Evaluation of effectiveness of Activity Based Costing (ABC) for ERP Projects

Abstract - The widespread environmental change has forced many organizations to change and rethink their business and competitive strategies, particularly cost management system, in order to achieve the competitive edge in the marketplace. Activity-based costing (ABC) (Cooper 1987a, 1987b, 1988), which uses various activities to trace overhead directly to cost objects, such as products, processes, services, etc., avoids the distortions of traditional costing systems. ABC provides accurate cost predictions and effective strategic decision making (Johnson and Kaplan, 1987; Johnson, 1987).

Activity-Based Costing (ABC) is primary used to enhance productivity and efficiency in the business process; to help create budgets and set prices; to identify customer costs and improve customer relations; to make decisions on strategic issues; and to address external negotiation issues. ABC has been often used together with other management tools and methods depending on the overall objectives of specific initiatives.

This paper presents a framework and evaluation of activity-based costing in ERP projects / programs in IT industries. This paper analyzes ABC project implementations in various industries, identifies issues related to such implementations and offers a framework for maximum benefits. The survey investigated the reasons for adopting activity based costing, the perceived and achieved benefits of activity based costing and the reasons for nonadoption. The reasons for adoption were more accurate costing and better use of resources. Thus this case study analyses how an ABC costing system improves operations and helps to meet the needs of IT projects / programs in effective manner.

Introduction

The nature of software development is undergoing a dramatic change, one that strikes at the core of how the industry will build software systems in the coming decade. Various companies are trying different approaches like Agile, Reusability, Modular development and cost reduction. Organizations are faced with many challenges during this time of economic recession. The most common organizational reactions are to button down the hatches, secure the turf, and start chopping staff positions. Forward looking organizations that seek out opportunities during a time of economic recession tend to focus on process improvement initiatives such as, business-process analysis; Activity Based Costing (ABC), life cycle compression metrics, among other things.

A couple of differences between ABC and traditional cost systems are ABC traces costs according to activities rather than by functions or departments.

Organizations are moving from managing vertically to manage horizontally.  It is a move from a function orientation to a process orientation. Total quality management (TQM), just-in-time (JIT), benchmarking and business process reengineering (BPR) are all examples of horizontal management improvement initiatives. These initiatives are designed to improve an organization’s work processes and activities to effectively and efficiently meet or exceed changing customer requirements.  

Activity-based costing/activity-based management fills this information need by providing cost and operating information that mirrors the horizontal view. The focus of ABC is on accurate information about the true cost of products, services, processes, activities, distribution channels, customer segments, contracts, and projects. Activity-based management makes this cost and operating information useful by providing value analysis, cost drivers, and performance measures to initiate, drive or support improvement efforts and to improve decision-making. ABC has been often used together with other management tools and methods depending on the overall objectives of specific initiatives. 

2. Framework of research

Following research questions were analysed to evaluate the effect of Activity Based Costing on various ERP projects. The responses were collected from Project Managers and Accountants of IT Industries from India.

2.1 The Research questions:

a) Check the feasibility of ABC principles to Internal ERP projects / programs in India

b) What is the extent of ABC/M’s adoption in Indian IT Projects?

c) What  are  the  reasons  for  the  introduction  of  activity  based  costing  in  IT Industry in India   

d)   How companies identify the cost drivers and the performance measures

e) Compare ROI and payback period of ERP projects / programs against traditional costing method and ABC.

f)   What are the benefits achieved by those who have adopted ABC/M?

g)   What are the rates of non-adoption and why?

2.2 Target Population:

Ø Project / Program managers from major IT industries

Ø  >Delivery Heads / Account Managers responsible for cost analysis of the projects

ØBusiness Analysts from Finance department of IT industry who are responsible for allocating overheads for the projects

3. Case Study:

Indirect Cost of the company is allocated to all BUs proportionately. Cost of the cost projects (non revenue project)  is allocated to other projects in the same BU.

Gross Contribution is the expected profit earned in a project after deducting the expenses / direct costs from the revenue. Net contribution is the expected profit earned after decuting the indirect costs. Net contribution of about 60% was normally the cut-off for selecting any ERP project.

Net contribution is inaccurate in traditional costing which might lead to faulty selection or rejection of the project. This is overcome by the Activity based costing where exact cost is known for key activities.

