A significant lesson learned from implementations of activity-based cost management (ABC/M) is the importance of working backward with the end goal in mind. That is, it is to management’s benefit to know in advance what it might do with the ABC/M data before the calculation effort is launched. The end determines the level of effort required.
Although ABC/M is basically just data, one of its ironic shortcomings is the wide variety of ways the data can be used. Different uses require more or less detail or accuracy. Accordingly, the system should be built with a clear idea of the types of decisions or assessments that the ABC/M data will be asked to support. Some ABC/M implementations may miss the mark by being initially designed as either overly detailed or not detailed enough.
Eventually, as the ABC/M data is applied as an enabler for multiple uses, the size of the system and level of effort to maintain it stabilizes at an appropriate level. Through using the data, the ABC/M system self-balances the tradeoff between the level of administrative effort to collect and report the data and the benefits as it meets various users’ needs.
Here are examples of the more popular uses of ABC/M by governments and defense organizations.
- Fees for service/cost-to-serve: to calculate costs of specific outputs as a means of pricing services provided to customers and other functions/agencies.
- Outsourcing/privatization studies: to determine which specific costs will actually remain or go away if a third party were to replace an existing part or all of an organization. Increasingly, commercial companies are positioning themselves to perform services once viewed exclusively as a public-sector domain. Some government agencies are learning that it is better to proactively measure their costs to prevent the possibility of a poor decision by an evaluation team. For example, the team may mistakenly conclude that outsourcing makes the most sense and discover after the fact that more accurate data would have reversed that decision. ABC/M can also help a government organization bring its costs in line with those of a commercial provider; its governing authority may allow a grace period for doing so.
- Competitive bidding: to excel and compete with commercial companies. Increasingly, commercial companies are positioning themselves to perform services, such as operating prisons, that were once exclusively the domain of the public sector. But the reverse is possible too. Some government departments, such as those performing road maintenance or tree trimming, may be able to compete with commercial companies.
- Merging/diverging agencies or functions: to identify administrative services that could be shared or combined among multiple agencies or functions.
- Performance measurement: to provide some of the inputs to weighted
and balanced scorecards designed to improve performance and accountability to taxpayers. - Process improvement/operational efficiency: to optimize resource use and, at times, to serve as a key to an agency’s survival. Some agencies are facing budget cuts (or taking on additional activities due to consolidation) and are unclear about the costs of their internal outputs. What does it cost to process a new registrant versus a renewal? Why might these two costs be so different? Do both costs per each event seem too high?
- Budgeting: to routinely plan for future spending not based on the current rate of spending but, more logically, on the demand volume and mix of services anticipated.
- Aligning activities to the strategic plan: to correct for substantial disconnects between the work and service levels that an organization is supplying and the activities required to meet the leadership’s strategic goals. It can be shocking for organizations to discover to what extent they are very, very good at things they do that are deemed very, very unimportant to the strategic plan.
There are many uses for managerial accounting data. The idea here is not to start an ABC/M implementation process just because it seems to feel right or because an authority commands or dictates it. Know in advance what problems the better data will be solving.
Multiple views of costs are empowering
When senior leadership, managers, and employee teams are provided reliable views of not only their resource spending but also the costs of work activities, costs of processes involved in these activities, and the total and unit costs of the various outputs deriving from the activities, they have a stronger basis for making decisions. Compare all that to what they have today. They have the spending view but no insight as to how much of that spending is or was really needed or why. Managers deserve to know the causal relationships.
An ABC/M system provides a good starting point for any non-profit or public sector organization to model its cost behavior. It is a solution looking for problems—and all organizations have problems. ABC/M provides a top-down look at how an organization’s resources get used, why, by whom, and how much. This is very logical and elementary.
ABC/M is a flexible and powerful methodology that has a unique ability to deliver true cost information from which critical decisions can confidently be made. As demand pressure mounts and budget funding is reduced, the public sector and not-for-profit organizations clearly need this kind of information to achieve effective results.
