For the “Haves” and “Have-Nots” of Cost and Profitability Solution

For a long time we have been talking about the benefits of having Cost and Profitability solution. We have been doing this during the presentations to the prospects, workshops, seminars, webinars etc. The Activity Based Costing/Management concept had been there for more than 20 years now. Still there is a majority of organizations across the globe that ‘have not’ embraced it. Some of the organizations have had it and later stopped using it. The concept itself had its ups-and-downs during those 20 years. On this background we see that most of the times people talk on this subject for those who are ‘Have-Nots’ of the concept. Today I am going to write primarily for those organizations which have already implemented Cost and Profitability solution. It’s just that I cannot resist myself writing about the benefits of this solution for those who do not have it, before I proceed for the ‘Haves’.

Benefits of Activity Based Management (ABM) for “Have-Nots”

a) Information for effective decision-making – ABM provides more accurate information about the profitability of the products, customers, channels etc. This helps the organization to understand the ‘cross subsidization’ among the products/services. It also tells about the profitability of the customers and more importantly the possible causes. This helps the organization to put the resources for the right set of customers to maximize the profitability.

b) Information to continuously improve processes and reduce costs – ABM provides the important information about the cost of various processes. Process is nothing but a set of activities performed in a sequence by one or more functions. With ABM we can understand the cost of those processes, benchmark them against internal or external targets and improve upon them.

c) A relationship between organizational cost and organizational value – ABM provides objective information about the cost of the various activities or processes. We can add other subjective or qualitative attributes like ‘value add’ to these processes. This added value can be seen for customer, organization etc. By comparing the cost of the process or product or customer against the value that is added by it, we can focus and create appropriate action plan.

d) A focus on significant costs – There are various programs running in any organization for the improvement of productivity, reduction of waste, managing processes etc. The unique ability of the ABM initiative is it helps to focus on ‘significant costs’. Otherwise people take various improvement programs, which may or may add significant cost improvement. ABM helps to prioritize the improvement program by combining the objective of the initiative like importance to strategic value, importance to customer value, potential to change etc. together with the cost of the process. By creating a 2x2 diagram organization can choose the processes with high customer value and high cost processes first for improvement.

e) Methods to measure performance with accountability – Performance of a process or activity can be measured at least by three ways. 1) Productivity 2) Cycle time 3) Quality. For example let us take an activity ‘Assemble a product’.

1) Productivity – Cost per assembly, # of assemblies per person
2) Cycle time – time to assemble a product
3) Quality - # of product assemble correctly in first attempt

With this kind of measure we can monitor the performance of various activities. Now the activities are performed by one or more persons. With this we can manage the performance of the activities and people together with the accountability of the same.

Now we talk about the benefits to the “Haves” of Cost and profitability solution. This is not talked about so often, but it is equally important as the use of the data that is calculated is also important for the organization. This helps them in taking business decisions. In the earlier days of ABM, the projects used to be for solving certain business issue. After the model was created and analyzed, people seldom updated the ABM model. The current situation is different, as the results of the cost and Profitability solution can be and is used in other business solutions like Planning and Budgeting, Scorecarding, Customer Intelligence etc. Also the improvement programs in the organization are looked upon as a ongoing exercise rather than one time project. For this actually American Productivity & Quality Center (APQC) had done an exercise and I will be elaborating on the findings.

Best practices for profitability calculations

a) At best-practice organizations, customer profitability is owned by marketing, with finance as a key stakeholder – Though the responsibility of calculating the profitability lies across the organization. The use of the information of profitability and related improvement lies with the marketing department. The Finance department is the custodian of the information.

b) Best practice organization create a organization wide view of the customer – With the help of initial understanding of the customer profitability, organizations use the same information for overall customer intelligence. This leads the organizations to create the ‘one view’ of the customer across the organizations. For example for Retail Banking the profitability of the customer is calculated across the products held like savings account, cash-credit account, fixed deposit account, housing loan account, car loan account, Demat account etc. With this single view the overall profitability can be seen and cross-subsidization in various service fees can be seen.

c) Best-practice partners have clearly defined customer segments and sub-segments – Organizations generally start the segmentation of the customers with the help of demographic information like age, education, life-stage, geography etc. Profitability information helps the organization to segment the customers according to the profitability. The organizations at least segment the customers with profitability deciles (creating 10 groups of customers). Once this is done analyze the behavior of the customer in each of the deciles to understand why the customer is in that category. This helps the organization to create the segmentation by behavior (psychographic). The profitability of the customer largely depends on the behavior and this information helps the organization to improve the profitability by managing the behavior of the customer.

d) Best-practice organizations capture revenues and costs at the transaction level for each specific customer account – This is possible only with the Cost and profitability solutions. With this information at their hands organizations can compare the cost of transactions across the products, channels, regions. The use of channels for various transactions can be seen and the customers can be properly channelized to use the low cost channels.

