FRAME
BREAKING
Management accountants should be prepared
to drive change.
by Paul A. Sharman
How do you react to the idea of frame breaking? What is the
first thing you think of? Frame breaking, sometimes described as out-of-the-box
thinking, is hardly a description of the way accountants think and work.
Frame breaking conveys a notion of disorder and unpredictability that is foreign to our
fundamental need to create order and control where there is none. Such methods as
double-entry bookkeeping and standard costing were designed by accountants to be applied
consistently with predictable results. Our mode of development is to move forward
cautiously in incremental steps.
In the world of operations management, however, the words are used freely to convey a
drive to discard the old bureaucratic methods of existing North American management
processes. The people and companies who use the terms are very serious. The underlying
theme is reengineering. Executives from all industries, whether manufacturing, financial,
or health services, are attending conferences on reengineering in droves to find out what
it is and how to do it.
Process reengineering involves the creation of diagrams of customer, supplier, and
functional interfaces known as relationship maps and flowcharting of activities to yield
process maps. One method was created by the Rummler-Brache Group of Warren, N.J., which
involves two types of process map. The first map, known as the "is" map, depicts
process steps as they presently exist. The second type is a "should" map and
depicts the process steps as an employee design team believes it should operate after
eliminating non-value added activities, reducing elapsed time dramatically, and applying
new technologies.
A multifunctional team works through the process steps searching for
"disconnects" or process steps that appear redundant. An example of disconnect
would be where an engineering department designs and develops new products without
obtaining customer specifications first. Under those circumstances, the engineers design
something that appeals to themselves but may have limited market appeal. The team also
identifies performance measurements from the point of view of output of the total system
as well as for each process within the system. Performance is compared to other
organizations that use similar processes in a method known as benchmark performance
measurement. The new performance measurements deal with four dimensions: time, quality,
responsiveness, and cost.
Why are reengineering and benchmark performance measurement important to management
accountants and what role can we play in driving change in our organizations? Although the
idea of making substantial change, or frame breaking, is a worrisome thought for most of
us, it becomes attractive if it can be undertaken in methodical fashion. The way in which
change happens is through the careful application of very tightly controlled activities
and processes.
Accountants are very busy people with big responsibilities. After all, the investment and
regulatory world depends on us for critical information. Management depends on us to
develop timely and accurate information on the performance of our companies and
organizations, to develop budgets and plans, and to evaluate business cases. Generally, we
are the first to cut headcount in a reduction in force program (RIF) or downsizing
program, and we tend to keep the pressure high within the accounting function.
Opportunistic Auditors
While employed as a controller in a large corporation a few years ago in Canada, I had the
following experience. A couple of ambitious senior qualified auditors working for a
customs agency thought they saw an opportunity to build their careers by claiming that our
corporation had underpaid duties by a significant amount of money in prior years. The duty
they claimed as outstanding before any penalties might have been sufficient to solve
Olympia & York's financial problems today. By applying conservative accounting
considerations and Generally Accepted Accounting Principles, the auditors argued, they
were able to substantiate their claim. Their calculation involved allocating total
operating expenses to exported goods on the basis of cost of goods sold.
Needless to say, the auditor's claim managed to grab the attention of more than a few
senior employees in our corporation. Actually, you could say the proverbial consequences
hit the fan. I had just transferred to the corporate office having fulfilled two
divisional controllers' jobs out in the field. Like most controllers my primary interest
was to help my business make money while ensuring that reasonable financial and
operational controls were in place. One responsibility of each controller was to ensure
that customs' valuations were computed correctly. The depth of analysis which went into
calculating duty rates was quite considerable.
It came as something of a surprise to learn that I was about to dedicate a year of my life
to studying customs regulars, tax regulations, and GAAP while conducting a corporate-wide
activity-based costing study involving almost 20,000 people. We did not know we were doing
an activity-based costing study at the time, but we did know that the analytical method
clearly undermined the customs auditors' position. At the end, we owed some money but no
more than "noise" in relative terms to the original claim.
The whole process was deeply unsettling. First, it became evident that the rules by which
we are required to live are a tangle of words with uncertain value other than to
bureaucrats, auditors, and lawyers. Second, for any qualified accountant to claim that
conservatism and GAAP were valid arguments to justify such wild accusations struck me as a
betrayal of our professionalism. It became really clear why operations people sometimes
suggest that accountants (and lawyers) are responsible for our economic woes in North
America.
