I recently met a managerial consultant whose intentions were sincere, however his advice was surprising, but not totally surprising, to me.
He mentioned to me that a company had inquired to him whether they should consider using activity-based costing (ABC). His next step was initially encouraging. He contacted the accounting departments of the inquiring company’s major competitors. He asked them if they are using ABC. The answer from them was that none of them are.
A missed opportunity for good advice
I was hoping the next thing he would tell me is this. I was hoping he would inform the inquiring company that they had an opportunity to gain a competitive edge.
I presumed he would say to them, “I have good news for you. Your instincts are correct. You have realized that the amount of your indirect and shared expenses have grown large relative to your direct expenses. You may understand that this expansion is a result that your products and services have expanded with much diversity and variations. And the result is that complexity has caused this increase to manage the complexity. By your using a highly aggregated indirect cost pool with a single allocation factor that has no cause-and-effect relationship with those indirect expenses, the consequence is that you are simultaneously over- and-under-costing your products. Their costs exactly reconcile in total but not in with parts. This is because cost allocations are a zero sum error condition. Your competitors do not realize this, but you do. Go for it. Implement ABC. Your company will much better understand their profit margin layers and where it makes and loses money – and why.”
Sadly, he advised the inquiring company that since its competitors do not use ABC then that is evidence that ABC is of little benefit.
How long can this ignorance continue?
My ranting and raving
Those readers who follow my blogs and articles about this topic recognize that I have been relentless in criticizing the ‘homo accounticus’ accountants who remain in the stone age. They are exposing their organizations to a risk that the enterprise risk management (ERM) community rarely references – invalid and flawed cost information that leads to misleading profit margin information.
I remain in awe. The advanced and mature organizations that have adopted ABC would never go back to traditional standard costing (unless a new mindless CFO or CEO shows up and rejects ABC as too complicated and abandons it).
The longer these types of primitive accountants delay applying ABC, the greater the risks. The issue here is not mainly about product and standard service-line costing. The issue is about the emerging need to report and analyze customer and channel profitability. This includes the broader scope of marketing, distribution, selling, and customer service expenses that are below the product gross profit margin line.
Open your eyes. It is apparent that today customers view almost all suppliers’ products as commodities. They want to be specially treated and serviced. This means that suppliers must provide differentiated services to increasingly differentiated micro-segments of customers. These are cost-to-serve costs, not product costs.
An increasing pressure comes when suppliers recognize that they have high maintenance customers, in contrast to low maintenance ones, whose extra costs erode profits. The objective of sales and marketing is no longer about growing market share and sales, but rather it is about growing profitable sales. Accountants must accurately measure the ‘middle line’ to subtract from the ‘top line’ because the ‘bottom line’ – profits – is a derivative from both of them. And to use large aggregated cost pools with a non-causal allocation factor (e.g., sales amounts, number of labor/machine input hours) to allocate costs is irresponsible. The results are distorted.
When the consultant advised his inquiring company that their competitors are not using ABC, then it is a case of the blind leading the blind. And, remember, that in the land of the blind the one-eyed man is king.
By Gary Cokins, EPM Contributor, from: http://businessfinancemag.com/blog/some-accountants-are-blind-leading-blind
Gary Cokins is an internationally recognized expert, speaker, and author in advanced cost management and performance improvement systems. He is the founder of Analytics-Based Performance Management LLC at www.garycokins.com in Cary, North Carolina. His career: First ten years as an executive with a division executive with FMC Corporation; next fifteen years in consulting with Deloitte, KPMG, and EDS; and last fifteen years as a Principal Consultant with SAS, a leading provider of business intelligence and analytics software. See Gary’s articles on EPM Channel here.
October 25, 2013 at 6:27 am
Nice article Gary. This approach of “Why fix it if it ain’t broke ?” approach is all pervasive. Even when you can see the tell-tale signs of the “it ain’t broke” slowly approaching the “broke” scenario, many senior finance professionals refuse to recognize the importance of accurate cost information and continue to lead their organizations by “peanut butter approach” cost systems. At times - this is also met by a frosty “We will cross the bridge when we come to it” response - particularly in the “gut-feel-based” decision-making cultures, or even plain ego.
October 26, 2013 at 1:40 am
Hi Gary, I couldn’t agree more. One major argument we get from “traditional” accountants is that “we’ve tried it before and it didn’t work”, and to use your analogy, the stone age man has been burnt by the fire, so “fire bad”! While his mates around the corner are inventing BBQ - hmmm BBQ…. Anyway, back to the point, education is key, we show them that things have changed a lot from the old manual interviewing and spread sheet days. There is significantly more good quality data available now than there was in the past, modelling software has improved significantly, drivers can be developed so that manual interviewing is no longer required or minimized significantly etc etc. and it takes time but we slowly bring them around to attempt to fry up a small myopic rodent.