Thus determining the true cost plays an important role in strategic decision-making. The ABC system provides more accurate cost management and enables the company Managers to calculate the ‘true’ cost of a project.

4. Discussion

4.1 Case Study:

In a nutshell, the ABC system clearly indicates that it can help the company to understand where the costs are, what drive them to occur, and which costs may be low value-added to the cost object. The system enables the project managers to analyze and see things through the lens of costs and work activities. This definitely will replace their decision-making behavior through intuition and assertions to fact-based.

4.2 Extent of ABC / M adaption:

An analysis of the responses of the survey indicates that 55.76% of the respondents had implemented or had considered implementing an activity based costing system. And 44.34% had not adopted this system in their organization. Further 34.61% have already adapted the ABC and others have considered / initiated adapting the ABC.

4.3 Assessment of accuracy of the costing System:

It was found that traditional costing is the most widely used costing allocation method with 42.30% of the companies employing it in their organization. 59.1% of those find this system an ‘accurate’ way of allocating their overheads. While ABC is the most accurate costing method.

4.4 Reasons for Adoption of ABC /M:          

The results are outlined show that the more accurate cost information and better use of resources are the major reasons of adoption of ABC.

4.5 Benefits received after ABC/M implementation:

Respondents, on average, agree that the use of an ABC system enables more accurate costing and improved insight into cost causation.

4.6 Measures taken for successful implementation:

Below table examines the measures deployed by organizations in an attempt to ensure the successful implementation of the ABC system. Many of them used the combination of these measures.

Ø  Extensive research into the similar implementations

Ø  Involvement of outside consultants

Ø  Staff training and education

Ø  Benchmarking against the other IT industries who have implemented ABC

4.7 Reasons for no adoption of ABC:

From the responses received, the responses of the companies which have not implemented ABC were analyzed to find the major causes of no adoption of ABC.

The 45% of respondents who have not adopted activity based costing cited the cost and complexity involved with implementation as the main factors in non-adoption. Senior management commitment to such an implementation was also seen as a prohibiting factor.

                                                                                                                         

5. Recommendations and Conclusion:

The ABC system provides more accurate cost management and enables the managers to calculate the ‘true’ cost of a product / service.

New version of ABC, time driven ABC, is to eliminate the problems involved in large scale ABC implementations because of a changed way of obtaining data on time required to perform the activities and a modification of activity cost calculation. Time driven ABC uses time as primary cost driver to allocate resource cost directly to objects e.g. transactions, orders, finished products, services and customers.

In a nutshell, the ABC system clearly indicates that it can help the project managers to understand where the costs are, what drives them to occur, and which costs may be low value-added to the cost object. This definitely will replace their decision-making behavior through intuition and assertions to fact-based. Therefore, the big opportunities of ABC system predicting planning cost estimation and elimination of non-added value activities, which are useful for operational strategic decision. In emerging economies, this change to a company’s cost structure could be especially significant, as many of these economies are notoriously known for high capital costs.

*This blog is based on my MBA dissertation report

Technology: Path to Paperless Business

Today the business has shadowed the geographical boundaries of world. Now it is the age of globalised business. In the present era of communication revolution, information can be sent from one end of globe to another end within seconds. Gone are the days of using diaries and posting letters.

It is possible to perform different business transactions without being presenting physically the parties involved. Now with a single mouse click, you can buy the best roses of the seasons from a distant shop or book a hotel room from the home computer or you can pay your telephone bill from your bank account without even going to the bank branch. All this is performed through Internet and termed as e-business just like e-mail. The websites involved are called business portals and are responsible for marketing, executing and safeguarding different business transactions through their sites. Electronic commerce can be between two businesses transmitting funds, goods, services and/or data or between a business and a customer and even between two customers.

"Electronic Record" means date, record or date generated, image or sound stored, received or sent in an electronic form or micro film or computer generated micro film. . Information captured through electronic means, and which may or may not have a paper record to back it up. It is also called machine readable record.

A digital signature is an electronic signature that can be used to authenticate the identity of the sender of a message or the signer of a document, and possibly to ensure that the original content of the message or document that has been sent is unchanged.

