UK: COST REDUCTION COULD BECOME AS EASY AS ABC - IS ACTIVITY-BASED COSTING THE FINANCIAL CONTROL OF THE FUTURE?

UK: COST REDUCTION COULD BECOME AS EASY AS ABC - IS ACTIVITY-BASED COSTING THE FINANCIAL CONTROL OF THE FUTURE? - In recent years financial controls have increasingly come under scrutiny. Conventional methods, it's said, too often lead managers into seri

by
Last Updated: 31 Aug 2010

In recent years financial controls have increasingly come under scrutiny. Conventional methods, it's said, too often lead managers into serious error. For example, in most manufacturing firms labour costs have shrivelled to the point where they are a very minor part of the whole. At the same time, overheads have ballooned. So a company which apportions overheads between its products on the basis of the direct labour costs could get a grossly distorted picture of the true cost of making different items. In this situation, management cannot make informed decisions about pricing or product mix - or where to wield the axe.The best known of the newer approaches identifies (and costs) various activities such as order entry, batch set-up, materials handling, invoicing, etc. Products (or processes or customers) can then be costed according to their demand for each activity. Activity-based costing (ABC) is widely reckoned to offer a sound basis for performance measurement, budgeting, stock valuation and a host of decisions relating to cost reduction, output, pricing and so on. These days the more ambitious users (and consultants) prefer to talk about ABM - activity-based management.

ABC has evolved over a decade or more precisely because of dissatisfaction with existing techniques. But why - if it's all it's cracked up to be - is it not in general use? On the face of it, the uptake has been remarkably slow. A survey of the Times 1000, carried out for the Chartered Institute of Management Accountants last year, turned up a mere 50 companies using ABC for any purpose (significantly, cost reduction was the most popular). Double that number confessed they had not thought about the subject.

'There's still a long way to go,' says Sarah Walton, ABM capability leader at KPMG Peat Marwick. Businesses don't get excited about ABC as a concept, she points out. 'They need to have an issue that they have to address.' But whether you think the rate of uptake is fast or slow is largely a matter of perception. The incidence of companies applying ABC is higher in the UK than in the US, believes Robin Bellis-Jones, a director of consultants Develin & Partners and chairman of CIMA's ABM working group. 'It is being adopted quite widely,' he insists - and in the service sector as well as in manufacturing.

The international courier DHL is a case in point. Up to the mid-1980s the firm was growing very fast, recalls costing project manager Martin Holden, and didn't worry too much about cost levels. Then it emerged that costs were rising 'almost in parallel'. Since people accounted for approximately 50% of total costs, it was assumed that they were the cause of the problem, and there was a tendency to 'kick backsides and make the couriers ride faster'. But when management dug deeper it found that the cause lay in the backroom and with IT.

DHL then set out to discover the relative profitability of its different customers and products, in order to target those with greatest potential. It has since launched a waste-elimination programme ('aimed at reducing unit costs, not downsizing', Holden emphasises), and is 'moving into ABM' via pilot projects in several countries.

Companies under pressure from customers tend to be among the more progressive users of ABC, finds Julia Collins, partner for the cost management group at Coopers & Lybrand. These include consumer goods manufacturers like H J Heinz, whose system is 'probably the largest in Europe at the present time' claims project general manager Mike Baldwin. Heinz UK began looking at ABC only in 1993. Yet today 'ABC-based product costs are used as the basis for cost standards and for regular review of our product portfolio ... When they are ready, customer costs will be used as the basis of our programme to improve supply-chain partnerships.' ABC, its proponents point out, blends wonderfully well with other management fashions of the day. It promotes business process re-engineering by dragging cost control out from the finance department and making it the business of other staff. Heinz and DHL both established multi-functional teams at the outset, to help design the system. DHL is seeking to build it into total quality programmes. Yet this versatility has its price. Identifying the relevant activities and cost drivers, and then assembling all the data - many of which are probably not available in core systems - requires a lot of work and not a little judgment. It's small wonder that businesses balk at the prospect.

ABC involves conceptual difficulties too. A typical study will favour long runs over small batches. New or niche products are therefore liable to become casualties, which may bring savings in the short term but endanger the growth potential of the business. John Darlington, operations manager at Allied Signal's Manchester factory, rejects ABC on these grounds. 'Set-up is perceived as non-value added,' he says. 'But not by me.' On the contrary, flexible response may demand a lot of short runs. 'In my factory we're doing set-up (cost) reduction because we want to do more set-ups.' But where conditions are right, ABC looks set to grow and grow. At the same time implementation should get marginally easier. As Coopers' Julia Collins says: 'Systems support is improving all the time.'.

Find this article useful?

Get more great articles like this in your inbox every lunchtime

Subscribe

Get your essential reading delivered. Subscribe to Management Today