Who's Driving?

Edition: September 2001 - Vol 9 Number 09
Article#: 1060
Author: Tom Pryor

Teenage drivers account for a disproportionate number of car crashes, according to a Reuters News report. Teens were involved in 19 percent of car accidents, even though they account for less than 6 percent of licensed drivers. If you were implementing Activity Based Costing (ABC) in an insurance company, ''Number of Teen Drivers'' would be a good predictor of claims process activity.

Linking causes to effects is one of the primary objectives and benefits of an ABC system. ABC systems use drivers to identify root cause-and-effect relationships between cost (labor and overhead expenses) and cost objects (products, services, customers).

ABC systems use three types of drivers:

Resource Drivers are the basis for assigning general ledger cost to activities or activity pools. The basic principle of activity-based management (ABM) is ''activities consume cost.'' Typical resource drivers include headcount, square footage, number of terminals, and kilowatt-hours. Resource drivers provide activity cost information that can be immediately used to identify and prioritize cost improvement opportunities.

Activity Drivers are the basis for assigning activities and activity cost pools to cost objects. The basic principle of ABC is ''Activities consume costs and products consume activities.'' ABC systems use activity drivers (also referred to as cost drivers) for the costing of product lines, products, services, customers or projects. Examples of activity drivers include number of parts, number of units, number of set-ups, number of orders and number of deliveries. Activity drivers provide product, service or customer Bills of Activity that can be used for costing, pricing, customer profitability analysis, target costing, shared services or strategic planning.

Revenue Drivers are the factors whose change causes an increase or decrease in the revenue of a product, service or customer. Many implementers of ABC have overlooked this driver. In addition to the volume of units sold, typical revenue drivers include number of sales price changes, number of advertising placements and number of defective orders. Companies can model combinations of cost drivers (types 1 and 2 above) with revenue drivers to analyze and predict profitability. Revenue drivers provide a tool to improve forecasting, reduce budget cycle time or perform ''what-if'' analyses.

Starter Kit for Simplicity

Research studies show that teen drivers are more likely to have fatal crashes when more teens are in the car. In a similar vein, case studies have shown that ABC implementations tend to crash proportionally with the number of activities and drivers in the software model. Too many activities and drivers create unnecessary complexity, resulting in crashes for both the software model and the managers using ABC reports. ABC should be a starter kit for simpler work, not the root cause for more work.

For example, when the international air express company DHL implemented ABC in 1994, it initially defined 85 activities and 47 potential activity drivers. As it continued its rollout to 25 countries, the number of activities increased to 106 but the number of activity drivers was reduced to 15. Most manufacturing, service or government organizations can create effective ABM/ABC systems with 200 or fewer activities, 10 or fewer resource drivers, 15 or fewer activity drivers and 10 or fewer revenue drivers.

Remember: Don't let too many back seat cost drivers distract you from the destination of cost and profit improvement!

Tom Pryor is an expert on the implementation of activity-based costing. E-mail your comments on this article to him at TomPryor@icms.net, or call ICMS at (817) 483-6511. Visit the company's website at www.icms.net/focusonabm.htm.