(rgmanalo25@yahoo.com, marivic.manalo@dlsu.edu.ph)
Abstract - This paper addresses an important issue – the nature of and evidence for success in the transfer costing of internal or shared services and products within a company. The case of Activity-Based Costing (ABC) is used to explore how the proponents have developed a framework linking Quality, Cost and Delivery (QCD) components of products and services.
The QCD performance indicators, which are the natural properties of products and services, will form part of the Service Level Agreements between the internal service providers (Shared Services Centers) and internal customers (Profit Centers) of the company. This framework optimizes the use of overhead expenses to the end products of the company.
This paper also discusses the various cost components of the products and services using the full absorption costing principle.
It is a revolutionary idea in the sense that all activity costs are considered variable costs and product costs come from activity costs using various cost drivers.
Keywords
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Quality, Cost and Delivery Performance Indicators, Activity-Based Costing, Profit Centers. Shared Services Centers, Service Level Agreement, Product Costing.I. INTRODUCTION
As deregulation is slowly implemented in the Philippines, the power sector of the energy industry will have to reengineer and adopt Activity Based Costing as a management tool to determine real value of businesses. The passage of the Electric Power Industry Reform Act (EPIRA) of 2001 or Republic Act No. 9136 prompted electric utilities in the Philippines to prepare their operations for the deregulation of their industry.
The RA 9136 mandates the creation of four sectors namely, generation, transmission, distribution and retail. This law opens the industry to competition especially in the generation and retail sectors of electric power [22].
Electric utility business is undergoing transformation worldwide similar to the restructuring and deregulation of other monopolies. Big power consumers have now a number of power supplier choices. Residential customers continue to grow, and customers will soon have supplier options. As the industry is divided, with processes performed by both utility and non-utility participants, investors and managers are trying to figure out what parts of this entire process from energy production to end-user delivery generate the most value.
Managers in business organizations belonging to this industry are always confronted with the tasks of improving their operations to keep the company competitive and profitable.
Unfortunately, traditional utility cost accounting practices do little to help respond to this concern. Traditional utility accounting equates spending and revenues only at the corporate
but not at the operating level, and accumulate large overhead or indirect expenses in relation to direct costs. Therefore, traditional utility cost accounting must be reengineered in an Activity-Based Costing technique in order to understand the basis for value in the new restructured energy industry. This reorganization will facilitate control of overhead expenses, determination of the costs of utility products and services, comparison of revenues and costs for profitability analysis, and strategic planning for positioning the utility for the future [13].
II. THEORETICAL FRAMEWORK
Figure 1 illustrates that a Shared Services Center’s (SCC) product or service has three natural properties linked and not independent of one another [20].
Fig. 1. Quality, Cost and Delivery Performance Metrics Model [20]
The natural properties are: Quality, Cost and Delivery (QCD). Performance measurements are based on the QCD model. Businesses today have to consider the three elements together. There must be integration and convergence of management disciplines. The role of cost data in this systematic model is simply the derivative and the dependent variable [7].
The Quality, Cost and Delivery (QCD) performance metrics model is patterned after the conventional Toyota (or lean) system in quality, cost and delivery wherein QCD is the framework in the process evaluation of the assembly systems [11]. Another source is the concept of QCDE (Quality, Cost, Delivery, Education) introduced by Soin [23]. He established four important categories as guide in crafting the corporate objectives of a firm. These are: Quality which includes customer satisfaction issues and product/process quality; Cost which includes all costs, such as administrative expenses,
manufacturing costs, and productivity issues; Delivery which includes new product design introductions, R&D and manufacturing product commitments, and delivery of products to the customer; Education which includes human resource training and education and organizational issues [23].
Activity-Based Costing (ABC) is a management accounting tool used to guide in the strategy formulations of a company. This costing methodology has been promoted and adopted as a basis for making strategic decisions and for improving profit performance [18]. In addition, as Kaplan [16]
predicted, ABC information is now also widely used to assess continuous improvement and to monitor process performance.
