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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