Article Review Accounting
T O O L K I T
Time-Driven Activity-Based Costing
by Robert S.Kaplan and Steven R.Anderson
Many companies
abandoned activity-based
costing because it did not
capture the complexity of
their operations, took too
long to implement,and was
too expensive to build and
maintain. Here's a way
around those problems.
I N THE CLASSROOM, activity-basedcosting looks like a great way to man- age a company's limited resources. But many managers who have tried to im- plement ABC in their organizations on any significant scale have abandoned the attempt in the face of rising costs and employee irritation. They should try again, because the new approach we lay out in the following pages sidesteps the difficulties traditionally associated with large-scale ABC implementation by relying on informed managerial esti- mates ratherthan on employee surveys. It also provides managers with a far more flexible cost model to capture the com- plexity of their operations.
ABC Made Difficult The roots of the problem with ABC lie in the way people traditionally con- struct ABC models. Assume you are an- alyzing a customer service department that performs three activities: process- ing orders, handling inquiries, and per- forming credit checks. The department's total expenses (the cost ofthe personnel,
management, IT, telecommunications, and other fixed resources) amount to $560,000. The actual (or estimated) quarterly quantities of work in the three activities are 49,000 orders, 1,400 in- quiries, and 2,500 credit checks.
To build a traditional ABC model for this department, you would survey employees to estimate the percentage of time they spend (or expect to spend) on the three activities and then assign the department's resource expenses ac- cording to the average percentages you get from the survey. Let's say employees report that they spend (or expect to spend) about 70% of their time on cus- tomer orders, io% on inquiries or com- plaints, and 20% on credit checks. This implies, under ABC, that each order con- sumes $8 of resource expense, each in- quiry $40,and each credit check $44.80, as shown in the exhibit "Doing ABC the Traditional Way." Armed with these fig- ures, known as the cost-driver rates, managers can assign the costs ofthe de- partment's resources to the customers and products that use its services.
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T O O L K I T • Ti m c - D n v e n A c t i v U v - B J ^ e d Cost i nq
This approach works well in the lim- ited setting in which it was initially applied, typicaiiy a sinĵ le department, plant, or location. Difficulties arise, how- ever, when you try to roll this approach out on cl large scale tor use on an ongo- ing basis, in one large bank's brokerage operation, the ABC data-gathering pro- cess required 70,000 employees at more than 100 facilities to submit monthly re- ports oftheir time allocation. The com- pany employed 14 people full-time just to inanage the data collection, process- ing, and reporting.
unprofitable products and customers, and excess capacity.
Traditional ABC models also often fail to capture the comple.xity of actual operations. Consider the activity "ship order to customer." Rather than assume a constant CList per order shipped, a com- pany may wish to recognize the cost dif- ferences when an order is shipped in a full truck, in a less-than-truckk^d (LTL) shipment, using overnight express, or by a commercial carrier. In addition, the order may be entered into the system either manually or electronically, and it
to process one month's worth of data. For example, the automated ABC model for Hendee Enterprises, a $12 million fabricator of awnings, took three days to calculate costs for its 40 departments, 150 activities, 10,000 orders, and 45,000 line items.
These problems have become obvi- OLis to most ABC implementer^. But a subtle and more serious problem arises from the interview and survey process itself. When peopie estimate how much time they speiid on a list of activities handed to them, they invariably report
Doing ABC the Traditional Way This table provides a traditional ABC analysis for a customer service department for its first fiscal quarter. The percentage
of time spent Oii activities is detei mined from employee surveys. Once activity quantities are known or forecast, cost-
driver rates are used to allocate the department's costs based on customers'utilization o f t h e department s activities.
