The ABC Of Relevance

Replete though it is with information about your real costs, ABC is also a trap of the trivia. The favourite cautionary tale that ABC consultants recount is of the US corporation that adopted ABC to ascertain its real product costs. Introduced across the enterprise, blended smoothly with orthodox accounting, and championed by the CEO, the CFO, and the chief of manufacturing to wear down resistance, ABC did its job spectacularly. It identified a staggering 79 cost-drivers, each of them contributing in different proportions to different products. Among these was stationery--allocating whose costs among different products posed a formidable challenge. Brainstorming over the problem, the company devised an ingenious solution: using the number and identity of the people who use the stationery--each individual's use, after all, is easy enough to calculate--as a proxy for its costs. Using an elaborate weightage system, people from accounts who used the most paper were accorded six points. By the same logic, the weightage for marketing personnel was 3.5, and for production people, 1.

The results were splendidly accurate, unfortunately, stationery was found, after the exercise, to contribute between 0.002 per cent and 0.008 per cent of the total costs. Cautions the Mumbai-based cost accounting consultant, N.S. Acharya, 59: "Companies often get into ridiculous and complicated details while identifying cost-drivers for ABC." Don't blame the methodology; blame the motive. For, while it can be used for measurement alone, ABC is really meant to be a guide to performance improvement. Adds Acharya: "When the enthusiasm is misdirected, the gains may not match the energy expended." So, while the first step in designing a new product-cost system must be the collection of accurate data on direct labour and material costs, a quick decision must be taken on which of the drivers you really need to focus on.
One way to filter out the trivia is to concentrate on expensive resources, homing in on categories where acting on the information offered by

ABC will make a significant difference in product costs. But that's not enough. It's also important to emphasise the drivers where the consumption of resources concerned varies significantly between products. And where demand patterns are not correlated with conventional allocation measures such as direct labour, materials, and processing time. After all, these are the classic situations where cost structures are distorted under conventional systems.

The ABC Of Activities

The starting point--the A of ABC--is, of course, to identify activities correctly. Distinct from transactions or processes, an activity in this context refers to a repeatable, adaptable action, or a series of such actions, that make a meaningful, complete contribution to the completion of the process or product in question. Most important, it acts as a causal factor in incurring a cost. Thus, a quality check, or inventory movements, or the power consumed, all qualify as activities whose costs can be measured. For the purposes of ABC, that would be enough. But when it comes to abm, the activities must also be of the kind that can be improved so as to lower the costs associated with them. Explains Coopers & Lybrand's Chawla: "That's why the most crucial task before implementing ABC is the elementisation of real activities at the operational level."

The next step: attributing as accurate a cost to the activity as possible. And while that's relatively simple for activities like power consumption or use of a specific and quantifiable resource, other activities like making quality checks or addressing customer complaints are far tougher to address. That's why involving the actual performers of those activities is a vital part of abm. Suggests V. Ramesh, 35, manager (product development) at Philips' loudspeaker equipment-making division in Pune: "The most effective way to sustain abm is to create user-driven cost systems." Prepare for prolonged exchanges between your abm consultant, the ABC champion within the company, and the activity performers. Says Shailesh Jain, 31, joint managing director, Emco Transformers (Emco): "One must not only find out the entire range of activities that an individual performs, but also understand why and how they perform them, and what are the cost-drivers behind each of them."

Emco Transformers believes as much. Having diversified its product line to manufacture a huge array of transformers--each to serve different needs--the company suspected that it had built plenty of duplicate and non-value-adding activities into its processes. Needing to cut costs, Emco consulted Coopers & Lybrand, which promptly applied ABC to weed out the needlessly-expensive activities from those providing the company value for its money. A five-member team, led by Emco's company secretary and executive director, elaborately quizzed every employee in the organisation on what he did and how--daily, weekly, monthly. Only through this front-line feedback did Emco track down the cost-enhancing activities. Since it had been mapping its processes simultaneously, the company succeeded in identifying just how the processes could be reworked to streamline and, if necessary, eliminate these activities. For instance, production planning was dissociated from the production function and clubbed with material planning to eliminate needless activities arising from the lack of integration between the order placement and purchase functions. Similarly, since tenders were being floated from two centres--Mumbai and Delhi--pushing up costs, the activity was centralised. Crucially, inputs as well as improvement suggestions were provided by the employees themselves.

Such efforts often flush out activities and sub-activities that no one knew existed. "At this stage, line managers usually catch on to the non-value-added activities," says P.P. Dabke, 36, director of the Pune-based Total Cost Management consultancy, Radiant Management Services. Hidden resources are unearthed, too. Says Dilip Mande, 53, senior general manager, Menon & Menon: "In conventional systems, resources tend to be clubbed as overheads and, thus, remain hidden. When the focus shifts to activities, these hidden resources become visible." Using an activity-resource grid to compare the usefulness of the result of the activity to the quantum of resources invested in it, you can quickly spot those activities that are boosting costs without adding value.

In early 1997, for instance, the management of Philips' components division decided to apply ABC for the twin purposes of analysing profitability with respect to servicing customers, as well as eliminating non-value-added activities from the value chain. Three pilot projects were chosen--in loudspeaker development, in the manufacture of passive electronic components, and in sales in southern India--with three separate cross-functional task forces being formed. Consider the effect of the first of the efforts. The new product-development team was constantly dealing with two or more projects. The key issue was to find out how much each project costs--information that wasn't thrown up by conventional cost accounting. Detailed activity analysis followed, elementising the work content from the product concept stage to the first bulk run. Creating a bill of activities-versus-resources matrix, Philips identified significant, but hitherto ignored, cost-drivers like the number of iterations in design and computer time. The company is now working on methods to cut down on these cost-drivers, if not eliminate them entirely.

More