Later, I worked with Robin Cooper of Harvard University and Peter Turney, formerly with
Portland State University, on the implementation of one of the very first ABC systems in
North America.1
We quickly discovered how inaccurate our inventory valuation was. We proved without a
doubt that our "traditional" costing system, which used direct labor to allocate
overhead, was overcosting high-volume products and understating the cost of low-volume and
specialty products substantially. At the extreme, some of our standard cost of inventory
items were understated by a factor of 20. We also identified high-cost processes as a part
of the exercise. By doing so, we focused attention on the companies' materials procurement
and handling process. This process consequently was reengineered to produce a considerable
reduction in cost and cycle time while simplifying material handling and paper work
tremendously.
During this time, I also became involved in Computer Aided Manufacturing-International
(CAM-I), the research organization in Fort Worth, Texas, and its Cost Management System
project. Jim Brimson and Tom Pryor ran the program, and these were heady days. We
discovered how management accountants could help their companies by changing cost systems
to focus on operational aspects of the firm rather than on satisfying the interests of
regulators.
These three events defined a challenge to me that could not be ignored. It became clear
that something had to be done to spread the word.
My first reaction was to become a consultant because that would be the best way to help
firms in need. I landed an associate relationship with one of the large
accounting/consulting firms, and we began to develop an activity-based costing practice.
As we were preparing material for an upcoming conference, the partner advised me that it
was good for me to speak at conferences on the merits of new approaches to cost management
as long as I did not criticize GAAP. He did not explain why I should not be critical of
GAAP, although it was not difficult to understand. It is interesting to reflect on the
fact that in relative terms, America has 10 times the number of accountants and lawyers as
the Japanese. Perhaps it has something to do with the Japanese building in quality at low
cost rather than attempting to inspect quality at high cost.
New Insights
Activity-based costing has been identified as the accountant's single most important
contribution to productivity improvement within any organization. ABC enables us to
reengineer our understanding of cost, profitability, and value creation within our
business. The analytical method also provides insight to operations processes and
performance measurements.
I have been involved in implementing ABC in many different industries, and it is clear
that in order to achieve long-term success it should only be implemented by practitioners
in their own organization. Why? Because ABC is cost accounting with a different name. Cost
accounting is so fundamental to the operations of the firm that it has to be undertaken
year in and year out; it has to be maintained and replicated constantly. Decisions
influenced by cost accounting information can be critical to the success of the firm. The
following examples will show how information provided by activity analysis can be crucial
to long-term success.
A national distributor of a brand name product, manufactured for it by contractors,
completed an activity-based costing analysis. The analysis produced was a complete
economic model that included revenue, product profitability, and customer costing. The
model identified the cost of activities and processes by cost object (products and
customers). The strategic goal of the organization was to increase the number of customers
by 50% within a specified period in order to increase market share and sales volume.
Analysis of customers showed that roughly 60% of all customers were very low volume; in
fact, the 80:20 rule applied very well here. Small customers were considered to be the
most profitable group because they received no discount; therefore, gross margin
(contribution to fixed) was higher.
Activity analysis identified that small customers consume a disproportionately greater
quantity of company resources relative to the sales revenue generated. To service a
customer, the company had to make sales calls, check credit rating, process orders, handle
product at various stages in the distribution center, pack and ship, handle customer
inquiries, invoice, and receive payment. The net effect of the analysis was to show that
small customers were unprofitable.
The analysis also showed that with the present process of satisfying customer needs, a
large increase in the number of small accounts would guarantee reduced profits. There was
no way this organization could contemplate dropping customers. But there was every
opportunity for it to examine the processes employed to service small customers and to
reengineer them.
We suggested the company talk to some dairy products distributors in the region to find
out how they make money while serving lots of small customers. To simplify the existing
process without understanding the economics of small customers would not necessarily have
solved the problem, especially if the system were optimized around high-volume shipments.
An automated parts manufacturer had built a fully automated production facility with
plenty of spare capacity so as to respond rapidly to demand increments and meet exacting
quality requirements. Old style overhead allocation had not revealed any particular
insight into the cost impact of this automation strategy other than to confirm that the
facility was producing product at a cost disadvantage when compared to its competitors.
