Without a thorough understanding of the organizations' work, even the best manager cant' create an effective plan.
Before any manager attempts to plan, budget, cut costs or improve performance, he or she must thoroughly understand what drives the organization's costs. The best way to do that is by defining of the organization's work in terms of its activities.
Activities--or what an organization does--are not emphasized enough in current management practices. The complexity of modern business requires elaborate organizations and procedures. Unfortunately, discussion and action then tend to follow these organizational and procedural lines. Saying, "I am in sales" only tells you what a person does in the broadest sense. Activity statements, on the other hand, convey more information: "I make cold calls and sales presentations on products A, B and C in Ohio."
Consider the flow of materials into a factory. The functions involved may be material management, quality control and accounting. The material flow and associated costs can be budgeted and managed in terms of these functions as well as a material overhead rate. Much more information, however, is contained in descriptions of the activities involved: receive material, inspect material, move material, store material, pay for material and supply material to assembly. Terms that describe activities provide a better basis for managing the work, improving performance, predicting costs and reducing costs.
An activity is the way a business employs its resources (labor, materials, time, information and technology) to produce particular outputs. These activities are determined by 1) required outputs, but also by inputs (automating time records in the payroll function eliminates or changes review, data entry and error correction activities without changing the output); and 2) management decisions regarding processes and procedures.
There are always hierarchies in activities; choose the level that is significant for the work and cost. For example, "prepare reports" contains the subsidiary activities "create reports" and "type reports." Only a word processing bureau would find these subsidiary activities significant. An engineering function may not even find "prepare reports" significant, choosing to include reports in activities such as "design product X" and "modify product Y."
Work Definition Process
Defining an organization's work in terms of its activities and cost drivers requires determination of its inputs, outputs and what dictates the outputs. The logical process is shown in the accompanying box (see page 36).
The last step in the process is necessary to see if there is a better or cheaper way to do the work. Different inputs change the required activities, an improve your organization's performance and/or lower its costs. Also, most organizational outputs within a company are another organization's inputs. Are there different outputs that will improve company performance and costs? For example, introducing a zero defects quality responsibility in a factory assembly organization changing its output quality specifications) eliminates certain inspections by a separate quality control organization.
Most organizations have more inputs, outputs and activities than are recognized intuitively. For instance, the outputs of a payroll organization may include timely pay checks for every employee, in the right amounts, with the correct deductions withheld; all the correct records needed for business, tax and employee purposes; submission of all required payroll tax returns; and satisfactory answer to inquiries and complaints. Its inputs may include pay and deduction instructions, charging instructions, time records, computer programs, data entry procedures, and company policies and procedures. Its activities may include reviewing and entering time records, reviewing payroll data prepared by the computer, entering changes in salaries and deductions, correcting errors, making adjustments, delivering pay checks, preparing tax returns and handling inquiries. In common with every organization, there is another activity that can be called administration: training, coaching, communication, compliance, etc.
Outputs, Output Dictators And Inputs
The particulars of an organization's work are unique to every organization and defining them isn't trivial. But general types of outputs, output dictators and inputs can be used as thought starters and checklists.
Considering outputs first, primary outputs usually follow directly from the organization's function: orders from a sales organization, pay checks from a payroll organization, meals prepared by a restaurant kitchen, and so on. Specifications are needed to complete the description of the primary outputs. For a factory assembly function, for example, specifications include product amounts, sizes and schedules. Information outputs include time records and reports of all kinds. Finally, there are service outputs: satisfying inquiries and complaints, providing expertise to other functions in solutions of problems, and the like.
Ordinarily, the primary outputs are the main determinants of activities and costs, but not always. A particular specification can greatly increase work and cost. Information outputs, such as compliance with federal environmental regulations can add considerable cost. Deliberate analysis and observation are needed because important outputs are not necessarily only the obvious ones.
Turning to output dictators, some organizations have outputs dictated directly by revenue, such as an engineering organization completely devoted to customer development contracts. Organizational outputs dictated by derivatives of revenue are more typical. Production schedules for factory organizations, back orders for a distributor's purchasing function, and customer transactions for a telephone company's operations are all derived from orders, and thus revenue.