Realizing true cost savings or future cost avoidance
Many organizations experience an illusion that if they introduce productivity improvements and streamlining actions, they will automatically save costs. But being more efficient does not equate to realized savings in expenses—as opposed to costs—unless resources are removed (or, when volume increases, extra resources do not have to be acquired).
When an organization works more efficiently and staffing remains constant, then there is a freeing up of unused capacity in the workers. These workers are more available to do other things. But as long as they continue to get paid their salary and wages, the organization does not realize expense savings. As efficiencies are produced, manpower cost savings or future cost avoidance can only be realized by management in two ways:
- Fill the freed-up employee’s time with other meaningful work, ideally addressing new volume of customer orders; or
- Remove the capacity—that is, removing the workers to realize the savings in expense.
The issue here is that of transferring employees, demoting them, or removing them. The loss of jobs must be dealt with openly, compassionately, and comprehensively. There are several ways to accomplish this. For example, in an outsourcing situation, the private sector company can rehire a portion of the existing government employees who are, after all, already experienced in the outsourced activities. Additional ways to address the loss of jobs is through transfer and attrition. Some employees can be placed in growth areas of the organization or elsewhere in the government as opportunities arise. In the interim, some organizations will set up a temporary “job bank” that uses the displaced workers in a meaningful way until attrition or new needs create job openings.
Why change now?
It is trite to say that change is the only constant, but it is so often true. The question for the public sector is whether it will drive change—or be driven by it. Competition from the private sector places pressures on governments, agencies, and the military to provide good service economically.
I believe that the public sector is moving past the initial stage of rethinking what it does and how it does it. Restrictive funding pressures have already jump-started that. Public sector units are adopting a greater performance orientation where the costs are justified by the benefits. ABC/M is now playing and will continue to play an important role to help the public sector manage better. Without visible, relevant, and valid data, it is difficult for organizations to stimulate ideas and evaluate what options are available—and their financial impact. ABC/M data provides fundamental information that stimulates ideas.
As important as it is, however, ABC/M is not a panacea. It generates questions rather than provides answers. But that is needed. ABC/M provides focus. Cost management, however, should always be done in the broader context of enterprise performance management that integrates time, quality, service levels, capacity planning, and costs. But an organization’s understanding of its cost structure behavior is critical, so a managerial accounting system that supports managerial economic analysis, which ABC/M does, is critical for all stakeholders—its employees, its citizens, and its community.
Enterprise Performance Management: an integrated framework of methods
ABC/M is one component of an integrated suite of improvement methods now popularly called “enterprise performance management” (EPM). EPM involves methods, metrics, processes, software tools and systems that manage the performance of an organization. EPM methods include three major purposes: collecting data, transforming and modeling the data into information, and reporting it to users and decision makers.
Think of EPM as an umbrella concept that integrates improvement methods that you are already familiar with (or likely have heard the terms for). Examples of the EPM’s methods are strategy maps and its companion balanced scorecard, driver-based budgets, lean management, and six sigma quality management, just to name a few. Most of EPM’s component methods have existed for decades and some even before there were computers. A reason there is interest in in EPM today is because the methods no longer need to be applied in isolation—they can be integrated. Early adopters have deployed parts of EPM, but few have deployed its full vision.
This article series described one component of EPM, activity-based cost management, and how it can be used in public sector applications. It also outlined the demand for improved cost accounting in the public sector and described reasons for misunderstanding and resistance to ABC/M.
I encourage you to learn more about the other EPM components and how they fit together. Today's powerful data management, business intelligence, and analytics software tools and solutions are uniquely positioned to provide organizations the power to maximize both their service levels and the use of their resources.
This is the final article (Part 4 of 4) in a four-part series based on the book, Activity-Based Cost Management in Government by Gary Cokins (Second Edition; Management Concepts, 2006, ISBN 978-1-56726-181-3).
