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WHAT’S INSIDE?
Implementing Shared Services in the Public and Private Sector
Activity-Based Costing in the Public Sector
Using Activity-Based Costing to Optimize Production Capacity Utilization
Created for Chief Financial Officers, Controllers and other senior Finance professionals
Financial Management
Edition 3, Spring 2007
WHAT’S INSIDE?
Implementing Shared Services in the Public and Private Sector
Activity-Based Costing in the Public Sector
Using Activity-Based Costing to Optimize Production Capacity Utilization
IBMInsights
To receive this complimentary newsletter, to request previous editions, or to read other IBM thought leadership, please visit our Web site: www.ibm.com/services/ca/bcs
On the subscription form, you will have the option to request the newsletter in hard copy or as a PDF by e-mail.
2 IBM Financial Management Insights
Page 4Implementing Shared Services in the Public and Private SectorThe popularity of shared services delivery model has grown significantly over the years from traditional finance, HR and IT functions to supply chain, back office and expertise areas (e.g. tax, credit risk management).While the benefits of shared services have been established, its success depends on a sound implementationapproach. In this article, we look at some of the common concerns and recommend how we can address them.
Page 12Activity-Based Costing in the Public Sector ABC can assist managers in understanding the linkages between products and services and how they consumeresources (people, assets, dollars). Using IBM’s proven ABC methodology, our project team is working with a ministry of transportation to implement ABC in the division that is responsible for all driver and vehicle products.One of our key objectives – beyond the typical ABC benefits – is to assist the ministry in complying with the “Eurig” decision. Managers within the ministry now have access to a host of new information and metrics abouttheir operation that will ultimately lead to more informed decisions.
Highlights in this issue:
Page 16Using Activity-Based Costing to Manage SKU ProliferationRecently, a leading manufacturer of soft drinks and other beverage products faced a major capacity shortfall at one ofits facilities and needed to assess its capability to take on added business. Management’s challenge was to ‘find’ thisextra capacity without physically adding to facilities or using third party manufacturers. Our activity-based costinganalysis demonstrated that it was indeed able to take on the additional volumes, in part by instilling a disciplinedapproach to managing individual SKUs.
IBM Financial Management ServicesIBM Global Business Services is a leading business and technologyadvisor in Canada. Our Financial Management practice has a provenand successful history in helping CFOs and finance organizationsdesign and implement the financial processes and underlyingtechnologies required to overcome today's most complex businesschallenges. Whether a finance organization needs guidance in planningits business strategy, acquiring the tools to measure performance moreaccurately or leveraging shared services to streamline its operations,IBM can help.
We are focused on helping clients better integrate process, technologyand information to:� Drive enterprise-wide profit improvement and shareholder value;� Create a "finance on demand" organization that is responsive,
variable, focused and resilient; � Reduce the cost of finance through efficient transaction processing; � Provide decision-makers at all levels with the right information,
when and where they need it; and � Effectively manage risk and opportunity.
For further information, please contact:
TOM WHELANPartner Canadian Leader, Financial ManagementIBM Global Business ServicesTel: [email protected]
3IBM Financial Management Insights
Welcome to the 2007 issue of IBM Financial Management Insights, a newsletter for senior finance
professionals in business and government organizations. This newsletter is written by Canadian subject matter
experts for CFOs, VPs of Finance and Controllers who have a keen interest in current financial management issues
and are seeking creative ways to meet the increasing demands facing financial professionals. We understand your
need to become more effective in supporting core needs across the enterprise while maintaining regulatory
compliance. The good news is that you are not alone.
The articles in this issue focus on how private and public sector organizations can:
� Discover a successful approach to implementing shared services;
� Improve cost-effectiveness by using activity-based costing to understand linkages between products,
services and resource consumption; and
� Optimize production capacity utilization using activity-based costing for SKU analysis.
IBM Financial Management Insights
4 IBM Financial Management Insights
Implementing Shared Services in the Public and Private Sector:What it really means and strategies to successfullymanage the change in your organization
Written by LISA KNIGHT Senior Managing Consultant
5IBM Financial Management Insights
Introduction The concept of “shared services” is certainly well known, and it’s due
to the fact that it is not a new concept; shared services centres were first
implemented in the 1990s and numerous organizations around the world
have since implemented a shared services model.
The early adopters of shared services were in the consumer products
goods industry. However, shared services today is much more widely
used and currently there is a strong focus on shared services as a
delivery model within the banking sector and by governments globally.
While the impetus to move to shared services continues to vary, the
benefits are evident. Our IBM 2005 Global CFO Study indicated that
organizations that have successfully migrated to a shared services model
have been the most effective at implementing process and technology
improvements enterprise-wide. In other words, these organizations
have succeeded in implementing best practices through standardizing,
simplifying, and more cost-effectively delivering services.
Based on our IBM 2005 Global CFO Study*,organizations that have successfully moved to a shared services model have been the mosteffective at implementing the following process and technology improvements enterprise-wide:
Process• A standard chart of accounts• Standard policies and business rules• Use of functional best practices• Process simplification
Technology• Rationalized finance budgeting/forecasting tools• Reduced the number of common finance platforms• Reduced the number of ERP instances• Rationalized the number of data warehouses
* IBM Global Business Services, in collaboration with theEconomist Intelligence Unit, conducted the IBM 2005 GlobalCFO Study of 889 CFOs (over 350 CFOs/Deputy CFOs) andsenior Finance professionals to gain perspective on currenttrends, key challenges and the future direction of Finance.
