ACTIVITY ANDDRIVER ANALYSIS TOIMPLEMENT ABCIn implementing activity-based costing,here's some practical help on how to identify the activitiesand their drivers in your organization.by Paul Sharman In past editions of CMA magazine, articles have discussed the concept of activity-based costing (ABC) and have provided real-life case studies. We have seen a shift in emphasis, from the original thrust for more accurate costing to a strong linkage with managing activities, process and performance. The practice has developed into activity-based management (ABM), which links activity-based costing with a number of other techniques, namely process re-engineering (and process management), performance measurement and benchmarking. Each technique is designed as a method of analyzing and measuring different measurement attributes of activities. An attribute represents a measurable dimension such as the amount of time required to perform an activity or whether it is value-added or not, whether the activity meets quality expectations and finally, how much it costs. With benchmarking, current performance of activities and processes is measured and compared to the performance of similar activities in other organizations. Benchmarked organizations are chosen because they are known to do the same things more effectively and efficiently. No single technique is capable of measuring all attributes. The purpose of measurement, using the activity-based management tools, is to motivate employees to perform better. ABM works for all organizations irrespective of whether for profit or not, service or manufacturing company. Despite the hoopla, activity-based management is not the silver bullet instant solution to all of management problems. ABM requires highly disciplined implementation by employees who are trained in the concepts of the ABM techniques and are fully familiar with their own organization. Far from being simply a concept, ABM is being implemented successfully by many organizations, so much so that the tools are now accepted as main stream management techniques. For management accountants, ABC is our contribution and responsibility. In the March 1993 edition of CMA magazine we discussed a nine-step activity-based costing implementation methodology. The nine steps have been followed by many organizations in their own implementation of ABC. The purpose of this articles is to discuss step 4: activity and driver analysis only for the purpose of undertaking activity-based costing. This method does not provide sufficient information and detail to do process re-engineering and for which driver information often is not required. Activity and driver analysis is a structured methodology with which to identify significant activities performed by an organization as well as the drivers and other characteristics of those activities. Activities are performed by people as they go about their lives, perform duties and complete work assignments. A process is a network of related and interdependent activities linked by the outputs they exchange. Activity analysis may be used to capture a variety of different attributes such as the amount of time spent performing activities, whether they are perceived to be value-added or non-value-added, what the quality level is of the process and its output and whether it was performed on time. Activity analysis is also used to determine what resources (people, machines, buildings) are consumed as the activities are performed. For the purpose of ABC, we find that it is better to limit the activity analysis to capture information on time spent performing material activities and to identify drivers. One of the least understood aspects of ABC is the concept
of activity drivers. An activity or cost driver is a quantifiable and natural operating
measurement of resource utilization and cost intensity. For example, the total cost
incurred in processing orders may be influenced by the number of orders received. The
total cost of selling may be influenced by the number of sales calls to be made and the number of customers to be called on. A common mistake is to attempt to identify cost drivers that will allow managers to trace the cost of a highly indirect function such as human resources directly to products. A driver is related only to the activity or resource it purports to measure; identification of the driver is independent of the product or downstream process which may consume the output. Activity Analysis Activity analysis can become an arduous and extensive interviewing task. This is particularly the case if outsiders, new hires, temporary people or the accounting staff by themselves undertake the work. Often questionnaires on which 10 to 15 questions are asked cause long and difficult meetings. Activity analysis performed by people who are not intimately familiar with the operations of the business is highly inefficient because additional knowledge of the organization has to be gathered, often things are missed or over-simplified. Alternatively, implementation involving a multi-functional team of experienced employees can be highly efficient because of their knowledge of the organization and is business already exists. With a little training and guidance, respected employees can understand and apply a structured, disciplined methodology to obtain solid results. Activity analysis involves team members in interviewing staff who occupy supervisor or manager positions. People who perform tasks (individual) contributors ONE OF THE LEASTunderstood aspects of ABC is the concept ofactivity drivers.generally need not be interviewed directly because their supervisors or managers usually have an adequate understanding of activities performed by the people for whom they are responsible. It is normal to provide notice to people who are to be interviewed; therefore, a supervisor who is not fully familiar with the activities of the people who report to him or her can take the time to prepare for the interview. Occasionally it may be necessary for a team member to interview certain individual contributors because of their special knowledge. Interviews are focused on completing an activity analysis grid similar to the one illustrated on this page. The purpose of the grid is to record the activities of all individuals in the organization, the proportion of total time taken to perform each activity, and an initial identification of each activity driver. To complete the grid during an interview, a team member asks, "What do you and the people who report to you, do?" The interviewer seeks to identify all significant and materially different activities. As a rule of thumb, only activities which require five per cent or more of an individual's time would be captured in activity analysis. It is not necessary to collect quantitative data on driver volumes or usage by products, customers or downstream activities and processes during activity analysis. Data collection occurs later when the team has interpreted and agreed on which activities are significant and which activities can be aggregated (because the drivers are the same). During activity analysis, the key questions are: 1. Who are the people in your organization? 