ABC, ABM, AND THE VOLKSWAGEN SAGA

The road to implementing activity-based costing and
activity-based management may be long and hard. But for Volkswagen Canada,
it was a road worth traveling in its quest to become the ultimate,
cost-conscious, world-class, customer-focused supplier.

by Jim Gurowka

Success is a journey, not a destination."

This quote by an unknown author certainly captures the situation at Volkswagen Canada's only manufacturing plant in North America. Volkswagen (VW) has been using activity-based costing (ABC) for the last five years, while persevering through management changes, company reorganizations, upsizing, downsizing, rightsizing, project leader changes, ABC software changes and, now, ownership changes. While the ABC system is presently stronger than ever, there are still more frontiers to push in the goal of fully ingraining ABM into the culture of the VW organization.

Volkswagen's story is not unlike many stories in the automotive or manufacturing industries of the 1990s. Massive changes in technology and competition have caused the company to take drastic action to continue being profitable and prosperous, and to satisfy ever-increasing expectations from the corporate head office. These actions range from aggressive pricing and selling policies to cost cutting and downsizing. Activity-based costing has helped management make tough decisions, with a degree of clarity that otherwise would not have been possible.

The company's facility, located in Barrie, Ontario (about 100 km north of Toronto) is VW's only manufacturing plant in either Canada or the United States. The plant currently makes aluminum wheels, catalytic converters and die cast engine parts. These parts are, in turn, sold to both Volkswagen and third party OEM (original equipment manufacturing) customers throughout the world. In the past, the Barrie plant almost exclusively supplied parts to its parent company but a strategic change dictated that the parent company would buy product from the cheapest producers, not just sister companies. This led to a 25 - 30 per cent decrease in prices, as well as an emphasis for the plant to not only cut costs, but to also find new third- party business to fill the gaps left from declining parent company orders.

The pilot project

An ABC project was first undertaken in 1991 in the die casting area. The initial results were encouraging enough to continue the project and expand it to the full plant. The results of this initial project came as a large surprise to some and a validation of already known, but unproved, results for others. "The initial study showed VW that while the die cast area in general was profitable, over 80 per cent of the products were either losing money or contributing very little to the operating results. There were a couple of parts with very high revenues that brought up the results of the whole area," explains John McIlmoyle, one of the two VW employees to be positioned as full-time ABC analysts at the beginning of 1994. This revelation brought a whole set of issues to management's attention that, before, were unknown.

ABC is all about giving management information it can use to make changes. Activity- based costing cannot make the changes itself. What VW lacked, when this information was presented, was a culture and an urgency to face these issues and tackle the problems in the die cast area. Back then, the focus was on expanding the wheel business and as long as the other areas were not losing money, they were not a priority. The net result was that nothing major changed, and the ABC information was essentially shelved. The leader of the project became very busy with other issues and, without a champion, the project went to sleep.

The rebirth

The summer of 1993 saw the reawakening of ABC at VW. "Management needed accurate cost information which was not being provided by the traditional accounting methods," explains John McIlmoyle. The ABC project had a new leader and a new team. They decided to use the information gathered from the old model to reconstruct a new ABC model.

The revitalization of activity-based costing coincided with a newly installed management team and the decision to re-engineer the major business processes of the company. As the ABC team worked away at building the ABC structure, the re-engineering team worked away at redesigning the plant's business strategies and processes. Preliminary ABC results were passed on to the re-engineering team which helped it in its decision making, and gave it a taste of the type of information available from an activity-based costing system.

The importance of ABC to the new design led the re-engineering team to recommend the repositioning of John McIlmoyle and Chris Atkinson as full-time ABC analysts in January of 1994. These two gentlemen brought a great deal of experience with them to their new jobs. "Our skills and abilities complement each other well. John has a strong financial and purchasing background, and I have a strong production background. Between the two of us we have a very good understanding of the plant," explains Chris.

As compared to the first attempt at ABC, which started with a pilot project, this incarnation of ABC began as a full- blown implementation. Pilot projects generally look at one small part of an organization. They look at one product line or one service area along with the shared resources of the organization such as finance, information systems, and sales and marketing. Pilot projects are generally small in nature and allow management to see if ABC will work before launching into a big, long-term project. A full ABC implementation, instead, looks at the whole organization or location and takes into account all of the activities performed. It aims to fully reconcile to the general ledger, and trace all costs to cost objects (products, services, customers, sustaining costs). A full implementation gives far more detailed information than a pilot project, and it is usually far more quicker to implement, organization-wide. There are efficiencies in data collection and model building that greatly speed up the process. As the people at VW had already tried a pilot project, they were confident the information would help them and, so, launched right into a full-blown ABC implementation.

Sharing the results

It was decided that the ABC results should get as wide a use as possible and, to that end, the results are shared quarterly with management and all other employees in the plant. Through the use of departmental meetings, all shop floor employees have the opportunity to see the ABC results, discuss them and, hopefully, try to act on them. John and Chris have also made

Figure 2: Volkswagen Canada's activity-based management model

themselves available anytime an employee wants to know the costs of a certain activity or consider potential activity-cost savings related to a particular improvement idea. Chris Atkinson explains their approach this way: "The results are shared with the process leaders, then at the production meetings with the personnel support co-ordinators, and then at departmental shift meetings with all production employees. In the shift meetings, we show them information on process costs, good and bad trends from the last quarter, and information relating to specific products. We find that if we can keep the information basic and specific to an individual product, the employees can relate better to it. For instance, a casting machine operator can relate much better to a wheel costing $3.30 to cast and a scrap wheel costing us $15.50 at the end of the process, than to a casting machine costing $50.00/hour to operate. Also, because I have a lot of experience working in many of the production departments, the message is much better received than if it were given by some "faceless" accountant."