6 IBM Financial Management Insights
A Wider ScopeWhat has changed since shared services models were first implemented
approximately 15 years ago is that the scope of functions involved in
shared services continues to expand. Traditionally, Human Resources,
Information Technology and heavily transaction-based Finance areas
(Accounts Payable, General Accounting and Reporting) were considered
for shared services. Today, the scope includes:
• More areas within the traditional HR, IT and Finance functions
(i.e., for Finance, fixed assets, accounts receivable, etc.);
• Supply Chain areas (e.g., procurement, catalog management,
warranty administration, etc.);
• Back office functions other than Finance (i.e., other operational
processing); and/or
• Expertise areas (e.g., tax, credit risk management, treasury, real
estate management).
For example, in the private sector area of banking, shared services
delivery models are being established for securities, loans, claims
processing and foreign exchange.
In addition to the broadening scope of shared services, more
organizations are adopting “enabling technology” such as scanning,
document workflow and storage tools to more effectively manage high
volumes of transactions. This helps them achieve greater control over
the transaction, both in terms of understanding the status of transactions
in a given process and in managing approvals of the transactions
(e.g., invoices in accounts payable).
What Hasn’t Changed: The People AspectOne thing that has remained constant is that once an organization
has made the decision to embark on shared services, the organizational
challenges in gaining acceptance are familiar. Implementing shared
services is a significant change to the organization. In addition, both
private and public sector organizations face many of the same challenges
even though the approach to addressing these challenges may differ.
The reality is that even if the changes are successfully made to implement
shared services (by addressing the potential improvements that can
be made in terms of processes, technology and organization), if the
‘people aspect’ is not paramount throughout the project, the shared
services centre will not be successful.
Change management is a critical component of success. This refers
to more than just communications and training (which are very
important). Change management is about helping all individuals
understand the change and its impact on them, then assisting them
through the change so they are successful in the new environment.
Unfortunately, based on IBM experience, change management
continues to be the most underestimated aspect of implementing
shared services. This is particularly the case in the public sector
where past failures of large projects often point to the lack of attention
focused on the change management aspects.
Addressing the change management aspects, or “people” aspect, is
by no means easy, so there is a low comfort level in addressing these
The most common concerns raised in implementing shared services are as follows:
• “Isn’t shared services just centralization…why all this effort to centralize our operations?”
• “How can there be any savings when we (the department) still need to approve everything and be accountable for the information;won’t establishing a shared service centre only fragment the process?”
• “Why does it take so much time and effort to transition to shared services; why can’t we just implement best practices in ourcurrent organization structure?”
• The perception that:o Their department is “unique”; their processes are substantially different than the other departments
(or business units) being considered for inclusion in the shared services centre.
o Departments being supported by the shared services centre will receive less service at a higher cost.
o It is necessary to retain a significant number of roles within the department or business unit rather than transition these roles to the shared services centre.
o There may be the possibility of a department or business unit to “opt out” of the shared services centre in the future.
o Their department/business unit will not be able to effectively manage their operations if they are required to move to a common ERP system instance.
7IBM Financial Management Insights
aspects amongst executives and senior staff. This is partially because
senior stakeholders understand the shared services concept at a high
level, while a true understanding of what it means to move to shared
services is not clear to them until implementation is underway. This
lack of clarity is often driven by the timeframe taken to assess the
feasibility of shared services, combined with the fact that centralization
and shared services are discussed interchangeably – even though
they are different service delivery models.
When embarking on shared services, similar concerns tend to surface
amongst both the private and public sectors. Individuals are trying to
grasp how the change affects them and their organization. It is
daunting to realize that the change is coming and it’s real. Hence,
a proactive focus on the people side of the implementation is required.
The challenge many organizations face is the difficulty of investing
money in this aspect of the implementation when there is often a focus
on minimizing project costs to realize the benefits. However, factored
into such a decision must be the implementation risks. The potential
risks range from losing key staff during implementation to an
unsuccessful implementation in spite of the dollars invested.
To assist customers in implementing shared services in their own
organizations and managing the change to shared services, a look
at the most common concerns that surface are highlighted below.
However, what is key are the strategies needed to successfully address
these concerns. We have provided a recommended approach based
on our experience with both private and public sector organizations.
1The question of: “Isn’t shared servicesjust centralization? Why all this effortto centralize our operations?”
Frequently, there is confusion amongst those impacted as to what
shared services means, because it is viewed as synonymous with
centralization. Therefore, it is important to take a step back to ensure
all employees truly understand what shared services is, what it really
means, and why this is a significantly different service delivery model
than their current organizational structure.
Recommended Approach
(public and private sector companies):
To address this problem, you should first discuss the similarity and
differences between shared services and centralized and decentralized
models so it is clear what shared services really is.
Second, you should explain that another key advantage of shared
services is a more disciplined approach to service delivery. This delivers
visibility to the costs for the services delivered, as well as the level
of service delivered, and ensures that clear accountability and
performance targets are defined (through a service level agreement).
People & Culture
Processes & Controls
OrganizationTechnology
• Lean, Flat, Organization
• Business Unit Maintains Control of Decisions
• Responsive to Clients Needs
• Common Systems & Support
• Consistent Standards & Controls
• Economics of Scale
• Independent of Business
• Synergies
• Dissemination of Best Practices
• Variable Standards
• Different Control Environment
• Higher Costs
• Duplication of Effort
• Remote from Business
• Unresponsive
• No Business Unit Control of Central Overhead
• Inflexible to Business Unit Needs
DecentralizedShared
Centralized
Shared services combines the benefits of both centralized and decentralized operationsto deliver value to business partners; it is the result of bundling business support
processes and non-strategic activities across an organization.