e) Best-practice organizations take a holistic view of customer profitability and include lifetime value and customer valuation metrics in the calculation – As we discussed earlier the customer profitability information is used for segmentation, marketing campaigns, retention etc. With the available information of past profitability together with the analytical values of propensity to buy and churn, the organization can calculate the ‘customer lifetime value (CLTV)’ and use this information to retain the customers with highest CLTV. Also analyze the behavior of those customers to align other customers.

f) Best-practice organizations include the majority, but not all, of their costs in the customer profitability calculation. Best-practice organizations use appropriate methods for cost assignment – With the help of ‘time driven activity based costing’, we take the cost that are relevant to the various processes. The installed capacity cost if not utilized completely is not taken to the product or customer. This is shown in the ABM model as ‘Cost Available to Use’. Also the cost of various departments that are not related to the customer or product are separated and shown as ‘Cost to sustain business’. This helps the marketing department to use relevant information for taking business decisions.

g) Best-practice partners all work closely with IT. Enabling technologies for calculating customer profitability include data warehousing, CRM systems, data mining, external databases, and predictive analytics – The work with the IT starts with the building of the ABM model. Here most of the data available in the transactional systems is brought into the ABM model with the help of the ETL tools. The no-system-data is also brought with the help of the web-based solutions. Once the results are calculated in the ABM model, it integrated with the other solutions using the warehousing solutions. The historical data is used for predicting the future behavior and the related profitability of the customer.

h) Best-practice organizations emphasize intelligence (e.g., decision support), not routine reporting, in customer profitability information dissemination - The organizations do not create large number of reports for everybody. In fact the information is provided to those who are decision makers and also as and when required. In this the OLAP tools help the organizations to create the ad-hoc reports and the slice-and-dice required across various dimensions of the report. The dissemination also happens now with the dashboards and intranet facilities.

i) Best-practice organizations secure buy-in from the users and upper-level support for customer profitability initiatives – This is the most important factor in the initiative. The buy-in helps the authenticity of the input data as well as the results. This helps the decisions makes to use the output freely for the improvement initiatives and business decisions.

j) Best-practice organizations hold employees accountable for customer profitability – Most of the times the compensation or incentives the sales force is on the basis of the revenue that is booked (may or may not be realized). Typically the sale people sell those products that are comparatively easy to sell and bring more incentive. This may not always tie-up with the overall strategy or profitability targets of the organization. By understanding the profitability of the customers and holding the employees accountable for the profitability, organizations can align the sales force to the overall performance and strategic initiatives of the organization.

k) Best-practice organizations use customer profitability and segmentation to appropriately align sales and marketing resources – With the Cost and profitability solution, organization understands the current profitability of the customers and more importantly the reasons for their current profitability. With this information and the future targets, organizations can plan and employ the resources to maximize the profitability. The Marketing campaigns can be also targeted for ‘right’ customers. This helps in optimizing costs for the campaigns as well as the success rate of the campaigns increases.

l) Best-practice organizations have specific programs/sales efforts geared to their more valuable customers – The cost and profitability solution provides the accurate and detailed customer profitability information. Based on this the organizations can focus on acquisition, retention, cross sell, up sell programs.

m) Best-practice organizations successfully convert unprofitable customers to profitable customers - The organizations can also put their efforts to move the customers from lower profitability to higher profitability zone either by providing alternate products, removing activities that are not required, menu-based pricing etc.

Finally it has been observed and accepted by various organizations that the insufficient profitability insight is hurting the performance of the organization. The most accurate and detailed profitability information is provided by the Cost and profitability solutions. The results of the same can be used for better strategy formulation & execution, better marketing efforts and better matching of the resources to potential.

Maturity of Cost Management in Organizations

While I was thinking on writing on this subject, I could see the possible reactions from the various stakeholders (is this a really big word with respect to costing?). Costing is generally looked upon as ‘we know it all’ in manufacturing to ‘we have never done it’ in service industry. Sometimes people say, in today’s world the price is decided by the market, so there is no need of costing. In India, there is a statutory need for some of the industries to provide cost data on a regular basis to the bodies. I have the experience that if I use the words Activity Based Management instead of Activity Based Costing, people are more ready to listen to. But there are few organizations in India which have undertaken the study of their maturity of cost management. This is what, it prompted to me to think on this topic.

When we talk about costing, there are various techniques that are available in this area. Some them could be Product or customer profitability (activity based costing), strategic cost management, target costing, lifecycle costing etc. Each of this technique has its own way maturing in its use. The levels could be just measuring, managing and optimizing etc. At each of this level the use of the technique could be ‘one off’ or a process used by a few people or it is spread across the organization. So when we are trying to gauge the maturity of the cost management within an organization we can do it, at least across three different dimensions; a) # of techniques used b) level of maturity of the use c) how far it is in operation. Some organizations may be using one or two of them but doing to the most, at the same time it is still in the hands of few people in the organization. Like this the level of maturity would be different in different organizations and across different dimensions. A formal study on this would be very useful to create a ‘best practices’ workbook for the use.

