FIGURE 4.9 Interorganizational Cost and Profit Transparency
Unfortunately, many trading partners across the supply chain have archaic and poor product cost allocation practices. In addition, most have no repeatable or reliable cost assignment methods for their expenses from distribution, sales, and customer management. Therefore, their cost assignments are incomplete.
The consequence of this is that even if suppliers disclose their specific product and service costs, from which profit margins can be derived, the calculated costs are likely to be bogus, or at least have uncertain error. This means that all the sup- pliers’ products are probably over- and under-costed within most supplier’s own cost accounting systems. Until each of the trading partners in the supply chain ap- plies some form of activity-based methods for absorption and direct costing, the supply chain participants will be weakened by making uninformed decisions.
Any dream of interorganizational costing will be just that—a dream.
During the transition period when companies will be implementing their ABC/M systems, some customers in the supply chain will be impatient. They will deduce their suppliers’ costs and profit margins. This means they will model their supplier’s cost structure based on known and estimated data. There is al- ready evidence that customers are hiring consultants who are skilled at con- structing cost and profit models of a customer’s suppliers. The consultants produce these models from knowledge provided by purchasing agents, buyers, and public domain data. In some cases, costs and profits are derived for even the supplier’s suppliers—one step farther back in the chain.
It is inevitable that trading partners will want to know costs and margins across the chain. During the transition period for shared inter-firm ABC/M sys- tems, where there will be broken gaps from suppliers without an ABC/M system, the downstream suppliers will apply best-guess assumptions about their upstream suppliers’ profits and margins. However, the best way to know for sure will be wheneachparticipant has its own ABC/M system in place.
ABC/M Integration with Enterprise Resource Planning Software: A Dramatic Shift by Vendors
One factor that may accelerate improvements in understanding among trading partners is the increasing popularity of ERP software systems. An ERP software system provides a method for effective planning and control of all the resources needed to take, make, deliver, and account for customer orders in a manufactur- ing, distribution, or service company.
These systems can be purchased from a single software vendor, or an orga- nization can pursue a best-of-breed vendor approach. In the best-of-breed ap- proach, several software packages are selected and combined as multiple, linked solutions. In the best-of-breed vendor approach, each software package is chosen on the basis of the fit of its features with the organization’s functional needs.
ABC/M can reside in either approach.
The information technology community enjoys endless debates about using a single vendor versus a best-of-breed solution. The single-package purists ad-
here to a philosophy that the package should be tightly integrated. They believe interfacing diverse systems should be condemned. Maintenance of software is their main concern. The best-of-breed advocates feel that as time goes on, busi- ness application software packages will be designed with standard interfaces—
referred to as middleware—to allow the user to link-plug-and-play multiple vendor applications. Until then, some interfacing is required. Many software ap- plications increasingly have built-in configurators and adapters that link to the middleware. This allows the host application software to link to the middleware, which in turn uses standards to integrate with other software as well as with In- ternet tools.
It is evident that mature ABC/M users have not found information technol- ogy integration or interfacing of ABC/M software to be an obstacle. In the late 1990s, there was a dramatic shift in the integrated application software industry.
Major ERP vendors, such as SAP, the giant German ERP market leader, made significant moves into the “analytical applications” arena, including the ABC/M application. These applications performed as data mining and conversion tools by using data that have already been accumulated or summarized from mainstream source transaction-intensive systems. For the ABC/M analytical application in particular, this indicated that:
• ABC/M was considered the foundation for a number of senior management initiatives (e.g., strategy, value-based management, performance manage- ment, profitability assessment, business process reengineering, etc.).
• ABC/M had become a fundamental selection criterion for organizations eval- uating financial/operational software applications resident in ERP systems.
The ABC/M data are clearly located at the intersection where an organiza- tion’s level and type of resources meets with the level of profit and degree of alignment with senior management’s vision and strategy. The ABC/M data match customers with the specific resources they consume.