The cost of idle capacity had been allocated across all products indiscriminately in the
past using machine hours. There management was unable to assess accurately what products
cost. The only thing management knew was that products that required more "machine
time" were less profitable than others.
Activity-based costing was used to identify customer and product profitability after the
cost of idle capacity had been segregated. The ABC team discovered that the cost of
maintaining idle capacity equaled about 20% of total indirect costs of the business. This
cost was associated with unused equipment capacity and associated facility space as well
as the equipment operators who were required irrespective of the volume of output. Because
of the sophistication of the equipment, the company retained a large maintenance crew.
Equipment routinely received preventive maintenance irrespective of the volume of
throughput or utilization.
Armed with the ABC information, a new logic was created. The cost of idle capacity is now
treated
FRAME BREAKING AT THOR*LO
There is nothing conventional about Thor*Lo. The
privately owned function or sports-specific athletic sock manufacturer based in
Statesville, N.C., competes in a $500 million annual market with unique products and a
distinctive flair. James Throneburg, the owner, skipped college and went to work as a
knitting machine operator for his parents in 1958. He defied the conventional path to
success and made it anyway. So much so that Thor*Lo and Thoroneburg were the
subject of an article in the April 13, 1992, issue of Forbes magazine.
Thoroneburg revolutionized the athletic sock market by creating sport specific socks. Thor*Lo
has designs for 18 different sports including tennis, aerobics, and basketball. Each
padded sock is scientifically designed and engineered to meet the needs and stresses of
each particular sport. These uniquely constructed systems of foot protection are so
different that they are protected by numerous patents.
Forbes reported how Throneburg's most profitable product came during a stint at a
weight loss clinic. To get his weight down, Throneburg was told to walk eight miles a day.
"Fine, but my feet were killing me," he recounts. "So I had the idea to
make a sock with as much terry as you could put in the sole, without making it too thick
in the arch."
The result, after many design attempts was Thor*Lo Padds. These socks had
high-density padding at the ball and heel of the foot to protect the foot from friction
and injury and cut down on blisters and athlete's foot. Due a large degree to Throneburg's
pioneering work, sport-specific socks sold in both large and small sporting goods stores
across the national are now a $150 million-a-year business at retail. Thor*Lo's
share of that market was almost 50% last year. This statistic is all the more impressive
if you consider that Thor*Lo spent just $47,000 on advertising during the same
period. Also Thor*Lo is not standing still. New products and facilities
expansion are in progress as this article goes to press.
In most companies David Higgins and Mike Rowe would be described as chief operating
officer and chief financial officer, respectively. At Thor*LO, however, because
of the serious commitment to employee empowerment and quality, they both carry the same
title - core executive facilitator. As an example of the company's commitment, each
employee at Thor*Lo is paid for 40 hours' work a week but is expected to spend
only 36 hours at his or her work station. Overtime is discouraged, and the other four paid
hours each week are dedicated to training, quality commitment, and employee and cultural
development. Recently Higgins commented to me, "You have to understand, this
corporation is not like most; we chose to be here."
No ordinary corporation indeed. About a year ago, Mike Rowe decided that activity-based
management (ABM) was to be a critical information and management control process in the
future of Thor*Lo. Rowe, a CPA, is chairperson of the IMA Member Interest Group
(MIG) on Cost Management. He researched the subjects associated with ABM thoroughly, read
the books and articles, attended conferences and seminars, and evaluated the software
tools. Rowe concluded, "the starting point to ABM is to understand the economic
structure of our firm using ABC." He also decided to adopt the technology transfer
process analysis approach to ABM I had recommended.
"In keeping with the Thor*Lo commitment to quality and employee
empowerment, we decided to apply ABM ourselves with my assistance as facilitator,"
Rowe said. "So far we have completed a number of major steps with our ABM team
members. These steps include training, activity, and driver analysis. Presently we are
creating a form of flowchart of our operational processes known as a schematic" The
team consists of key employees from all functions including sales, marketing,
manufacturing, MIS administrative operations, MIS, and finance. "Once we have
completed ABC we plan to proceed to the next ABM steps of process reengineering and
performance measurement."