This new methodology provided the firm with improved cost information and more accurate product/service cost.
Figure 2 classifies the organization’s resources into activity-specific and non activity-specific.
Fig. 2. Activity-Based Costing Product Model
A resource is an economic element that is applied or used in the performance of activities [21]. Activity-specific resources refer to economic elements used to perform activities. Activity-specific resources come in the form of:
Direct Costs (DC), Cost of Using Assets (CUA) and Reassigned Costs (RC). DC are resource costs directly charged to the organization or are costs normally being budgeted and managed. These are labor, materials, transportation, contracted services and other expenses. CUA are resource costs incurred in the use of company assets, to perform the activities. They come in the form of depreciation, property taxes, insurance, registration and license fees, interest expenses and amortization on debt expenses which include internal cost of capital based on weighted average cost of capital as the hurdle rate. RC- Internal are activity costs or internal overhead expenses that are incurred by administrative personnel of SSC in providing support to the core activities.
Non activity-specific resources refer to economic elements that are directly attributable to specific products and services.
They are not affected by the consumption patterns of the activities or cannot be controlled through the changes in the level of activity.
Figure 2 also illustrates that activities are driven to cost
objects through a cost driver. Cost objects are the products and services produced as a result of the activities rendered and the non activity-specific resources consumed. A cost driver is any factor that causes a change in the cost of an activity [21]. These are brought about by diversities in technology, location, quantity, quality, environment, season and even culture.
III. REVIEW OF RELATED LITERATURE
The changes in the world require continuous innovation not only in terms of technology, but also in terms of quality service performance and the manner management accounting is performed. The focus of cost/management accounting has shifted from providing cost data for external financial statement preparation purposes to providing information for internal cost management. Internal cost management provides information to guide managers better evaluate and manage operations [1]. Innovations in terms of service quality performance require proper cost accounting. With the advent of the use of shared services centers in a firm’s operations, the challenge is to devise new internal accounting systems that will support this new strategy to improve quality, inventory performance, productivity, flexibility, and innovation [17].
The Concept of Shared Services Center and Profit Center A management revolution called Shared Services is considered a new way of organizing support functions and is being implemented across firms around the world. The reasons and drivers behind shared services concept are practical.
Bangemann cited the following motivations why companies create Shared Services Centers: (1) concentration on core business so that it is possible to grow horizontally and provide services or products on a more competitive basis, (2) increased speed in the globalization approach in order to act in a geographically wider market, possibly with global reach and coverage of developing markets, (3) acceleration of standard organic growth through acquired growth from mergers, acquisitions and divestments, and (4) restructuring and re- engineering of both processes and organization occurring as permanent improvement cycles instead of exceptional projects [3].
Many organizations have reduced the costs of providing support services to their businesses simply by concentrating them in corporate Shared Services Centers. Theoretically, by shifting the workload out of the individual business units and into a consolidated center responsible for providing the functional needs of the organization, cost reduction could be achieved and service levels maintained, if not improved. This move resulted in a step change in the costs of support services such as IT, HR, and facilities, and was considered to be a best practice [4].
In the article “Electric Utilities: A New Operating Model”, the authors stated that the progressive liberalization of the electric utility industry has inspired energy companies to seek new strategic positions on the value chain of power.
Traditionally, vertically integrated firms, the limitations of
which were defined by geography and history, the power sector have undergone restructuring in recent years. Government regulations and the market have driven the development of wholesale markets and new business models in transmission, generation, trading and retail services. The new operating model has organizational building blocks. The two main blocks are Profit Centers and Shared Services Centers [8].
In the Profit Center, managers have responsibility and authority for both production and sales. They make plans about what products and services to produce, how to produce them, their quality level, price, sales and distribution systems. But these managers don’t have the authority to determine the level of capital investment in their production facilities. The operating profit may be the best (short term) performance measure for how well the managers are creating value from the resources the firm has put at their disposal. Such a unit (Profit Center), in which the manager has almost complete operational decision-making responsibility and is evaluated by a straightforward profit measure [15].
