Core  values

Buying software is not the first step in an ABC project plan, or in any other type of upgrading process. Core values are at the heart of any project planning process. The challenge is determining what these are.  An example of how Bank of America views its core values for ABC helps explain the process

By Alan Vercio and Lee Champion

The activity-based costing (ABC) failure rate has been significant. There are many factors that contribute to these failures, but none as conspicuous as the tendency of companies to buy software as one of the first steps in the project.

It appears that when an individual buys software, that person has purchased two licenses. The first is for the software and a second that reads, “You are no longer authorized to think. This software will do anything and everything for you. It has all the answers. All you need to do is fill in the blanks. We have made this software so user friendly that it does all of the thinking for you.”

At a recent CAM-I Cost Management System quarterly meeting (for more information visit www.cam-i.org), the Activity-Based Cost Management Design Framework Interest Group stated, “Software acquisition is not a precursor to model design.”

We know why ABC projects fail. Shame on us if we let a known factor obstruct our project’s success. The sidebar on this page lists ten reasons for a failed cost measurement improvement project. Most of these have been well documented and published.

Why Core Values?

Lou Gerstner, former IBM CEO, noted in his book Who Says Elephants Can’t Dance the importance of core values in making any project work:

...I believe all high-performance companies are led and managed by principles, not by process. Decisions need to be made by leaders who understand the key drivers of success in the enterprise and then apply those principles to a given situation with practical wisdom, skill, and a sense of relevancy to the current environment.

The requirements (procedures) for a cost measurement system are specific to the business context. Unlike the procedures in a cost measurement process, core values transcend these specific requirements. Core values serve as a guide when building business specific solutions. If the design of the measurement system doesn’t begin with core values, then subsequent design and development won’t likely be optimized.

McDonald’s, for instance, was based on core values set out by founder Ray Kroc — a commitment to quality, service and cleanliness (QSC). As John Love noted in McDonald’s: Behind the Arches, “QSC long ago became the most popular acronym among fast-food operators, but the phrase originated with Kroc, and he used QSC to distinguish McDonald’s from all other competitors...”

Core Values

Ten core values have directed our cost measurement work at Bank of America. Without considering these values first, no software purchase would be relevant.

1. Customer profitability is the single most important “cost related” metric in the company.

Projects are driven by this objective. Supporting productivity is a distant second objective. It is very easy to get bogged down in productivity improvement opportunities. However, there are other programs available to companies in which the primary mission is productivity, such as Total Quality Management and Six Sigma.

We have also found that approaching a business unit for activity analysis is much easier when one of our first pages in the presentation states that we aren’t there to conduct a productivity assessment; we are there to understand how the customer uses particular services.

By creating causal cost data for customer profitability, meaningful process and activity information will also be available for use by the quality and productivity teams.

Why customer profitability? Why not just focus on quality and productivity? Henry Ford said it best: “There is nothing in quality of goods or quality of service that can overcome the economic error of selling at a loss. Profit is essential to business vitality.”

2. Cost will be based on facts and independent of pricing, profit, and behavioural incentives.

Building an economic mirror of operations doesn’t begin with asking what you want the cost to be. It doesn’t begin with identifying the product you want to be profitable. It begins with the reality of operations. Although a relevant cost measurement methodology isn’t driven by behavioural incentives, when it delivers better cost data, behaviour change will be evident through different decisions about customers, products, processes, activities, and suppliers.

For instance, one factory management team, working closely with their finance team, began increasing the cost of a process they didn’t want in their factory. This “behavioural” costing drove the profit managers out of that market. A year later, that process was transferred to another factory. That factory established the relevant cost, which, of course, went down and the profit managers were back at their customers’ doors begging to reengage. Putting market decisions in the hands of operations and finance or anyone else that doesn’t have responsibility for a bottom line is risky business.

 There are a number of ways to influence behaviour without distorting the economics of the business. Those include financial and non-financial incentives. There is no reason to artificially change the activity cost of a product or customer.

3. Relevant cost measurement is a mirror of operations.

Approximately 90% of data is operational data. This data should be owned and used by operations. It shouldn’t be developed and then owned by an ABC team. When the ABC team owns the operational data, operations will be reluctant to use the data or endorse the resulting cost data.

