Most firms benefit from Activity Based Costing, yet 90 percent of companies studied abandon their ABC systems.
This alarming dropout rate is one of the findings published Summer 2001 by Dr. Annie McGowan of Texas A&M University. Her research paper titled “Activity-Based Change Management: A Literature Review” states, “Although activity-based costing models often reveal new insights into cost and profitability, many firms report that operating managers are reluctant to act upon this information.”
Research has found the principles of ABC to be sound. And case studies consistently report improved decision-making and process improvement information flowing from ABC systems. Why then do so many firms abandon their systems? Dr. McGowan and her cohorts tackled that question in their study. The number one reason for ABC curtailment was lack of top management support.
You are likely familiar with moral support, technical support and financial support. But what exactly is top management support (TMS)? Project leaders, consultants, professors, authors and pundits all say you need it, but what exactly is it? Is TMS a feeling? Is TMS like love … we need it but we can’t buy it? Or is TMS a fact, one that we need to analyze and understand?
To better understand TMS and why it is the primary root cause for ABC abandonment, I focused on the verb “support”.Support is a good thing, but it is passive, not active. Support falls short of what is needed to achieve a sustainable breakthrough in an organization’s cost management. Here are five examples of passive ABC support:
Most “supporters” of ABC implementations do not start with intent to sustain the system. ABC is doomed from the onset because it has been labeled a “project”. Projects have a beginning and an end. As a result, many ABC implementations are abandoned at a pre-defined date (i.e. end of the 90-day pilot project) or goal line (i.e. The project team created an ABC software model). Without direction, employees revert back to old methods and practices after the ABC project is completed.
Dr. McGowan’s research repeatedly noted the existence of “reluctance” in those organizations that abandoned ABC projects. Without a strong leader, managers are reluctant to use ABC data for decision-making. As a result, for ABC to have a significant, lasting impact on an organization, top management must lead, not just support Activity Based Costing.
Top Management Leadership (TML) can be described as:
An actual case of TML … ABC implementations with management “support” tend to falter and fail. ABC with strong, visible “leadership” consistently sustains success. A great example of TML can be found at Pioneer Flour Mills in San Antonio, Texas. October 2001 is the tenth anniversary of their ABC system.
In 1991, this privately-held company had sales under $50 million, low margins and slow growth. Overhead costs were allocated on one method … pounds of raw material. Pioneer hired a new CFO, John Casey, to revitalize the financial performance of the company. He started that process with Activity Based Costing.
STEP 1: Use ABC to Get Financial Facts The CFO implemented ABC, using ICMS training and software, to improve the accuracy of product costs and eliminate cost allocation arguments between managers. ABC was also used to expose the profitable core products and customers of the firm.
STEP 2: Combine ABC with SVA to Focus on Cash The CFO combined the ABC product-line P&L’s with the cost of capital to determine Shareholder Value Added (SVA). With the guidance of SVA experts from LEK, the cost of capital was subtracted from each product- line P&L to determine the value added by each product line. ABC coupled with SVA focused management on the lifeblood of Pioneer … cash flow.
STEP 3: Use a Bonus to Create a Consequence To promote and sustain the interest in ABC and SVA, the CFO and LEK consultants developed a bonus program. Payouts were based on product-line and total company Shareholder Value (cash). If SVA increased from year-to-year, management got a 10% bonus. If value decreased, due to a P&L loss or an increase in capital spending, no bonus was paid.
TML Case Results … Using strong leadership plus the principles of ABC and SVA, Pioneer Flour Mills has grown sales from $50 to $200 million, increased operating margins 50% and significantly increased shareholder value. CFO John Casey did more than support the implementation of ABC, he led it!
TMS versus TML…
Activity Based Costing has consistently provided financial benefits to those organizations that use it. The keys to eliminating abandonment of ABC after benefits are achieved lie not on a PC keyboard, but in the hands of senior management. For ABC to reach its fullest potential, management must be known less for what they support and more for what they lead, less by their position and more by their vision, less for their motives and more for their motivation, and less by what they control and more by what they build. “The leaders job is not just to aspire, but also to act.” says professor Dave Ulrich, University of Michigan School of Business. Take steps in your organization to convert TMS into TML.