Throneburg, Higgins, Rowe, and the members of the ABM team are totally committed to making
change happen, and they know it has to come from within. Thor*Lo is living
proof that frame-breaking thinking combined with visionary leadership, management, and
employee commitment can produce outstanding results. *
Paul Sharman
as a period expense that is not allocated to product. Instead it is viewed as a
"management expense." The idea of a management expense is based on the fact that
only managers can decide whether or not they wish to continue to incur the cost associated
with maintaining idle capacity. Of course, if the cost of idle capacity becomes very
severe, the bankers may make the decision for them.
For this company, the ABC analysis caused managers to focus some of their attention on how
to make better use of the facilities that had been paid for and had a substantial
reoccurring cost. It also demonstrated that their process could produce cost competitive
products. The key to understanding was to have a decent cost analysis.
The economic information identified with ABC is used to prioritize process reengineering
projects and then to focus new multidimensional performance measurements. In all cases,
the information identified should be monitored routinely. It is impossible to eliminate
20% of a factory, and it would be terribly damaging to drop large numbers of customers or
products that customers depend on.
The Challenge
The new costing method needs to be institutionalized because change does not happen
overnight. In order to internalize the changes associated with activity-based costing,
companies must do the analytical work themselves. The decision managers make, premised on
the information available, are so important that the future of the company depends on
them. Therefore the quality of the underlying process of information gathering is critical
to the future of the company.
So profoundly important are these findings that they demand management prepare for them.
It is insufficient to "try out" an ABC process reengineering or benchmark
performance measurement project just to give it a spin. Management must commit to
implementation for the long haul.
Training key people to undertake frame-breaking projects is vital to long-term
competitiveness. Training involves a series of stages; two days at a fancy hotel is nice
but insufficient. Training programs begin with developing awareness in the organization,
followed by seminars that lead to facilitated application projects. Only when the staff
involved actually has done the first job with the help of an experienced practitioner will
they be able to replicate the application again and again.
Assign employees to do the analysis work. If you use outside help, the experience base
will leave with them when they finish. Of course, you could always have them come back
next time, and the next, and the next ... or maybe you will just not bother. A pilot
project is the beginning of the rest of your information life. Mess it up and it will be
difficult to get the picture right. Do it right the first time so that employees can
implement for the long term.
Our challenge as management accountants is to be prepared to embrace change. We should ask
ourselves:
* Why do we continue to use labour-based allocation of overhead to calculate standard
costs when it produces demonstrably distorted values?
* Is it reasonable for us as professionals to continue to allow the decision makers in our
organizations to use standard cost information to influence potentially significant
courses of action?
* Are we so busy doing what we do that we are unable to meet the needs of all of our
customers?
* Why is it that so much of the consulting firms' revenue comes from doing cost analysis
for corporations? Should we be doing the analysis?
* Have we allowed the rules to give us a feeling of security, such that we have subverted
our individual responsibility and professionalism?
* Who really benefits from the creation of all of the rules and regulations?
* How much of our work adds value to our organizations or its customers? What activities
could we eliminate completely?
Management accountants can drive change by becoming trained in the application of cost
management techniques. Learn how to use the tools, and then initiate projects in your own
organizations.
Identity high-cost activities and processes so as to prioritize and focus process
reengineering efforts. Initiate benchmark performance measurement programs by decomposing
your company's return on assets into its components and then comparing to the performance
of competitors.
Cost management is about managing processes more efficiently and making good strategic
decision. Having adequate information is critical to both. Handling information is
something we management accountants excel at, far more so than any other functional group,
and yet we have limited our interests to financial information. If the role of information
systems is to provide the mechanisms of information handling, it is the role of management
accountants to be the information architects, analysts and integrators. We can do more! *
Paul Sharman is an associate member of The Chartered Institute of Management
Accountants (UK) and the IMA (USA). He is president of Focused Management Information
Inc., (FIM) and features editor of CMA Magazine, published by The Society of Management
Accountants of Canada. You may reach Paul by phone at (416) 829-2658.
1Paul A. Sharman, "A Practical Look at Activity Based Costing" CMA
Magazine,
The Society of Management Accountants of Canada, February, 1990.
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