The Profit Center is the front line of a company’s business strategy, the place where the company’s output meets the market and succeeds or fails in creating value for the company.
Traditionally, the only Profit Center in a power utility has been the utility itself. Every function from generation through transmission and distribution to customer care has been integrated and housed within a unit. Profit and loss responsibility has never extended below the CEO or COO;
other executives merely managed costs. However, the new opportunities ushered in by deregulation; Profit Centers have taken root at levels below the CEO or COO. This devolution of decision-making authority and the evolution of Profit Center has been the most important outcome of recent industry restructuring. Even energy companies that continue to regard themselves as “integrated” nevertheless operate today through multiple profit centers. The Profit Center should have discretion to decide what resources it will draw on, and from where. If it surrenders administrative resources to a common corporate pool of Shared Services Centers, it should be assured, in return, a benefit in the form of more efficient support services. The Profit Centers are the lifeblood of the corporation. All other units exist to help them flourish. To perform that role effectively, those other units need to realize what the Profit Centers need and how they succeed [8].
Although Profit and Investment Centers are independent units with their own goals, the external market of goods and production factors, and their own profit responsibility, they are not totally independent from the other profit oriented organizational sectors of the company. In other words, many business transactions could be performed between the units (centers). Internal exchanges of products and services are the basis of the internal transfer. The output of one Profit Center may be sold to the other profit units inside of the company.
This is the way to develop an internal market inside the decentralized enterprise, its products and services become intermediate, and valuable expression of the internal transfer seems to be internal transfer prices [2].
Service Level Agreement between Shared Services Centers and Profit Centers
Service level agreement (SLA) is a type of contractual agreement between the service provider and the customer. SLA is the basic instrument of a Shared Services model. This tool spells out expectations to internal business unit leaders in terms of cost and deliverables in much the same way an external vendor would [10].
Bangemann states that the SLA in general specifies the service scope, service level and the pricing and can include a range of other topics. A typical SLA would include components such as (1) scope and description of services provided, (2) customer-service delivery description, (3) cost information, (4) external benchmarks which is a comparison of current performance service levels and cost against external benchmarks, (5) performance-level commitments by the provider based on key performance indicators(KPI) such as quality, cost and delivery, (6) customer commitment which is a comprehensive outline of customer requirements that will enable the provider to meet specified performance-level commitments, (7) process improvement, (8) issue resolution which is an outline of how issues and disagreements will be resolved, and (9) terms which is the length of time over which the agreement is enforced [3].
The capability to bill Shared Services consumption to internal customers is valuable [5]. Each internal customer can be billed on the quantity of service consumed, times the price.
The price can be cost-based (full-absorption costing), market- based or the combination of the two. It is important that the SSC is aware of the regulatory issues when developing Shared Services pricing. Whatever pricing methodology is chosen, the Activity Based Costing (ABC) model houses the consumption volumes needed. It is an excellent “front end” to a shared services billing solution.
The Activity-Based Costing techniques can be used to explain cost information to customers. This ABC model can be used and expanded with the information required to determine the cost of providing each service. This process known as service level costing, involves identifying the activities and costs associated with providing services using that information to support discussions with customers, and then providing the level of service for which each customer is willing to pay.
Triplett and Scheumann claimed in their study that customers can relate to the concept of costs in terms of how they are caused by activities [24].
It’s also possible to establish differential pricing, thatis, to charge customers different prices for the same service. These prices can be determined by identifying the specific impact that each customer has on cost, based on behavior as measured by cost drivers. A model to support differential pricing takes more time to develop and more complex to maintain, but some SSCs feel that it’s worth the effort [24].
