29 AM