If relevant operational data isn’t available, that part of the business has a much bigger problem than cost measurement. Variability will be extremely high. Planning and communications from and to other business areas will be limited at best. The ABC team should work with operations to establish that data. This will slow down the ABC project, but the alternative isn’t a wise choice.

4. Cost and quality should never be viewed in isolation of the other.

Kaoru Ishikawa notes in What is Total Quality Control, The Japanese Way, “Cost control and quality control are two sides of the same coin. To engage in effective cost control, effective quality control must be implemented.”

Quality represents the voice of the customer and will range from response time to a power consumption engineering specification. Cost represents the organization’s resources to provide that quality for the customer.

5. The only reason to perform cost measurement is to improve   a decision.

Not just any decision, a targeted decision. Accordingly, targeted decisions should be analyzed and non-relevant cost data required for planning, executing, and controlling be screened and kept from the decision maker.

As Peter Drucker has noted, executives are now computer literate, but not enough are yet information literate — they may know how to get data but don’t necessarily know how to use it:

Few executives yet know how to ask: What information do I need to do my job? When do I need it? In what form? And from whom should I be getting it? Fewer still ask: What new tasks can I tackle now that I get all these data? Which old tasks should I abandon? Which tasks should I do differently? Practically no one asks: What information do I owe? To whom? When? In what form?

It may sound disrespectful to say that an executive isn’t allowed access to this or that data, but giving executives data not required for decisions they are responsible for comes with three hazards. First, the data they do need will be hidden and potentially lost. Second, the time it takes to sort through all the data to find what they need will be  high. Third, they may be tempted to poke their noses in other managers’ business because they can see their data.

This core value might be overwhelming but it shouldn’t be. There are a few important decisions that the cost project should focus on. These include decisions about customers, products, end-to-end processes, activities, resources and suppliers. These decisions can be subdivided into acquire, change, or delete (see the diagram below).

6. There will be one cost accounting methodology.

Celebrated companies don’t have 40 different ways to do the same thing. Differences drive variability. Variability drives quality down and cost up.

There are two sources of variability — in the metrics and in the process. The first target for variability reduction is in the metrics so the process owner can get a relevant measure of variability in the process.

In Six Sigma terms, the targeted level of cost methodology across the organization should be no lower than “reproducible”. In the Software Engineering Institute (SEI) Capability Maturity Model (CMM), this is referred to as “defined”. At this level of process discipline, governance across the organization is required to ensure that all participants are using the same policy, standards, processes, and procedures. This will drive synergy in tools and training, subsequently increasing understanding and use. It will minimize management confusion and frustration. It will minimize the start-up time for associates that transfer from one business unit to another.

7. Cost measurement is a process.

This process and the resulting sub-processes should be managed with a high level of process discipline. This begins with project management, carried out according to the Project Management Institute’s guidelines, and continues with process management.

“In the past the man has been first. In the future the system (process) must be first.”  Frederick Taylor wrote this in 1911 after he had demonstrated how productivity improvement begins with process understanding, definition, measurement, and controlled management. The productivity results were impressive — in some cases approaching 300%. Taylor’s process required the worker to become subservient to the process. For this, he has received a fair amount of criticism. However, there is no other way to take variability out of the process and provide the customer with a reproducible experience. Consider what you would expect if each store manager was in charge of the menu at McDonald’s, or each worker was in charge of the recipe at the Pringles Potato Chip production process, or each CFO was in charge of their own accounting standards, or each business unit cost accountant was in charge of their own cost methodology.

The process discipline driven by the SEI’s Capability Maturity Model (CMM) is almost identical to the work that Frederick Taylor pioneered in the late 1800s. The productivity improvement results are similar. The primary difference is that Taylor’s work was targeted at the blue-collar worker. The CMM work is targeted at the knowledge worker.

8. The primary value-add from relevant cost measurement is in the up-stream decision processes.

These decision processes include customer selection, product design, process design, tool selection, resource selection, and supplier selection.

As a general rule, 80% of the life cycle “opportunity” — revenue and cost — are determined in these early decisions. Most of the productivity improvements brought about by Total Productive Maintenance, Six Sigma, Total Quality Management, and Supplier Management processes are undoing decisions that were made early in the process.

