As you will see in the coming pages, we will explain how ABC (Activity Based Costing) has come from being used as a tool that western companies used to help compete with the Japanese in the 1980's, to now being used as a key tool in business strategy management.
In the 1980's the Japanese were using things like Total Quaility Management and Just in Time that were never even heard of in the Western world. The Western world had to create a system where by large industry could have cost clarity in the products and services that they were making in their different industries. It was at this stage, ABC was born out of need to identify areas within the different companies for better efficiencies, helping to drive change. As you will see in the following pages, ABC has been modified over the period of some years to its form used in business today. We will explain its uses within the company structure, its advantages and disadvantages and give an insight into how management perceive the uses of ABC withn the company structure.
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You will see, like any new change or adoption, that the initial stages can be expensive and that sometimes this can hinder or halt the adoption of ABC, even before it gets off the ground, but with the added benefit of software applications, this has brought the implementation expense down and now ABC is slowly becoming an adopted business performance tool around the world for large industries with many product mixes. We will start below with the Adoption of ABC in the Industrial World.
Industry Adoption of Activity Based Costing Systems
ABC Adoption History - the Hype Cycle
Like many new technologies, adoption is marked by changes in perception and increasing diffusion into the market over time. ABC has been no different. From the initial hype in the 1980's, ABC has gone through subsequent periods of falling out of fashion, then steady periods of development and maturity, finally arriving at the point where it is currently widely accepted and adopted in many industries:
Technology Trigger (1984-1987) Innovations in Cost Accounting
Peak of Inflated Expectations (1987-1991)
Trough of Disillusionment (1991-1995)
Climbing the Slope of Enlightenment (1995-2000)
Plateau of Productivity (2000-2006)
Post Plateau (2006-present)
Figure 1: ABC Hype Cycle - Source: Turney 2010
Technology Trigger (1984-1987)
For many new disciplines, discontinuous innovation is driven by external influences which act as a trigger to initiate sudden and dramatic changes within a domain. For accounting, one of the trigger's in the development and initial adoption of ABC by western companies, was the sudden rise in competition from Japanese manufacturers. This forced western companies to look more closely at their cost accounting systems, adopt more innovative costing methods in order drive ongoing efficiencies in order to compete with Japanese.
Peak of Inflated Expectations (1987-1991)
By 1987 ABC had gained widespread exposure in the literature. The first generation of methods and tools emerged, with the first commercially available ABC software packages introduced around 1990.
Trough of Disillusionment (1991-1995)
Like many other new ideas, overinflated expectations and hype results in a failure to live up to expectations. Such was the case with ABC. As a result of a combination of the immaturity of the ABC method, the immaturity of software tools to support it, some well-publicized failures and attention shifting to new management methods, e.g. business process reengineering and enterprise resource planning(ERP) systems, interest in ABC began to decline after 1992.
Climbing the Slope of Enlightenment (1995-2000)
Despite having lost its initial lustre, ABC continued to develop and mature during this period. With these developments ABC became applicable outside the initial scope of cost accounting, to include sales, administration, marketing, R&D and supply chain. ABC implementations expanded into more and more industries, including insurance, healthcare, energy and banking as these industries faced increasing competition. The addition of predictive modelling to ABC expanded its use from a historical cost accounting tool into a planning and analysis tool.
Plateau of Productivity (2000-2006)
In this phase, ABC entered the mainstream where the benefits of the model were seen to exceed the cost of adoption. Adoption was driven by the emergence of a new generation of ABC methods and more powerful software to compliment it. While adoption varied from industry to industry, and country to country, several surveys showed adoption rates reaching the 30% typical of this phase of the hype cycle. Gartner (2004) estimated global adoption of ABC by the global top 1000 firms at between 20% and 50%. Research by Business Finance (2004) indicated an adoption rate of 37% for companies with an annual revenue exceeding $1bn.
Post Plateau (2006-present)
Always on Time
Marked to Standard
The latest phase of ABC development has brought it to a point where its potential has been fully recognised. After 20 years of continuous evolution, ABC is now an integral component in a new generation of business performance management tools., including placing ABC at the centre of Performance Management (Figure 2: ABC as the foundation of performance management -Source: Turney 2010).
Figure 2: ABC as the foundation of performance management -Source: Turney 2010
Four Generations of ABC
ABC has greatly evolved over the last two decades, with four distinct generations of development (Figure 3: Four generations of ABC - Source: Turney 2010). At its inception its goal was to be an accurate cost accounting method. Designed to improve the accuracy of product costing using cost pools and drivers.
