Retail Solutions: Time-Driven Activity-Based Costing

A Simpler and More Powerful Path to Higher Profits
By Robert S. Kaplan and Steven R. Anderson

It's been twenty years since activity-based costing (ABC) first attracted attention as an innovative way for companies to identify the true costs of providing a product and its related services. With ABC, companies began enhancing the profitability of their products and customers, better managing capacity utilization, and improving process efficiency.

But even as ABC offered important new advantages over older methods of costing, it also had limitations. For example, ABC systems were expensive to build, complex to sustain, and difficult to modify. Many people also questioned the accuracy of cost assignments based on employees' subjective estimates of how much time they spent on various activities. Moreover, managers wondered whether employees—anticipating how the data they provided might be used—could be tempted to distort their responses. Focused on these concerns, managers in operations, sales, and marketing spent more time arguing about the accuracy of ABC-derived cost and profitability estimates, than addressing the cost and profitability problems that their ABC efforts had uncovered.

In TIME-DRIVEN ACTIVITY-BASED COSTING: A Simpler and More Powerful Path to Higher Profits, Robert S. Kaplan and Steven R. Anderson present a simpler, cheaper, and far more potent approach to ABC. With time-driven activity-based costing (TDABC), managers no longer need to interview and survey employees to allocate resource costs to activities before assigning costs to orders, products, and customers. Instead, managers exploit the data now available from the enterprise resource planning (ERP) systems in place in many companies.

With TDABC, managers spend less time and money gathering and maintaining data and more time addressing the problems this approach reveals—such as inefficient processes, unprofitable products and customers, and excess capacity.

Kaplan and Anderson present the two fundamental questions managers must answer to build an effective TDABC model based on time equations:

• "How much does it cost to supply resource capacity for each business process in our organization?" For example, what is the total cost of personnel, supervision, occupancy, technology, and supplies used to run the company's order-processing department?
• "How much resource capacity (time) is required to perform work for each of our company's transactions, products, and customers?" To illustrate, how much time does it take to process a particular customer order?

A typical TDABC model requires fewer equations than the number of activities used in a conventional ABC model—thereby affording simplicity. Meanwhile, TDABC also permits much more variety and complexity in orders, products, and customers—thus adding accuracy at little extra cost and effort. And unlike conventional ABC, managers can also easily update their TDABC models to reflect changes in their companies' operating conditions.

In addition to providing the normal benefits afforded by activity-based costing, TDABC offers new applications critical to any company seeking to control costs, make smart investment decisions, and better manage service levels within and outside the organization. Specifically, managers can now link strategic planning to operational budgeting, enhance the due diligence process during mergers and acquisitions, and support continuous improvement initiatives such as lean management. TDABC also enables managers to eliminate unnecessary complexity in their companies' supply chains and optimizing staffing in strategic parts of their workforce.

Consider Sanac Logistics, a family-owned Belgian company that distributes and retails branded plant-care products to farmers, growers, public sector companies and landscapers, and large and small consumer shops. In 2005, Sanac had revenues of €62 million, 7,000 products, a transportation fleet of 25 trucks, and 129 employees.

But by the year 2000 competition had stiffened, and Sanac's profit margins were coming under increasing pressure as customers grew more diverse in their needs and asked for more services. To deal with these new challenges, Sanac switched from a growth strategy to a profitability-enhancing strategy.

Through TDABC, Sanac quickly identified and improved inefficient processes and transformed unprofitable customer relationships. Its near-term profit improvements enabled Sanac to win a reputation as a well-run company in a highly competitive market. Its profit turnaround attracted the attention of AVEVE, the sector's market leader, which acquired Sanac in December 2005.

During the due-diligence process by AVEVE, Sanac used its TDABC system to show profitability by process and product group. The time equations revealed some idle capacity, facilitating the reorganization of some business processes and the preparation of the company for the planned acquisition. Sanac's CEO, Gertjan De Creus, maintained that he never imagined that the TDABC project would play such an important role in creating shareholder value.

TIME-DRIVEN ACTIVITY-BASED COSTING provides numerous richly detailed case studies in addition to Sanac to illustrate the TDABC approach and its advantages. Featured organizations include Kemps LLC, ATB Financial, Citigroup Technology Infrastructure Division, and Jackson State University. A vital new resource, this book gives managers the tools and examples they need to maximize the value of their activity-based costing system.

About The Authors
Robert S. Kaplan, a cocreator of both Activity-Based Costing (ABC) and the Balanced Scorecard, is Baker Foundation Professor at Harvard Business School.

Steven R. Anderson is the founder and chairman of Acorn Systems, a software and consulting firm headquartered in Houston, Texas.

Source: Acorn Systems