Targeting Process Improvements
Activity Based Costing + Activity Based
Management
Activity based costing
can be used to identify areas that would benefit from process improvements.
Indeed, managers often cite this as the major benefit of activity based
costing.
Activity based management (ABM) is used in conjunction with
the activity based costing to improve processes and reduce costs.
Activity based management (ABM) is used in
organizations as diverse as manufacturing
companies, hospitals, and the US marine Corp.
The first step in any improvement program
is to decide what to improve. The
theory of constraints approach discussed
in the
business improvement programs chapter is a powerful tool for
targeting the area in an
organization whose improvement will yield the
greatest benefit.
Activity based management (ABM) provides another approach. The
activity rates computed in activity based costing can provide valuable clues
concerning where there is waste and scope for improvement in an
organization.
Benchmarking provides a systematic approach
to identify the activities with the greatest room for improvement. For
example, the marketing resource group of US WEST, the telephone company
performed an ABC analysis of the activities carried out in the accounting
department.
Managers computed the activity rates for the activities of the
accounting department and then compared these rates to the costs of carrying
out the same activities in other companies. Two benchmarks were used:
- A sample of fortune 100 companies,
which are the largest 100 companies in the united states.
- A sample of world class companies
that had been identified by a consultant as having the best accounting
practices in the world. These comparisons are as as follows:
| Activity |
Activity
Measure |
US WEST Cost |
Fortune
100 Benchmark |
World-Class Benchmark |
| Processing
accounts receivables |
Number of
invoices process |
$3.80 per invoice |
$15.00 per
invoice |
$4.60 per
invoice |
| Processing
accounts payables |
Number of
invoices processed |
$8.90 per invoice |
$7.00 per
invoice |
$1.80 per
invoice |
| Processing
payroll checks |
Number of
checks processed |
$7.30 per check |
$5.00 per
check |
$1.72 per
check |
| Managing
customer credits |
Number of
customer accounts |
$12.00 per account |
$16 per
account |
$5.60 per
account |
It is clear from this analysis that US
WEST does a good job of processing accounts receivable. Its average cost
per invoice is $3.80, where the cost in other companies that are
considered world class is even higher - $4.60 per invoice. On the other
hand, the cost of processing payroll checks is significantly higher at
US WEST that at benchmark companies. The cost per payroll check at US
WEST is $7.30 versus $5.00 at Fortune 100 companies and $1.72 at world
class companies. This suggests that it may be possible to wring some
waste out of this activity using total quality management, process
reengineering, or some other method.
Real Business Example:
Disciplining the Software Development Process
Tata Consultancy Services (TCS) of India
is the largest consulting organization in India, serving both Indian and
international clients. The company used activity based management to
identify problem areas in its software development business. An early
finding was that "quality assurance, testing and error correction
activities made up a significant chunk of the overall effort required to
build a system, and this cost had to be kept under control to improve
productivity and profitability." The company already had in place a
quality management system that helped identify the types of errors that
were occurring and the corrective action that would be required, but no
costs were attached these errors and actions. The activity based
management system provided this cost information system, which allowed
managers to set better priorities and to monitor the costs of
error-correction activities.
As another example of the usefulness of
the system, 54 person-days in one software development project at TCS
were charged to the activity "waiting for client feedback" - a
non-value-added activity. Investigation revealed that the client was
taking a long time to review the graphical user interface (GUI) designed
by TCS. The client was showing the GUI to various end users - often
resulting in contradictory suggestions The solution was to draw up
guideline for the GUI with client, which were enforced. "As a result of
this corrective action, subsequent client feedback was well within the
time schedule. Most of our screens were accepted because they conformed
to standards . . . . ."
Source: Maha S.
Mahalingam, Bala V. Balachandran, and Farooq C. Kohli, "Activity based
management for systems consulting industry," Journal of cost management,
May/June 1999, pp. 4 - 15. |
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