2. What are their key activities? 3. Does an individual activity take different amounts of time to perform under different circumstances, and what are those circumstances? 4. What percentage of each person's total time is spent performing each activity? (Includes overtime within 100 per cent of the job) 5. What are the drivers of each of the activities? Having completed activity analysis for every individual in the organization operating within the scope of the study, the team meets as a group to interpret the results. During the interpretation meeting, the team will check for the right level of aggregation, to ensure drivers have been correctly identified and that they agree with the interpretation of the information provided. Activity analysis and the team's collective knowledge become the basis for developing a cost and operational flow diagram. It is important for the team to avoid getting hung up on details. Although there is no correct number of drivers in an ABC system, most practitioners agree that the simpler solutions are the most robust and easy to use. It is useful to remember the 80/20 rule. In reality the number of drivers is strongly influenced by the size and complexity of the organization; the more complex the operation, the numbers of drivers will likely increase. Often a large number of drivers indicates that activity analysis has drilled down to lower levels of activity or tasks. There may be a level of redundancy in drilling down too far. Frequently, the correct driver is the simplest and most obvious. Identification of activity drivers requires that the multi-functional team include a high proportion of people from operating functions. Each activity may have only one driver. Occasionally the team will evaluate an activity for which the suggested driver appears to be inadequate in terms of their understanding and experience. The cause may be that there is really a more complex series of activities which have been aggregated and need to be broken down further. For instance, it is generally not acceptable to conclude that the driver for the purchasing activity is the number of purchase orders issued. Often, purchasing involves other activities such as vendor certification and contract negotiations. Each significant activity has its own driver; however, related activities with the same driver may be aggregated. It may be necessary to substitute alternative drivers when the team knows that data will not be available for the correct one. Often the team knows during activity analysis that data will not be available later. Generally, however, the team waits until they are involved in the data collection stage before worrying about substitute drivers. The team should not involve themselves in data collection at the activity analysis stage because they will initiate a step before they are ready to deal with it. It is inefficient to begin data collection because they really do to know exactly what data they need until after they have completed the cost and operational flow diagram (step 4). Some ABC practitioners use the activity analysis exercise as a vehicle with which to identify value-added and non-value-added activities. Experience has demonstrated that many people find value analysis confusing and difficult to treat objectively during the activity analysis stage of activity-based management. Value analysis is an inherent step within process redesign. This involves process maps and cycle time compression driven by customer needs. Activity-based management is outside of the scope of this document; however, it is important for practitioners to understand that ABC is best implemented within an ABM framework. Another vehicle with which to collect activity information
that is sometimes used in large Process maps are often used as a source of information for activity analysis and offer the potential to eliminate the need to interview managers. Process maps need to be prepared at the right level of disaggregation and must be interpreted by the people who prepared them. Also, when identifying drivers, operations people need to be on hand to provide insight into the activities. Often, process maps do not identify diversities within process steps by characteristic of output; for example, an order processing process map may identify the process steps which all orders low, but may not identify that an order for a special product takes twice as long to handle as a stock order. Process maps frequently have the disadvantage of not representing all of the activities in the organization. Care has to be taken to ensure a complete reconciliation of the number of people in the organization and the number of people represented by the activities documented by the process maps. During the ABC implementation, it is often most efficient to employ the services of an experienced facilitator to train the team, build consensus, advise on system architecture, and to lead team members through otherwise tricky situations. This person should be highly familiar with ABC principles and applications to ensure the right level of activity analysis is conducted rather than allowing the team to get into too much detail. To sum up, activity and driver analysis is an important step within the process of implementing ABC. It requires a multi-functional team of employees to complete a disciplined exercise. Activity and driver analysis is not difficult or complicated when the right people are involved. MANAGEMENT
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organizations is the activity dictionary.
Activity dictionaries are used to simplify interpretation and interviewing, typically in
larger applications (thousands of people). An activity dictionary is prepared by the team
in advance of interviews taking place and represents a list of all the major activities
performed by the organization and their definitions. Each activity is given a reference
number. A copy of the dictionary is given to all supervisors so that they may complete an
activity grid using standardized activities. In order to be effective, the dictionary must
be prepared with great care. The team needs to understand surveys of functions to find out
which activities are performed by each group of people. Often interviews with supervisors
are performed in large groups; they are asked to fit the activities of their people into
only the activities in the dictionary. This method is most useful when used for
organizational redesign or restructuring. As an ABC tool, it has some major limitations
because it may not adequately address the diversity within an activity or the drivers.
However, once the activity analysis is completed, an activity dictionary is a useful form
of documentation to provide a reference for future use.