Over time ABC extended its scope outside the narrow focus of cost accounting and into the areas of predictive modelling,process analysis and aid to drive cost savings. Its third incarnation saw ABC integration with Enterprise Resource Planning(ERP) and Business Intelligence systems to increase the value of information derived. Finally ABC has emerged as a platform for integrated performance management solutions, incorporating profitability management, financial planning and human capital management.
Figure 3: Four generations of ABC - Source: Turney 2010
Factors Influencing ABC Adoption
Activity-Based Costing (ABC) is widely perceived as improving the accuracy of product / service costing and also assisting managers in understanding and evaluating how resources are used across a firm's value-chain in delivering strategic out-comes. It is attractive to firms in competitive environments that require a continual focus on cost reduction as it provide the data required to make strategic decisions in relation to improving efficiencies.
While ABC implementation rates generally increased during the early 1990's , worldwide adoption rates have remained relatively low. In some literature it is claimed that the rate of new adoptions is actually declining (Innes et al. 2000).
Byrne et al (2007) collated evidence from the literature to back this assertion. Between 1994 and 1999 in ABC implementation by large UK corporations fell from 21 percent to 17.5 percent. A study in New Zealand reported an adoption rate of 20%. A similar US study reported an adoption rate of 18% in the food and beverage industry. Other studies indicated even lower rates of 14% in Canada and 13% in Australia.
Based on their research Byrne et al (2007) concluded that overall ABC is widely regarded within those companies who have successfully adopted it as their costing system. In particular they highlight the following four areas where the perceptions of ABC are positive:
User Attitude: Individuals report positive attitudes toward the implementation of ABC.
Technical Characteristics: Individuals perceive that the technical characteristics of the information produced by their ABC system are superior to those of a traditional cost system.
Perceived Usefulness in Improving Job Performance: Individuals perceive that their ABC system information is more useful in improving their job performance than that of a traditional cost system.
Impact on Organisational Processes: Individuals perceive that the implementation of their ABC system has resulted in more improved organisational processes compared with those of a traditional cost system.
Benefits of ABC
It is widely claimed in the literature that ABC provides many significant benefits over traditional cost accounting systems. This includes improved costing accuracy, more comprehensive costing information and more relevant information for decision making. Abusalama (2008) provides a comprehensive literature search to compile a list of the benefits and advantages of ABC system, namely:
More accurate cost information for product costing and pricing
Improved cost control and performance measurement and assessment
Improved insight into cost causation and behaviour
More accurate customer profitability analysis
Assistance in cost reduction and cost control applications
Improved the calculation of the product profit margin
Improved decisions on sales price, product mix and client mix
Superior decision-making information
Better encouragement of commitment to quality and continual improvement
Increases the effectiveness of budgeting
Increase in profitability and better overhead cost allocation
Improved the inventory valuation
Improved production/service decisions
Improved new product or service design
Provides more in-depth analysis, and value adding decisions
Improved efficiency value-based reporting
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Provides more accurate evaluation of capital investment
Facilitate pricing strategy and product line performance on profitability and efficiency
Improvement of the decision making process in relation to product cost
Changes of product mix in order to better suit customer needs
Improvement of outsourcing decision procedures
Motivation of personnel that deals with cost accounting
Identification of 'loss making' suppliers
Difficulties in Adopting ABC
While the implementation of ABC appears to result in obtaining and achieving the above benefits, at the same time the adoption rates are low. Abusalama (2008) performed a comprehensive literature review on this topic. He identified the following areas of difficulty encountered during ABC implementation:
Identifying and aggregating activities
Assigning resources to activities
Selecting cost drivers
Assigning activity costs to cost objects
Top management support
Uncertainty of ABC benefits
Data collection difficulties
Suitable accounting staff, computer stuff
Inadequate computer software
Amount of work and time needed
Human resource availability
Lack of knowledge/experience
Satisfied with current systems
Categorization of Adoption Barriers
Abusalama (2008) then broke down these barriers to adoption into three separate categories: Technical Issues, Behavioural Issues and Systems Issues (Figure 4: Barriers and difficulties to ABC implementation - source: Abusulama 2008):
Technical Issues: Related to problems in moving to a new costing method, such as defining activities, selecting cost drivers and assigning resources and costs to activities.
Behavioural Issues: Stemming from human related issues, such as lack of support from management, resistance to change amongst staff, lack of appreciation of the benefits that ABC would bring over the current accounting system.
Systems issues: Resulting from inadequacies in the support infrastructure, including hardware, software, data collection and the time and effort required to implement the feature required to support the adoption of ABC.
