using activity-based costing to implement supply chain improvements
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Using Activity-Based Costing to Implement Supply Chain Improvements. Terrance L. Pohlen Lt Col, USAF, PhD. Overview. Why transportation and logistics managers require more accurate cost information How activity-based costing can provide greater management insight - PowerPoint PPT PresentationTRANSCRIPT
Using Activity-Based Costing to ImplementSupply Chain Improvements
Terrance L. PohlenLt Col, USAF, PhD
Overview
• Why transportation and logistics managers require more accurate cost information
• How activity-based costing can provide greater management insight
• Using ABC to support transportation and logistics decision-makers
• Applying ABC to supply chain management
•Critical link exists between corporate profitability and logistics costs and performance
•Many logistics costs and effects of logistics decisions buried in overhead costs
•Logistics particularly requires accurate costing
– Diversity in resource consumption
– Products and resource consumption not correlated with unit based allocation measures
•Identifying and costing activities may reveal opportunities to improve operating efficiencies
Transportation and logistics managers need more
accurate cost information
Problems typically encountered in transportation and logistics
accounting systems
• Visibility frequently lost--included as part of
SG&A• Allocated using cases shipped, miles, or sales• Costs not available by product, customer, or
supply channel• Affect of logistics decisions/improvements not readily apparent• Output measures frequently not captured
“The imaginary profits--and losses--that arise from flawed cost systems can lead to very expensive blunders. We may be giving away the best business (high volume, but supposedly low margin products) to foreign companies. Competitors don’t want your cats and dogs--they want the volume business. Once the high volume products are abandoned, those that remain must carry a greater share of overhead, and thus they too become less profitable.”
Fortune Magazine12 October 1997
Activity
DIRECTMATERIALS
DirectLabor
Activity
DIRECTMATERIALS
Activity
DIRECTMATERIALS
Activity
DIRECTMATERIALS
OUTPUT $$
Traditional Cost Accounting
DirectLabor
DirectLabor
DirectLabor
Overhead
Problems with Traditional Costing of Transportation & Logistics
• Unit based allocation suggests costs will vary with volume--cannot accurately determine how changes in customer service effect total costs
• No reward for reducing indirect cost categories--benefits diffused across all products
• Costs “reduced” by eliminating direct labor
• Overhead costs appear “fixed” and not affected by management action
• Rewards based on cost center performance and not on total product/customer/channel profitability
Are U.S. Manufacturers’ AccountingSystems a Major Tool Used in
Management Decision-Making?
Source: National Center for Manufacturing Sciences, Focus, 1993
Yes82%
No18%
Warning Signals:
• Division managers want to drop seemingly profitable lines
• Product or customer profitability is hard to explain
• Departments develop internal costing systems
• The accounting department performs many special projects
• Competitors’ prices appear unrealistically low
• You have a high-margin niche all to yourself
• Customers don’t mind price increases
Adapted from Cooper, Robin, “You Need a New Cost System When...,” Harvard Business Review, January-February 1989, pp 77-79.
SupervisionSupervisionOfficeOffice
SupportSupport UtilitiesUtilities SuppliesSupplies EquipmentEquipment
ReceivingReceiving Put-AwayPut-Away Set-UpsSet-Ups
Resources
Activities
Cost
Objects
Packing &Packing &
ShippingShipping
ProductProductDivision ADivision A
ProductProductDivision BDivision B
ProductProductDivision CDivision C
ProductProductDivision DDivision D
a technique to assign more accurately direct and indirect costs to the activities, customers or products which consume an organization’s resources
Activity-Based Costing
Activity-Based Costing
IS:
An overhead allocation technique which generates the cost of activities
IS NOT:
A bookkeeping system
A consolidation system
GeneralLedger
(accountbalances)
ABCModel
Data
DecisionMakers
Activity-basedinformation
Cost datatranslatedby ABC
ABC translates traditional costing into actionable information for decision-makers
SupervisionSupervisionOfficeOffice
SupportSupport UtilitiesUtilities SuppliesSupplies EquipmentEquipment
ReceivingReceiving Put-AwayPut-Away Set-UpsSet-Ups
Resources
Activities
Cost
Objects
Packing &Packing &
ShippingShipping
ProductProduct
Division ADivision A
ProductProduct
Division BDivision B
ProductProduct
Division CDivision C
ProductProduct
Division DDivision D
How Does ABC Assign Costs?
