Cokins SAS May 5 2011 No 2

Key Questions for ABC What? So what? Then what?
Gary Cokins SAS gary.cokins@sas.com http://blogs.sas.com/cokins 919 531 2012 Cary, North Carolina ABC Forum May 5 , 2011 Oslo, Norway
Copyright 2010 SAS Institute Inc. All rights reserved.
About Gary Cokins

B.S. Industrial Engineering & Operations Research; Cornell University, 1971 M.B.A. Finance & Accounting; Northwestern University, Kellogg Graduate School of Management, 1974
Previous Associations: - FMC Corporation - Consultant with: Deloitte, KPMG Peat Marwick, & Electronic Data Systems [EDS]
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Copyright 2010, SAS Institute Inc. All rights reserved.
Of 151 ABC titles, ranked by bestselling volume ..
Gary Cokins 2001 book ranks #1
Gary Cokins 1996 book ranks #2

SAS is the Worlds Largest Privately-Held Software Company

(Prepackaged Software)
52 countries
11,115 employees
$2.5 billion sales More than 400 offices
2010 - 2011 Best Company to Work for Fortune Magazine

Hundreds of user groups
43,000+ customer sites in 112 countries

4
Who will benefit from this presentation?

Managers who have previously failed or are struggling at promoting or implementing ABC into their decision support systems. Managers who intend to champion any or all improvement techniques and need a compelling call to action.
Key questions
What? So what? Then what?
Six Eras of Managerial Accounting

standard cost accounting (to precious metal reflect Frederick and paper Winslow money piles, Taylors ultimately manufacturing leading to Consumer scientific double-entry methods, 1910) bookkeeping Regulatory (Luca Pacioli, Compliance 1492).
Stage Of Costing Maturity
The USAs Great Depression resulted in regulatory reforms to protect investors (1930s).
Causal cost tracing of increasingly diverse types of products, services, channels and customers
Predictive Analytics
A shift of emphasis from a historical to a predictive view of strategy and operations
Industrial
Rocks and stone piles.
Medieval
Ancient
20,000 BC
1492
1910
1930
1980
2015
Will our young managers herald the BA era?
http://www.youtube.com/watch?v=_CqgnZhb--Q
Your young generation of managers are already very clever. The next slides demonstrate examples of how they answered university exam questions.
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AGENDA
What is enterprise performance management?
What is business analytics? Three barrier categories: technical, design and organizational behavior 5 Design Barriers obstacles and impediments with measurements, accounting, customer value management, budgeting and their root causes. How to overcome the barriers What does enterprise performance management look like?
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Mistrust of the managerial accounting system

for accuracy and transparency lead to applying activity based costing.
A simple explanation of ABC
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Multiple-Stage Cost Assignment Tracing

Resources Resources Activities
Activities
Objects
Objects
Simple ABM
Expanded ABM
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ABC/M Cost Assignment Network

Resources
(general ledger view)
Salary, Fringe
Benefits
Direct Material
Phone, Travel Supplies
Depreciation
Rent, Interest, Tax
Work Activities
(verb-noun)
Support Activities
People Activities
Equipment Activities
cost-to-serve paths
Costs Measure the Effects
Final Cost Objects
(1) Demands On Work Costs (2)
Products, Services Suppliers Customers Business Sustaining
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More important than a better costing method are its results.
$ 30 sales - 28 expenses = $ 2 profit

Net Revenues Minus ABM costs = profit
Unrealized profit revealed by ABM
$ 2 profit
13
Activity Costs pile up into outputs.

ABM provides insight for the products or services cost drivers and driver quantities.
Work Activities
each activitys driver quantity
unit activity driver cost

(eg. # of registrations)
Price/Fee (Revenue)
Activity Costs
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Processes: Six Sigma, Lean Management, and Value Stream Mapping

Processes include activities that have high to low value-adding content.
$ $
VA
Business Processes
$
$ $
NVA
$
Supplier (direct material)
Process A
Enterprise
ABM also provides unit costs of outputs for cost visibility and benchmarking.
Key: Cost
15
Rapid Prototyping with

Iterative Remodeling
Each iteration enhances the use of a PM system.