Techniques used – There are various techniques that are available for cost management. Starting from the standard costing, absorption costing to calculate the product costs and variances to activity based costing, target costing, lifecycle costing, strategic cost management etc.

In manufacturing industry the bare minimum use of costing is there for inventory valuation. For this generally the absorption costing method is used, where the expenses booked in the period are charged to the products as manufacturing or admin or sales overheads. The method to charge the overheads to the products is bead on volume drivers. In service industry this is not required statutorily so you wouldn’t find there. Most of the times, the same information is used to understand the product profitability and take the business decisions. And we have seen time and again that this leads to incorrect decisions making.

Some organizations use activity based costing to calculate the product, customer profitability. Here the cost of the cost objects is calculated by calculating the cost of the activities first. The cause and effect relationship is used. The cost objects consume the activities and activities consume resources. Based on this relationship the cost flows to cost objects. This is a better way to arrive at product and customer profitability.

In target costing, the organization looks for introducing a product. Before doing this a market survey is conducted to understand the features that are desired by the target customer segment and the price that they are ready to pay for the same. A study of competitor’s product features and the corresponding price is also done. Based on this information the features of the new products are defined. A target price is decided with an expected profit. So the cost is the resultant factor. Target Price – Target Profit = Target Cost. Once this is done, a cross-functional team is formed to work on the design of the product, material, processing, marketing etc. Vendors are involved in this process. With the help of this team the organization tries to achieve the target cost.

In Lifecycle costing, the organization looks at the costs of the product throughout the life of the product. From the design, R&D, introduction, enhancements to the phasing out of the product. This helps the organization to plan the costs as well the price at various stages of the lifecycle of the product. You can plan the overall profitability of the product and manage the costs accordingly. The similar concept is now being introduced for customers also and called as Customer Lifecycle Value (CLV).

Strategic cost management relates the management of the costs based upon the strategic direction of the organization. I repeat, it is the management of the costs according to the strategy of the organization. Quite often I have seen people confusing strategic cost management as the cost of the strategy. In other words, that will be cost to the organization if they have to take certain strategic decision. This is like a cost benefit ratio. Typically if use the Porter’s concept of competitive strategy, there are two ways, a) Cost leadership b) Differentiation.

In case of ‘cost leadership’, the organization has to manage the costs in such a way that costs are at a minimum level without compromising the value to the customer. For this one can use cost driver analysis, waste elimination etc. Activity based costing can help the organization to understand the non-value adding consumption of resources.

In case of differentiation, the organization looks at capturing the market, beating competition and making money by making differentiation in product features, customer services etc. For this the Lifecycles costing concept can be useful, as it will help the organization to make money on overall life of the product and pricing can be defined at various levels of the life-stage of the product. Activity Based Costing can help here to understand the future resource requirement and costs of the same.

Another way of defining strategy is by ‘target customer segment’ management. In this the organization defines its target customer segment and tries to capture, retain and benefit from the customer segment. In this case the target costing can help the organization to manage the product costs.

Maturity level of the technique – The maturity level can be defined at least as a) measurement b) management c) optimization. One can define more in between each of these levels. The level measurement is where the organization is collecting the data. For example in product costing, the organization is just calculating the cost of the product for inventory valuation purpose. No other use of the information is made. Here the typical argument made is ‘the price is defined by the market and we cannot do anything about it’. Here goes into the trap they neither manage the price nor the costs (which at least is in their hands). Some organizations do calculate the costs and start managing those costs. For example they have budgets at expense level; they have standard costs for products. They compare the actual expense and product costs with the standard periodically find the variance, the reasons for the variance and take action plan to improve upon the ‘unfavorable’ variance. It helps to think of cost-optimization in terms of a weight-loss program -- you may temporarily lose weight on a crash diet, but in order to maintain an ideal weight, you must adopt a healthy lifestyle and diet over the long term. Similarly, only executives who take the time to examine the cost structure throughout their business and embed cost discipline within their organization's culture will see gains that can be sustained over the long term. To do this, organizations need to look at costs across whole processes, not just within functions. Ultimately, this means rethinking the entire business model around lower costs, possibly taking out whole layers of the organization or supply chain, examining customer interfaces, and considering outsourcing, shared services, and off shoring. The focus should be on creating a leaner, more efficient organization, with cost reduction as the consequence, not necessarily the target. The other way of looking at maturity level is the ‘SMILE’ pattern. S – see M – measure I – improve L – Learn E – Evolve.