ABC uses a two-stage process to assign costs– Resource costs are
assigned to activities based on use
– Activity costs are assigned to the products or customers consuming the activity
Activity
DIRECTMATERIALS
DirectLabor
Activity
DIRECTMATERIALS
Activity
DIRECTMATERIALS
Activity
DIRECTMATERIALS
OUTPUT $$
Activity-based costing approach
OverheadDirectLabor
OverheadDirectLabor
OverheadDirectLabor
Overhead
Resources
• Resources are usually derived from the general ledger accounts
• Represent the resources the organization has to perform its mission
• Many ABC models use budget information to determine resources
Office Labor9%
Dock Labor
32%
Yard Labor5%
Utilities1%
Pickup & DeliveryDrivers
18%
License1%
Fuel7%
Maintenance5%
Depreciation
4%
Insurance2%
Terminal13%
Supervision3%
Assigning Resource Costs
• Resource drivers used to assign costs to activities
• Interviews frequently used for making the cost assignments
• Activity costs are sum of all resources needed to perform the activity
Office Labor9%
Dock Labor32%
Yard Labor5%
Utilities1%
Pickup & Delivery18%
License1%
Fuel7%
Maintenance5%
Depreciation4%
Insurance2%
Terminal13%
Supervision3%
Billing4% Handling
10%
Pickup6%
Deliver LTL17%
Deliver TL8%Accessorial Services
5%
Line haul8%
Scheduling3%
Load line haul6%
Load delivery6%
Unload8%
Maintain vehicles10%
Process Claims4%
Marketing5%
Activity Cost
• An activity’s cost is the sum of the resources used in performing the activity
• Consumption used to trace resource costs to the activities
Labor
47%
Facility
36%
Supplies10%
MHE2%Supervision
4%Maintenance
1%
LTL Shipping Activity
Identification and Number of Activities
• Activities identified by implementation team
• Level of detail determined by:• Cost• Diversity• Management Focus
• Most DCs using 20-40 activities for costing
Pick listsPlaced inWindow
Pallet pickssent by RFto Fork lifts
WarehouseSigns for and
Takes Pick List
Property pickedandPalletized
Pallet movedto Shrink
Wrap Area
PalletShrink-Wrapped
Pallet moved to Staging
Area
Pallet pickssent by RFto Fork lifts
WarehousemanAnnotatesWork Log
Orders RequiringCHEP PalletsRe-palletized
Receiving CartageUnload and inspectPutaway
Storage Bulk storageAerosol storage
Transp Planning Pre-shipment schedulingTruckload planningPost-shipment supportTransportation Administration
Picking Manual pickingMechanical pickingStage pallet for orderBuild pallet
Special Handling Adjust pallet heightClamp off/slip sheetSpec Hdling/Warehouse office
Shipping Load palletCheck full palletCheck mixed palletShip international orderShip small package order
Administration ReturnsReworkAdministration
Product
Customer
Brand
Assigning Activity Costs
• Activity costs assigned using cost drivers
• Costs assigned on a per activity basis (per case, shipment, bill of lading)
• Desired behavior should be considered when selecting a cost driver
Billing4% Handling
10%
Pickup6%
Deliver LTL17%
Deliver TL8%Accessorial Services
5%
Line haul8%
Scheduling3%
Load line haul6%
Load delivery6%
Unload8%
Maintain vehicles10%
Process Claims4%
Marketing5%
Customer A32%
Customer B26%
Customer C17%
Customer D10%
Customer E8%
Others7%
Assigning Distribution Center Costs
We assign thecost of thisactivity
Manual pickingReworkUnload & inspectTruckload plngBulk storageAdministration
tothiscost object:
customerbrandproductcustomerproductbrand
usingthisactivity driver
cartons mech pickedcartons reworkedpallets unloadedpounds shippedavg pallet on handno. of cartons shipped
Cost Objects
• The final output of the organization
• Typically a customer, product, service, or distribution channel
• Provides total cost of logistics support
Customer A32%
Customer B26%
Customer C17%
Customer D10%
Customer E8%
Others7%
Cost Object: Bill of Activities
Pickup15%
Billing2%
Line Haul55%
Delivery6%
Dockhandling-Origin10%
Processing Claims1%Dockhandling-
Destination8%
Scheduling3%
Breakout ofCustomer A Costs
Product Division A31%
Product Division B40%
Product Division C
16%
Product Division D13%
ABCResults
Product Division A29%
Product Division B30%
Product Division C20%
Product Division D21%
TraditionalCosting Results
Comparison of ABC and Traditional Costing
• Focus shifts from correlating unit level cost drivers (direct labor hours) to correlating cost drivers at the unit, batch, and process levels