Outside requirements, independent of revenue, also dictate outputs. These include legal and regulatory requirements (annual reports, customs and tariff regulations), market requirements (government procurement regulations, varying product specifications from different customers), and competition (all the discount arrangements that airlines feel compelled to offer). The physical procedural and organizational way a company does business also dictates outputs. For example, having multiple facilities in different states dictates a set of shipping, tax return, communication and security outputs. Finally, reproduction, art departments and the facilities department that handles office modification are examples of functions mostly driven simply by requests for service.
There are three general kinds of inputs. First are the things on which an organization operates, traditionally considered inputs in the narrow sense, such as electricity, computer data and cement. Additionally, every organization needs tools, the things from other functions needed to conduct its activities. These include computer programs, candidates for hiring from human resources, machinery and actual tools. Finally, instructions are inputs that prescribe how the work is to be done. Examples are engineering drawings, data entry procedures, bills of material, and policies and procedures.
Traditional inputs can be physical things (components for assembly, goods for sale in a retail store) or information (activity records for accounting, signed applications for insurance rating and pricing). Tools can be physical items or information. Instructions are always information.
The final step in the work definition process, and the prerequisite for planning and budgeting, is to understand what drives the organization's costs. Required outputs and their dictators are obvious cost drivers.
Costs are also driven by the choice of activities and inputs. These are procedures and processes, or the way the work is done. In general, there are two major factors in this driver:
* THE DEGREE OF AUTOMATION. Compare manual and automated factories. The former has large labor costs. The latter expends labor only for setup and maintenance of machinery, while amortization of that machinery becomes a major cost. Manual factory costs are thus driven mainly by the production schedule, a derivative of revenue. Many costs in the automated factory, however, are independent of the production schedule, being "fixed" or driven by the earlier choice of equipment.
* "BUYING" VERSUS "MAKING" changes activities, inputs to subsequent activities, and types of costs. Labor activities and costs should be less when buying, while material costs and purchasing activities should increase. If the "buy" decision is correct, total costs should decrease.
The price level for everything the organization buys, including labor and rent, is the third general category.
The recommended approach to identification of cost drivers is three-fold. First, concentrate only, on the important cost drivers--those things that most strongly determine the organization's cost level. If monthly reports are an incidental cost, don't worry about what drives their costs.
Second, progress from the definition of activities and costs to the drivers of those costs. That is, rather than general categories of cost drivers, look for what drives the individual cost elements--labor, purchased material, rent, utilities, etc.--for the particular activities.
Third, where there is more than one way to describe a cost driver, choose the one that is "closer to the organization" thus better pointing the way to things that management can influence and change. For example, the costs of a product modification can ultimately be said to be driven by a "business decision" or by "competition." Choose the former, because that correctly reflects something that can be investigated for cost reduction.
To plan and budget effectively, a manager must fully understand his or her organization's work. The only way to do this properly is to define and plan that work in terms of what an organization does (its activities), what dictates and supports those activities and, as a result, what drives its costs.
THE WORK DEFINITION PROCESS
1. Define your organization's outputs.
2. Determine what dictates those outputs.
3. Define the activities needed to provide the required outputs.
4. Decide the inputs needed to accomplish the activities.
5. Identify, from all the above, what drives your organization's costs.
6. Iterate among inputs, activities and out-Puts.
For an existing organization, the process of capturing the way things are currently done is neither more nor less than thorough observation and recording. The existing organization must then analyze all of the elements of the work definition to answer the question, "Is there a better way to do the work?"
When existing organizations are presented with new outputs, the process of defining the work is one of design. This is natural and common management work: What combination of possible inputs and activities is the best way to provide these new outputs? (Interestingly, this design is always done for new outputs, but things that have been done for years are often difficult to describe, and the reasons for doing them a certain way even harder to remember.)
A new organization must define its work from scratch, and this is the manager's first task The starting point is defining all the required outputs, with activities and inputs determined almost simultaneously. This is a trial and error process over time, but is easier if approached deliberately as a process of work definition as advocated here.
Robert G. Finney, a former president and CEO of Electronic Associates Inc., is author of "Powerful Budgeting for better Planning and Management" and "Basics of Budgeting" (AMACOM, 1993) from which this article is delivered. Two articles based on his first book appeared in the September and October issues. To order either book, call 800-AMA-9699.…