Paper signatures v/s Digital Signatures

Parameter	Paper	Electronic
Authenticity	May be forged	Cannot be copied
Integrity	Signature independent of the document	Signature depends on the contents of the document
Non-repudiation	Handwriting expert needed Error prone	Any computer user Error free

M-Commerce is the buying and selling of goods and services through wireless handheld devices such as mobile telephone and personal digital assistants (PDAs). M-Commerce is a platform where a mobile customer can avail various banking and other related commercial facilities through his mobile phone. The main areas of m-Commerce use are in text messaging or SMS, mobile payment, financial & banking services, logistics, goods/services buy/sell information services and wireless customer relationship management etc.

 The advent of personal computers brought the storage, retrieval and processing capacities of computers to Government offices. By the late 1980s, a large number of government officers had computers but they were mostly used for ‘word processing’. Gradually, with the introduction of better softwares, computers were put to other uses like managing databases and processing information. Advances in communications technology further improved the versatility and reach of computers, and many Government departments started using ICT for a number of applications like tracking movement of papers and files, monitoring of development programs, processing of employees’ pay rolls, generation of reports etc. Recent technological developments has enabled the entire business functions to go online using technologies and tools like Cloud computing, ERP, CRM, Business Intelligence, RFID, Bar coding etc.

With the affluent power of technology, comes the misuse of technology. Hence the law relating to ‘information technology’ cam into existence as the Information Technology (IT) Act, 2000 which came into force on 17th October, 2000. It is the first Cyber Law in India. It is mainly based on the UNCITRAL Model Law.  The United Nations Commission on International Trade Law (UNCITRAL) adopted the Model Law on Electronic Commerce in 1996. This Model Law provides for equal legal treatment of users of electronic communication and paper based communication.

Following course of action is required to prevent the misuse of technology:

•      Need international co-operation

•      Mutual co-operation between countries

•      Transfer of technology between countries

•      Deportation of criminals

•      Educate the masses

•      Spreading awareness about crimes (related to Ecommerce, digital signature,M-cmmerce and electronic Record )

•      Training and educating policemen

•      More and more stringent norms

Green Supply Chain Strategy to spearhead tomorrow’s Growth

Green Supply Chain Strategy to spearhead tomorrow’s Growth

Abstract:

            Green Power in Supply Chain Management has been increasing in consciousness of the environment in the last few decades.  More people are aware of the world’s environmental problems such as global warming, toxic substance usage, and decreasing in non-replenish resources. GSCM (Green Supply Chain Management) is gaining attention among supply chain researchers and practitioners driven mainly by deteriorating environment. The applications are beneficial to organizations environmental and Financial functions.

GSCM initiatives ranges from reactive to proactive practices implemented through various Re’s…..!! (Reduce, Reuse, Rework, Refurbish, Reclaim, Recycle, Remanufacture, Reverse logistics etc.) Not only manufacturing, but GSCM can also be used to other business sectors such as government, education and services.

Market forces like scare resources, bottom line improvement needs are driving firm’s new focus on greening their supply chain. Stricter European Environmental Regulations (RoHS, WEEE, REACH) have influenced other governments to pass similar laws.

This paper describes the various strategies to implement of GSCM to various areas with some examples of its application.

1.1 Introduction to Green Supply Chain Management:

An integrating environment thinking into supply chain management , including product design, material sourcing and selection and manufacturing processes, delivery of the final product to the customer and end-of-life management of the product after its useful life. (Srivastara, 2007)

According to this definition, GSCM relates to a wide-range of production from product design to recycle or destroy, or from cradle to grave.  This principal is similar to lifecycle of product.   Product lifecycle is an idea that products pass through a cycle of life, similar to human, birth, maturity, death.  The product lifecycle provides a degree of structure to the life of products and thereby provides direction for the diverse functional efforts required to produce and deliver product/service offerings (Birou, Fawcett, & Magnon, 1998).   Many studies addressed product lifecycle along with supply chain or GSCM, for example, (Stonebraker & Liao, 2006) discussed that the stage of lifecycle variables is associated with the various dimensions of supply chain integration.

