Activity Based Costing
The technique is described as an approach towards monitoring of activities and costs through correlation of consumption of resources and costing the final outputs. Resources are usually assigned to activities and the activities to their respective cost subjects. In addition, the method provides for utilization of cost drivers correlated to activity costs of outputs. Activity Based Costing was first developed in the 1980s by William Burns and Robert Kaplan. It was developed with particularly interest and focus on the manufacturing industry because of the effects of technology and productivity enhancement that had resulted in significant reduction of material costs and direct labor. ABC has emerged as an effective alternative to the traditional method of allocation of overheads to services, products, and customers (Anderson & Young, 2001, p.17).
When compared to the traditional costing approach, ABC initially accumulates overheads across single activities in an organization. This is followed by the assignment of such activity costs to the services, products, or customers (cost objects) that bring about the activities.
ABC uses cost drivers to assign the costs of resources to activities and unit cost as a way of measuring an output. Initial activity analysis has been described as the most difficult element of activity based costing. The analysis of activities is described as a process that involves identification of appropriate output measures of resources (cost drivers) and activities as well as their respective effects resulting costs of developing products or provision of services.
In addition, activity based costing systems have relatively flexibility towards provision of special information such that management in organizations is able to make appropriate decisions in relation to the costs associated with production, sales and delivery of products or services. The main aspect of activity based costing is the focus on accumulation of costs through activities. Organizations are increasingly focusing on costs, their factors, and behavior, as a means of understanding what drives costs associated with delivery of services and production of goods and services. Such has brought about confusion on avenues that may be utilized in understanding costs and distinguishing them from competing cost measurement techniques such as standard costing, activity based costing, target costing and others.
Such has resulted in confusing amongst employees and managers on the appropriate costs to be measured and subsequently controlled for profitability. In addition, increasingly competitive business environments, and organizations seeking to enhance competitiveness through cost control relying on accurate and relevant cost information. Activity based costing has provided organizations with a means to overcome over-generalizations of previous traditional costing systems. Such systems are reliant on cost modeling which identifies organizational expenses (direct and direct) and relating such to services, products, customers and channels that drive such costs.
The growth in interest in activity based costing, according to existing literature, has been because of the displacement of direct expenses by indirect costs in the production of goods and services. It is suggested that the displacement has taken place because of shifts in technology, automation, and emergence of new equipment. In addition, such is attributable to the extensive levels of automation undertaken by companies as they seek cost-cutting measures to enhance productivity and profitability. In addition, such can also be attributable to the gradual proliferation in the different types of service and product lines being utilized by organizations. Over the past few decades, a majority of organizations have focused on improving product and service variety offered by utilizing new manufacturing technologies, distribution, and sales channels.
Furthermore, organizations have also been catering to a consumer base that has grown in terms of diversity of needs, expectations, and wants. Such has introduced extensive levels of variation and heterogeneity resulting in enhanced complexity and increased overhead costs for organizations. It is important to note that the overhead components of expenses are gradually displacing recurring labor costs, may not signify inefficiency or high bureaucracy. Such may be attributed to the provision of goods and services to an increased variety of consumers. The main issue with traditional costing is the relatively high amount of indirect expenses being associated with factors not related to cost drivers. In essence, consumption of resources should be identified and assigned because of their cause and an effect relation, which is appropriately provided through activity-based-costing (ABC).
Activity based costing and activity based management have brought radical changes within cost management systems. The philosophies and principles associated with activity-based thinking are applicable equally to manufacturing and service sectors. In addition, management practices and methodologies have also shifted significantly over the past few decades and will likely change more in the foreseeable future. In addition, organizations have shifted from vertical to horizontal management. Such has also contributed towards process orientation, away from traditional function orientation.
On the other hand, management information systems utilized in tracking and analyzing of information related to horizontal business aspects have not been adequate in catering to the needs of modern managers. Activity based costing and related models provide relief to such needs by delivering operation and cost related information that assumes a horizontal perspective. By utilizing activity based costing, organizations are able to understand their respective business processes and related cost behavior. Such information provides management with the necessary basis for decision-making at operational and strategic levels.
Value Chain Analysis
The international political economy is increasingly structuring itself within the confines of global value chains, which has been associated with increasing international trade, employment, and global gross domestic product (GDP). Globalization has brought about a number of questions related to appropriation of benefits, wealth and production and unequal social and economic developments. In essence, value chain analysis delivers relatively critical perspectives into issues of unequal appropriation, interactions between globalization and inequality and dispersal of manufacturing activities.