As examples of this shift in ERP software vendor emphasis, SAP made a substantial equity investment in ABC/M Technologies Inc., the worldwide mar- ket leader in stand-alone commercial ABC/M and performance measurement software. The ABC/M Technologies software product, Oros, extends the SAP ERP functionality.
Variations in the ERP vendors’ approaches to ABC/M involve the amount of prior experience the ERP vendors have had with ABC/M systems and how pas- sionate their end-users have been about ABC/M. SAP had ABC/M functionality for many years prior to its competitors. But SAP learned from its customers that there was much more to managing costs and profit margins than just the math.
There are substantial issues dealing with organizational learning rates and the human discovery experience that ABC/M can positively catalyze.
The ERP vendors now better appreciate that non-accounting personnel, such as supply chain managers, truly benefit from being involved in determining the assumptions about costs that have historically been made for them by those in the Measuring Supply Chain Profits and Costs: ABC/M to the Rescue 171
accounting functions. Operations and line personnel benefit from the exposure and involvement in designing and constructing their cost measurement systems.
These people no longer wish to rely on convenient cost allocation rules selected to make the numbers tie-out and balance on a cost accountant’s desktop com- puter. Managers, teams, and employees are increasingly in need of valid data to analyze and make trade-off decisions.
Another reason ERP vendors are increasingly receptive to analytical appli- cations is that analytics accelerate attaining meaningful results from the ERP software. Implementations of ERP have traditionally been phased in over time.
This means that ERP software modules are implemented sequentially, rather than in parallel. One consequence of this approach is that the time required for imple- menting the entire ERP system greatly exceeds the timeline required to imple- ment an ABC/M system. This denies to managers data they need now, not next year.
Customers of ERP vendors have stated that they traditionally implement the financial modules first, followed by purchasing, materials management, then the managerial modules. The managerial modules are the ERP analytical applications within which ABC/M functionality is usually contained. Typically, a large ERP implementation would not allow for the managerial modules to be implemented untilafterthe transaction-intensive baseline modules are implemented. But there is hope. Many organizations have realized that because ABC/M is basically a modeling methodology, it can actually be implemented at the beginning, not at the end, of an ERP implementation. The ABC/M model can be maintained at a higher and more aggregated level in parallel with the ERP implementation. In this man- ner benefits and results can be much more quickly realized. At a much later stage in the ERP implementation, ABC/M can then be more tightly integrated.
Four-Wall Intra-Firm ABC/M versus Inter-Firm ABC/M
As previously described, for those organizations that have already become lean and agile through reengineering efforts, a substantial portion of their cost structure now tends to exist to respond to the “demands on work” placed on them by their suppliers and customers. Organizations that use ABC/M realize that managing their costs is best accomplished by managing how their trading partners place de- mands on them. In ABC/M lingo, this involves the frequency, quantity, and in- tensity of the activity drivers that cause activity cost.
When some of the demands on work from customers or suppliers are ques- tionable, of low value, a result of errors or nonconforming events, or in some way a candidate for reduction or outright elimination of the cost driver, then further discussion among the trading partners becomes possible. By using ABC/M, these discussions can be based on fact-based data. In other cases, to better serve cus- tomers, a supplier may wish to self-impose increases for the demands placed on it through more services—but perhaps it should charge for them. With ABC/M data, supply chain managers can evaluate alternative supply chain networks and
structures. They can better understand the costs of the complexity they strive to manage. They may even select alternative supply chain trading partners.
If only one of the trading partners has ABC/M data and the others do not, dis- cussions may be limited. The ABC/M-enriched company understands how its cost structure is being affected by cost drivers; however, its trading partners will not adequately understand how they generate their portion of cost impact on oth- ers. When all trading partners understand their costs at their boundary-spanning activity touch points, they can better discuss how they might collectively shift, lessen, or altogether remove costs. The combined effect of their actions can result in lower overall costs.
