The role of economic
and performance analysis in
process re-engineering

Here is a way to ensure that process re-engineering
will produce positive bottom-line benefits in terms of customer service,
employee behavior, cycle-time reduction, and cost savings.

by Paul A. Sharman

Thousands of organizations have attempted to use process re-engineering techniques during the past five years, but many applications are considered to be failures. This is often the case because of unrealistic expectations, inadequate analysis, and a lack of understanding about human behavior.

Two years ago a Business Week magazine article chronicled the woes of consultants Hammer and Champy as they blamed middle management for the failure of process re-engineering. The argument in the article implied that it was not the fault of the consultants who were responsible for providing advice to management. But, shouldn't the consultants have anticipated the problems? What they lacked was an adequate measurement framework with which to plan re-engineering work, and monitor implementation, performance, and results.

Measure performance to
manage performance

On occasion, I have been asked to evaluate the benefits of planned process re-engineering projects, where the design work is complete, but initiatives are not yet fully implemented. One recent example of this serves to illustrate the theme of this article. It relates to a company that had a team of employees working for a year to re-engineer what had been identified as "the critical process." It was called the "order-to-cash process," which began with customer-order generation, and ended with cash being received. Expected re-engineering benefits included improvements in cycle time, accuracy of order fulfillment, consistent on-time performance, and substantial savings. Management's goal was to reduce division payroll cost by 20 per cent. This expectation was based on an analysis of strategy that was used to identify the critical process. It appeared reasonable to everyone that because the "order-to-cash process" was the critical process, then, by definition, it was the one that consumed the vast majority of resources employed by the company.

In spite of this perceived logic, the vice-president responsible for the project, who was a canny numbers person, made this request of the team. "Before I approve implementation of your re-engineering recommendations, prove to me that we will achieve the cost-improvement goals."

"Well," the team members sputtered, "we didn't do any analysis of costs. But we know from our process maps that the identified critical process touches every major department -- the changes we have suggested are significant, and so it follows that cost will reduce."

The team members knew that to determine the cost benefit of their recommendations would be difficult, subjective, time consuming, and maybe costly. It would certainly require them to go over stuff they had already covered and were already convinced about, and, moreover, they felt it would be boring. After all, the interesting work would be implementation!

Fortunately, the VP prevailed. She instructed the team to hold off while the corporate controller conducted an economic analysis to determine the costs and benefits of recommended process changes.

The controller knew that, to determine the cost of the process, he would have to calculate the cost of the resources consumed by that process. Because steps in the process were performed in virtually every department, a question was raised on wheth er asking people how much time they spent working on the process, would be adequate. "Will we reconcile to the books?" asked

The availability of verifiable numbers-based facts changed the emphasis from process
re-engineering to measuring and managing processes and performance.

the controller, and, "How will people know when they are spending time working on this process versus others? What about the other things they do, like administration, training, attending meetings and supervising staff? Most people perform all sorts of activities."

After some consideration of these matters, it was decided to undertake a complete analysis of all of the activities that were performed in all of the departments. That way, it could be certain that all activities relating to the "order-to-cash process" would be accounted for.

Initially, this approach appeared to be overwhelming, because the departments involved employed 800 people and incurred expenditures of roughly $100 million. However, it was perceived that the analysis was sufficiently important to proceed. Management established a separate team to perform an economic analysis of the process, using activity-based costing principles. This independent approach ensured that the progress of the initial process-analysis team would not be hampered.

The economic-analysis group comprised a cross-functional team of eight employees. They conducted a series of interviews with selected personnel from each department, which involved less than 10 per cent of the company's employees, overall. During the interviews, department employees were asked to speak on behalf of all of the employees in their immediate section. Department managers were given advance warning so that they could ensure informed people were involved, and so that these people might come prepared.

Information was gathered on what activities were performed by department staff members; the percentage of their time each activity consumed; what activity drivers were involved, and what caused activities to consume so many resources (cost-driver analysis). Finally, information on non-financial measures was gathered on quality and cycle time for each activity. Interviews were completed within six weeks of initiating the process. During the interview period, team members met each week to review each others' progress and to validate results.

The economic analysis team included a member of the controller's staff, whose role was to build a computer model of the activity information, receive information about activities performed by departments, and assign the cost of the resources consumed to the activities. As information was received from the interviews, data was entered into the computer software. Within two weeks of completing the activity analysis, costs were calculated for every activity in every department.

The process re-engineering team had previously conducted an analysis to identify all of the processes employed in the organization, in addition to the "order-to-cash process."The outcome of this effort was a complete list of significant cross-functional processes with which the organization got work done. The list, described as a process inventory, included information on the names of processes, inputs, outputs, definitions, and a few other items. When the activity analysis was complete, two meetings were conducted between the economic-analysis team and the process-analysis team.