All levers of change must be addressed (particularly people and culture) when implementing shared services.
2 The question of: “How can there beany savings when we (the department)still need to approve everything and be accountable for the information? Won’t the establishment of a sharedservices centre only fragment theprocess?”
When the current process is working, it can be challenging to visualize
how it can be more effective, particularly from an individual department
perspective. The other factor that drives this concern is the lack of
control over the entire process in the future. Since traditionally
transactional-based activities move to a shared services centre, the
departments will retain some process aspects but fewer than before,
while the shared services centre manager will be responsible for
the other process aspects. What remains unchanged is that the
accountability remains with the departments; hence, this can create
a high level of discomfort.
Recommended Approach:
There is a fundamental transformation in shifting from a centralized
or decentralized model to shared services – which initially may not
be obvious. Rather than focusing on work from functional or individual
tasks, an end-to-end process perspective is taken. For example, rather
than having separate procurement and accounts payable functions,
it would make sense to have a Procure-to-Pay structure where the
two organizations physically and organizationally work together.
As we examine the processes themselves, the ‘future state’ incorporates
both process and technology best practices. So, in the case of accounts
payable, an optimal model could be to have all non-purchase order
invoices received centrally in one location, scanned into the system
and then, if the key information is acceptable in the ERP system,
the invoice is routed via workflow for approval. This represents a
substantial change in the process. With shared services, the processing
of invoices for multiple departments will be managed centrally.
3The question of: “Why does it take so much time and effort to transitionto shared services? Why can’t we just implement best practices in ourcurrent organizational structure?”
Even though many organizations seem to have embarked on some
degree of process improvement in recent years, improvements have
typically occurred in a particular department rather than across an
organization. Often, the degree of change in terms of what was actually
implemented compared to what was planned has been significantly
less as well. Conceptually, simplification, standardization and
reengineering of processes could be examined without moving
to a shared services model.
Procure to Pay Cycle
Purchasing - Dept #1
Purchasing - Dept #n
A/P - Dept #1
A/P - Dept #n
8 IBM Financial Management Insights
Central Services Unite.g. Accounting
Allocation of Costs
Departments or Business Areas/Units
Shared Services Centre
Cost and Value of Service
Departments or Business Areas/Units
Centralized Services Shared Services
Cost Unknown Cost Explicit
Shared services enables service delivery costs to be visible todepartments/business units and customers then associate actual costs with the
service provided. This is a key strength of shared services over a centralizedmodel. Service level agreements are established so that costs are explicit ad
service levels are known and agreed upon prior to any services being provided.This allows for greater accountability within the Shared Service Centre and
provides clear expectations for service delivery to customers.
So why has this not already been done? The reality is that there is
significant effort in coordinating across the departments (e.g., multiple
Finance departments) and moving to shared services focuses the
departments to work together to make improvements. Furthermore,
depending on how long individuals have worked in the departments,
often there is no awareness of what best practices other organizations
are implementing in their quest to derive more substantial savings.
In fact, a key reason why shared services centres enables greater
efficiency and effectiveness over the long term is due to the formal
establishment of services levels, performance measures and more
disciplined processes tied to the service level agreements – ensuring
that the benefits can be sustained.
Recommended Approach:
Shared services is a fundamentally different delivery model and can
achieve significant savings if implemented appropriately. Strong project
management and leadership support for the initiative is key, as well as
priority placed on the people aspects. External support to implement
shared services tends to be the most effective means to drive
organizations towards adopting best practices and for providing
guidance on lessons learned from other shared services implementations.
The greatest time and effort involved in implementing shared services
lies in addressing the “one-off” activities in any of the departments
in terms of scope and managing all the people aspects associated with
the change (i.e., determining the new organization and who is transitioning
to it, reorganizing the former department structure, defining the
activities that are managed by the shared services centre, etc.).
4 The perception that “a given departmentis “unique” – that their processes aresubstantially different than the otherdepartments (or business units) beingconsidered for inclusion in the sharedservices centre.”
With most organizations, what is truly “unique” is the business areas
being supported or in the case of the public sector, the type of services
offered to the citizens through that particular department or agency.
For transaction-based activities, the actual processes can be very
similar or can be standardized to a common process. Having said that,
“unique” activities may still occur in some of the departments and it
• Reduction of the fixed cost base
• Potential reduction in real estate costs
• Redefinition of the organizational structure
• Leverage the economies of scale with both suppliers and customers
• Make it possible to achieve
and sustain benefits from
initiatives such as
Strategic Sourcing
• Improved customer
service
• New service products
that enable business
transformation
• Consolidate operations on a common platform
• Using document
management technologies
• Improved reporting and
decision support to
enhance view of individual
business unit performance
& performance across
companies
• Focus on the business drivers
• Standardization & simplification of processes
• End-to-end process improvement
reduction/elimination of non value-added activities
fewer errors and less rework
more timely and accurate information
Consolidation
TIME
BEN
EFIT
Reengineering &Productivity Enhancements
TechnologyEnhancements
Value Creation &Continuous Improvement
Savings can be achieved through the various stages of change undertaken in a typical shared services implementation.
9IBM Financial Management Insights
will need to be determined how those activities will be managed in the
future. However, this is often a small number; the majority of activities
can follow a common process. The perception often ties to service
levels as well, with the main concern being the need to provide
“flexibility to customers.”