Activity
Process customer orders
Handle customer inquiries
Perform credit checks
Total
% o f T i m e Spent
70°;,
10%
20%
10096
Assigned Cost
$392,000
^56,000
$112,000
$560,000
Activity Quantity
49,000
1,400
2,500
Cost-Driver Rate $8 per order
$40 per inquiry
S44.80 per credit check
The time and cost demands of creat- ing and maintaining an ABC model on this scale is a major barrier to wide- spread adoption at most companies. Since the systems that are put in place are updated infrequently (because of the costs of reinterviewing and resur- veying), the [iiodel's estimates of pro- cess, prodLict, and customer costs soon become inaccurate. What's more, people waste their time arguing about the ac- curacy of cost-driver rates that are de- rived from individuals'subjective beliefs rather than addressing tlie deficiencies the model reveals: inefficient processes,
Robert S. Kaplan lrkaplan(g>hb.'i.i'dii) is
the Marvin Boiver Profe<'Sor of Leadcr-
•ihip Di'vclopmcni ol Harvard Busiiws^
School in Boston. Steven R. Anderson
(sanderson(aJacornsys.com) is the founder
and chairman of .Acorn Systems, a soft-
ware and con.mltiiif^ firm headquartered
in Houston. Kaplan serves on the board
ofAeorn Svstems.
may be either a standard or an expe- dited transaction. To allow for the signif- icant variation in resources required by the differeiil shipping arrangements, new activities must be added to the model, thereby expanding its complexity.
As tbe activity dictionary expands- either to i"etlect more detail aboLit activ- ities or to expand the scope ofthe inodel to the entire enterprise-the demands on the computer programs used to store and process the data escalate. Suppose a company has \^o activities in its en- terprise ABC model, applies the costs in these activities to some 600,000 cost objects (products and customers), and runs the model monthly for two years. That woLild require data estimates, cal- culations, and storage for more than 2 billion items.
Such expansiLin has caused ABC sys- tems to exceed the capacity of generic spreadsheet tools, such as Microsoft Excel, and even iiiany ABC software packages. The systems coLild take days
percentages that add Lip to 100. Few in- dividLials ivport that a significant per- centage oftheir time is idle or unused. Therefore, cost-driver rates are calcu- lated assuming that iesL)u]ces aie work- iiig at full capacity. But as we all know, operations often ruii at considerably less thaii their capacit>'. That means that the estimated cost-driver rates are usu- ally much too high. (Technically, they will be overstated by tbe reciprocal of the capacity utilization percentage: At 8o"<. utilization, the rates are 25% too high; at 67% utilization, the rates are 50% too high.)
The New ABC The solution to the problems with ABC is not to abandon the concept. ABC after all has helped many companies identify important cost- and profit-enhancement opportLMiities through the repricing of unprofitable customer relationships, process improvements on the shop floor, lower-cost prodLict designs, and ratio-
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T i m e - D r i v e n A c t i v i t y - B a s e d C o s t i n g • T O O L K I T
nalized product variety. Its potential on a larger scale represents a huge oppor- tunity for companies. Fortunately, sim- plification is now possible through an approach that we call time-driven ABC, which we have successfully helped more than 100 client companies implement, including those described in this article. In the revised approach, managers di- rectly estimate the resource demands imposed by each transaction, product, or customer rather than assign resource costs tirst to activities and then to prod- ucts or customers. For each group of re- sources, estimates of only two parame- ters are required: the cost per time unit of supplying resource capacity and the unit times of consumption of resource capacity by products, services, and cus- tomers. At tbe same time, the new ap- proach provides more accurate cost- driver rates by allowing unit times to be estimated even for complex, specialized transactions.
Estimating the cost per time unit of capacity. Instead of surveying employ- ees on how they spend their time, man- agers first directly estimate the practical capacity of tbe resources supplied as a percentage of the theoretical capacity. There are various ways to do this. As a rule of thumb, you could simply assume that practical full capacity is 80% to 85% of theoretical full capacity. So if an em- ployee or machine is available to work 40 hours per week, its practical full ca- pacity is 32 to 35 hours per week. Typi- cally, managers would allot a lower rate - say 80% - t o peopie, allowing 20% of their time for breaks, arrival and de- parture, communication, and training. For machines, managers might allot a i5%differential between theoretical and practical capacity to allow for downtime due to maintenance, repair, and sched- uling fluctuations. A more systematic approach, perhaps, is to review past activity levels and identify the month with the largest number of orders han- dled without excessive delays, poor qual- ity, overtime, or stressed employees. Whichever approach you prefer, it's important not to be overly sensitive to smal! errors. The objective is to be ap- proximately right, say within 5% to io%
ofthe actual number, rather than pre- cise. Ifthe estimate of practical capacity is grossly in error, the process of run- ning the time-driven ABC system will reveal the error over time.