• Overhead assigned to activities based on consumption--costs assigned to products based on the consumption of the activities performed
• “Fixed costs” viewed as long-term variable costs affected by short-term management decisions
• Isolation of costs enables managers to trace cost reduction efforts to specific products, customers, or supply channels--benefits no longer diffused
• Managers can trace the effect of decisions on product or customer profitability--ABC captures the effects of diversity
• ABC provides significant amounts of non-financial information--useful for integrating cost management with performance management
How ABC Can AssistLogistics Decision-makers
• Can more accurately determine how changes in service requirements will affect logistics costs
• Provides ability to trace indirect resources to logistics activities and outputs
• Focus on high cost activities or processes
• Translate logistics performance into corporate profitability
• Greater visibility over logistics costs--better trade-offs within the firm
• Simulate changes and impact on logistics costs
Benefits Obtained From ABC
Identify cost driver
Performance measures
Improved cost info
Better pricing
Elim redundant work
Cost control
65%
59%
47%
41%
41%
23%
LaLonde and Pohlen, Journal of Business Logistics, 1994
Office Labor9%
Dock Labor32%
Yard Labor5%
Utilities1%
Pickup & DeliveryDrivers
18%
License1%
Fuel7%
Maintenance5%
Depreciation
4%
Insurance2%
Terminal13%
Supervision3%
Load delivery
Billing4% Handling
10%
Pickup6%
Deliver LTL17%
Deliver TL8%Accessorial
Services5%
Line haul8%
Scheduling3%
Load line haul
6%
6%
Unload8%
Maintain vehicles10%
Process Claims4%
Marketing5%
Customer A32%
Customer B26%
Customer C17%
Customer D10%
Customer E8%
Others7%
ABC demonstrateshow logistics resources
and activities are consumed
Problems frequently encountered during ABC implementation
• Management and employee buy-in • A new “system” and stand alone initiative• Accuracy versus precision• Delay in immediate pay-off• Multiple views on cost allocations and costs• Putting controller in charge• Too much detail--costing vs reengineering• Cost and effort required during implementation
Where ABC best practices are being implemented
General Analysis: Nabisco, Roundy’s, Food Lion,Tops, Coca-Cola, Pepsi-Cola,Dial Corp, Bozzotos, Kroger,Shaw’s
Category Analysis: Procter & Gamble, Super Valu,Fleming, H.E. Butt
Menu Pricing: Spartan, Fleming, Super Valu
Application of activity-based costing tosupply chain management
• ABC can evaluate alternative supply chains• Activity analysis can achieve a sustainable competitive advantage by lowering costs or differentiating services• Supply chain analysis enables firms to exploit linkages and perform trade-offs across the entire supply chain• ABC/ABM provides means for assessing individual firm as well as supply chain performance
Vendor(Upstream)
Customer(Downstream)
Perspective ofthe Firm
MarketplaceLanded Cost
Total Cost ofOwnership
DPP, ABC
DPP, ABC
Sup
ply
Cha
in C
ostin
g
Why supply chain costing?
• Determine overall effectiveness of the supply chain
• Identify opportunities for improvement
• Measure performance• Evaluate alternative supply chain
structures• Select supply chain partners• Support “make versus buy” decisions• Negotiate prices• Evaluate effects of technology
improvements• Reengineer the supply chain
Supplier
MaterielsManagement
Operations
PhysicalDistribution
Customer
Tra
nsa
ctio
n c
ost
s
Info
rma
tion
co
sts
Ph
ysic
al f
low
cos
ts
Supply Chain Costs
Inve
nto
ry C
arry
ing
Co
sts
Why use supply chain costing?: customer and channel profitability
• Type of customer and distribution channel generally have greater affect on costs than product type• ABC can determine how customers/ channels drive indirect costs• Customer/channel costing provides technique for assessing profitability• Joint action between supply chain members can reduce costs
Using ABC to simulate cost changeswithin the supply chain
TargetSetting
ActivityAnalysis
Processredesign
Activity-basedcosting
Performancemeasurement
& benchmarking
Problemsolving
Time Quality Cost Flexibility
The Continuous Improvement Cycle, Paul Sharman, CMA Magazine, Vol 66, No. 4
Distribution Center Application:Activity Volume Change
• Determine how anticipated shifts in activity volumes will affect distribution center costs.