Recommended Approach:
Without a doubt, subject matter experts from each of the departments
need to be involved in defining what responsibilities will move to the
shared services centre and what will remain in the business. This is
important, not only because of their expertise but to also gain acceptance
of the changes being made. A clear definition of the criteria for inclusion
in the shared services centre needs to be developed upfront and utilized
in defining responsibilities. In addition, strong leadership is required
to ensure that what the shared services centre is managing is not
significantly reduced. In the consensus decision-making environment
of the public sector, this can be particularly challenging. However, the
consensus approach can only be used to a point; ultimately, the project
leadership may be required to make some tough decisions that may
not be popular with all the departments involved.
5 The perception that “departmentsbeing supported by the shared servicescentre will receive less service at ahigher cost.”
The greatest concern of department managers is that any of the work
that is transferred to the shared services centre will be of lower quality
or less customer focused than their department would deliver and that
they will have to pay a higher amount for the services received. This
fear is most substantial with departments that are smaller and will have
fewer people moving in the shared services centre. However, once a
decision is made to implement shared services, this concern can
become widespread as department managers realize that they will
be losing control of some of their department’s activities.
Recommended Approach:
The key to successfully managing this concern is ensuring that current
performance levels of the various departments are gathered. These
performance levels indicate the volume of transactions processed in
each of the departments in addition to the service levels currently
being provided. Without this baseline, there is the risk of departments
viewing their individual performance levels prior to shared services
as being superior to the shared services centre. Furthermore, this
baselining is necessary in terms of defining what service levels will
be provided to the departments in the future and what the costs for
the services will be.
6 The perception that “it’s necessary to retain a significant number of roleswithin the department or business unitrather than transition these roles to theshared services centre.”
Once again, as the “rubber hits the road” and implementation becomes
a reality, there is an increased concern over the loss of control over
activities and the level of support that will be received by the
departments in the future. Suddenly, there is a desire to revisit FTEs
that are being considered for the shared services centre and a multitude
of reasons surface as to why some of these resources must remain
in the group. There is a fine line distinguishing between the support
required for the “unique” activities that will remain in the department
and the activities that will be transferred to the shared services centre.
This is an important distinction and strong leadership is once again
required for these decisions. Otherwise, the shared services model
will be sub-optimized if much of the staff and work remain in the
departments.
Recommended Approach:
The first step is to clearly define what is going to be transferred to the
shared services centre. Depending on the desired culture for the shared
services centre, the physical location and a number of other factors,
the actual staff being considered for the positions may vary. However,
a number of things are necessary: a net reduction in the departments
the shared services centre will support; a reorganization of responsibilities
retained by the departments; defining the number of FTE; and roles
and responsibilities within the shared services centre. In a unionized
environment, this will be driven by the union agreements and therefore
is more complex to address both in terms of responsibilities being
transferred into the centre and the unionized individuals affected.
Having said that, shared services centres have been established
successfully in unionized environments. However, union involvement
and agreement at the outset is a critical success factor.
10 IBM Financial Management Insights
7The concern that there may be thepossibility of a department or businessunit “opting out” of the shared servicescentre in the future.
This concern arises most prevalently when shared services is
implemented by departments, business units, regions, or countries
in different “waves” or phases. Departments in the first phase are
very concerned that they will be required to be part of this significant
change but departments in later phases may not be mandated to do so.
This comes back to the executive leadership supporting the project. If
the desire is to truly implement a shared services model, an “opt out”
option will only be to the detriment of the planned benefits in the
business case.
Recommended Approach:
Typically, those departments viewed as being at higher risk for
implementation problems (note that criteria needs to be established
for this decision) will be addressed in later phases, as it is essential to
have initial success with the shared services centres, and then address
the more complex departments. The service level agreements should
stipulate whether “opting out” is ever an option; however, this is not
recommended.
8 The perception that their department/business unit “will not be able toeffectively manage their operationsif they are required to move to a“common” Enterprise ResourcePlanning (ERP) system instance(which is typically a common, non-customized configuration).”
This is of great concern, particularly in organizations where multiple
ERPs/multiple instances of an ERP are currently used and when
flexibility was given in the past to customize some aspects of the
system. Again, the objection is that “things are fine now but we won’t
support moving to shared services unless the new system has the
same customization.” The reality is that the benefits that are derived
from technology in the shared services business case are a combination
of moving to a common ERP/common instance and lower maintenance
costs and upgrade costs going forward. The only way to ensure this
happens is to minimize or eliminate the system customizations, even
though this is not a popular option.
Recommended Approach:
Many of the ERP systems (particularly Finance modules) are very
advanced, with new features being provided in each release. Hence,
there is a significant amount of inherent flexibility. Often the departments
in scope are not aware of this, so early education during the project is
required to answer the question, “Will the system work the way the
current processes are designed?” The answer is, “Not necessarily,
particularly if the common ERP system selected is different than what
is currently used in a given department.” That’s why there is a need to
re-examine the way things are done today and incorporate best practices
into the new processes which align with the systems. This change,
combined with enabling technology, should address many concerns.
The “one-off” customizations that aren’t covered by the “out-of-box”
ERP system can be looked at, but typically a hard line is taken (e.g.,
if there is even consideration of a system customization particularly
department specific, consideration will be given to having that department
incur a greater portion of maintenance and upgrade costs).
ConclusionAddressing organizational challenges early, understanding what
concerns typically arise, and having strategies to overcome them are
key. Placing priority on change management aspects helps to mitigate
risks associated with the loss of key personnel during implementation.
Process, technology and organizational aspects are necessary to
achieving business case benefits – but ultimately, what matters most
in successfully implementing shared services is properly addressing
the “people aspects.”
