Insanity Test
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17 August 2013 - 22:51, by , in Activity-Based Cost Management, No comments

There is a test that doctors used in years past to determine if a mental patient was ready for release from the asylum. If your organization has had a headcount reduction in recent years, you may need to take the same test.

The test goes as follows: The patient is brought into a small room that has a sink. The doctor plugs the drain and turns on the faucet. When water begins to overflow onto the floor, the doctor hands the patient a mop and instructs them to “Clean up the mess.” The doctor leaves for 15 minutes. Upon the doctor’s return, if the patient is still mopping the floor with the faucet flowing, the patient is kept for further treatment. If instead the patient had the common sense to turn off the faucet, they are released from the asylum.

Has your organization experienced a painful cost reduction initiative in the past 3 to 5 years? Do you still have the same cost accounting system, performance measurements and budgeting process in place that allowed the non-value added waste to infiltrate the business?

If you answered “yes” to both these questions, it is very likely that you will have to experience another painful headcount and cost reduction in the near future. Cost reduction initiatives temporarily “mop up the waste”. However, because the old cost management system “faucet” is still turned on, waste will flow back into the business. The only way to permanently prevent waste is to treat the root cause. Check the faucet!

Cost reduction initiatives address the symptoms, not the root cause of waste. Typical symptoms include P&L losses, unfavorable budget variances or repeatedly missed new product introduction targets. Layoffs, freezing of specific expense categories or across-the-board budget cuts are similar to mopping the floor. The mop will temporarily clean up the mess and waste. In fact, the mopping initially cleans up things. Things like the Profit & Loss Statement look better, at least temporarily.

But, because the faucet is still turned on, the mess slowly returns. In an organization, the “faucet” is the traditional budget and costing system. All cost planning and expenditures “flow” through the faucet. An organization that continues to budget and measure resources instead of the activities and business processes that consume the resources always see the non-value added waste return. Implementing Activity Based Management (ABM), Activity Based Costing (ABC) and Activity Based Budgeting (ABB) turns off the faucet of waste and alleviates the mess.

The fourth principle of ABM says “Insanity is defined as performing last year’s activities using last year’s methods yet expecting improved results this year.” Are you mopping up after another frustrating budget cycle? Turn off the faucet and implement ABM, ABC and ABB. If your organization needs to simultaneously improve financial results and address the root cause of waste, implement an Activity Based Management system. Let us know if we can help.

 

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Tom Pryor
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