During the first meeting, team members reviewed the list of activities performed by each department, and made a decision for each activity as to which process, or group of processes, the activity contributed to. This analysis took less than a day to conduct, and was performed this quickly because team members were each experienced, respected employees, with good communications skills. Among them, they also had a thorough understanding of activities and processes. When all the activities had been assigned to processes, process costs, and activity-detail-by-process, could be calculated.

The second meeting involved a smaller subset of each of the two teams to
review process re-engineering recommendations, and determine the cost impact of each. This was accomplished by knowledgeable team members reviewing the recommendations to determine which activities would be affected by any proposed changes. Knowing which activities were affected, team members were then asked to assess what impact the recommendation would have on the resources employed by the activity. Would the resources consumed within the process increase, stay the same, or decrease as a result of the recommendation? They were also asked to determine the impact on cycle time and quality performance of the process. The team also assessed roughly what investment would be required to accomplish the change. Finally, the team was asked to assess the impact of the recommendation on other processes in the organization.

The outcome of this analysis was a set of economic results that surprised everyone:

1. Cost of resources consumed by the "order-to-cash process" would be reduced as a result of re-engineering efforts, by 25-35 per cent. Good news!

2. Overall cycle time and quality performance for the "order-to-cash process" would improve substantially. Good news!

3. Contrary to original expectations, overall, the cost of the "order-to-cash process" was only 19 per cent of the total cost of the corporation. Therefore, it was impossible to meet the goal of freeing up 20 per cent of corporate resources by re-engineering this "critical process." Despite the fact that all but one small department "touched" the process, the departments were all performing many more activities in support of other processes. The problem was that no one had made the effort to analyse activities before, and, as a result, incorrect assumptions had been made. Bad news!

4. Twenty-five per cent of resources employed by the organization were considered to be used in order to sustain the business. Business-sustaining activities are ones that have no immediate impact on the performance of the operating processes, but are somewhat discretionary for management. Bad news, if the primary objective was cost reduction. Management might have had better results if it had chosen to reduce the costs of business-sustaining activities.

5. Work displaced by the "order-to-cash process" improvement recommendations migrated to other processes, and actually caused their costs to increase. Costs increased less in other processes than the reduction in cost in the "order-to-cash process," therefore, there was a net saving for the corporation. While these net savings ended up at about 15 per cent of the "order-to-cash process," it only amounted to three per cent of total organization cost -- substantially short of the expected 20 per cent. Bad news!

The vice president in charge of the project was quite surprised by the results of the analysis. While they were not at all what she was expecting, she was glad that she had insisted on the undertaking. It was clear to her that she now had facts with which to make balanced decisions and evaluate performance. The VP instructed the process re-engineering team to proceed with the implementation of its recommendations. She said, "It is clear that the 'order-to-cash process' is critical to our future

The challenge for management accountants
is to integrate financial and non-financial measurements into a logical structure that works as a complete mechanism.

performance, and we must get it right. That it won't deliver the cost savings we were hoping for, is less important than being assured, with the facts provided by calculating the cost of activities and of all processes, that we now know, with relative certainty, where the opportunities lie! We can now prioritize our actions and assign our people to improvement teams in a way that will maximize the benefit derived from the efforts of each team." She had one more concern. "How will we track actual performance on a continuous and current basis so that we will know whether our actions are accomplishing what we expected?"

In response, the teams recommended that the economic and measurement analysis be maintained and updated on a quarterly basis so that, as improvement recommendations were implemented, management could track whether it had delivered what was promised. Affected operating managers would have to participate in the approval cycle prior to implementation of improvement recommendations, so that they could sign up for the actions that they would then be held accountable for. The measurement system would facilitate evaluation of their performance. The availability of verifiable numbers-based facts provided relief to everyone!

As a result, the emphasis was changed from process re-engineering to measuring and managing processes and performance. It was decided that to re-engineer a process, when it was performing poorly, was a legitimate process-management option.

Another significant lesson for the company was that, had the economic and performance analysis been completed before the re-engineering work was launched, management would have established a completely different set of expectations. Perhaps the focus would have been on a different process to re-engineer in the first place. Management might have handled the business sustaining costs first, or may have chosen to stop some the dozens of other "team-based" projects, and focused people into a few critical processes.

Role of management accountants

Management accountants own the critical measurement process in every organization -- the "financial performance measurement process." Financial performance is used as an aggregate planning and tracking mechanism for money. The opportunity, as many organizations are finding out, is to integrate the money measurement system into operational measurement systems. The market is afloat with new measurement theories, such as the Balanced Scorecard or Control Panels. The challenge faced in all of these initiatives is to integrate financial and non-financial measurements into a logical structure that works as a complete mechanism. This is a strategically important role for management accountants. All of our organizations need integrated numbers-based facts -- and management accountants are well positioned to deliver them. cma

Paul Sharman, features editor for CMA magazine, is president of Focused Management Information, an Oakville, Ontario-based company that helps organizations implement new cost-management techniques.