Operationalization – The third dimension that we mentioned earlier was the opertionalization of the use of the technique. In here we first have to look at how frequently the techniques are used. Sometimes the techniques are used once in lifetime, may be due to the influenced by someone at the top and then it ends there. The word ‘used’ here means used in taking business decisions including defining and managing strategy. Quite a few times we see that there are various variance reports are generated but nobody looks at them seriously. In some cases the information generated is very useful, but it given the status of ‘confidential’ and kept in the hands of few people. What I mean by real operationalization is the technique is used regularly for creating information, used for taking business decisions and provided to the people who are going to take those decisions.

In the current scenario, the operationalization can also be looked from the angle of ‘use of technology’ for the cost management techniques. Spreadsheets are the minimum that people use and they know it is not the best of the ways always. There are various stand alone software solutions are available in the market and use of those does help the organization to make most of the techniques. Going further, the results of cost management techniques can be integrated with other cost techniques or overall performance management methodologies.

The maturity of the organizations can then be plotted as shown below.

The horizontal axis talks about the # of techniques that the organization is using. The Vertical axis talks about the overall maturity of various techniques. The diameter of the circle shows the level of overall operationalization in the organization. When I am saying ‘overall’, it is the combined effect for all the techniques that are used. With this we will try to understand the position of various organizations from the graph.

The organization ‘A’ is using may be only one technique and at a very low level i.e. measurement and it is still not operationalized. Organization ‘B’ is using many techniques but their overall maturity of use is low but they have achieved some progress in operationalization. Organization ‘C’ is using couple of techniques only but achieved best of the overall maturity and operationalization. Organization ‘D’ is using few techniques with middle level of maturity and operationalization. Organization ‘E’ is using most of the techniques at a very high maturity level but not operationalized it.

Once such a study is conducted it will definite help to understand the cost maturity of the organization, industry, geography and help the organizations to see which type of technique at what level of maturity and oeprationalization would help them.

Finally, wish you a happy fools’ day.

The ROI of an Activity Based Costing (ABC) project

This is the most common question that is asked to all the vendors that propose any concept, solution to any organization. I, as a management consultant have answered this question a lot of times. Surprisingly, when I am at the client’s place and see various internal projects (managed totally by the employees of the organization) launched, almost none of them are proved (or may be asked) on their positive ROI. They are run as a necessity and the outcome is ‘expected’ to be good but does not guarantee anything. Especially the marketing campaigns and sales improvement related projects.

Today I am going to talk about the return on investment (ROI) of an ABC project. As you know from my earlier post that ABC has already completed 20 years of its existence. Over those 20 years various experts have explained the ROI of ABC project in different ways. I will try to put most of them as well as my own view.

ABC methodology came into existence, as the US markets were facing tough competition from the Japanese market on the costs. The earliest use of the concept was to take costs to the products with a more logical way. The method that was used to take overheads to the product, before ABC was based on ‘Labor hours’. After this it has been used for various purposes like Product profitability, Customer profitability, Process improvements, Cost reduction, Resource planning, Activity based budgeting, customer segmentation, marketing campaigns, customer life-cycle value (CLV) etc.

Now we will look at the components to calculate ROI, i.e. Cost and benefit. On the cost side it is easier to compute as you know the costs for the components like software solution (from spreadsheets to enterprise wide integrated solution. Now you can get ‘pay per use’ type of option also), hardware cost to host this application (not an investment in case of ‘pay per use’ option) and the consultancy costs for initial modeling and training of the team. The ongoing costs are those for the software licenses and hardware maintenance. The internal costs, are related to the time spent by various personnel in collecting, uploading the data; creating and circulating reports. This is comparatively simpler to calculate.

Now comes the difficult part that is calculating the ‘value’ of the benefits in monetary terms. I remember the days when various ERPs were introduced in that market and the ROI was calculated on the benefit that ERPs can improve your business processes hence; the organization can improve the inventories and less number of people would be require to run the business. In case of ABC, the experts have various views on the calculation of benefit. Some say that the use of the ABC information is for taking better business decisions. Hence, it is very difficult to calculate the benefit of ABC. Some say, as it is used for talking better business decisions, the benefit due to the business decision taken can be attributed to ABC. In other words the benefit can also be calculated as the ‘Loss avoided’, if we had not got the information given by ABC project.

Let us take an example here. An organization is looking at increasing a market share. This is aimed at acquiring more number of customers in a particular segment. The reason behind acquiring such type of customer was they were giving more and more revenue to the organization. The logic presented was more number of customers will more revenue and definitely more profit to the organization. A marketing campaign was run and the organization got more customers with increased revenue. To cater to the increased requirement of the products/services the organization has invested in infrastructure and facilities. But the financial statements statement showed that the profitability was unchanged (sometimes it is even worse as the profitability decreases).