While the re-engineering project came and went, the ABC data is actively being used by the processes and structures that the re-engineering left behind. It is fair to say that the re-engineering outcome had met with very mixed results, whereas the activity-based costing team that was created has thrived, and has expanded its role in the decision-making process of the entire company.

ABC is primarily a management decision-making tool. In order to track progress, the ABC analysts, along with the finance-process leader, share the quarterly results with the management team, as well as information on progress towards certain cost, quality and cycle-time goals. Management has accepted the task of using the information to drive the organization towards its strategic goals.

Using ABC information to
drive the business

So, what is Volkswagen Canada's Barrie plant currently doing with its activity-based costing information? In short, it is gradually moving from activity-based costing to activity-based management. From product and customer profitability, to quotation pricing (see chart 1), to budgeting, to cost of quality and non-conformance report costing, to process improvement initiatives, to outsourcing decisions, to new investment studies, and to product rationalization. It is using the information any way it can to help the decision-making process (see chart 2). Activity-based costing provides valuable core information that helps management make key decisions around pricing, product costing, and purchasing. This is only a first step in the use of ABC. By extending the ABC analysis, Volkswagen has been able to transform ABC into full activity-based management (ABM). It has been able to use the information to support KVP2 (total quality), process re-engineering, cost of quality, resource utilization and much more. While not the only factor, it is hoped that the ABM information will help VW to achieve its goal of becoming the ultimate, cost-conscious, world- class, customer-focused supplier.

The quotation costing sheet has allowed management to see exactly where costs are incurred in producing a product. It very clearly highlights areas that increase product costs, and areas where costs need to be cut. The costing sheet has found uses, both for pricing current products, and also for pricing future business. It is one of the many pricing and analysis tools VW has developed to utilize the ABC information.

ABC results to increase efficiency

The ABC system is used extensively in Volkswagen's process-improvement work. VW uses a tool named KVP2 (Kontinuierliche Verbesserungspozess) to drive all of its process improvement work. KVP2 is a form of continuous improvement whereby a group of employees, knowledgeable about a particular process, will spend a week at a time delving in to process in an effort to improve it. "First we take an area and map out the exact process as it is happening, right now," explains Chris Atkinson. "Next we take that process and brainstorm on waste, listing all the problems that are occurring. Then we brainstorm on improvements, implement them, and measure their effectiveness." One of the ABC analysts are included in every KVP2 session. This ensures that the team has accurate cost information. Process-improvement projects which lack costing information tend to be unfocused exercises which concentrate on perceived problems. The cost and economic data provided by ABC ensure the process-improvement team concentrates on what is important, and allows it to prioritize its improvement targets.

Strategic uses

While the ABC information and its many uses have proved invaluable to many functions and improvement initiatives, in the end, the ABC information simply helps managers and all employees do their jobs better and with more certainty. It provides accurate, precise data that decision makers can use. While standard costing gives you detailed but incorrect product information, activity-based costing gives you accurate and detailed product, customer, process and activity information. It tells you not only what your organization does, but also, how well it does it.

The die cast pilot project showed that, overall, the area was profitable but only because two of the parts were making most of the profit, and five of the parts were making all the profit. The other 15 parts were losing money or, at best, breaking even. In general, we find that, in most companies, 20 per cent of the parts produce 80 per cent of the profits. What happens when strong competitive forces hit the die cast business? In Volkswagen's case, several things occurred. The first was a price reduction of the two big money makers in the neighborhood of 75 per cent. This knocked the profit margin on these parts down to almost nothing. The second blow occurred when two of the other three profit-producing parts were discontinued.

Unfortunately, while improvements had been made, they were not enough to turn the area around. The ABC model was able to show that, even under the most optimistic scenario, the die cast area would not make a sufficient return on investment in the near future. Consequently, the decision was made to move the die casting operations to another VW plant.

In this case, the ABC data was used to help make the toughest decision management ever has to make -- the decision to close down an operation with its corresponding effects on employees, and the community at large.

While activity-based costing has proved to be a very useful tool to help drive improvements throughout the company, and to provide management with a clear picture of the costs and profitability of the Barrie operations, the biggest opportunity and challenge may lie in the not too distant future. Volkswagen has decided that it no longer wishes to operate the Barrie plant, and has put the operations up for sale. Only time will tell if ABM at VW remains a healthy, vibrant process, or ends up as a victim of company reorganization. The new owners will have to see for themselves how useful the ABC information is, and chart their own course for its use. The journey has only yet begun.

As Volkswagen's experience has shown, the road to implementing activity-based management is long and hard. It is full of many ups and downs and requires a strong, dedicated leadership team to drive the project forward. The rewards of such perseverance, however, are worth it. The information ABC provides can dramatically alter the way a company does business. It cannot tell management what to do to improve results but points it to where the potential opportunities are. As a decision-making tool, it provides the most potentially valuable data that decision makers can have in their toolbox of resources.

Jim Gurowka, a former senior financial analyst at Volkswagen Canada, is an associate of Focused Management Information Inc., of Oakville, Ontario. He specializes in profit and performance improvement, and the integration of human performance systems with workplace change projects.

Reprinted from the CMA magazine with permission from The Society of Management Accountants of Canada.