Activity-Based Costing as a Management Tool
As a management tool ABC is used as a major source of information. Activity-Based Management is viewed as an information system that has the broad objectives of improving
decision making by providing accurate cost information and reducing costs by encouraging and supporting continuous improvement efforts [14]. An integral component of effective cost control and performance evaluation is the ability to accurately estimate relationships between activities and overhead costs (i.e., activity costs) [12]. The management accounting innovation of Activity-Based Costing provides leaders with analytic tools to offset individual and organizational tendencies toward chaos and disorder.
Innovative techniques such as Activity Based Costing are being implemented by management in response to the new global competitive environment [19].
The ABC innovation revealed more clearly the underlying economics of the multi-product, multi-customer firm, and provided the language and analytics for explaining the diseconomies of scope experienced by firms as they grew through proliferation of products, services, and customers.
Until ABC came along to deconstruct so-called fixed overhead costs into the specific resources demanded by individual orders, products, services, customers, and channels, companies could not explain why supposedly fixed costs were not only staying fixed but, in many cases, were increasing faster than unit volumes.
These different ABC applications have direct implications for Activity-Based Costing practice. Service-based economies rely heavily on time estimation in their cost allocations, with many areas such as billing, tendering, and project accounting tracking activities’ time estimates. Given the extent to which time estimates are used, decision makers who use the figures produced by costing systems should be aware of the measurement error that impacts the accuracy of the costing figures so that they avoid making flawed decisions. The results also highlight the need for costing system designers to find ways to reduce the probability of such error in a costing system’s design, and offer several tools that can be used toward this end [6].
This management tool is costly to implement but have demonstrated its ability to create value far in excess of its costs through the creation and communication of valid information that guides decisions made by thousands of employees and dozens of business units about products, processes, customers, and transactions. Activity-Based Costing is a new management accounting system that extends business history, industrial organizations, and strategy literatures on aligning strategy and structure for competitive advantage [14].
IV. METHODOLOGY
This study will use the case study approach, which is an empirical inquiry that investigates a contemporary phenomenon within its real-life context, especially when the boundaries between phenomenon and context are not clearly evident [25]. In particular, this case study used the eclectic research design. The eclectic research design delves in developing models as an output of the research study.
To prove that the Quality, Cost and Delivery performance
metrics model can be utilized, various Shared Services Centers of a utility company will implement the model in a pilot application to 162 internal services or products and their costs based on the ABC information. These products or services were classified according to their product categories (Refer to Table I). Since these products were made up of activities or processes, they cut across organizations and were not exclusive in one particular department.
TABLE I
SHARED SERVICES CENTERS’ NUMBER OF PRODUCTS Product Categories Number of Products
Human Resources Services 6
Information System Services 27
Information Technology Services 10
Telecommunication Services 11
Finance and Auditing Services 8
Legal Services 6
Fleet, Tools and Work Equipment Services 54
Materials Management Services 29
Space, Office and General Services 11
Step 1. Classifying performance indicators.
The procedure starts with classifying the organization indicators to quality and delivery performance indicators, and map them to the products. The existing covenant indicators of every organization or budget responsibility unit (BRU) have to be classified either quality or delivery. Quality is based on completeness and accuracy or correctness. Delivery is based on timeliness and availability. Then, the indicators will be mapped to their associated products. The output will be the organization’s quality and delivery indicators and performance level per product.
Step 2. Mapping activities and resources to classified indicators.
The next step is mapping the organization activities and resources to quality and delivery performance indicators.
Product cost is made up of activity costs and non activity- specific resources (NASR). Since activities and NASR are already in place per product, the activities and NASR to quality and delivery can be mapped. This step will produce a document that will match the existing covenant indicators based on quality and delivery to the activities and NASR of every product or service.
Step 3. Assigning weights or percentage factors.
The third step qualifies that if an activity or resource contributes to both quality and delivery performance indicators, then weights or percentage factors can be assigned. For activities and NASR that match a single indicator, one hundred percent as weight is assigned. For other cases, specific weights are assigned. The total should always be one hundred percent.