If ABC had been implemented in this organization to calculate the customer profitability and product/service profitability (sometimes region wise also), then the organization could have known that which products/services to be offered to which customer segments and which regions, based on the profitability information of the existing customers coupled with their demographic and psychographic information. This would have made the marketing campaign more effective towards the ultimate aim of increasing market share with profitability. In this example the benefit of ABC project can be calculated as the increase in the revenue and profits of the organization. Alternatively it can be also calculated as the loss of expenses on the campaign that did not increase the profitability of the organization.

I am sure it can be also applied to the other uses of ABC projects, but would not be always so simple to calculate the benefit which could be more implicit than this. The experience of implementing ABC over 20 years has shown that at a gross level the benefit can be stated as reduction of installed overheads by 3-5 % or improvement of the profitability by 200% percent.
When we talk about the reduction of overhead costs, people in various types of industries tell that our overheads are very less. For example in manufacturing, they say 65-90 % of our costs are material costs. So why take so much of efforts and try to rock the boat (by change management) for 10% of the overheads? To answer this, we take an example of an organization with INR 5 billion (approx USD 100 million) of revenue. We will assume that the profitability is 10% i.e. INR 0.5 bn. This leaves us with a cost of INR 4.5 bn. The material cost is 90% of this, i.e. INR 4 bn approx. So we are talking about 3-5 % of INR 500 mn (approx USD 10mn), which comes to INR 15 mn (approx USD 300,000). In Indian context this would give less than a year’s ‘pay back’ period for this organization. If we couple the improvement of the profitability it would look like the payback period is in few weeks. This is explained in more detail in my earlier blog http://activitybasedmgmt.blogspot.com/2009/03/activity-based-management-in-company.html

Actually a blog post by Dr Peter Turney, founder of Cost Technology Inc., has given me a stimulus to write on this subject in detail. It will also help all the readers, especially those who are thinking of implementing ABC (even more for those who have postponed or cancelled the ABC implementation). In this article of Dr Turney, has mentioned three reasons for implementing ABC, viz. a compelling business need, recognition that ABC is superior to whatever you currently have or don’t have, and a positive return on the required investment. I also present the ABC case as to answer three challenges,

• Making strategic decisions based on a true understanding of which business segments are profitable




• Determining the business processes that drive cost and how to control them




• Predicting future resource needs, and costs in dynamic organizations, and the impact they will have on future financial performance
  

In 'Sanskrit' (an old Indian language), we used to have small riddles. In this, there used to be three questions in first three lines and the fourth line used to be the answer of those three questions. The amazing part was the answer used to be in 'single word'. This single word had three different meanings, which used to be the answers to the three questions. I want extend the same idea here. I would say whatever the reason for implementing is; the results give you an 'INSIGHT'. You use this insight to find answers to different questions.

We will now focus on the 'ROI' part, for a long time experts have mentioned that the ROI comes from either improving costs or profitability. The percentage would vary from organization to organization. It is dependent on how good and how bad you are. Actually it would 'how bad' and 'how good' you are, if we want to look at it sequentially.

Let us take the ‘How bad’ part of this. This is nothing but haw bad are the internal processes today. How much is the ‘non value added’ part in these processes. This non value added part can come because of doing activities that are not at all required or doing activities again and again or to do them because the information or material is not of proper quality or any other reason. This tells us the ‘Potential to improve’ in an organization. The same logic can be applied to the profitability information also. The 2x2 diagram with customer profit plotted against customer revenue will tell how good is our understanding about the customer profitability and how well we know the requirements of our customers to add or manage or retain our best customers.

Now comes the most difficult part. The 'how good' part. This is nothing but the ability of the organization to implement the action plans to achieve the benefits. This actually talks about the ‘potential to change’ in the organization. So the ABC project may have identified various opportunities to improve (may be worth 5% of the overheads), but the actual benefit achieved will depend on the willingness of the people at various levels in the organization. To help the organization to reap maximum benefit, I suggest plotting a 2x2 diagram of potential improve v/s potential to change.

The quadrant that talks about the highest potential to improve and also highest potential to change is the priority area. I also call this as the ‘low hanging fruit’. Once you start implementing these actions and show the results of the same. These people or actions can be shown as the ‘islands of excellence’. This actually can propagate the chain of actions in your organization to achieve maximum of the ‘potential to improve’.

Finally the ROI of the ABC project can be calculated, though difficult. It can be as high as 300-400%. It can be seen as a payback period of less than a year. It actually is different for each organization as the potential to improve and potential to change does differ from organization to organization.

The best time to plant a tree was 20 years ago. The second best time is now.....

