Beneath The Surface Suspicious not all areas of your company are bringing in a profit? Break it down with activity-based costing.

Among the 1,500 plant varieties Bluemount Nurseries Inc.stocked, Nick Pindale suspected that some yielded profits and someonly losses. Unfortunately, Pindale, the CFO and grandson-in-law ofthe founder of Monkton, Maryland-based Bluemount wasn't surewhich was which.

Pindale sought answers from an accounting technique calledactivity-based costing, or ABC. Dividing nursery tasks intocategories such as potting and planting, he assigned costs to each.Then he determined which ones Bluemount performed cost-effectivelyand which would be better outsourced, trimmed or omitted. Theinformation identified the most profitable plants and even helpedprovide documentation for a bank loan needed to boost production ofmoneymaking lines.

Bluemount bloomed with ABC. "Five years later, not one ofour original greenhouses is still standing," says Pindale ofthe 65-person nursery. "We've added state-of-the-artmachinery in our potting line. And we've doubled insize."

By focusing on such activities as "processinginvoices" instead of departments such as "payables,"ABC differs from traditional cost accounting. Advocates sayit's an improvement, providing information of far more use thancustomary ledger reports. Its ability to help companies find andtrim money-losing products, customers and processes, as well asidentify those with profit potential, has led to its adoption bywell-known companies, including Mobil, Fidelity Investments andCoca-Cola.

"Within 10 to 20 years, everyone will have some form ofABC," predicts Gary Cokins, author of Activity-Based CostManagement: Making It Work(McGraw-Hill) and director of industryrelations for ABC Technologies Inc., a leading ABC software andservices firm in Beaverton, Oregon. "It's a matter ofwhen, not if."

Mark Henricks is an Austin, Texas, writer who specializes inbusiness topics and has written for BIZ Experiences for nineyears.

Learn Your ABCs

Activity-based costing showed up on the business scene in theearly 1980s, largely through the writing of Harvard Business Schoolprofessor Robert S. Kaplan. Driving the interest in ABC was thegrowing proliferation of products and segmentation of customers andmarkets, along with generally tougher competition, says Cokins.

"Kaplan realized that accountants were using a singlefactor to assign cost to products," Cokins says. "It wasusually labor hours, or sometimes gallons or pounds. When productdiversity increased, this became nonsensical. Some thingsinevitably got over-costed, and others got under-costed relative totheir true consumption of costs."

Today, ABC is considered particularly useful to companies withdiverse products, many types of customers and tough competition.Firms in industries experiencing rapid price reductions are alsoprime candidates.

The first step in applying ABC is to define cost categories.These may include salaries, materials, utilities and the like.

Next, identify primary processes and key activities for eachcategory. For instance, the process of addressing customer helprequests involves activities such as answering the phone andresearching questions.

Then calculate the costs of each activity by, for example,dividing the number of help requests processed into the combinedsalaries and benefits of your help-desk workers. Finally, youassign each activity's costs to the appropriate category.

Done right, the ABC exercise accurately assigns the costs ofactivities done for specific customers, products and services. Thatcan point to activities that waste time. It can also highlight thecustomers, products and services that are actually keeping youafloat. It's not unusual, say advocates, for ABC to reveal thatmost of a firm's customers or products are actually losingmoney.

Details, Details

One ABC risk is getting bogged down in excessive detail.There's no end to the minute activities that can be identifiedin the process of conducting business, notes Cokins. The trick isto keep the level of detail manageable, collecting and analyzinguseful information without expending too much time and energy.

ABC uses data from several sources. Some firms engage intime-motion studies to analyze complex activities. Others interviewworkers about what they do in their jobs. Most use information fromexisting accounting systems. Key data commonly includes figuressuch as the number of customer orders processed, total purchasesand the number of new accounts opened, says Cokins.

Most ABC practitioners find that special-purpose ABC software isrequired to make the task manageable. At $6,000 and up for onepackage sold by ABC Technologies, software can add significantly tooutlays for this type of accounting technique. There are, however,some pilot packages available for $500.

ABC produces bottom-line results only after practice. Althoughsome companies see results almost instantly, it typically takesthree months or so for most businesses to experience the benefitsof ABC. And, depending on your product or business cycle, it couldtake much longer.

Seeing an ABC project through to payoff can be tough because ofthe time and attention to detail required, Cokins warns. "Itfails when it doesn't catch enough people'sattention," he says. "When it fails, it means itdidn't catch fire."

Cokins recommends starting small with broad cost categories andrelatively sweeping assignments of activity costs. For instance, afirm with 10,000 customers might divide them into 15 or 20 typesand analyze activities associated with each group rather than eachcustomer. "Think of it as a pyramid, and start at thetop," advises Cokins. "Disaggregate costs only as needed.And ask yourself first, `Is the climb worth theview?' "

One way to improve management buy-in while limiting the downsidefactors is to involve only a small group of well-informed workersin the ABC project, at least in the beginning. These people can beused to gather data and perform analyses, then spearhead the effortto communicate findings back to workers.

Communication is delicate, adds Pindale. Some Bluemount workersfeared ABC would result in job cuts as tasks were automated. Infact, automation did take the place of some employees, but thoseworkers were redeployed into activities that added value but werenot suitable to automation, says Pindale. At Bluemount, making sureemployees understood the goals and techniques of ABC was essentialto controlling dissent.

From ABC to XYZ

A little more than a decade after it became widely known, ABC isstill in its youth, according to Cokins. He predicts a majorupsurge in interest in the technology after the turn of thecentury, as trends toward product and market proliferation continueand competition steadily increases.

Despite the optimism of ABC advocates, the technique isn'tfor every business. Companies with only a few products and marketsaren't likely to get as much benefit from basing costs onactivities as companies operating with diverse products, servicelines, channels and customers.

But one of the most attractive features of ABC is that it'ssomething you can experiment with without making a huge commitment."If it doesn't work," says Cokins, "you juststop doing it." Benefits, on the other hand, can be both bigand long-lasting.

At Bluemount Nurseries, ABC helped Pindale determine he couldbreed some plant varieties at about half the cost of buying fromwholesalers. "Using those numbers, we were able to sit downwith the bank and borrow to build a new propagation facility,"he says. "They were really impressed with our figures andgraphs, and that loan went straight to the bottom line."

Contact Sources

ABC Technologies Inc., (503) 617-7100, http://www.abctech.com

Bluemount Nurseries Inc.,http://www.bluemount.com