15 Mai 2015 Logistics & Activity Based Costing: Can you afford not doing it !
As logisticians you are faced, on a daily basis, with struggles to reduce costs while providing a world-class service level to your demanding customers. On many occasions you are also faced with unexpected demands from the purchasing department (truckload promotions) or the marketing department (special deal, customized packaging) that greatly impede your operation. These oblige you to incur additional costs that are, most of the time, not considered in the rational analysis performed by the other departments.
Throughout the years, as the logistics functions gained more and more place in organizations, the total cost concept has emerged. Within this concept, the total cost of a product (manufacturing, storage, distribution,…) is calculated prior to taking any action. Already widely used in the manufacturing industry for product profitability analysis, the Activity Based Costing methodology is growing in popularity in the logistics field. Such approach easily allows managers to understand the total cost of a product or process and also to pinpoint any non value-added activity.
Over the past years, The “Logistics Consulting” division of The GCL Group has acquired a solid experience in Activity Based Cost Management (ABCM) in the fields of the integrated logistics. Our typical mandates cover the order fulfillment process from order taking through to cash collection. We provide our clients with a user-friendly model allowing them to perform “what-ifs” simulations. Our interventions are either focused on product costing or customer costing.
What is Activity Based Cost Management ?
Activity Based Cost Management (ABCM) is a process to align revenues and costs to business processes and activities. It is based on the premises that effective cost management should:
- Focus on what an organization does rather than what it spends;
- Recognize that all costs are variable in the long run;
- Provide insight into how an organization’s resources are used to make products and serve its clients;
- Employ specific and quantifiable performance measures;
- Facilitate management of business segments.
What does it do ?
- Identifies the cost of activities performed throughout a company:
- Focuses attention on high cost activities;
- Quantifies the benefits from eliminating low value added activities.
- Develops the cost of activities per unit of output:
- Understanding this relationship provides better insight into cost behavior;
- Identifies the most important drivers for possible inclusion in performance measurement systems.
- Provides total cost of products, services, customers and distribution channels:
- Leads to meaningful profitability analysis;
- Provides direction to assessing alternative strategic scenarios, repricing services and cost/benefit of increasing or decreasing emphasis on particular customers.
The successful steps to the development of an ABCM model
The development of an accurate Activity Based Cost Management model is the road to success and will allow you to gain respect within management. It is a tedious process that requires a structured methodology in order to ensure that every portion of a process is captured by the model.
Through the completion of many successful projects, we have developed a structured approach in six steps that allows the development of an accurate model. Following is a description of these steps:
Step 0 – Project scope
Prior to performing any observation and analysis, it is of utmost importance to clearly identify the scope of the project, the expected results and expected utilization of the model. Such clarification allows everybody to clearly state their expectation and also understand the limitations of the model to be developed.
Step 1 – Process mapping
Once the objectives and scope have been clearly identified, you must proceed to the mapping of the current processes. Such mapping can be achieved through observations and interviews with related individuals. We adopted a top-down approach in which we start by defining the core operating processes followed by the business processes, then we identify the activities that are themselves composed of tasks (refer to drawing). Once the relationships between all the activities have been clearly understood, we are ready to proceed to the next step.
Step 2 – Data collection
Once the processes have been clearly identified, we proceed to the data collection. Such data will then be used to feed the model with costs, practices and patterns (e.g.: customer order pattern). Do not underestimate the length of this step, as valuable information is always hard to obtain due to the numerous sources of information and systems in place. At this time, the data collection should also be focused on providing the activities of the process with the required information in a fashionable format.
Step 3 – Activity costing
The purpose of this step is to link resources to activities in order to develop activity costs. At this stage, the information gathered through the interviews and data collection will come in handy as you will have to determine the first stage or “resource” drivers. These drivers should be selected in such a way that they are easily measurable through time and that will remain meaningful, as process becomes more efficient. As an example, you may use resource drivers such as: percentage of time spent, minutes per activity unit,… In order to perform the activity costing, you will have to assign the costs from the general ledger to the activities.
Step 4 – Product (or customer) costing
Once the activities have been costed, you are now ready to proceed to the product or consumer costing. At this stage you will assign activities to products based on your previous observations and data collection. Each product or customer will consume activities at its own pace and quantity. In order to proceed, you will have to determine second stage or “activity” drivers. These drivers may be: number of work orders, receipts, customers, calls, lines processed,…. According to the type of process analyzed and objective of the model to be developed (product or customer oriented).
Step 5 – Model development
This step is also of utmost importance as it will allow you to format the information in such a manner that it will easily be understandable while providing accurate and quick response to any simulation to be performed following the model development. When developing the model, be sure to document any assumption made and calculation steps. Once developed, the model should be benchmarked with current practices in order to ensure its validity. We also recommend that you perform simple and instinctive simulations to verify that the model responds accordingly.
Step 6 – Simulations
Following the development and benchmarking of the model you are now ready to proceed with “what-ifs” scenarios. Simulations should focused on evaluating the impact on eliminating non value-added processes or changing the logistic practices of your clients. Once you will start generating scenarios you will realize the power of these models and the related savings that you will be able to attain. As a rule of thumb, experience shows that you should only plan for 2/3 of the announced savings due to the assumptions made throughout the process and all the unexpected events that will occur prior to realizing the expected results.
Unleashing the power of numbers
While traditional accounting fails to provide logisticians with a clear and realistic view of their operation, Activity Based Costing proves itself to be a very powerful tool that can, when properly used, be a very efficient tool to outline any non value-added activities. As customers become more and more demanding, suppliers are faced with a need to cut any excess activity in their processes in order to be more efficient and remain competitive. Furthermore, through information exchange supplier can accompany their clients in improving their logistics practices to develop a win-win situation. All these are now reality to many industries and what better tool is Activity based Cost Management to clearly picture an operation and streamline its processes.