Returning to our example, let's as- sume that the customer service depart- ment employs 28 reps to do the front- line work and that each puts in eight hours per day. In theory, therefore, each worker supplies about 10,560 minutes per month or 31,680 minutes per quar- ter. The practical capacity at about 80% of theoretical is therefore about 25,000 minutes per quarter per employee, or 700,000 minutes in total. Since we already know tbe cost of supplying
cessing orders) but how long it takes to complete one unit of that activity (the time required to process one order). Once again, precision is not critical; rough accuracy is sufficient. In the case of our example, let's suppose that man- agers determine that it takes 8 minutes to process an order, 44 minutes to han- dle an inquiry, and 50 minutes to per- form a credit check.
Deriving cost-driver rates. The cost- driver rates can now be calculated by multiplying the two input variables we have iust estimated. For our customer service department, we obtain cost- driver rates of $6.40 {8 multiplied by $0.80) for processing customer orders.
In the revised approach, managers directly estimate the resource demands imposed by each transaction, product, or customer.
capacity-the $560,000 in overhead costs-we can now calculate the cost per minute of supplying capacity ($0.80).
The capacity of most resources is measured in terms of time availability, but the new ABC approach can also recognize resources whose capacity is measured in other units. For example, the capacity of a warehouse or vehicle would be measured by space provided, while memory storage would be mea- sured by megabytes supplied. In these situations, the manager would calcu- late the resource cost per unit based on the appropriate capacity measure, such as cost per cubic meter or cost per megabyte.
Estimating the unit times of activi- ties. Having calculated tbe cost per time unit of supplying resources to the busi- ness's activities, managers next deter- mine the time It takes to carry out one unit of each kind of activity. These num- bers can be obtained through interviews with employees or by direct observation. There is no need to conduct surveys, al- though in large organizations, survey- ing employees may help. It is important to stress, though, that the question is not about the percentage of time an em- ployee spends doing an activity (say, pro-
$35.20 (44 by $0.80) for handling in- quiries, and $40 (50 by $0.80} for per- forming credit checks. Once you have calculated these standard rates, you can apply them in real time to assign costs to individual customers as transactions occur. Tbe standard cost rates can also be used in discussions with customers about the pricing of new business.
Note that these rates are lower than those estimated using traditional ABC methods {see again the exhibit "Doing ABC the Traditional Way"). The reason for this difference becomes obvious when we recalculate the quarterly cost of performing the customer service activities. In the exhibit "The Impact of Practical Capacity," time-driven ABC analysis reveals that only 83% ofthe prac- tical capacity (578,600 ofthe 700,000 minutes) ofthe resources supplied dur- ing the quarter has been used for pro- ductive work, and hence, only about 83% ofthe total expenses of $560,000 were assigned to customers or products dur- ing this period. This takes care of the technical drawback of traditional ABC systems we mentioned earlier-the fact that surveyed employees respond as if their practical capacity were always fully utilized.
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T O O L K I T • T i m e - D r i v e n A c l i v i l y - B a s e d C o s t i n g
in the case of our customer service department,the traditional ABC survey produced a work distribution of jo%, 10%, and 10% ofthe employees'time per- forming the department's three activ- ities. But while that distribution did reflect how workers spent their pro- ductive time, the fact that their total productive time was significantly less than their practical capacity of 32 hours per worker per week was completely
new investments in capacity. For exam- ple, the vice president of operations at Lewis-Goetz, a hose and beit fabricator based in Pittsburgh, saw from his time- driven ABC model that one of his plants was operating at only 27% of capacity. Rather than attempt to downsize the plant, he decided to maintain the ca- pacity fbr a large contract he expected to win later that year, for which he other- wise would have created new capacity.
troduction of new technology can en- able the same activity to be done in less time or with fewer resources. When per- manent, sustainable improvements in a process have been made, the ABC analyst recalculates the unit time esti- mates (and therefore the demands on resources) to reflect [he process im- provements. For example, if the cus- tomer service department gets a new database system, the reps may be able to
The Impact of Practical Capacity This table shows the effect on cost assignment when we use rates based on practical capacity (700,000 minutes), assumed
here at 80% of theoretical full capacity. We can see thai only about 83% of the customer service department's practical capacity
was actually put to productive use during the first fiscal quarter.