The assignment of weights or percentage factors is needed only when an activity or resource is believed to be contributing to both quality and delivery. The rationale is that the activity cost has to be considered where it matters. So that during the SLA negotiation, the Shared Services Center negotiator will know where to increase or reduce the cost of the service or product based on the customer requirements.
Step 4. Converting weights or percentage factors to product costs.
The fourth step shows weights and percentage factors converted to product costs. The following sub-steps include (a) Determining the activity costs contributing to quality and delivery performance indicators for each product, (b) Determining the non activity-specific resources costs contributing to quality and delivery performance indicators of the product, (c) Combining activity and non activity-specific resources costs contributing to quality and delivery performance indicators of the product.
Step 5. Computing total product cost and product unit price
The fifth step computes total product cost and product unit price. The summation of the quality and delivery costs to obtain the total product cost is determined. Then, the total product cost divided by the total product volume to get the product unit price is determined.
Step 6. Developing service level agreement (SLA).
In the sixth step, the service level agreement (SLA) is developed. Product unit prices (PUP) shall be acceptable given the projected quality and delivery performance levels in the validation process. The customer’s preferences in the agreement if attainable should be included. The SLA shall be the legal basis for any discussions in the implementation phase.
During the negotiations, salient provisions of the EPIRA shall be considered especially the Performance Based Rating (PBR), Wholesale Electricity Spot Market (WESM), Generation and Transmission Services.
The data analysis will be done using Multivariate statistical tool called Principal Component Analysis (PCA). PCA is a method of reorganizing information in a data set of samples. It can be used if the set contained information from only a few variables but it becomes more useful when there are large numbers of variables [9]. Principal component analysis finds those linearly weighted combinations of the observed variables – at each stage of the analysis – the proportion of the total variation.
The principal component method of extraction begins by finding a linear combination of variables (a component) that accounted for as much variation in the original variables as possible. It then finds another component that accounted for as much of the remaining variation as possible and is uncorrelated with the previous component, continuing in this way until there are as many components as original variables. Usually, a few components account for most of the variation, and these components replace the original variables. This method is most often used in reducing the number of variables in the data file.
V. CONCLUSIONS
The model shows that it is possible to link cost performance metrics to quality and delivery performance
metrics using ABC model as a management tool. Products and services can be optimally priced given the right information.
Full absorption costing and ABC capture every detail in the cost structure of the products and services of the Shared Services Centers. The direct costs, cost of using assets and reassigned costs-internal represent every aspect of the activity cost which in turn becomes the component of the product cost.
The use of activities to determine the product unit price is a revolutionary concept. The use of activity costs simplifies the allocation of overhead resources to the products and services.
Operations people can easily determine which resources were consumed by which activities. Then, they can also easily determine which activities were spent on which products. If ever the same activities were spent on various products, at least they can determine how much time was spent on every activity per product.
A Service Level Agreement requires a particular mindset of Shared Services Center (SSC). The SSC create a serious commitment from top-level managers from both the service- provider and the user groups to negotiate an agreement. The agreement should be negotiated on a level playing field as possible. Members should have in-depth business knowledge about how the service affects the user department’s productivity or knowledge about the technology that the service provider needs to provide the requested service level.
This study will be most valuable to companies having multiple strategic businesses to optimize the use of their resources especially their support services. However, the minimum requirement of this framework is the adoption of ABC in the cost management of the firm.
ACKNOWLEDGMENT
The authors thank the following: De La Salle University – Br. Armin Lusitro, FSC, Dr. Julius Maridable, Dr. Myrna Austria, Mr. Arnel Uy; Manalo-Valenzuela Family – Florencio S. Manalo and Guadalupe G. Manalo, Jose Valenzuela and Rosario D. Valenzuela, our supportive parents and Rose Guada Marie V. Manalo, our precious daughter.
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