• Use cost per activity and activity volume to assess effect
• Example:
Customers order more frequently but in smaller quantities
Activity volume example
Activity
Load Whse Transfer
Load Pool Shipment
Load LTL/UPS
Storage
Process Orders
Process Returns
Pull/Put Full Pallets
Ship Priority
Ship Routine
Pick/Build Orders
Receive Whse Transfer
Cost per Activity
$150/truck
210/truck
16/shipment
125/pallet/year
18/order
75/return
4/pallet
$40/shipment
36/order
95/WT
Activity Volume
+300
+300
-2,100
4,800
+5,400
$10,800
-10
+300
Net change to the DC: +$18,900
$25/shipment
Change
INDICATOR LEVEL 0 LEVEL 1 LEVEL 2 LEVEL 3 LEVEL 4
ReceivingOptimization
Non-staged or unitizedshipments manuallyreceived with driversoften expected to unload;information processed attime of delivery with noadvanced preparationand poor document andload integrity
Pallets staged to reducehand unloading andimprove unloadingefficiency; informationprocessed at time ofdelivery with no advancedpreparation and limiteddocument and loadintegrity
Pallets staged and loadedto minimize in-transitdamage; manufacturerelectronically transmitsinformation (ASNs andEDI) prior to delivery toupdate files, increasedocument integrity andallow retailer receiptpreparation; somedelivery exceptions
Manufacturer hasestablished cost effectivefreight configurationguidelines to optimizespace and unload time fordifferent load types,supports drop and hook,uses EDI and ASNtransmissions; allowsretailer receiptpreparation (matching,label printing, etc);minimal deliveryexceptions
Joint assessment foreach order and shipmentto reduce receiving timeand space, using freightconfiguration, “tie andhigh” capability, and DCreceiving area utilization(drop and hook usedwhere applicable)supported by EDI andASN transmissions thatsupport pre-deliveryactivities; rare deliveryexceptions
CrossDock—CustomCubes
Cross docking at retailerDC not supported bymanufacturer
Cross docking supportedonly for promotionalitems for largest storesand with extended orderlead time
Cross docking done forpromotional items formost stores and withabove normal lead times;beginning to support turnitems
Manufacturer supportssystemic cross dockingfor both promotional andturn items, primarily forsingle SKU pallets;normal lead times;deliveries accompaniedby ASNs/Pallet UCC 128
Manufacturer supportscross docking of store-ready pallets; minimallead times; deliveriesaccompanied by ASNs
Pallet andCaseLabels(Barcoding)
No labels supplied orsupported
Testing UCC/EAN-128pallet labeling withretailer; UPC (SCC-14)bar codes available onmost outgoing cases
Supports UPC (SCC-14)and UCC/EAN-128 (SSC-18) on outgoing casesand pallets; included onASNs, but not used toreceive via scanning;considering complianceissues
Pallet and case labelingis integrated fully withASNs to automatereceiving via scanning;consistent compliancewith industry standards
Joint implementation ofpallet and case labelingwith retailer based on acomplete analysis of allcosts including the cost ofapplying labels;consistent compliancewith industry standards
Using ECR scorecards to determine supply chain capabilities and costs
Activity-Based Management
• Use non-financial data provided by ABC to drive continuous improvement and reengineering
• Link performance measurement system to changes in process costs or profitability
• ABC can trace effect of management decisions to changes in total process cost or profitability
The Two-Dimensional ABC Model
Activities Performance Measures
Cost Drivers
Cost Objects
Resources
Process View
Peter B. B. Turney, Common Cents
Cost Assignment View
Cost Assignment View
Focus of early ABC efforts
Objective - more accurate product costs for product mix, sourcing and product design decisions
Activities
Cost Objects
Resources
Cost Assignment View
Process View
Focus of newer ABC implementations
Objective - improving operational processes by identifying (and
eliminating)
non-value-added activities
Activities Performance Measures
Cost Drivers
Process View
Balanced scorecard approach
Financial Perspective
Goals Measures
Internal Business Perspective
Goals Measures
Innovation andLearning Perspective
Goals Measures
Customer Perspective
Goals Measures
How do we lookto shareholders?
What must we excel at?
Can we continue toimprove and create value?
How do customers see us?
Kaplan, Robert S., and David P. Norton, “The Balanced Scorecard - MeasuresThat Drive Performance,” Harvard Business Review, January-February 1992, pp. 71-79.
Vendor/Carrier Evaluation
• Vendor selection affects the costs of ordering, expediting, receiving, inspection, production, and distribution
• ABC provides a means of more accurately tracing how vendor decisions affect total costs
• Purchasing managers can use “total cost of ownership” in vendor selection and evaluation
• Activity analysis opens potential for exploiting vendor-buyer linkages to reduce costs and differentiate service
Use ABC to assess current carriers and vendors:
Key References
• Turney, Peter B. B., Common Cents: The ABC Performance Breakthrough, Portland, OR: Cost Technology, 1993.
• Player, Steve and David Keys, Activity-Based Management: Arthur Andersen’s Lessons from the ABM Battlefield, New York: Mastermedia Ltd., 1995
• Journal of Cost Management published by Warren, Gorham & Lamont
• Brinker, Barry, editor, Emerging Practices in Cost Management: 1996 Edition, Warren, Gorham & Lamont, 31 St. James Avenue, Boston, MA 02116, (800) 950-1213
• Cokins, Gary, Activity-Based Cost Management: Making It Work, Chicago, IL: Irwing Professional Publishing, 1996