11IBM Financial Management Insights
ABC: THE KEYDIFFERENCE BETWEENPRIVATE AND PUBLICSECTOR CLIENTSAs an ABC practitioner with a focus on the public sector, one of
the questions I frequently encounter is, “What is the key difference
between private sector and public sector clients?” The most significant
difference is the legal implications of “total cost” for publicly mandated
products and services. In simple terms, governments cannot make a
profit on mandated services. An example of this would be regular
license plates. Since all vehicles require them, the cost attributed to
the plate should equal the price being charged; however, for custom
or “vanity” license plates, governments are free to set the price without
consideration of the cost incurred to create and deliver the product,
since it is the consumer’s choice to buy this type of specialty plate.
In all jurisdictions in Canada, this distinction stems from a Supreme
Court of Canada ruling from October 1998, Eurig vs. The Registrar
of the Ontario Court (General Division) and The Attorney General for
Ontario. In this case, Marie Eurig – as executor for her late husband’s
estate – refused to pay the applicable probate fee, contending instead
that the fee was, in fact, a tax.
IS IT A TAX, OR A FEE-FOR-SERVICE?The primary distinction between a tax and fee-for-service is that taxes
raise government revenues and fees defray the cost of providing the
service or the cost of regulation. The government must be able to
demonstrate what it costs to provide a service or to perform a regulatory
function by supplying analysis and documentation of how government
resources are consumed in the process.
13IBM Financial Management Insights
ACTIVITY-BASED COSTINGIN THE PUBLIC SECTORWritten by CHRIS REDMONDSenior Managing Consultant
USING ABC METHODSIn selecting ABC as their preferred costing methodology, clients
can expect that it will:
• Inform managers about the full cost of current processes,
and the drivers of those costs;
• Reveal opportunities for business process improvements
and re-engineering;
• Provide benchmarking internally and in relation to other
organizations/jurisdictions;
• Reveal the costs of complexity and uniqueness;
• Promote a cross-functional look at how products and
services are delivered;
• Set target costs;
• Determine performance measurement
(quality, efficiency and cost) criteria; and
• Provide feedback on “Eurig” tests
(see more in “The Key Difference,” below).
In one of our engagements, most line managers were able to
quote the price they charged for providing certain transactions
but had no idea of what it cost to process that transaction. In
addition, there was no linkage to activities being consumed
by the Cost Objects (in this case, products and services).
In our experience, models range from transaction-oriented
processing to areas that provide advice and consulting services
to other parts of the government. In this respect, governments
are similar to the private sector since they have both internal
and external customers.
Upon examination of the fees in question in the Eurig case, the Court
concluded that they were, in fact, taxes since there was no consideration
of the activities and costs associated with the service of granting the
probate; the larger the estate the greater the fee (tax).
Since the statute did not expressly authorize the imposition of taxes,
the taxes were inconsistent with Section 53 of the Constitution Act
1867, and therefore, unconstitutional.
As a result of the Eurig case, all governments in Canada must now
understand and document all costs associated with the myriad of
products and services that are mandated for public consumption
to protect itself from similar legal actions.
HOW IBM’SMETHODOLOGY CAN HELPOne of the key objectives – beyond the typical ABC benefits – would
be to determine the effect of the Eurig decision with respect to existing
costing and pricing practices.
Working with subject matter experts, we document and understand the
required linkages between products and services offered to the public,
and the work activities and resources that they consume.
Diagram 1 illustrates the “bottom up” concept of consumption where
Cost Objects consume Activities, as defined through Activity Drivers,
and Activities consume Resources (dollars, time, assets) through
Resource Drivers.
In order to provide visibility into certain categories of cost, we segment
the resources into user-defined resource pools. This facilitates the
simplification of resource drivers in terms of logic and the number
required to show the linkage between different resources and activities.
For example, a resource pool called “Labour” can be expected to reflect
the cost of salaries, wages and benefits; however, it also contains costs
for office supplies, telephone and similar expenses. The logic behind
this grouping reflects the fact that those costs behave in the same
manner as the consumption of labour in performing the respective
activities.
Resource drivers show causal linkages that illustrate the relationship
of how activities consume the resources. This linkage is defined by the
people responsible for the work, but generally reflects the percentage
of time spent on performing specific activities by all people directly
or indirectly involved in the process.
14 IBM Financial Management Insights
Resources
ABCTrace costs based on their demand
for activities
Resource Driver
Activities
Activity Driver
Cost Objects
Diagram 1
During activity workshops, we work with a cross-section of staff to
document and understand the activities that are performed to create
their Cost Objects. Our sessions vary from leveraging process maps,
to story boarding, to just having a person tell us what they do. The
documentation of these activities would be an integral part of the
process of demonstrating fees for service as it relates to the Eurig
decision.
The next step in the process is to identify the linkage between the defined
activities and the products or services they create. This linkage helps
to distinguish a fee which relates to the cost of goods and services
provided, versus a tax where the fee is not related to the cost of goods
and services.
Activity drivers measure the frequency, complexity, and duration of
performing an activity one time, for a specific Cost Object. Let’s look
at a department that is responsible for processing public requests
relating to commercial vehicles in any provincial government. The
activity of processing an “Oversize/Overweight Permit” used by large
commercial vehicles will not always consume the same amount of effort,
depending on the different type of vehicle it is being processed for.
Where multiple types of permits exist, the activity needs to be analyzed
to see if it is performed equally for all Cost Objects. In our example,
a Single Trip Permit may require five minutes of effort to process, but
a “Wide Load” Permit may take 60 minutes to complete since there are
many additional steps in determining allowable routes based on bridge
reports for clearance and gross vehicle weight allowances. In this case,
the cost consumed for a Wide Load Permit is 12 times greater than
it is to perform the same activity for a Single Trip Permit.