Activity
Process customer orders
Handle customer inquiries
Perform credit checks
Total
Unit Time (minutes)
8
44
50
Quantity
49,000
1,400
2,500
Total Minutes
392,000
61,600
125,000
578,600
Total Cost
S313,600
S49,280
S 100,000
$462,880
ignored. The calculation of resource costs per time unit forces the company to incorporate estimates ofthe practical capacities of its resources, allowing the ABC cost drivers to provide more accu- rate signals about the cost and the un- derlying efficiency of its processes.
Analyzing and reporting costs.Time- driven ABC enables managers to report their costs on an ongoing basis in a way that reveals both the costs ofa business's activities as well as the time spent on them. In our customer service depart- ment example, a time-driven ABC re- port would look like the exhibit "ABC, the Time-Driven Way."
Note that the report highlights the difference between capacity supplied (both quantity and cost) and (he capac- ity used. Managers can review the cost ofthe unused capacity and contemplate actions to determine whether and how to reduce the costs of supplying unused resources in subsequent periods; they can then monitor those actions over time. In somecases,the information can save companies that are considering expansion from making unnecessary
Updating the model. Managers can easily update their time-driven ABC models to reflect changes in operating conditions. To add more activities for a department, they don't have to reinter- view personnel; they can simply esti- mate the unit time required for each new activity.
Managers can also easily update the cost-driver rates. Two factors can cause these rates to change. First, changes in the prices of resources supplied affect the cost per time unit of supplying ca- pacity. For example, if employees re- ceive an 8% compensation increase, the resource cost rate in our example in- creases from $0.80 per supplied minute to $0,864 per minute. If new machines are substituted or added to a process, tbe resource cost rate is modified to reflect the change in operating expense associated with introducing the new equipment.
The second factor that can cause a change in the activity cost-driver rate is a shift in the efficiency ofthe activity. Quality programs, continuous improve- ment efforts, reeiigineering, or the in-
perform a standard credit check in 20 minutes rather than 50 minutes. To accommodate the improvement, just change the unit time estimate to 20 minutes, and the new cost-driver rate automatically becomes $16 per credit check (down from $40). Of course, you then have to add back in the cost impact of purchasing the new database system by updating the cost per time unit esti- mate, so the final figure may be some- wbat higber than $16.
By updating the ABC model on the basis of events rather than on the cal- endar (once a quarter or annually), you get a much more accurate reflection of current conditions. Any time analysts learn about a significant shift in the costs of resources supplied or the prac- tical capacity of those resources, or about a change in the resources re- quired to perform the activity, they update the resource cost per time unit, or resource cost rate, estimates. And any time they leam ofa significant and per- manent shift in the efficiency with which an activity is performed, they update the unit time estimate.
134 H A k V A K D BUSINF.SS RF.VIFW
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Time Equations to Capture Complexity So far, we have rehed on an important simplifying assumption that all orders or transactions of a particular type are the same and require the same amount of time to process. But time-driven ABC does not demand this simplification. It can accommodate the complexity of real-world operations hy incorporating time equations, a new feature that en- ables the model to refiect how order and activity characteristics cause processing times to vary. Time equations greatly
Let's say that ifthe chemical is already packaged in a way that meets standard requirements, it should take 0.5 minutes to prepare it for shipment. Ifthe item requires a new package, however, the manager estimates, either from experi- ence or from making several observa- tions, that an additional 6.5 minutes will be required to supply the new packag- ing. And ifthe item is to be shipped by air, he or she knows (or can quickly de- termine) that it will take about 2 min- utes to put the package in an air-worthy container.
than the traditional ABC system could, which might well have had to account for varying transaction times by treating each variant ofthe process as a distinct activity. Consider the case of Hunter Corporation (not its real name), a large, multinational distributor of scientific products, whose 27 facilities process more than one million orders each month to distribute up to 300,000 dif- ferent product SKUs to 25,000 custom- ers. Its old ABC model required that employees in its inside sales department (the salespeople handling phone and
ABC, the Time-Driven Way This reporting template for time-driven ABC shows the customer service department's costs in the second quarter of operations.