The touch points, similar to the flat surface that results from pressing two balloons together, will usually involve the following three pairs of organizational relationships:
Supplier Customer
Shipping receiving
Sales purchasing
Design engineers process engineers
For example, if the supplier packages its product in a complicated way, and perhaps uses nonstandard containers, then there will probably be extra work for the cus- tomers’ material handlers at the receiving dock. Figure 4.10 presents the inter-firm relations. Any changes that may be mutually beneficial will also imply reduced time and effort, resulting in increased capacity to be redeployed or eliminated.
Measuring Supply Chain Profits and Costs: ABC/M to the Rescue 173
The extended enterprise requires B-R-O-A-D-E-R scope beyond the enterprise’s boundaries.
Suppliers An
Enterprise
Supplier’s
Suppliers Customers Customer’s
Customers
“A supplier’s invoice does not represent the total cost of doing business with it.”
—Enterprise
“Different customers and their orders place varying demands on the activities within our processes.”
—Enterprise Shipping
Sales
Design Engineers
Receiving Buyers
Process Engineers
Shipping Sales
Design Engineers
Receiving Buyers
Process Engineers
FIGURE 4.10 Extended Enterprise
Source:Gary Cokins, Activity-Based Cost Management: Making It Work, © 1996, McGraw-Hill.
Reproduced with the permission of The McGraw-Hill Companies.
By better understanding inter-firm costs, opportunities will surface to re- structure which trading partner may be more efficient at performing an activity.
Redundancies can be eliminated. Functional shiftability can be deployed to reor- ganize which trading partner should do what specific work activities. Functional shiftability is what I would call micro-outsourcing. One organization agrees to have the other perform work that it previously did—and the fee must somehow be reflected in a change in price or service. These costs are usually transparent to the consumer at the end of the value chain. In many cases, consumers may sim- ply be interested in low cost.
Who Benefits from the Cost Savings?
When cost savings are indeed generated and realized, who benefits? How are the cost savings to be shared? This will always be a thorny problem. ABC/M will not provide the answer, but it will at least provide unarguable data to use in dis- cussing sharing the newly generated savings.
From a supplier’s perspective, there are three potential beneficiaries from improvements and cost savings itself, its direct customer, and that customer’s customers all the way through to the chain’s end-consumers. The last beneficiary could potentially be you or me in the form of a lower price. But for that to occur, the upstream groups of trading partners will have consciously agreed to a no- profit-impact arrangement in which any change in their cost is identically matched with an exact same change in price. In practice, this incremental savings
“pie” from productivity improvements can be split among the chain’s trading partners, in various-sized portions.
Predictably, the profit motive of each trading partner will make the sharing of cost savings an awkward experience. ABC/M data can at least lessen any de- bates; but they cannot stop greed and aggression. The more proficient each trad- ing partner is with its ABC/M system, the more practical these discussions can be.
ABC/M and Professional Societies
One way to increase the chances that trading partners are effectively communi- cating with each other is for them to share a common framework of understand- ing and terminology. International professional societies and trade associations, such as the Supply Chain Council International (SCCI), the Council of Logistics Management (CLM), and the American Society for Production and Inventory Management (APICS), have helped address this area. For example, SCCI has constructed a descriptive framework, with a standard glossary of terms, named SCOR (Supply Chain Operations Reference-model). SCOR breaks down, from the highest level of any organization’s four basic business processes (plan, source, make, and deliver), to a fifth level containing hundreds of recognized work activities. Much of SCOR’s structure and elements are drawn from existing
materials, such as the American Productivity and Quality Center (APQC), so it avoids reinventing the wheel.
The SCOR “template” is an ideal mate for ABC/M at any level of disaggre- gation, summary, or detail. One can visualize SCOR as a material and document process flowcharting tool. It maps the flow of product, paperwork, and decisions from suppliers to warehouses to distribution centers. At the lower levels of the SCOR framework, software tools for process documentation and simulation can be applied for learning and problem solving. ABC/M links to these process- oriented tools. ABC/M reinforces SCCI’s desire for consistent and standard mea- sures. It calculates and reports allocation-free “unit costs” (e.g., cost per processed invoice) that traditional accounting cannot. ABC/M can also perfectly and flexi- bly scale up or down, level-by-level, in harmony with SCOR. ABC/M’s power is in segmentation, and then providing reliable and consistent benchmark data.