October 27, 2013 at 3:36 am
Lea … I love your “fire bad” analogy. My sense is the reasons for the slow adoption rate of ABC is a long one, of which “failed ABC models in the past (usually from being unnecessarily over-designed with 1,000s of activities)” is just one of them. Others are natural resistance to change, fear of knowing the truth, and weak leadership.
Progress will come with time. I will continue speaking out with my MBE voice …. management by embarrassment !
October 28, 2013 at 6:30 am
Gary,
Why was the opportunity missed? Success is NOT logical.
Logical is doing what everyone else does. Yet upon investigation you commonly learn most the “everyones” you are being encouraged to emulate are not successful. Such was the case you describe.
It’s difficult for most accountants to differ from the logical crowd. I’m not logical. I’m glad neither are you.
October 28, 2013 at 3:28 pm
Great article; enjoyed every word of it, especially, the title.
October 28, 2013 at 6:59 pm
Tom … Thanks for your comment. When I read a supportive comment from you, where you are arguably one of the top global thought leaders in activity-based costing (ABC), it confirms that I am not alone in my position.
It is taking way too long for the adoption rate for ABC to speed-up.
Gary … Gary Cokins
October 30, 2013 at 5:39 pm
Gary, I believe you once wrote, “…accountants count the beans, but they are not tasked to grow the beans.” In my opinion, this perverted approach to the minutiae of financials, this myopic vision of after-the-fact financial reporting, leads directly to the exclusion of activity-based costing from many a corporation. And while this attitude may be changing (forward thinking CFOs are leading the charge), it is still, sadly, slow going. “No-going” when you consider the federal government. After twenty-five years of ABC work, I’m not sure I fully understand why that is…
From my vantage point, a well-implemented ABC system and tool is a distinct competitive advantage. It seems so simple to me. ABC practitioners regularly beat their competition; that can’t be pure circumstance. What better way to determine your most profitable customers and channels? How much better would your decisions be if you fully understood the drivers of profitability? Just think of the revolution that knowledge makes in your sales strategies, the direct linkages created between your strategy, tactics and operations…
Forces invariably work against ABC… everything from culture, to change management, to software, to project execution, to simple fear. We need a new generation of managerial accountants to take the banner and charge the hill again as well as some fearless leaders to stake their territory. Those of us who have shouted ABC from the mountaintop need to keep our voices strong and make others see. Thanks for a great article.
November 1, 2013 at 7:51 am
Hi Gary,
This is excellent article and bigger opportunity for most of accountants. I believe every accountant/Finance person should learn to challenge status-quo and always grab opportunities that provides competitive edge.
Accountants are becoming more process oriented and less business oriented. They tend to focus more on the accuracy of reporting standards then helping business to gain some extra miles. This also comes with the reason of fear. They should actually differentiate between things that add value to business or not.
Good food for thought!
November 1, 2013 at 12:47 pm
It is a rare opportunity to exchange ideas with all of you, Gary and Lea being old “cyber” friends. I could not agree more with everybody and let me add one or two points. One: there has been possibly little investment in higher education in ABC; those who have access to universities programs, check this, please. Two: maybe wrong people has been targeted most of time; for instance, I believe technical people, like engineers who deal with everyday’s operations are better targets than hard to change accountants. Those who need better cost information may be the ones who will in the future lead a change in the way costing systems are built and operated. Accountants will never be users of ABC information, so why should they bother about it? For the purposes they really care they already have what they need. Do you see any government or private body telling them to do otherwise? In my mind, the best we can expect from accountants is to provide us with GL data that we are able, by ourselves, to cleanse, process, mix with non financial data and produce good cost information. To conclude, let us target the right people and build profitable partnership with them. More food for thought?
November 4, 2013 at 6:32 am
The trouble with all costing systems including ABC, it is like measuring the size of the stable after the horse has bolted. ABC uses the latest electronic measuring device to measure the stable. The only way to maximise profits is to maximise the use of limiting resources/ Goldratt/opportunity. This is almost the opposite of costing because the most important factor is using critical resources which are not fully utilised, especially bottlenecks. These are given a cost of zero in all costing models. which further minimises their usage. the opposite of what is needed
November 4, 2013 at 2:39 pm
Gary,
Don’t stop shouting the message! I too am continually amazed at the number of institutions that are “just fine” with their high-level, volume-spread allocation methodologies where all products or customer are treated the same.
A couple of core factors seem to contribute from what I see: 1) Getting the connection between Operations and Finance is still a key component. Operations fully understand the variability in production or use of resources to produce output; 2) Finance teams have become almost too lean. Creating a new methodology and a new view of costs requires time and effort. Most Finance groups are barely keeping up with the normal day-to-day work.
Both of these factors can, and should, be overcome. It just takes a lot of banging on the door.