Here we assume that the department processes 51,000 customer orders, handles 1,150 inquiries, and performs 2,700 credit
checks.The data reveal that the company supplied S85,l 20 v\/orth of unused resource capacity during this period, representing
opportunities for savings or growth depending on the company's circumstances.
Activity
Process customer orders
Handle customer inquiries
Perform credit checks
Total Used
Total Supplied
Jnused Capacity
Quantity
51,000
1,150
2,700
Unit Time
8
44
50
Total Time Usec (In minutes)
408,000
50,600
135,000
1 593,600
700,000
106,400
Cost-Driver Rate Total Cost Assigned
S6.40
S35.20
S40.00
$326,400
S40,480
$108,000
$474,880
$560,000
$85,120
simplify the estimating process and pro- duce a far more accurate cost model than would be possible using traditional ABC techniques.
The key insight is that although trans- actions can easily become complicated, managers can usually identify what makes them complicated. The variables that affect most such activities can often be precisely specified and are typically already recorded in a company's infor- mation systems. To take an example, let's assume a manager is looking at the process of packaging a chemical for shipment, ln this situation, complexity arises from the potential need for spe- cial packaging and the additional de- mands of air as opposed to ground transportation.
This information allows the manager to estimate the time required for the packaging process:
Packaging Time = 0.5 + 6.5 [if special packaging requiredj + 2.0 j if shipping by air]
Many companies' ERP systems al- ready store data on order, packaging, distribution method, and other charac- teristics. These order- and transaction- specific data enable the particular time demands for any given order to be quickly determined using a calculation like the one above.
Thanks to this extension, the time- driven approach to ABC can capture the complexities of business far more simply
Internet orders rather than dealing with customers face-to-face) estimate each month the percentage of their time that they spend on three activities: customer setup, order entry, and order expediting.
With the time-driven approach, Hunter's ABC team of analysts was able to group the three activities into a single departmental process,called inside sales order entry. The team learned that it took about 5 minutes to enter the basic order information, plus 3 minutes for each line item, and an additional 10 minutes i f t h e order had to be expe- dited. Ifthe customer were new, 15 more minutes would be required to set up the customer in the company's computer system.
2004 135
T O O L K I T • T i m e - D r i v e n A c t i v i t y - B a s e d C o s t i n g
Strategic Change at Kemps LLC
Kemps, headquartered in Minneapolis, is a full-line dairy,
that produces milk,yogurt, sour cream, cottage cheese, and
ice cream products. Its customers are retailers and dis-
tributors as large as SuperValu and Target and as small
as convenience stores. Kemps markets its products under
its own branded portfolio along with products sold through
private label and copacking contracts. Like most dairies,
Kemps was experiencing consolidation in its customer base.
It decided to shift from its former customer relationship
strategy-willing to do whatever the customer asked-to a
lower-total-cost strategy The new approach clearly required
an accurate understanding of cost by product and customer
that Jim Green, Kemp's CEO, would use to instill a "low total
cost" culture throughout the organization.
As a critical component of the cost-to-serve model,
Kemps implemented a time-driven ABC system so it could
track the costs ofchangeovers in producing and packaging
all its products and the costs of picking, loading, and deliv-
ering products to its diverse customer base.The model cap-
tured differences in how the company entered orders from
customers (customer phone call, salesperson call,fax, truck-
driver entry, EDI, or Internet}, how it packaged orders (full
stacks of SIX cases, individual cases, or partial break-pack
cases for small orders), how it delivered orders (commercial
carriers or its own fleet, including route miles), and time
spent by the driver at each customer location. The extra
time for changeovers to clean out allergens (such as nuts,
eggs, soy, or wheat) used in certain ice cream products
could now be accurately assigned to those products. The
model also captured the extra packaging costs for special
promotions and customer-specific labels and promotions.
