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Activity-Based Cost Management: An Executive's Guide

Just a moment while we sign you in to your Goodreads account. Once you have calculated these standard rates, you can apply them in real time to assign costs to individual customers as transactions occur. The standard cost rates can also be used in discussions with customers about the pricing of new business. The reason for this difference becomes obvious when we recalculate the quarterly cost of performing the customer service activities. This takes care of the technical drawback of traditional ABC systems we mentioned earlier—the fact that surveyed employees respond as if their practical capacity were always fully utilized.

But while that distribution did reflect how workers spent their productive time, the fact that their total productive time was significantly less than their practical capacity of 32 hours per worker per week was completely ignored. The calculation of resource costs per time unit forces the company to incorporate estimates of the practical capacities of its resources, allowing the ABC cost drivers to provide more accurate signals about the cost and the underlying efficiency of its processes.

Note that the report highlights the difference between capacity supplied both quantity and cost and the capacity used. Managers can review the cost of the unused capacity and contemplate actions to determine whether and how to reduce the costs of supplying unused resources in subsequent periods; they can then monitor those actions over time. In some cases, the information can save companies that are considering expansion from making unnecessary new investments in capacity.

Rather than attempt to downsize the plant, he decided to maintain the capacity for a large contract he expected to win later that year, for which he otherwise would have created new capacity. Managers can easily update their time-driven ABC models to reflect changes in operating conditions.

The New ABC

Managers can also easily update the cost-driver rates. Two factors can cause these rates to change. First, changes in the prices of resources supplied affect the cost per time unit of supplying capacity. If new machines are substituted or added to a process, the resource cost rate is modified to reflect the change in operating expense associated with introducing the new equipment.

The second factor that can cause a change in the activity cost-driver rate is a shift in the efficiency of the activity.

Quality programs, continuous improvement efforts, reengineering, or the introduction of new technology can enable the same activity to be done in less time or with fewer resources. When permanent, sustainable improvements in a process have been made, the ABC analyst recalculates the unit time estimates and therefore the demands on resources to reflect the process improvements. For example, if the customer service department gets a new database system, the reps may be able to perform a standard credit check in 20 minutes rather than 50 minutes.

By updating the ABC model on the basis of events rather than on the calendar once a quarter or annually , you get a much more accurate reflection of current conditions. Any time analysts learn about a significant shift in the costs of resources supplied or the practical capacity of those resources, or about a change in the resources required to perform the activity, they update the resource cost per time unit, or resource cost rate, estimates.

And any time they learn of a significant and permanent shift in the efficiency with which an activity is performed, they update the unit time estimate. So far, we have relied on an important simplifying assumption that all orders or transactions of a particular type are the same and require the same amount of time to process. But time-driven ABC does not demand this simplification. It can accommodate the complexity of real-world operations by incorporating time equations, a new feature that enables the model to reflect how order and activity characteristics cause processing times to vary.

Time equations greatly simplify the estimating process and produce a far more accurate cost model than would be possible using traditional ABC techniques. The key insight is that although transactions can easily become complicated, managers can usually identify what makes them complicated. In this situation, complexity arises from the potential need for special packaging and the additional demands of air as opposed to ground transportation.

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If the item requires a new package, however, the manager estimates, either from experience or from making several observations, that an additional 6. And if the item is to be shipped by air, he or she knows or can quickly determine that it will take about 2 minutes to put the package in an air-worthy container. These order- and transaction-specific data enable the particular time demands for any given order to be quickly determined using a calculation like the one above. Thanks to this extension, the time-driven approach to ABC can capture the complexities of business far more simply than the traditional ABC system could, which might well have had to account for varying transaction times by treating each variant of the process as a distinct activity.

Consider the case of Hunter Corporation not its real name , a large, multinational distributor of scientific products, whose 27 facilities process more than one million orders each month to distribute up to , different product SKUs to 25, customers. Its old ABC model required that employees in its inside sales department the salespeople handling phone and Internet orders rather than dealing with customers face-to-face estimate each month the percentage of their time that they spend on three activities: customer setup, order entry, and order expediting.

The team learned that it took about 5 minutes to enter the basic order information, plus 3 minutes for each line item, and an additional 10 minutes if the order had to be expedited. Following the approach described earlier, the previous three-activity model was replaced by a single time equation:. The model multiplied the estimated sales process time by the departmental cost per minute to arrive at the cost of processing each order.

Hunter could now obtain a more accurate and nuanced estimate of its costs in the unit while simultaneously reducing the complexity of the process for gathering and analyzing the data. Hunter has since rolled out time-driven ABC over all its operations. The results have been dramatic:. The kind of rollout Hunter conducted is not difficult to achieve.

Time-driven ABC models can be easily applied and customized for other plants and companies within an industry because the processes they use are similar.

You could probably apply the same time-driven ABC model to all of us. The ability of time-driven ABC to identify and report complex processes in a simple way also provides a powerful negotiation tool when it comes to dealing with customers. Wilson-Mohr, an industrial controls company in Houston worked as a subcontractor to engineering contractors ECs on the construction of custom process-control systems for refineries and chemical plants.

Its time-driven model revealed, for the first time, the high cost of engineering change orders issued by the ECs to replace parts or reconfigure the design. In the past, Wilson-Mohr charged an EC only for the predicted materials cost changes resulting from the change orders.

Now it can also clearly itemize the cost of additional sales, design, engineering, and manufacturing labor time consumed when implementing change orders, which makes it easy to recuperate these costs through price recovery. Kemps, headquartered in Minneapolis, is a full-line dairy, that produces milk, yogurt, sour cream, cottage cheese, and ice cream products. Its customers are retailers and distributors as large as SuperValu and Target and as small as convenience stores. Kemps markets its products under its own branded portfolio along with products sold through private label and copacking contracts.

Activity-based costing. : Toronto Public Library

Like most dairies, Kemps was experiencing consolidation in its customer base. It decided to shift from its former customer relationship strategy—willing to do whatever the customer asked—to a lower-total-cost strategy. As a critical component of the cost-to-serve model, Kemps implemented a time-driven ABC system so it could track the costs of changeovers in producing and packaging all its products and the costs of picking, loading, and delivering products to its diverse customer base.

The model captured differences in how the company entered orders from customers customer phone call, salesperson call, fax, truck-driver entry, EDI, or Internet , how it packaged orders full stacks of six cases, individual cases, or partial break-pack cases for small orders , how it delivered orders commercial carriers or its own fleet, including route miles , and time spent by the driver at each customer location.

The extra time for changeovers to clean out allergens such as nuts, eggs, soy, or wheat used in certain ice cream products could now be accurately assigned to those products. The model also captured the extra packaging costs for special promotions and customer-specific labels and promotions. The company soon learned it was losing money with one of its customers, a chain of specialty high-end shops, because of the low volume and high variety of products ordered and the small just-in-time deliveries the chain requested.