Cost Reduction Could Become as Easy as ABC

Management Today, August 1995 | Go to article overview

Cost Reduction Could Become as Easy as ABC


In recent years financial controls have increasingly come under scrutiny. Conventional methods, it's said, too often lead managers into serious error. For example, in most manufacturing firms labour costs have shrivelled to the point where they are a very minor part of the whole. At the same time, overheads have ballooned. So a company which apportions overheads between its products on the basis of the direct labour costs could get a grossly distorted picture of the true cost of making different items. In this situation, management cannot make informed decisions about pricing or product mix - or where to wield the axe. The best known of the newer approaches identifies (and \costs) various activities such as order entry, batch set-up, materials handling, invoicing, etc. Products (or processes or customers) can then be costed according to their demand for each activity. Activity-based costing (ABC) is widely reckoned to offer a sound basis for performance measurement, budgeting, stock valuation and a host of decisions relating to cost reduction, output, pricing and so on. These days the more ambitious users (and consultants) prefer to talk about ABM - activity-based management.

ABC has evolved over a decade or more precisely because of dissatisfaction with existing techniques. But why - if it's all it's cracked up to be - is it not in general use? On the face of it, the uptake has been remarkably slow. A survey of the Times 1000, carried out for the Chartered Institute of Management Accountants last year, turned up a mere 50 companies using ABC for any purpose (significantly, cost reduction was the most popular). Double that number confessed they had not thought about the subject.

There's still a long way to go,' says Sarah Walton, ABM capability leader at KPMG Peat Marwick. Businesses don't get excited about ABC as a concept, she points out. `They need to have an issue that they have to address.' But whether you think the rate of uptake is fast or slow is largely a matter of perception. The incidence of companies applying ABC is higher in the UK than in the US, believes Robin Bellis-Jones, a director of consultants Develin & Partners and chairman of CIMA's ABM working group. `It is being adopted quite widely,' he insists - and in the service sector as well as in manufacturing.

The international courier DHL is a case in point. Up to the mid-1980s the firm was growing very fast, recalls costing project manager Martin Holden, and didn't worry too much about cost levels. Then it emerged that costs were rising `almost in parallel'. Since people accounted for approximately 50% of total costs, it was assumed that they were the cause of the problem, and there was a tendency to `kick backsides and make the couriers ride faster'. …

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