The company soon learned it was losing money with one
of its customers, a chain of specialty high-end shops, be-
cause o f t h e low volume and high variety of products or-
dered and the small just-in-time deliveries the chain re-
quested. Kemp's vice president of sales called on the cus-
tomer, explained the situation, and offered three options:
accept a price increase and a minimum order size; elimi-
nate its private-label ice cream, replacing it with Kemp's
standard branded productthat was already being produced
in efficient, high volumes; or find another ice cream sup-
plier. When the customer inquired why Kemps was making
the change, the VP responded that after 25 years, Kemps
only now understood its true manufacturing costs and
the impact of specialty production on its margins. The cus-
tomer accepted a price increase of 13%, agreed to the elim-
ination of two low-volume products, and agreed to accept
full rather than partial truckload orders, thereby eliminat-
ing internal storage charges for Kemps. The changes pro-
duced immediate benefits of $150,000 per year, transform-
ing this unprofitable customer into a profitable one,
Kemps also used its time-driven ABC model proactively
to become the leading dairy supplier to a nationa! cus-
tomer. Kemps demonstrated that it could Identify the spe-
cific manufacturing, distribution, and order handling costs
associated with serving this customer on the basis of actual
order characteristics: DSD (direct store delivery) or ship-
ments to distribution centers, gallon versus pint deliveries,
and volume and mix of products. The time-driven ABC
model facilitated an open, trusting relationship between
supplier and customer that differentiated Kemps from its
competitors.
Kemps also became aware that some of its smaller con-
venience store customers had been overordering and re-
turning product when the date code expired- To avoid the
high cost ofthese rebates and returns, Kemps offered these
retailers a 2% discount if they would manage their own
inventories without the return option. In this way, Kemps
eliminated 95%ofout-of-code returns, generating a net sav-
ing of $120,000 per year.
F o l l o w i n g the approach described
earlier, the previous three-activity model
was replaced by a single time equation:
Inside Sales Order Entry Process Time =
5 +(3 X number of line items) + ?5 [if
new customer! + 10 [if expedited order I
This was straightforward to imple-
ment since Hunter's ERP system already
tracked the number of line items for
each order and included fieids that iden-
tified whether it was a rush order and
whether the customer was new. The
model multiplied the estimated sales
process time by the departmental cost
per minute to arrive at the cost of pro-
cessing each order. Hunter could now
obtain a more accurate and nuanced
estimate of Its costs in the unit while
simultaneously reducing the complex-
ity of the process for gathering and
analyzing the data. Hunter has since
rolled out time-driven ABC over all
its operations. The results have been
dramatic:
• Hunter has reduced the number of
items tracked from 1,200 activities to
200 department processes.
• Managers can add complexity to the
model by simply adding new elements
to the time equations, which places less
strain on Hunter's accounting system
than incorporating new activities would.
• Cost estimates are now based on
actual order characteristics and direct
observations of processing times, not on
subjective estimates of where and how
people spend their time.
136 HARVARD BUSINESS
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• The new model is easier to validate. Hunter can reconcile the total process time - that is, the total absolute time spent on all the activities tracked in a given period - t o other measures of re- soLirces supplied, such as head count. If the total process time is lower than the time implied by the head count, for ex- ample, managers know that some of their unit time estimates are too low or that people are not working to ca- pacity. This validation is difficult with traditional ABC, which is based on esti- mated proportions of time spent and rarely incorporates idle or unused ca- pacity time.
• Hunter's time-driven ABC model requires only two people workinî two days per month to load, calculate, vali- date, and report findings, compared with the ten-person team and three weeks that were necessary to maintain the previous model. Employees now spend time generating profits from the information rather than iust updating and maintainini^ it.
The kind of rollout Hunter conducted is not difficult to achieve. Time-driven ABC models can be easily applied and customized for other plants and com- panies within an industry because the processes they use are similar. Dave Deinzer, CEO ot Denman & Davis and president ofthe North American Steel Alliance, commented, "For the most part, we are all pretty much the same...cutting, sawing, and finishing metal with the same equipment and the same procedures. You could proba- bly apply the same time-driven ABC model to ali of us." The chief infonna- tion officerof another steel distributor, TW Metals, noted,"We were able to roll out our time-driven ABC template model to all ib of our facilities within three months."
