Precisely what value to the business does the ABC system provide? We'll get to that momentarily, but first let's examine in a bit more detail some additional points of content that the ABC system produces, particularly when the power of online analytical processing (OLAP) hyper-cubes and MDX are thrown into the mix as the platform for delivery of the ABC system's output. MDX provides the ability to generate, dynamically and on the fly, some extremely valuable financial ratios from the ABC system's output.
The first is a ratio that we might call activity expense as a percentage of sales. Anyone with some background knowledge in financial analysis is familiar with the idea of margin-percentage. Typically, similar companies are compared on the basis of their gross-margin or operating-margin percentages to see who is more efficient and in what respects. ABC, particularly when platformed in OLAP, extends this useful ratio deeper down to the root of the activity hierarchy, where every product, every supplier, and every customer, and every mix of the three, can be benchmarked and compared on how expensive they are as a percentage of the sales dollars involved, business process by business process.
Second, the OLAP platform facilitates the ability for dynamic capacity analysis. That is to say, the activities that the ABC system tracks involve corporate resources contributing time to an activity, and partners and products consuming that activity time. Dividing the total consumed time (which is an ancillary output of the ABC system's allocation process) by the total available and contributed time of the corporate resources involved shows the productive utilization of those resources.
Third, most companies have some pool of dollars and resources with the intended purpose of revenue generation, typically the spend involved for sales and marketing/advertising. Leverage analysis, that is, the mathematical division of net margin by the amount of money and resource time spent engaged in revenue-generating activity, shows how much bottom-line bang the company is getting for the dollars and resource capacity spent on those revenue generating activities, vis-à-vis every corporate resource and every product and customer or supplier involved, dynamically analyzable by any combination of the aforementioned entities.
Fourth, many companies make some level of high-dollar upfront investment in fixed cost assets, without which they simply can't run their business. It is important in performing profit analysis to understand how much of a drag the allocated portion of a company's fixed costs has upon a particular product, customer, or supplier's performance, versus its variable costs. Drag in fixed costs versus variable costs typically calls for different types of tactical or strategic maneuvers on the part of the business and over different time horizons in order to address the performance issues seen with particular products, customers or suppliers. The fixed/variable designation typically comes down to a categorization of the general ledger (GL) accounts from which the ABC system begins its allocation process, and MDX provides the ability to dynamically marshal the contribution percentages of various fixed and variable accounts to the activities they pay for and then finally to the products and partners which consume those activities.
So as to the question of specific, quantifiable value: how much value does the ABC system deliver to the enterprise, and how is this value achieved? Based on experience, it would be a conservative estimate to say that a company who uses ABC (and has the conviction to act upon the ABC system's output) can typically expect to drop 10 to 100 basis points right to the bottom line, as a percentage of sales. That is, a 1 billion-dollar company should conservatively be able to improve their bottom line by 1 to 10 million dollars, per annum. It is possible that a company might be so efficient and intuitively aware of the operational drivers of their own performance that improvements of this magnitude won't be achieved. And the smaller the company or the simpler and more manageable its operating model, the more likely this is to be the case. More than likely, however, the performance improvements achieved will be at least in this ballpark, and very likely more. And how are those results achieved?
- Precision-guided rationalization of customers, products and internal resources. ABC provides the basis for intelligent expense reduction efforts that weed and thin out or otherwise better engage unprofitable customers, suppliers, and product lines, as well as internal departments with low-performing staff or excess capacity.
- Improved negotiating results with both customers and suppliers. At the negotiating table, knowledge and information are everything. Understanding the fully burdened expense (i.e., not merely gross margin) of dealing with a particular product or partner is the difference between deals that ultimately make the company money or lose it, particularly in highly competitive, low-margin markets.
- Implementation of incentive compensation programs that align staff compensation with the net profit impact (not gross profit) they deliver. For a manufacturer, the salesman may be king. For the retailer, it's the buyer. For other organizations, it may be the marketing group. Whoever is tasked and recognized as a direct and immediate front-line contributor to the company's success (read "sizably compensated on their individual contribution to the company's performance") also needs to be measured on whether the volume they drive ultimately attains the bottom-line performance benefits for which they are so handsomely rewarded. ABC provides true visibility into net-profit performance, superior to volume or gross margin-based incentive or commission plans that may or may not be profitable at a net operating level.
- Pricing policy adjustments. While a pricing/marketing purist would most likely say that prices should be set so as to maximize revenue and volume in line with whatever the market will bear, the fact remains that in many competitive markets, and particularly for large enterprises who might be easy targets for lawsuits by partners disgruntled over pricing tactics, a cost-justified approach to pricing is the easiest to defend from assault both at the negotiating table as well as in the courts.1 ABC provides the basis for intelligent discounting and surcharging via the rate at which partners under- or overconsume various handling and support activities (read "Consider charging for value-added services").
- Various other operational policy refinements. Perhaps the handling expense of shipping or receiving mixed pallets eats away at a company's margin, so the practice is stopped (or implemented with an additional charge). Perhaps a particular product line involves too much consultative selling, configuration or support effort, so customers are guided to a Web site or automated voice system to handle most aspects of their ordering needs. Perhaps RFID would be a more cost-effective way of performing inventories than physical counts. There are numerous operational decisions that a business may need to make, and the ABC system provides complete, traceable understanding into the financial tradeoffs involved, business process by business process.
