Adding Time to Activity-Based Costing

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Q: What are the key benefits to an organization for implementing this model? Can it be benchmarked and evaluated?

A: The benefits come from having detailed and accurate understanding of the company's actual economics. Once managers see what causes them to make or lose money, they easily identify multiple actions that transform loss or break-even operations into profitable ones.

The actions include improving internal processes and eliminating waste, partnering better with suppliers and customers to reduce demands on capacity throughout the supply chain, introducing menu-based pricing in which customers pay for the features and services they use, while other customers receive discounts because they have large order volumes and do not require special features, and, finally, redefining customer relationships that create financial benefits to both parties.

As I noted earlier, profit improvements of up to 2 percent of sales generally come in less than a year. Some companies have realized hundreds of millions of dollars in benefits from reducing capacity they saw was not needed, or that customers were unwilling to pay for, and by focusing on their most profitable products and customer segments.

Q: How does this relate to your work on the Balanced Scorecard?

A: The two work streams are different, but complementary.

They are distinct since TDABC provides enterprises with an accurate model of the cost and profitability of producing and delivering their products and services, and managing their customer relationships. TDABC provides companies with vital cost information but says little about what customers value.

The Balanced Scorecard fills this void by describing how companies create value for customers and shareholders. The BSC measures the customer value proposition, and links critical processes and intangible assets to customer and shareholder value creation. Thus, ABC provides a model of cost while BSC describes a model of value creation. They provide different levers for measuring and implementing a company's strategy.

Companies whose BSC describes a low total cost strategy need ABC for accurately measuring the costs of critical processes. Otherwise they run the considerable risk of implementing a low-cost strategy with faulty information about their fundamental cost drivers. Companies that use a BSC to describe and execute a differentiation strategy need ABC to measure whether the value they create from their differentiation for customers exceeds the cost of achieving this differentiation.

The complementary nature of the two approaches becomes even more tangible when companies contemplate adding customer profitability information to their BSC customer perspective. The ability of TDABC to measure, simply and accurately, profitability at the individual customer level allows companies to consider new customer metrics such as percentage of unprofitable customers, and dollars lost in unprofitable customer relationships.

Such customer profitability metrics complement conventional customer success metrics, such as satisfaction, retention, and growth, to signal that customer relationships are desirable only if these relationships generate increased profits. They provide the link between customer satisfaction and improved financial performance. Scorecard measures of the incidence of unprofitable customers and the magnitude of losses from unprofitable relationships focus the organization on managing customers for profits, not just for sales.

The newest and potentially most powerful linkage between the BSC and ABC is articulated in a book chapter that illustrates how a time-driven ABC model bridges the gap between the Balanced Scorecard's strategy focus and the budget, which authorizes spending for the resources required to create, produce, and deliver on the company's strategic plan. TDABC's ability to measure and manage the costs of a company's capacity resources can be tightly linked to fulfillment of the company's strategy, as articulated in the company's strategy map and Balanced Scorecard.

Q: What are you working on now?

A: I hope to work with companies to learn more about how to use the TDABC model to link strategic planning and operational budgeting. This work is central to the next book, which Dave Norton and I are currently writing, on using the Balanced Scorecard to link strategy and operations. Our four previous Balanced Scorecard books focused almost exclusively on strategy and its implementation. Now we are identifying the important linkages between strategy and operations that will give companies a comprehensive, integrated system to manage both for short-term results and long-term value creation. Norton and I are quite excited about how all this is coming together.