Figure 4: Barriers and difficulties to ABC implementation - source: Abusulama 2008
Stages of ABC Implementation
Study of the early implementation process at large coporations suggest that success in implementating the ABC depended on the different stages of implemenatation of the process.
Coporations found that there were six stages of ABC implementation and that it was only after implementing all the stages that management could use ABC as a proper tool to help within the business strategy of the company. Essentially the six stages of implementation can be identified as:
Initiation- feasibility analysis is completed
Adoption - decision to invest some level of resources is made
Adaption - analysis is made of the firms; activities and cost drivers, ABC information is available but not yet used by non-accounting departments
Acceptance- occasionally used by upper management for decision-making, but still considered a project.
Routinization - commonly used by upper management for decision- making and considered a normal part of the information system.
Infusion/intergration - used extensively and fully intergrated within the primary financial system.
It is seen that the further that ABC is implemented within the company,the more benefits appear for the use by mamagement and by all the different departments within the company.Once an ABC system has been fully implemented and users are familiar with it, they are better able to make informed judgements within their departments and for the better efficences and strategic business decisions. From above it can be seen that if a company does not implement all of the stages of ABC it experiences most of the costs associated with setting it up but little of the benefits. It is perceived that if a larger company uses ABC in conjunction with an enterprise planning resource sytem or balanced scorecard system or other general management tools,the company as a whole will see great benefits in helping with the business strategy into the future.
Use of ABC in Western and Eastern parts of the world
In eastern countries business strategies are a little bit different to western companies. In leading eastern businesses, product functionality and quality are taken as a given and it is the reduction of cost that drives strategy implementation.
The east did however differentiate between market driven cost reduction prevalent in the east and process driven cost reduction that is more typical in western companies. In the West, ABC is being used as a part of the business strategy to reduce cost base structure and identify products, services that are revenue positive, but in the east the business strategy was a little bit different, in that they had a process of evolutionary change and as such thought about price in the initial stages of product or service development.
It would seem in the last twenty years that mainly businesses in the east have not really used ABC as their preferred cost control method. It was on the other hand, first used by companies in the west in the 1980's that were experiencing financial stress and needed to improve business focus in order to compete with the eastern companies. It has since first being used for this purpose, become a part of the business strategy process for larger westernised companies and it is slowly being adopted by different countries around the world.. The Japanese for instance, have not been using ABC as a large part of their business strategy process, as they had a method of using "Kaizen", business strategy process which was an evolution process by which it was everyone's responsibility to find more efficient and productive ways to find efficiencies within the business structure. This encouraged innovation from all the personnel within the company to improve the cost base of the company. In the western companies, ABC is used more as a top down tool for management to control cost and understand the revenue producing, products/ services in the company and to evaluate whether to increase prices or drop products that are not adding to the bottom line of the company. The eastern companies business strategy process of the past has been more bottom up with every employee in their daily works, finding ways to innovate and find processes to reduce the company's cost base so that they could compete on the international markets.
With ABC been used mainly in western companies, eastern companies argued that there was an over emphasis on the "information for decision making". The reality of modern business instead of it being on "scientific management" should be more focused on "moving constraints" that happen in business constantly.
In saying all this, eastern companies are now in part considering using ABC costing to start helping with business decisions on product pruning, being highly focused to reshape a product portfolio and with radical innovation in estimating specific future costs.
With the differences in the management strategies between eastern and western countries being quite far apart, we then have a country like Jordan that in 2008 with 88 of the largest companies surveyed 55.7% were using ABC methods within their companies. The most cited factors for the implementation of ABC were that adequate training was available and that with an information system backing up its implementation, it could be updated in real time so that management could use it on an ongoing bases to update its business strategy. The most influential factors in applying ABC within firms was increasing proportion of overhead costs, growing costs including production costs administrated costs and an increase in the number of product mixes been offered.
ABC Implementation Rates
While ABC implementation rates generally increased during the 1990's, there was a reported fall between 1994 and 1999 in ABC implementation by large UK Coporations from 21% to 17.5%.
In the context of Ireland in a survey in (Accounting in Emerging Economies) shows us that out of 204 Irish manufacturing companies there was only 26 rejecting the ABC method for management decisions. Of the other companies some were still considering their options and others either had or were starting to use ABC as a management tool within their companies. Significant differences were seen in size, as ABC was mostly used in the larger manufacturing companies like pharmaceuticals and healthcare.
It seems the most important reasons for implementing or not implementing ABC in companies within the different countries were different management styles, in the case of the eastern countries and consultants, training and cost of implementation for the benefits quoted in other countries. Companies in Australia reported that out of 213 manufacturing firms only 12% had implemented ABC within their businesses, citing problems with implementing ABC due to resistance of management and employees to implement the changes required.