Another key component of work is the documentation and linkage of
previously unrelated costs from an organizational standpoint. Amounts
that were previously viewed as another department’s costs and
considered unrelated to a product may now be linked via a deeper
analysis of the cause and effect of a product’s consumption. Typical
examples are costs associated with Information Technology, Corporate
Finance and Human Resources. Organizationally, these costs belong
to other divisions and may have been viewed as overhead. By examining
the costs of the Information Technology area, we are able to identify
and document transactional-level relationships of what is being
processed by the various automated systems being maintained. This
linkage can show that these previously defined overhead costs can
be viewed as a direct cost in the provision of specific products and
services. These systems can be integral for processing transactions
at the counter, at the kiosk or over the Internet.
SUMMARY OF BENEFITSManagers now have access to a host of new information and metrics
about their operation that will ultimately lead to more informed decisions.
The following list summarizes the benefits of ABC derived to date:
• Informs managers of absolute and relative cost
of a product or service;
• Identifies cost and unit cost of activities;
• Shows activities used to produce a product/service
(bill of activities);
• Reveals number of people doing each activity;
• Identifies gaps in the organization;
•Reveals opportunities for business process improvement
and reengineering;
• Reveals costs of complexity and uniqueness; and
• Assists with the determination of Eurig compliance.
While ABC can directly benefit managers in the private and public
sector alike, the attribution of costs for the “Eurig” analysis will
assist governments in determining the impact on their costing and
subsequent pricing of mandated products and services to the public
in the future.
15IBM Financial Management Insights
Using Activity-BasedCosting to ManageSKU Proliferation
16 IBM Financial Management Insights
Written by ROBERT TOROKExecutive Consultant
NOTE: This article is based on the author’s experience with a leading global consumer packaged goods manufacturer.All financial and operational data has been disguised to preserve confidential and competitively sensitive information.
Recently, a leading manufacturer of consumerpackaged goods faced a major capacityshortfall at one of its facilities. Its largestcustomer, extensively served through thisparticular facility, was planning for a substantialincrease in sales and approached themanufacturer to assess its capability to take on the added business.
Management’s challenge was to ‘find’ thisextra capacity without physically adding tofacilities or using third party manufacturers.
To understand the context of this challenge, it is important to note that this company’sproducts shared a number of key
characteristics with similar products in theindustry, such as:
• Low unit cost/value;
• High unit weight (relative to cost or value)since the major ingredient is water;
• Large unit size (again relative to cost orvalue);
• Transportation challenges; in otherwords, both bulk and individual packagequality can degrade when shipped longerdistances (generally accepted in theindustry as being no more than roughlyone day’s distance by truck);
• Highly seasonal sales patterns, i.e., muchhigher sales in certain seasons than atother times, and further emphasized by regional climate differences;
• Capital-intensive production that requiresdedicated equipment by package size;
• High turnover (at the retail level, often the product line with the highest turnover);and
• Very similar direct unit costs within agiven package size, i.e., costs vary moreby size than by brand or flavour (singleserve items vs. 1 litre or 2 litre bottles, etc.).
Finding Extra Capacity: Background Information
The combination of these characteristics
means that manufacturers are generally
reluctant to add physical capacity to their
plants, and thus seek to maximize existing
facilities, often relying on third-party
manufacturers (“co-packers”) – contracted for
‘spike’ volumes or to serve customers distantly
located from core manufacturing facilities.
In this particular case, plant management
viewed its manufacturing facility to be at or
very close to capacity, producing almost 17
million units/year spread across approximately
400 SKUs1 , already operating on a 24/7
basis in and around peak season.
While some production could be shifted from
peak season to shoulder or even off-season,
that option brings with it accompanying
inventory storage challenges (cost, degradation
of quality, and reliance on dubious forecasting
accuracy). That is why management needed
to find capacity without physically adding to
their facilities or using co-packers.
Hypothesis and Key DataOne hypothesis that management put forward
was that certain SKUs were likely to be
unprofitable in their own right and thus their
elimination might free up capacity. This
hypothesis is what the author was engaged
to analyze. Activity-based costing analysis
was undertaken to identify the least profitable
SKUs, based on the following definitions and
categories agreed upon by the plant, the sales
organization, and the author/consultant
(A being the highest volume items, D the
lowest):
• Single serve SKUs:
A > 52,000 cases sold per year,
D < 4,000, with B and C in between;
• Multiple Serving SKUs
(1, 2, and 3 litre bottles):
A > 36,000 cases sold per year,
D <11,000, with B and C in between.
While the above data clearly suggested both a
serious problem and an opportunity, the next
question was to determine the costs associated
with the most obvious inefficiencies of the ‘D’
SKUs, and to a lesser extent, the ‘B/C’ ones
as well. The first step in this analysis was to
identify the key activities that were performed
at different levels of the business, such as:
• SKU: Product line change-over, largely
consisting of a new supply of single
serve packaging materials which arrive
pre-labeled by brand and flavour (empty
bottles are identical for all brands and are
labeled during production), clean-out of
preparation and production equipment,
and certain new raw materials;
• Package Size: Production line change-
over, largely consisting of line change-
over from one size to another 4;
• Brand: Consists of many elements but
certainly includes all the SKU changes,
likely the package size changes, and new
labels for bottles. This also includes the
periodic redesign of labels as logos
change and/or as regulatory requirements
for label information change.
As is the case with virtually all manufacturing
processes, every time a production line
changes, some type of loss is experienced.