According to (Boks & Stevels, 2007), they categorized “green” into 3 types depended on the different perceptions of the environment among different stakeholders involved: scientific green, government green, and customer green.  In scientific green, life cycle assessment (LCA) was used to determine the environmental impact of products, processes, and systems.  However, it concerned only the emissions, not other aspects.  In government green, several factors were involved such as population density, geographical position, and the availability of energy sources.  These factors affected the government agenda to maintain or improve quality of life.  For customer green, the perceptions of green were strongly linked to emotions that were directly impacted to people, especially health and safety, than resources or emissions.

 GSCM recognizes the disproportionate environmental impact of supply chain processes and offers an expanded way to think about Cost reduction and profit improvement. It is much more than just a mere reducing usage and pollution. Consequently, the benefits are not limited only less toxic consuming or less waste.  The GSCM principle can be applied to all departments in the organization.  The effects of GSCM expand to all area, both tangibly and intangibly.

Some studies mentioned benefits of adopting GSCM, such as (Stevels, 2002).  He demonstrated the benefits of GSCM to different roles of supply chain including environment and society in terms of different categories: material, immaterial, and emotion.   For material, GSCM helps lower environmental load for environment, lower cost prices for supplier, lower cost for producer, lower cost of ownership for customer, and less consumption of resources for society.  In terms of immaterial, GSCM helps overcoming prejudice and cynicism for environment, less rejects for supplier, easier to manufacture for producer, convenience and fun for customer, and better compliance for society.  For emotion, GSCM helps motivation of stakeholder for environment, better image for supplier and producer, feel good and quality of life for customer, and make industry on the right track for society.  He also provided examples of company that were successfully adopted GSCM.

1.1.1 Drivers:

•     Scare resources and unstable prices means competitive advantages from better resource use and efficiency.
•       International customer pressure and competitive advantage for supplier
•       Consumers are environmentally conscious and apply institutional pressure.
•       Government introduction of stricter domestic and international regulations.
•       Employee moral and Ethical imperative.

1.1.2 Inhibitors:

     Insufficient management commitment and supply chain partner support.

     Insufficient green SCM knowledge.

     Fear of high upfront costs and long payback period.

     Inconsistent government regulations across different countries.

 2.1GSCM best Practices:

Approximately 50-60 % of the carbon footprint exists within the organization’s supply chain. The low risk, Lost Cost Tactical Approach to a Green Supply Chain Management is to implement a Pilot Green Supply Chain Management project.

The first step might be to implement a pilot project with a customer and a supplier, such as implementing a green energy and carbon emission reduction mandate, a recycling or a GSCM scorecard system. In all cases, a well-documented roadmap allows businesses to gain the support and involvement of all stakeholders for the implementation of their GSCM action plan.

2.1.1 Implementing Best Practices:

Key Components to a pilot green supply chain project: Plan, Measure, Implement, Monitor and Control

Plan:  Common sustainability strategy, Align existing and Planned priorities, Secure Buy-In forms from EHS, CPO, CFO, Marketing, Supply chain, Legal.

Measure: Measure energy demand, Standardize UOM for each energy demand category, utilize low cost automated tools.

Implement: Define risk for not performing, Define supplier performance risk, understand Branding potential, understand supplier cost potentials, Align functional area goals.

Monitoring and Control: Contract compliance, Carbon footprint implementation results data and reporting, pilot program supplier scorecard, continued strategic alignment.

3.1 GSCM strategies according to different critical factors (Dayna Simpson):

3.1.1 Risk Based strategy: This strategy is based on minimal inter organizational investment engagement. Such efforts might involve the inclusion of basic clauses in purchasing contracts for suppliers to meet all relevant regulatory requirements. Mostly this involves cascading of international standards such as ISo14001. The end result is minimized risk and reputation enhancement without additional innovation and economic benefits.

3.1.2 Efficiency based strategy: This strategy derives environmental benefits for supply chain beyond regulatory compliance through operations based efficiency targets. Much of the benefit arises from manufacturing practices that have been found to give secondary environmental benefits. It has dual economic and environmental benefits and requires the higher levels of engagement from between customers and suppliers. But it lacks the more knowledge intensive environmental activities like product design, innovation or material substitution.

3.1.3 Innovation based strategy: Once supply chain begins to consider specialized processes, technologies or complex performance standards, the level of knowledge exchange and investments changes and requires specialized environmental resources. These resources could be used to incorporate innovative environmental planning into specific product designs, characteristics, functionality or life cycle related activities.