I passed my management accountancy exam in 1992. This was the same time when Activity Based Costing, was at its peak (may be first peak). Although I was not aware that such a concept exists then. I heard about this concept for the first time, when I was asked during one of the employment interviews in 1993, “What do you know about Activity Based Costing?” I was zapped, as I had never heard about such a thing in my life. Life took me back to Activity Based Costing again in 2000, when I started reading about anything and everything about it on Internet. Since then I have been hooked on to this concept till date. The only reason why I telling all this is, when I look back, I see Activity Based Costing and my alliance with Costing have crossed 20 years of mark. In those twenty years I have changed a lot, as well as the concept of Activity Based Costing. Let me put the life of the Activity Based Costing for last 20 years as I know it. Correct me, wherever I am wrong, by posting your comments.

In the late eighties, the western organizations were facing competition from the Japanese organizations. These Japanese organizations (especially in electronics and automotive) had a distinct advantage of cost over the western organizations. This was due to the various management techniques used by Japanese (SPC, JIT, Continuous improvements etc.). At the same time some of the western organizations were looking at their decreasing margins, without knowing the real reasons behind it. During that time costing was used for completing the financial reporting by calculating the inventory costs. The same information was used to calculate the product cost. This was obviously leading to ‘not-so-correct’ product costs and decreasing margins.

This is when people built their first ABC models. These models provided them the information that helped them to understand that the basic reason for the wrong business decisions was the cross subsidizing product costs. Organizations then started ABC results for pricing and product mixes as well. With this came the flood of ABC implementations. Both the consultants and organizations went overboard. The models were designed with in detail (sometimes in too detail). The corresponding technological solutions could not cope with such detailed models and this led to the early reactions. ABC is very much time consuming. ABC takes too much time to build. ABC was also used for product costing only, then. So it has to face the criticism of not being customer focused or process oriented. Also the followers of ‘theory of constraint’, also criticized that ABC can only be used for long term decisions and not for short term decisions.

A lot of changes have happened to the modeling concepts, technology, uses of the concepts etc. The irony is that, people criticize the ABC concept even today, based on the state that ABC had 20 years back. It could be so because they do not know about the changes that have happened to the concept of ABC. Let me give a try to provide this information.
The concept of costing was relevant to manufacturing industry, because costing was always synonymous to ‘Product Costing”. With this understanding the modeling was such that each and every ‘penny’ spent was taken to the product. Over the years people have understood the ‘cause-and-effect’ relationship of costs and now the ABC models separates the costs that are caused by Products, Customers, Capacity and costs not related to any of these (business sustaining costs). Due to this segregation of costs organizations are able to calculate and understand the product as well as the Customer profitability also. As the costs are separated for the resources provided and resources used, organizations are able to calculate and understand the resource utilization of the various functions. Earlier capacity was always synonymous to machine capacity. When you know the capacity utilization you can use the concept to plan your resources. Hence, ABC can be used for resource planning.

In the early days of ABC modeling it was a single stage modeling. This means costs from resources taken to activities and from activities to the cost objects (products). The current ABC models can have multiple level assignments. You can assign resources to resources (Cost of HR function assigned to various other functions), activity to activity assignments (secondary activities supporting primary activities), reciprocating assignments (HR providing services to IT and IT providing services to HR in turn). By using various attributes one can view the cost of process at various stages. For example we can see the cost of procurement process at various stages as requisition, purchase order, QC, returns, payment etc. This analysis helps the organization to directly attack the areas that are inefficient. All this is possible because of the technological solution as well as changes that have happened in modeling.

The changes in technology have also happened in parallel. From the early days PC based solutions to the current enterprise wide application, is one way. Various functionalities like multi-stage assignments, reciprocating assignments, attribute etc. For me the most important is the ability to do the multi-dimensional modeling and viewing the results as OLAP views (for those who not so technical OALP are very similar to the ‘pivot tables’ in MS Excel). With the use of this feature we can not only see the product or customer profitability, but this can be seen as product wise – customer wise profitability (or vice-a-versa). This combination can possibly lead to understand profitability of a customer – for a product – sold in a region – thru’ a channel. Alternatively one can see profitability of a customer can be seen for a telecom company as a set of customers falling as private customer – acquired thru’ retail outlet – with a prepay plan – having very low technology aptitude – with a life stage as matured family – age group of 44 to 55.

As I said the costing as well ABC was initially used in manufacturing industry. It has had such an effect on people’s mind that people still think that ABC is useful for manufacturing industry only. In the early nineties came the CAM-I cross.

This diagram helped organizations to understand that ‘Activity’ was the most important part of the ABC model. Process in nothing but set of activities performed in sequence by one or more functions. Analysis of cost drives as the ‘cause of the cost’ helped organizations to use ABC results to improve their processes. Here was the answer to the people who criticized that ABC is useful only for product costing (and hence for the strategic use and not for operational improvements). This modeling concept led to the use of ABC in various service industries because the ‘products’ of those service industries were their ‘services’ and nothing but various processes. Initially the service industry used this concept to calculate the customer segment level profitability. In case of Retail it was used to calculate the category level or product group level profitability. The technological challenge was, it could not handle the millions of assignments. Today the commercial software solutions are available that can handle 100s of millions of assignments, which can be used to calculate profitability at subscription level in telecom, account level in banking or SKU level in retail. The time driven activity based costing equations have helped to model these millions of assignments very easily.