At a minimum, it is simply time; in this case,
in addition to time (the most valuable
commodity here), raw materials are lost
as they are flushed out during the cleaning
process.5 This is referred to as yield loss,
and what was considered relevant was not
the absolute amount (some, of course, is
inevitable) but the relative amounts across
SKU types. We defined yield loss as the
number of cases of finished product that
would have been produced with the raw
material lost during a flavor change-over,
17IBM Financial Management Insights
Single 1 Litre 2 Litre 3 Litre Serve2 Bottles Bottles Bottles
# of ‘A’ SKUs 38 19 22 4
# of ‘B/C’ SKUs 57 18 26 9
# of ‘D’ SKUs 16 37 41 12 Average Annual 217 151 174 50Sales of ‘A’ SKUs3
Average Annual 35 16 18 21Sales of ‘B/C’ SKUs3
Average Annual 4 4 2 3Sales of ‘D’ SKUs3
Average Length of 5.0 4.3 4.0 4.0Production Run3 ‘A’
Average Length of 2.3 1.2 1.0 1.9Production Run3 ‘B/C’
Average Length of 1.8 0.7 0.7 1.2Production Run3 ‘D’
expressed as a percentage of total cases
produced. For example, 7,798 cases’ worth
of ingredients was lost during change-overs
within the 1 litre package size for ‘A’ items;
this represents a loss of 0.23% of cases
produced.6 For ‘B/C’ items, the equivalent
figure was 3,312 cases, but with a significantly
greater percentage loss at 0.79%.
Next, the team calculated the efficiency-loss
ratio; namely, the number of cases lost as per
the yield analysis and divided by the total
number of cases produced in that production
run (using averages). As above, the 7,798
cases lost represented about 5.09% of the
1 litre cases produced.
Continuing the format of the above table,
here is what was found:
Two major conclusions can bedrawn from these two tables:
1. The yield loss increases very substantially
as one moves from A to B/C and especially
to D items. Essentially, the yield loss on D
items is 2.5 to 5 times greater than for A
items. Similar results are seen for the
efficiency loss ratio.
2. The average length of an A production run
is 2.5 to 6 times longer than for a D item,
leading to much higher efficiency losses for
D items relative to A items.
Based principally on this data, the team was able to determine the relative costs of A, B/C, and Dcategory SKUs:
• Single Serve: D items cost 6 to 12 cents
more per case to produce than A items,
plus an additional 1 to 2 cents in yield loss.
• 1 Litre bottles: D items cost 50 to 80 cents
more per case to produce than A items,
plus an additional 2 to 4 cents in yield loss.
• 2 Litre bottles: D items cost 22 to 36 cents
more per case to produce than A items, plus
an additional 1 to 2 cents in yield loss.
Initial ConclusionsThe operational data clearly demonstrated
that D SKUs were particularly inefficient and
relatively high cost to produce. In addition,
a number of semi-fixed and fixed costs were
being incurred to create and maintain these
SKUs. While the same costs were incurred
for all other SKUs as well8, due to the lower
volumes, the ‘amortization’ of these costs
generated a much higher per case cost for
the D items.
Therefore, the initial conclusion was that
the facility would be more profitable if it
manufactured a greater volume of A SKUs
instead of D SKUs, but this was hardly
actionable information. That’s because
eliminating SKUs that are profitable – as most
of the D SKUs were, albeit significantly less
so than A items – might reduce profitability as
well as alienate the customers of those SKUs.
Extension of AnalysisAs a result, the analysis was extended to
review specific D SKUs with the view to
determine the likely impact of their elimination.
These results were somewhat surprising,
as shown by these five examples:
1. Brand A, Flavour 1:
Sold in a 2 litre bottle as well as two different
single serve package formats, all D items.
2. Brand 2, Flavours 2, 3, 4, 5, and 6:
Each sold in a 2 and 3 litre bottle as well as
one single serve package format, all D items.
3. Brand 3, Flavour 2:
Sold in a 2 litre bottle as well as two different
single serve package formats, all D items.
4. Brand 4, Flavour 2:
Sold in a 2 litre bottle (D SKU) as well as
three different single serve package formats
(two of which were B/C and one was a D
SKU).
5. Brand 5, Flavour 6:
Sold in a 2 litre bottle and two single serve
package formats (A SKUs), a third single
serve format and 3 litre bottle (both B/C),
and a 20 ounce bottle (D).
18 IBM Financial Management Insights
Single 1 Litre 2 Litre 3 Litre Serve7 Bottles Bottles Bottles
Yield loss from ‘A’ 0.30% 0.23% 0.18% 0.16%
Yield loss from ‘B/C’ 0.56% 0.79% 0.68% 0.34%
Yield loss from ‘D’ 0.74% 1.30% 0.92% 0.53%
Efficiency loss from ‘A’ 6.7% 5.1% 4.7% 4.0%
Efficiency loss from ‘B/C’ 12.9% 18.2% 18.0% 8.5%
Efficiency loss from ‘D’ 16.4% 29.8% 25.8% 13.3%
19IBM Financial Management Insights
In other words, it was not the individual SKU
that was inherently unprofitable. Rather, while
the total volume of many brand-flavour
combinations was at the A or B volume levels,
the sheer number of packages offered made
most of the individual SKUs appear to be poor
performers.
This led the team to the next question: if
certain SKUs (i.e. brand-flavour-package
combinations) were eliminated, would those
sales be lost or would they migrate to other
package sizes within the same brand-flavour?
This of course is a sales or marketing question,
not one likely to be adequately answered by
a team of cost accountants! But it does
demonstrate the linkage and importance of
ABC to other parts of the business.