Providing value to these decisions requires an historic economic mirror of operations at the process and activity level; the capability to access this data during the up-stream decision processes; and the ability to do “what-if” analysis to reflect the differences that come with the new.

9. The definition for the product will be the complete definition as viewed through the eyes of the customer.

“Everyone knows what a product is. It is what you buy at the store, the services of a doctor, or the advice of a consultant. Interestingly, the device often obscures the product. When shopping for food, the food, (the device) is being purchased, but so are the retail environment, the display of the food, the cleanliness of the store, and the ease of parking (the product). A product is the totality of what a customer buys.” William Davidow noted this in his book, Marketing High Technology. He explains that optimizing the whole buying experience for a customer serves as a basis for defining the “total” product.

While we may not be able to apply a relevant cost of brand image to a customer, we can measure the cost required to provide quicker response time to the first class passenger. We can measure the cost of a customer using a retail outlet channel or an e-channel. We can measure the additional cost of processing a loan application for a customer with high risk. These differentiated services for our customers are included in the product definition. The impact to process, activities, capacity, and resources are factored into the cost measurement.

10. We will provide a best in class solution as defined by our internal customers, our competitors, and non-competitors.

Customer managers and product managers have an advantage over internal shared services such as cost measurement services. They learn quickly if their product is competitive relative to the competition and substitute products. In a support role, with a captive market, free market forces don’t affect us. We must  create them.

Creating a competitive solution in a shared service requires looking outside your company. It means reading, learning, and teaching. The CAM-I CMS Program is a very good forum to learn about and to contribute to cost measurement.

Software isn’t the starting place for an ABC or any cost measurement process. Software can’t define customer requirements, product requirements, or a set of reasoned cost measurement requirements. Software is only a tool.

A cost measurement process not grounded first in core values will never be fully coherent. By establishing core values first, it forces you to think through what is relevant and isn’t relevant. By establishing core values as the initial step, a deliberate path is established, one that can’t be compromised by the unique characteristics of certain business units, irrelevant reporting, duplicate work, or an end product that doesn’t meet the decision maker’s requirements.

As Ashok Vadgama, CAM-I President, told a recent CAM-I Cost Management Systems audience: “A fool with a tool is still a fool.”

Alan Vercio, CPA, MBA, PMP-2000 (alan.vercio@bankofamerica.com) works for Bank of America and has had responsibility for their Strategic Cost Services team. He has been active in the CAM-I Cost Management Systems Program since 1988 and has been a member of the IMA’s Committee on Research and Committee on Academic Relations. Lee Champion (lee.a.champion@bankofamerica.com) works for Bank of America and is a manager on the strategic cost services team. His recent work has concentrated on business process design and cost measurement integrated with customer profitability.

For a list of references please contact the editor at rcolman@cma-canada.org.

Reasons for ABC Project Failures

1. Too much focus on software too early in the project.

2. Lack of project management discipline as defined by the Project Management Institute.

3. Insufficient training and knowledge transfer.

4. Not integrated into the formal measurement system.

5. Missing business process discipline and the lack of relevant data.

6. Unbalanced ownership between operations, profitability management, and finance.

7. Project haste makes waste.

8. Too much focus on unit level cost and not on the non-unit level activities - product level, customer level, idle, and administration.

9. Not obtaining methodology buy-in before the users see the numbers.

10. Not establishing a set of core values.

The Fallacy in the Rear-view Mirror Analogy

How many times have you heard that cost accounting is like driving your car by looking in the rear-view mirror? Imagine starting a trip by car or plane where you have no history.  You do not know the history of how much your fuel tank will hold, how much gas you have added, or how many miles per gallon.  Imagine not knowing when you started, how far you have come, or how long you have been traveling.  Would people who make those mirror statements be willing to fly with an airline that does not have a good rear-view mirror and know how to use it.

History is something that we know and use to provide relevant data for a majority of future business cases.  Studying and using history does not preclude a manager from taking risks about or creating changes in customer behaviour or taking advantage of or creating opportunities presented by technology changes — or in the case of the airline, being prepared and trained to avoid risks that have never happened in history.