Value chain analysis is effective in overcoming a number of critical weaknesses inherent in traditional sectoral analyses, which have a tendency for being static and are bound by parameters. In addition, by being restricted within the confines of sectoral analysis, value chain analysis struggles with the dynamic linkages that exist between the activities, which go beyond the specific sector. Such takes place irrespective of activities being of a formal, informal, or inter-sectoral nature. Furthermore, value chain analysis also extends beyond firm-specific analyses in innovation literature (Cattaneo, Gereffi, & Staritz, 2010, p. 9).
The concentration on inter-linkages provides value chain analysis with an easy means of uncovering the synergism and dynamic movement of organizational, coercive, and economic activities that exist between producers across diverse sectors even to a global scale. For instance, informal sector scrap metalworkers in sub-Saharan Africa are linked to the global export trade. They are provided with prices prevailing in London and the scrap metal is delivered to various locations around the world. Such is illustrative that the notion of inter-linkages between organizations underpins the essence of value chain analysis, which makes it relatively easy to undertake interrelationship analyses between informal and formal work as opposed to viewing them as disconnected elements of activity.
Moreover, value chain analysis is critical for new procedures-including poor economies and producers, seeking entry into new global markets such that they are able to achieve sustainable profitability and growth. In addition, value chain analysis is a critical analytical tool that provides an effective means of understanding policy environments, which delivers a means of efficient allocation of various resources within a domestic economy. Such is achieved notwithstanding the main use, which is to understand means that organizations and states participate within the international global political economy (Cattaneo, Gereffi, & Staritz, 2010, p. 23).
Value chain analysis is important due to three primary sets of reasons, given the incidence of rapid globalization:
- First, the high division of labor and dispersion of production and systemic competitiveness in the global market has become important
- Secondly, the efficiency levels in production is a condition in successful penetration of global markets
- Thirdly, entry into the global markets that provides means of sustaining income growth (best part of globalization) needs an understanding of the inherent dynamic factors present in an entire value chain
In essence, existing literature suggests that value chain analysis can be utilized to develop competitive strategies by understanding the factors that contribute towards the development of competitive advantage. In addition, it may contribute towards identification or development of interrelationships and linkages between the various activities that contribute towards development of value in an organization or economy. Competitive business strategies are reliant on integration of activities across the value chain. For instance, the interconnectedness between areas such as research and development (R&D), marketing, information systems, and production contributes towards the value chain of an organization. Thus, analysis of such linkages and interdependencies across activities, the ability to undertake coordination of interrelationships is important towards accrual of competitive advantage (Cattaneo, Gereffi, & Staritz, 2010, p. 25).
Integration remains critical for organizations, as it provides entities with a means of enhancing their respective capacities to implement strategies such as responding to market conditions and improving flexibility in responding to the needs of consumers or reduction of operation costs. Thus, value chain analysis contributes towards development of competitive strategies that focus on the necessary activities essential towards enhancement of value of services or products offered by an organization.
In essence, it is critical to note that competitive advantage and strategy are interrelated. Competitive advantage is arrived at using competitive strategies, which focuses on the creation of value. In addition, value is influenced by the unique integration of attributes of a product or service, which are important to the consumers. Value is added when specific functions or activities are executed in the delivery of a service or product. Competitive advantage and strategy may arise from different configurations of activities and functions within the organization. In addition, competitive strategy must be related to the capacity of the organization to sustain its competitive positive and in the process achieve long-term profitability and growth in its market of operation. In the establishment of competitive strategy, organizations may focus on specialization or cost leadership. Such is further divided into three generic strategies namely differentiation, cost leadership, and focus. It is important to note that generic strategies do not generally promise superior performance to the organization unless it is a sustainable endeavor when compared to the competitors.
The Balanced Scorecard was introduced in the year 1992 by Robert Kaplan and David Norton as a means of assessing organizational performance in organizations. Kaplan and Norton (1992) note that performance measurement remains critical for management as it provides organizations with a means of enhancing management of their respective intangible assets. Studies suggest that the most successful organizations rely on performance measurement models to understand and make decisions related to utilization of resources and effectiveness and efficiency of operations, activities, resources, and programs (Kaplan & Norton, 1992, p.73).