The latest technological evolution is the integration among the various software solutions. Because of this, the data required for the ABC model to update the model can be directly pulled from the ERP or any OLTP application running in the organization. For the ‘non-ERP’ data we can develop a small web-based solution, so that employees can enter the empirical data for the ABC model. The results of the ABC model can be integrated with various Customer Intelligence (CI) solutions like segmentation, retention, campaign management etc. ABC model can feed up-to 20% of the KPI data in a scorecard. This has increased the usability of the ABC information.

The use of ABC has also changed over the years. It started with calculating product costs, to customer, channel, Business unit profitability etc. This has been used to calculate the resource planning and activity based budgeting. After creating the activity based budgets, organizations can start reporting activity based variances. Route optimization in supply chain for various organizations like Retail or CPG, can be supported with more accurate costs of various activities at multiple places. This cost information coupled with optimization techniques can help them to find the optimal route for various vendor-item category-location combinations. ABC information can support any other process improvement program that is running in the organization, by providing accurate costs of various processes and help to prioritize the program. For this we can use the ‘2 x 2 diagrams’ methodology. We can use cost v/s potential to improve (the potential to improve will depend on how badly you are performing the process or activity). From here we can choose the quadrant that is ‘high cost and high potential to improve’. For the activities in this quadrant we add another attribute ‘potential to change’ (that is how easy it is in the organization to change the way in which we perform the activities). The first set of activities would be then ‘high cost – high potential to improve – high potential to change’. This seems to be the low hanging fruit.

It is no longer that the organization would start looking at business as a portfolio of customers. Then managing business is managing these portfolios of customers. To form the customer portfolios, customer profitability would be one of the most important information. Soon the board of directors would start demanding the customer profitability information and will challenge management to act on it. Who knows, shareholders would also start asking for this information. While mergers and acquisitions people will start running ABC project to understand the customer profitability, because in the acquisition, organizations are acquiring a portfolio of customers. The bid would also depend on the portion of the customers that match the profile but also portion of the customers that are profitable and matching profile.

During all this discussion, I wanted to explain that since the introduction of the concept of ABC till today and in future, it has gone through various cycles. Some people have used it, some have criticized it. It has taken its path of crests and troughs. Looking at the maturity of the use of the concept, technology available, consulting resources and competitive market situation, I feel the right time to start using ABC is TODAY. I will modify my title little bit and say “The best time implement ABC was 20 years back. The second best time is now….’

Profit plus Cost is Revenue

We have seen the business planning happening majorly as ‘Sales Planning’. In other words we can say that it is the ‘Revenue’ planning. Based on the planned revenue and returns expected the ‘Cost Budget’ is targeted. With the equation ‘Revenue – Profit = Cost’. The pressures are majorly on the costs. With this pressure the management as well as the line managers try to cut costs which is nothing but cutting expenses (read as ‘resources’). Activity Based Management (ABM) helps to understand the ‘non-value added’ activities and those can be scrapped with reducing the expenses and resources can be freed to perform the customer facing activities. This would in turn help to maintain the ‘Customer Value’.

Instead of starting with revenue if we can start with the profit expected by the management, then understand the market situation to bring that profit. With this study we can understand our product offering, their pricing, our customer segments, their requirements, competition etc. With this understanding we would be able to build our business strategy comprising of ‘what to sell’, ‘whom to sell’ and ‘how to sell’. This will help the organization to understand their current business processes and the plan the future one. This planning would define the activities to be performed and the resources requirement for the same. This information can be converted into cost budgets. What we know now is profits plus the costs, and the sum of this should be the revenue that needs to be brought in. Based on this information we can break down the revenue into various products, customers, channels, prices, geographies etc. Based on this a detail sales plan can be defined and monitored further.

In recent past various organizations are using ‘Balanced Scorecard’ as their performance planning and managing methodology. In this methodology organizations define their ‘strategy map’. Based on this map and the strategic objectives various KPIs are defined. Among those are the cost related and profit related KPIs. While defining this strategy map and the KPIs, if we can use the ABM models where in we can create various ‘what-if’ scenarios based on various options that the organization may have to achieve their ultimate goal, then the organization can choose the strategic path that is matching with their ROI targets. This is based on the assumption that the strategy map (by itself) does not give the numbers that can be achieved. But the ABM scenarios can help the organization to understand the impact of various actions on the profitability. Before choosing a path the organization can understand the effects of their future action converted into bottom line.

I have posted this with few assumptions and I would be interested in getting the feedback from readers on at least following questions (more than that is always welcome);

1) Is this concept already used by the organization?