As supply chain management consultants (internal or external) and ERP ven- dors further encourage organizations to adopt SCOR as a framework to think, communicate, and accelerate learning toward solutions, ABC/M will probably become the accepted basis for measuring costs.
Regardless of how well an organization’s “back office” execution systems serve to fulfill customer orders, the “front office” may be even more critical. Or- ganizational effectiveness may be necessary but is not sufficient alone. In the end, customer satisfaction is essential. The next section discusses the “front office.”
HOW CAN ABC/M RESCUE CUSTOMER RELATIONSHIP MANAGEMENT TOOLS?
The consumer will become king or queen as Internet-enabled e-commerce shifts power from the seller to the buyer. From a supplier’s perspective, customer reten- tion becomes even more critical and treating customers as “a lifetime stream of revenues” becomes paramount. With e-commerce each customer can express his or her unique desires and will increasingly search for customized goods and ser- vices. Technology can make this possible. As widely varying customization and tailoring for individuals becomes widespread, how will supply chain manufactur- ers and distributors distinguish profitable customers from unprofitable ones?
Information technology, provided by ERP and other business planning and execution software vendors, is enabling all the trading partners along the value- creation chain to better coordinate and collaborate. Some of the essential ingre- dients for successful supply chain management are
Continuous replenishment (demand-pull material flow) Electronic commerce (EDI, bar coding)
Category management APS and ERP systems
Customer relationship management (CRM) systems True and actual cost information (activity-based costing
How Can ABC/M Rescue Customer Relationship Management Tools? 175
ABC/M translates the traditional (but incomplete, structurally deficient, and often inaccurate) cost accounting system’s data into a more usable structure.
Role of Customer Relationship Management Systems
It used to be that lowering costs and quickly bringing product to market could ensure a company’s success. Now e-commerce is creating a customer-focused approach to business. Suppliers are seeking ways to engage in more content- relevant communications and interactions with their customers.
Increasingly companies are realizing that improving their profitability re- quires more customer contact and more intimate customer relationships. Al- though the marketing and sales functions clearly see the links between increasing customer satisfaction and generating higher revenues, the accountants have tra- ditionally focused on encouraging cost reduction. Some of the best opportunities may be in improvements, such as attaining higher quality, that achieve both lower costs and higher revenues from increased customer satisfaction.
Regardless of whether the focus is on the top line (sales) or middle line (costs), profitability measured by each customer (or customer segment) is be- coming critical. It is inevitable that customer profitability reporting will become standard reporting. Customer profitability reporting, enabled by ABC/M, brings marketing, sales, operations, and accounting together to analyze and improve customer profitability.
Customer relationship management systems evolved as a result of advanced information technology and large databases used to refine marketing and sales ef- forts. Its tools enable companies to target individual customers or micro-market segments with pinpoint accuracy and manage the dialog and interactions. In the earlier applications of CRM in the 1990s, the goal was to simply promote prod- ucts and emphasize key services to specific types of prospects or existing cus- tomers, individually and collectively.
However, without measures of customer profitability in CRM systems, procla- mations about CRM and customer value management strategies were at best state- ments of good intentions. One should not construct one-to-one customer propositions, a CRM tactic, unless one understands the profits and profit potentials of individual customers and their expected behavior from the proposition. Beware of unintended consequences. Customer relationship management systems are a promising start but not the final bell. Without measure of customer profitability, CRM systems have not fulfilled their potential.
Companies who already have ABC/M cost measurements can advance their application of CRM to determine if a customer is spending, or will spend, enough on the right items to warrant a marketing effort. Alternatively, an ABC/M-enabled supplier can adjust its marketing effort, including its level of expenses, to optimize the expected profit from a customer segment—not more or less than is needed to maximize the return.