3.1.4 Closed Loop Strategy: This is more recent strategy which represents more complex and collaborative form of activities. It involves ‘Reverse Logistics’ e.g. capture and recovery of material for re-manufacture or recycling. This strategy tries to integrate environmental performance to the whole supply chain by seamlessly integrating issues of economic, operational and environmental performance.

3.2 GSCM Strategies according to Supply Chain Areas:

3.2.1 Technology: In our age of technology, here is a disconcerting thought:  more than half of the warehouses in the world still rely on paper rather than an automated system.  Essentially, companies lack inventory visibility, suffer operating inefficiencies and waste resources within the supply chain.  Leaders in manufacturing and logistics industries should consider an environmentally responsible strategy which not only offers the universal benefits we’re familiar with, but also financial ones that strengthen their profit margins. 

Top green SCM best practices include leveraging the tools that you already have, using technology for communication between stakeholders and suppliers, avoiding unnecessary and wasteful activities and encouraging customers to also go green through their purchases.

The most beneficial green supply chain technology creates sustainable environmental benefits as well as improves company bottom lines. That's why, across industries, companies are extending CSR and green activities to their suppliers. Manufacturers have a variety of choices when it comes to applying green SCM, including packaging engineering and redesign, materials substitution, certification and logistics optimization.

3.2.2 Design: From product lifecycle concept, the cycle starts at the designing of product.  According to (Srivastara, 2007), literatures related to green design emphasize both environmentally conscious design and life cycle assessment/analysis.  In designing a product, the designing team can change the raw materials or substances used during the manufacturing to be less toxic, more environmental friendly.  Some terminologies are related to design for green such as design for environment or EcoDesign.  An example of green product is hybrid car.  Due to the increasing demand and decreasing amount of petroleum, automobile manufacturers needed to redesign the engine that consumes no or less gas.  Hybrid car has been developing from day to day.  One article about automobile design is (McAuley, 2003), he discussed the green design of automobile, which tend to change to advanced lightweight materials and fewer materials in vehicle design.  In designing a product, the manufacturing company needs a high level of cooperation with their suppliers.  An example for the research on supplier-manufacturer cooperation in EcoDesign is (Stevels, 2002).  He also presented two examples of successful green supply agenda between manufacturer and suppliers.

3.2.3 Manufacturing Processes: GSCM initiatives ranges from reactive to proactive practices implemented through various Re’s…..!! (Reduce, Reuse, Rework, Refurbish, Reclaim,Recycle, Remanufacture, Reverse logistics etc.). In manufacturing process, the company can apply green by several methods to reduce the energy and resource consumption.  This is where reuse and recycling are referred.  Several papers provided green practices such as (Duber-Smith, 2005).  He suggested some practices including reducing energy consumption, recycle and reuse, using biodegradable and non-toxic materials, minimize harmful emissions, and minimize or eliminate waste.  In a Chinese sugar manufacturer, Guitang Group can reduce the wastes and improve their financial performance by using waste from the upstream as raw materials for downstream production (Zhu & Cote, Integrating Green Supply Chain into An Embryonic Eco-Industril Development: A Case Study of the Guitang Group, 2004).

While transportation carriers are sensitive to energy prices, manufacturers face energy surcharges.  This uncertainty along with current economic conditions affects the growth of inventory.  The consequences are far reaching since shippers will carry extra inventory or safety stock, and order less frequently, adopting a cost-reducing strategy to select a cheaper, slower mode of transportation.

Companies like Sharp Electronics are shifting their final assembly closer to point of sale, a return to the practices of the 1980’s and 90’s prior to off-shoring becoming a no-choice option for manufacturers to survive. 

3.2.4 Distribution and Transportation: The rising energy prices and limited supply furthers our efforts to adopt alternative solutions.  Much talk centers on the expense and complexity of adopting green initiatives, but green business and revenue growth are not mutually exclusive of each other.

The most commonly used GSCM transportation practices (such as load maximization) are low-risk and require minimal capital investment. Applying several transportation GSCM practices in multiple areas can benefit firms and their supply chain partners even. Air and truck transportation are the most agile modes but emit the highest level of CO2 emissions per ton of goods moved per KM.