2) If yes,
a. What type of industry is using?
b. In which geography this organization is?
c. How useful is this?
d. What are the challenges faced?

3) If no,
a. Does this sound practical?
b. In which type of industry this would be helpful?
c. What are the lacunae?
d. What type of alternatives can be used?

4) Any other comments (for or against), as this will make us the concept understand better.

You can post here or send me an email at rajenpatil12@gmail.com

Workshop on Profitability and Cost Management

Indian industry, notwithstanding its growth projection, continues to face an uphill battle to identify the ‘real’ opportunities for growth amidst reduced consumer confidence and a customer population that is prone to churn and attrition. Many Indian enterprises, having invested heavily in good times are now finding it very difficult to sustain the cost structures with reduced margins. While the economic crisis will have serious impact on the growth and profitability of the companies, the crisis offers an excellent opportunity for companies to transform themselves towards long term profitable growth and increased stakeholder value. Not surprisingly several leading firms in India have started comprehensive transformation programs. The question though is – what should be the goal of such transformation programs? Should they focus on growth or profitability? Wouldn’t cutting costs offer immediate return of profits? Should more customers be acquired? Do more customer means more revenue and importantly more profits? While these are very common questions that the executives driving these transformation programs address, the reality behind these transformation programs is that often companies undertake these programs on “Gut feel” rather than basing them on “complete and consistent facts”.

To improve financial performance is a high priority in most organizations today. But to find accurate information on costs and profits for decision-making can be difficult. The problem is that traditional accounting systems were developed mainly for external reporting purposes. As a result, these systems often provide inaccurate and misleading information about costs and profitability. What you need is a system that will enable you to accurately measure costs and profitability for products, services, customers, and processes. It should also reveal the root causes of a certain cost or profitability level, enabling you to make the right decisions and take action to improve financial performance. What you need is Activity-Based Costing and Management. An unmatched concept that enables you to make better strategic and operational decisions to increase profitability, manage costs, and improve operational efficiency.

With ABC/M you can:
– Identify the most and least profitable products, services, customers, or sales Channels
– Accurately determine true costs for products and services

We are pleased to invite nominations from your organization for our One Day's Workshop on "Profitability & Cost Management". The details of the same are as under:

Date of The Workshop - Friday, 22nd January, 2010

Time - From 9:00 a.m. to 5.30 p.m.

Venue of the Workshop:
B.V. Rao Hall , 1st Floor
Deccan Gymkhana Recreation Building
Deccan Gymkhana Club
Opp Hotel Ait / Near Chitale Sweet Mart
Pune - 411 030

Faculty:
Mr. Rajendra Patil is B.E. - Polymer Engineering from Pune Univ. & a Cost Accountant (AICWA). He is a technocrat with 17 years of proven experience in Business Analysis, Providing Consultancy in Strategic Cost Management, Profitability Analytics, Organisational Performance Management and Business Process Management. He was working with SAS Institute R&D India Pvt. Ltd., Pune, a US based Enterprise, as a Specialist – Performance Management Solutions for Indian Customers. In 2008 he ventured into consulting and started APPS Consulting.The major objective of APPS is to provide consulting services to organizations in Banking, Insurance,Retail, Communication, Manufacturing, IT and KPO sector. The unique proposition of APPS is to prove and earn. Mr. Patil has undergone Training on Activity Based Costing & Profitability Management as well as on Expert Modeling and OLAP analysis at SAS, U.S.A. He has handled various projects related to (ABC/M) various Business Organisations from Manufacturing, Telecom, Retail and Banking Sector. His clients are Kirloskar Group, Suzlon Energy,Thermax,JK Files and Tools,Merck India,Syngenta India,Waterville TG, ING Vysya Life Insurance, SAS R&D India, Systems America Inc.,Mercedes Benz India,Finolex Cables.

Who Should Attend the Workshop:
• CEOs, Senior as well as Middle Level professionals from Finance, Marketing, Costing, Operations, Sourcing who are keen to take their functional expertise to the next level.
• Note: This is not just a workshop but this can lead to Consultancy on ABM Projects. Systimatic Implementation of ABM will add to your bottom line in Lacs!!
• Workshop Charges / Fees - (Includes Course Material, Break-fast, Tea-Coffee & Lunch & Certificate)

Rs.4800/- for 1 participant.
Rs 4500/- per participant for 2 participants from the same organization.
Rs.4200 /- per participant for 3 or more participants from the same organization.

Payment to be made by cheque in the name of "Human Capital Consultants".

With Best Regards,

Ajay Walimbe
Director
Human Capital Consultants
A/16, Pradnyangad Apartment
Opp. Haripriya Hall
Navsha Maruti Mandir Lane
Off Tanaji Malusare Marg
Pune - 411 030
Tel: 020-66203576
Mobile: +91-9881060190
We Turn People into Asset!

ajaywalimbe@vsnl.net