The ability of time-driven ABC to identify and report comple.x processes in a simple way also provides a power- ful negotiation tool when it comes to dealing with customers. Wilson-Mohr, an industrial controls company in Hous-
ton worked as a subcontractor to engi- neering contractors (ECs) on the con- struction of custom process-control sys- tems for retineries and chemical plants. Its time-driven model revealed, for the first time, the high cost of engineering change orders issued by the ECs to re- place parts or reconfigure the design. In the past, Wilson-Mohr charged an EC only for the predicted materials cost changes resulting from the change or- ders. Now it can also clearly itemize the cost of additional sales, design, engi- neering, and manufacturing labor time consumed when implementing change orders, which makes it easy to recuper- ate these costs through price recovery. (Eor a detailed example of how time- driven ABC helps companies manage customers, see the sidebar "Strategic Change at Kemps LLC")
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T O O L K I T • T i m e - D r i v e n A c t i v i t y - B a s e d C o s t i n g
introduce time-driven ABC into their processes. Most have reported substan- tial improvements in profitability that they attribute to the information gen- erated by the new approach. Take the case of Banta Eoods, a Midwest food
people to increase the net profits of their customers. It also renegotiated with vendors to recoup the cost of pro- cessing customer rebates. The general manager of sales used the information to transform his sales representatives
Profitable Decisions at Banta Foods This table details the opportunities for profit revealed by the introduction of
time-driven ABC and the estimated impact on total profits at a SI 55 million food
distributor.
Opportunities Identified
Establish minimum order size
Recover vendor rebate processing costs
Conduct what-if profit analysis on new business
Perform vendor reviews
Total
distributor with revenues of $155 mil- lion from 17.000 SKUs and 5.000 cus- tomers. It operated on a razor-thin net margin of about \%. Historically, its profit drivers were increasing the num- ber of orders taken per day, increasing aggregate revenues, and controlling ag- gregate expenses.
Banta's time-driven ABC system, which was fully implemented within 16 weeks, revealed much more granularity in its expense structure by tying costs to products, orders, customers, and ter- ritories. Managers learned that a $1,000 order, previously considered the smallest size to break even, could either be quite profitable or a loss depending on the distance to the customer, the location of the product in the warehouse, the size of the order, the frequency of delivery, the type of service, and the credit rating of the customer - all of which were in- corporated in the algorithms in its new time-driven ABC system,
Based on the data in its ABC model, Banta instituted a nonnegotiable mini- mum order size, reduced the inventory of unprofitable products, promoted sales of high-profit products, negotiated with customers either to reduce the de- mand for high-cost services or to reprice them, and offered incentives to its sales-
Total Profit Impact
22%
21%
20%
5% 68% (1.4% of revenues)
from order takers to consultants, help- ing them to create customers and terri- tories that were more profitable for Banta. He reports,"Salespeople can now increase their gross profits not by simply adding points to their margin but by knowing which items to sell."
By accurately projecting the cost and profits of proposed business, Banta has been able to take on new business that
has increased revenues by 35* ^̂ nd gen- erated immediate profit improvements of 43%. with a further 25% yet to come through from future opportunities. (See the exhibit "Profitable Decisions at Banta Foods.") Its performance has led to the distinction of being named "In- novator of the Year" by the industry journal, lii'^titutiouai Distributor.
Over the past 15 years, activity-based costing has enabled managers to see that not all revenue isgood revenue and not all customers are profitable cus- tomers. Unfortunately, the difficulties of implementing and maintaining tra- ditional ABC systems have prevented them from being adopted on any sig- nificant scale. Time-driven ABC has overcome these difficulties, offering a transparent, scalable methodology that is easy to implement and update. It draws on existing databases to incorpo- rate specific features for particular or- ders, processes, suppliers, and custom- ers. Activity-based costing is no longer a complex, expensive financial-systems implementation; the time-driven ABC innovation provides managers with meaningful cost and profitability infor- mation, quickly and inexpensively.
Reprint R04111
To order, see page 151-
"Don't ask how I am, Sims. Then I'll have to ask how you are. And I really don't care."
138 MAKVARD BUSINESS REVIEW
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