Sophisticated technology boosted supply operations such that Wal-Mart’s efficient retail stores has become the manifestation of a fast and flawless distribution business. It has adapted the strategy of how to be the low cost operator and low cost leader by focusing on logistics and distribution. It moves the product faster and efficiently and maximizes the use of suppliers and internal distribution lines ensuring that they meet social and environmental standards. E.g improving fuel mileage efficiency in trucking fleet, Recyclable or Biodegradable packaging, Green colored shelf tags etc.

3.2.5 Suppliers: Further than design and manufacturing, other departments in an organization are involved with the green.  Purchasing could become an important agent for change regarding environmental initiatives in the supply chain (Preuss, 2001).  In (Walton, 1998) article, he conducted a qualitative study to explore the primary areas for change to increase purchasing’s impact on environment. 

Escalating labor costs and ever-increasing government regulation are creating reverse globalization.  As the world becomes smaller, moving offshore isn’t a cost-effective way to outsource.  Instead, companies view outsourcing from a more strategic perspective with a deeper understanding for what the business demands.  Pull-based supply chains are again becoming popular, displacing push-based initiatives that encouraged off-shoring manufacturing and other long-lead, long-life transit time strategies to market.

Increasingly, companies are asking suppliers to green not just their products but themselves. Volvo, for example, has mandated that its suppliers to go through ISO 14000 or equivalent certification by the year 2000. Few other companies have taken that route so far. Most efforts to improve suppliers' overall eco-performance center around encouraging compliance with voluntary industry standards, or on participation in such government voluntary programs as the EPA's Green Lights.

3.2.6 Customers: Market demands to improve performance while simultaneously reducing costs is changing the playing field, and highlights the need for technology to support both the agile, energy-efficient supply chain as well as for socially responsible green initiatives.

While educating corporate buyers will help, the key to success will come from educating sellers. "The challenge is to make the case that there is a business for the environment," says Bill Shapiro, Volvo's director of environmental affairs. "That is what we need to convince our suppliers of. It is a continuous challenge to educate the business community about our philosophy and what we expect of them."

(Ref.:IMEC 2010, Ninlawan C., Saksen P., Tossopal K., Pilada W.)

4.1 Examples of GSCM:

The Chinese sugar refinery and Indian paper firm case studies brilliantly apply the green ‘3R’ s principle of ‘Reduce, Reuse and Recycle’; with both firms diversified into related industries like sugar, paper, alcohol, cement and ethanol etc. and utilize the waste products of other industries as raw material or for power generation.

Case studies also highlight the importance of building effective incentives with external parties (suppliers, competitors, customers and government) to improve the robustness of the supply chain systems on all levels; Local, National and International.

The Japanese IT Multinational case study illustrates the benefits of centralization, sharing infrastructure and route optimization in local context that can result in relatively large efficiency improvements and cost reduction.

For a largest retailer in the U.S., Wal-Mart has an interesting story of adopting GSCM to their organization.  In October 2005, Wal-Mart CEO committed the company to 3 goals: to be supplied 100% by renewable energy; to create zero waste; and to sell products that sustain Wal-Mart’s resources and the environment, and Wal-Mart was launching a business sustainability strategy to dramatically reduce the company's impact on the global environment and become "the most competitive and innovative company in the world (Plambeck, 2007).  In this study, she provided 8 practices engaged with 14 network partners.

5.1 Future Trends:

A green strategy provides prudent business processes. Successful Green supply chain will feature cross functional collaboration, emphasize innovation, and stay tune to the strategic focus of supply chain and enterprise as a whole. Such a framework emphasizes network redesign, packaging changes and business collaboration that promote a smaller carbon footprint and generates cost savings.

6.1 Rethinking Supply Chain:

The most strategic way is also the most fundamental—improve supply chain “visibility” and tactical knowledge, to help close the gap between the time you learn about something with significant impact and when you can actually do something about it.

One of the biggest shortcomings in the industry is the lack of communication and accessibility to information. We need to look at our supply chain networks with a sense of urgency which means developing an understanding of future economic conditions.

Unlike other trends that become fads, adopting a green strategy provides long-term benefits.  The green movement may seem daunting to many companies, but more resources are becoming available every day.  While the challenges may change, the fundamentals of good business remain the same.

*This blog is based on my paper published in World BPR Conference (2010)