In Malayisa most manufacturing companies have not adopted the ABC as their overhead costing system and the ones that have are still in implementation stage. We will see in the future when Malayisan companies have find further efficiencies in the future that they may turn to ABC as a method to carry out this process.
Although explaining above the countires that have implemented ABC as a costing system, generally world wide implementation rates appear low, in light of the apparent superiority of the ABC over traditional costing systems.
Impact of ABC as an Activity of the Business Strategy Process
When a company decides to implement ABC it needs to weight the benefits against the costs of implementation and training of staff. Although ABC is a great tool for manufacturing companies who have many product mixes, there are some companies where it is just not suitable to implement. It takes a great deal of cost and effort on the part of the management to implement the ABC system and it is only as good as the information it receives, so it is very important to have the company employees agree to its implementation.
The ABC Data is typically used for making product line decisions such as discontinuation of unprofitable products, changing prices, and introduction of new products similar to existing profitable products. Within the Business Strategy process ABC can help a great deal in giving management vision to implement new products from the design stage at profitable prices. It can give them a better understanding of the cost bases that they need to acquire and the prices that the market are willing to pay. It gives management a better understanding of what kind of products they should release to market, whether it is high cost, high value products/ low cost, low value products.Although ABC is seen as an expensive costing method to set up, if it is not fully implemented, a company will never see the full benefits of the ABC system. If a larger company uses ABC in conjunction with an enterprise planning resource sytem it can help in many area's as descrided in section 4.1.2
Activity Based Costing - Software
The success of a company's conversion to activity based costing is very closely linked to the efficacy of the software package chosen to implement ABC. Accurate reporting is the lifeblood of ABC, and technological improvements have aided its popularity. These days, an ABC software package is generally part of a suite of decision management software packages including Enterprise Resource Planning (ERP) tools and Online Analytical Processing (OLAP) systems. Some of the following are amongst the more popular software packages known:
SAP Strategic Enterprise Managment (SEM) - SAP SEM is an ERP software suite that can generate financial and managerial reports for a business. Has the ability to aggregate data from both SAP and non-SAP systems, so ideal for a globally distributed organisation.
Oracle Hyperion Profitability and Cost Management (HPCM) - This software helps discover drivers of cost/ profitability, and can be configured for any costing method including ABC. Integrates seamlessly with Oracle's OLAP software for deeper cost analysis.
SAS Activity-Based Management is an analytic application that model business process to determine cost, profitability and drives. It also has data integration with other packages/databases that allow for more complex cost analysis
These three software packages are only three of many thousands of varied offerings. However, these would represent some of the more costlier packages, in particular SAP and Oracle. If a company was deciding to implement ABC, purchasing either of these would significantly show management's commitment to it's implementation as licencing costs can run in to the hundreds of thousands, not to mention a large initial outlay on high-end hardware required to run such complex systems. If a company is to reap the benefits of ABC, then it must consider carefully its software requirements.
As can be seen from the detailed information above, Activity Based Costing, when implemented fully and as part of an overall coherent Business Strategy can contribute greatly to an organisation in creating efficiencies and change so that companies can be more competitive within their associated market places. On the other hand, ABC does not seem to be generally implementedaround the world.There seems to be many reasons for this, but the most prevalent seems to be lack of knowleged base on the implementation side and the cost of implementation over the benefits perceived by management. In most countries, it seems that ABC is used in large manufacturing or service companies with many different product mixes. Although in the past ABC has been cumbersome to implement, now with the introduction of technology based solutions that can intergrate all the informantion from different departments of a company it has become alot easier and cheaper to implement in larger organisations. Unfortunately, at present the costs associated with implementing ABC seem to prohibit small or medium companies experiencing the benefits that are associated with ABC as a modern costing tool. In the future, as the cost of settting up ABC decreases and the knowledge base of implementing the system increases, you could see more companies both from the west and the east implementing ABC. At present, the high cost and the fact that an organisation might not see the benefits of ABC for sometime until it reaches maturity within the organisation, block further companies from seeing the benefits that ABC can contribute to the organisation or company in the future. It can be seen until these prohibiting factors are addressed that ABC as a modern costing system will not overcome the traditional costing methods already employed within existing organisations. It seems that when ABC is implemented fully into an organisation, that the users do perceive that it is a system that is a key factor in the business strategies that are made to progress into the future. Low adoption rates are not the result of a perceived lack of success of ABC practice, but again the high costs and knowledge require to implement it. Unfortunately ABC in itself is about creating change and managing its consequence and monitoring its output, and as we all know change is difficult within an organisation as it creates the unknown.