The team then reviewed what became known
as the ‘package proliferation problem’ across
every brand-flavour combination, in order to
identify situations where a substantial volume
migration/retention could be expected. The key
assumption to volume retention was that
consumers of 2 and 3 litre bottles would not
migrate to 1 litre or single serve formats and
vice versa (the former being ‘take-home’
products and the latter generally being
consumed immediately), while consumers
of single serve formats required at least one
other such package format from which to
choose. The company assumed that a
consumer of a particular single serve package
would not switch brands just because the same
flavour was now sold in a different package
configuration (but still as a single serving).
Conclusions andLessons LearnedThis analysis enabled the team to determine
that the majority of ‘lost’ sales would in fact
not be lost, but simply transferred to other
package sizes. This allowed the facility to
reap a cascading set of benefits:
1The elimination of about 60% of the D
SKUs in the facility, and the associated
yield and efficiency losses, as well as
related soft costs associated with inventory,
obsolescence, materials management, etc.
2The migration of about two-thirds of
the eliminated sales volume to other
package sizes, effectively boosting the
sales volumes of a number of remaining D
SKUs and some C SKUs. This meant that
almost 90% of the original D SKUs were
either eliminated or now produced in C
or better volumes.
3The creation of approximately 7% more
production capacity than had existed
previously (over and above the
incremental migration volumes noted above),
through the elimination of the D efficiency
losses as well as a portion of the C efficiency
losses.
4Although a ‘softer’ benefit, there was a
material simplification in the facility’s
business and an opportunity to reduce
indirect expenses or take on additional
volumes at current indirect expense levels.
Most importantly, the facility was able to
demonstrate to its key customer that it was
indeed able to take on the additional volumes,
in part by instilling a disciplined approach
to managing individual SKUs.
The application of this type of analysis can
easily be extended to virtually any industry
or product/service situation. The organization
must accept the key underlying philosophy
that complexity carries cost, not necessarily
measurable at the individual product or service
level, but very measurable in the aggregate;
furthermore, potential savings that are deemed
very small at the individual SKU level can
have dramatic business impact in total.9
The activity-based analysis allows an
organization to identify the specific work steps
pertaining to individual products/services and
groups of products/services. Then, one can
identify the costs that are expected to ‘go away’
should a SKU be eliminated. However, as this
example demonstrated, costs that do not ‘go
away’ might be better deployed by producing
more profitable products/services or even to
serve customers with greater potential.
1. An SKU is a single item at the manufacturer or retail level, in this case, a unique combination ofbrand, flavour, packaging, and unit size. For example, Flavour 1 manufactured under brand X,produced in a 1 litre bottle and sold as a single bottle is a different SKU from exactly the sameproduct sold as a 6-pack of single serve items. Each SKU is produced in volumes rangingfrom hundreds to tens of thousands of cases.
2. This manufacturer produced single serve items in a number of different formats, but theseare combined here for simplicity.
3. In thousands of cases4. Generally speaking, single serve SKUs are produced on one line and bottles on another,
with no sharing of assets between them until packages come off the line, at which timewarehouse transfer and subsequent assets are common.
5. No consumer wants to find traces of say honey mustard in a vinegar dressing (perhaps dueto health, allergy, religious, or other dietary restrictions).
6. Cases produced closely approximate cases sold but not exactly.7. This manufacturer produced single serve SKUs in a number of different formats, but these
are combined here for simplicity. 8. Examples of such costs – in order from semi-fixed to fixed - include production scheduling,
warehouse space for raw and finished goods, materials procurement and management, billof materials/formulation maintenance, and package development.
9. It was once said that “Just because peanuts are light does not mean you can carry a billion of them.” (author unknown).
Endnotes
This publication has been prepared by the IBM Global BusinessServices practice of IBM Canada Limited for general informationpurposes only and is not intended, and should not be construed, asprofessional advice or opinion. The information reflectsinterpretations and practices regarded as valid when published basedon available information at that time. Readers who are concernedabout the applicability of the information in this publication to theiractivities are advised to seek legal or professional advice based ontheir particular circumstances.
IBM and the IBM logo are trademarks or registered trademarks ofInternational Business Machines Corporation in the United States and are used under licence by IBM Canada Ltd.© Copyright IBMCorporation 2006. All rights reserved. Other company, product andservice names may be trademarks or service marks of others.
Oracle – a registered trade mark of Oracle International Corporation
EDITOR: EDMUND LEE Senior Managing Consultant IBM Global Business ServicesFinancial Management ServicesTel: [email protected]
20 IBM Financial Management Insights
OUTSOURCINGIS GOOD FOR THEBOTTOM LINE Today's business leaders are looking for innovative ways
to deliver shareholder value and bolster investor confidence.
Common strategies include implementing new management
practices, revitalizing business processes or engaging in
information technology outsourcing. Questions naturally
arise: Is there value in outsourcing information technology?
Will shareholders see the return? A study conducted by
scientists in the IBM Watson Research Center of companies
outsourced to a number of service providers says: "Yes!"
Long-term effects on companies that outsourced a major
portion of their IT infrastructure between 1998 and 2002
were investigated. Unlike previous research that relied on
the case-study approach, the IBM Research study is the first
to apply rigorous statistical analysis to measure the impact of
an outsourcing agreement on a company. The study concludes
that companies outperformed their peers on a long-term
basis in key business metrics, specifically SG&A expenses,
ROA and EBIT. Further the research indicates the larger
the outsourcing contract, the more likely the improvement
in bottom-line results. A summary of the study results
"Business Impact of Outsourcing — A Fact-Based Analysis"
and a video are available to download at www.ibm.ca