The balanced scorecard is a measure that includes four perspectives used in the assessment of health and strategic performance. These elements include:
- Customer Perspective
Evaluates customer satisfaction based on:
- Percentage of consumers satisfied with the organization’s timeliness
- Percentage of consumers satisfied with the organizations product and service quality
Evaluates effectiveness of service partnership based on:
- Percentage of consumers satisfied with the organization’s cooperation, communication and responsiveness
- Internal business processes
Acquisition excellence, which comprises of an effective quality control system:
- Assesses the ratio of protests that are sustained by general accounting office
Acquisition excellence in regard to effective usage of various alternative procurement practices
- Covers the number of actions that utilize electronic commerce
Fulfilling public policy objectives
- Assess the percentage of successful achievement of socioeconomic goals
- Assesses the percentage of competitive procurement of the total number of procurements
Information availability towards strategic decision-making
- Assesses the extent of reliable information related to management of the organization
- Assesses the percentage of employees adhering to mandatory qualification standards
Employee satisfaction, focusing on quality work environments
- Assesses the percentage of employees who are satisfied with prevailing work environment in the organization
Employee satisfaction, focusing on executive leadership
- Assesses the percentage of employees who are satisfied with the culture, values, empowerment practices and professionalism prevailing in the organization, as initiated by the management
- Financial perspective
Minimization of administrative costs
- Assesses the cost to spend ratio
Maximization of contract cost avoidance
- Assesses cost avoidance by focusing on the utilization of purchase cards
- Calculates percentage of the number of prompt payment interest paid in relation to the total number of funds released
The four perspectives provide management in organizations with minimized information overload, through limitations on the number of measures utilized. It is critical to note that organizations rarely suffer from utilizing few measures. In essence, the balanced scorecard provides managers with an avenue to focus on the most relevant issues relating to measurement of organizational performance.
The balanced scorecard integrates, into a single report, numerous disparate elements of an entity’s competitive elements such as enhanced customer orientation, quick response times, and improvement in quality, teamwork, and new product development. In addition, the scorecard provides safety against suboptimisation. Such takes place by ensuring that critical operational elements and measures are considered together, and in delivering insights on the effects of strategies on all areas of the organization. In addition, the most important objective may be executed and achieved poorly. Thus, an organization may be able to achieve reduction in time to market through improved product release practices (Kaplan & Norton, 1992, p.75).
Essentially, the balanced scorecard is representative of the significant changes in the assumptions related to performance measurement in organizations. Traditional performance measurement systems have solely relied on the finance function, resulting in a control bias. In addition, they provided specific actions that should be undertaken by the employees, resulting in controlled behavior. The balanced scorecard is appropriate for the modern organization, seeking to gain competitive advantage in global markets marked by uncertainty. Balanced scorecards places vision and strategy at the core, as opposed to controlling activities and behavior of employees. In addition, it develops goals, but does not dictate the behavior of the actors in achieving such goals and objectives.
The new approach towards performance measurement provided by balanced scorecards is highly consistent with the initiatives employed by modern organizations such as customer-supplier relationships, cross-functional integration, global scale, business continuity, continuous improvement, and team accountability. The combination and integration of customer, financial, organizational learning perspectives and internal processes and innovation, the balanced scorecard provides modern managers with a means of understanding diverse interrelationships between activities, functions, and resources in their organizations. Such perspectives can provide managers with the capability to transcend the traditional notions related to functional barriers, and in the process achieve enhanced problem solving and decision-making capacities.
Balance scorecards arose from the need for comprehensive and structured methodologies for performance measurement by enabling establishment of agreeable and realistic performance goals, allocation, and prioritization of resources and informing management on the need to either change or retain policies and programs to meet established goals and objectives (Kaplan & Norton, 1992,p.77) Leading organizations around the world with a framework for translation of the vision and mission of an organization into distinctive performance indictors that are distributed across the four perspectives namely, internal business processes, customer, financial and organizational learning, and growth. It is critical to note that a number of indicators are maintained for the measurement of the progress of an organization towards achievement of its vision. In addition, other indicators are maintained for measurement of the organization’s long-term drivers and factors influencing success. Through balanced scorecards, organizations are able to assess current performance and their respective endeavors to enhance business processes, educate and motivate employees and improve their information systems for efficacious learning and growth.
Cattaneo, O, Gereffi, G, & Staritz, C, 2010, Global Value Chains in a Postcrisis World: A Development Perspective, The World Bank, Washington.
Anderson, SW & Young, SM 2001, Implementing management innovations: Lessons learned from activity based costing in the U.S. automobile industry, Kluwer Academic Publishers, Boston.
Kaplan, RS & Norton, DP 1992, ‘The Balanced Scorecard-Measures that drive performance’, Harvard Business Review, p.71-79