PM Models PM System (repeatable, reliable, relevant)
#0
#1
#2 #3
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With ABC, it is counter-intuitive that error does not compound. It dampens out.
ABC Error has Offsetting Properties

The Two Path Views Resource Assignment View
Activities
Final Cost Objects
Contribution View Many-toOne
One-toMany
The Dispersion of Error contained in upstream assignments offset as each downstream paths aggregated into each final cost object.
Assignment error has a zero-sum property: Under Overcosted costed path $s path $s (-) (+)
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Balancing Levels of Accuracy with Effort
100%
Accuracy of Final Cost Objects
A B
World Class ABC System Design
0% Little Modest Great
Level of Data Collection Effort
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Proof of error dampening from academics

ERRORS IN COSTING SYSTEMS
SOMETIMES ONE MISTAKE COMPENSATES FOR THE OTHER!
-- MCA November, 2007 (p. 18-24) by Dr. Eva Labro, London School of Economics
A Simulation Analysis of Interactions among Errors in Costing Systems

-- THE ACCOUNTING REVIEW, Vol. 82 No. 4, 2007 (p. 939-962) by Dr. Eva Labro, London School of Economics; and Dr. Mario Vanhoucke, Ghent University
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Correlation Analysis of Activity Drivers
20
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Why are some customers more profitable than others?
21
Recursive Partitioning / Decision Trees
The single, largest factor for explaining the profit variation is Average Transaction Value Customers with lots of a small average transaction value are less profitable
22
Managing IT as a business
Managing IT as a business is now an imperative. No longer can IT be seen as a technology supplier it must be seen to be adding value to the organization and providing strategic capability. IT performance management enables IT to become service oriented, aligning itself with the organization to provide internal customerdriven solutions to problems.
But it is difficult to maximize returns from IT when the products and services appear to be free to internal customers.
23
Two Types of IT expenses: Assets and People

Fixed Costs (virtual) IT assets become sunk costs immediately at purchase. The objective to is maximize capacity use. Flexible / Variable Costs (physical) People-related expenses (e.g., salaries) can be flexibly assigned to different work. Headcount is adjustable. The objective is to use people efficiently.
24
Hardware
People
IT Assets as a Visual Tile Chart
An existing Tile Chart as seen through the SAS Information Delivery Portal
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Asset Expenses are virtual (Fixed Costs)

A tile chart illustrates how IT workloads can be analyzed and optimized. The left hand chart shows a number of servers that are significantly under-utilized (shaded blue). Under-utlized servers were removed and the existing workload was shifted to lower-cost, multi-core servers. After 10 months, the chart on the right shows a fairly balanced workload (reds and oranges indicating workloads higher in processor utilization).
January
Optimizing the Factory driven improvements
October
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AGENDA
What is enterprise performance management? What is business analytics?
Three barrier categories: technical, design and organizational behavior

5 Design Barriers obstacles and impediments with measurements, accounting, customer value management, budgeting and their root causes. How to overcome the barriers
What does enterprise performance management look like?

27
But what about the Other Below-the-GM-line Calculated Costs?

Products and standard service-lines are not the only thing for which accountants should compute costs. What about costs that have nothing to do with products and standard service-lines?
The problem with traditional accountings gross margin reporting is you dont see the bottom half of the picture.
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What about Costs Below Product Costs ?

INCOME STATEMENT Sales $ 100 - Product direct costs -20 - Overhead cost -10 ---------------------------------------------= Gross profit margin $ 70 - selling costs -20 - distribution costs -10 - marketing costs -20 - administrative costs -10 ---------------------------------------------= Total Profit $ 10
The accountants report these by each product (but they are wrong without ABC).
?
We have no visibility of these costs by customer (except in total) !
29
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Costs from Sales & Marketing are not Products

Customer + Channel + Product
Direct material, Direct labor & Equipment
Indirect expenses
Distribution, Sales & Marketing General, and Administration
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Why Do Customer-related Costs Matter? The Perfect Storm
# 1- Customer Retention It is relatively much more expensive to acquire a new customer than to retain an existing one.
# 2 Sources of Competitive Advantage As products and standard service-lines become commodity-like, then the shift is towards service-differentiation.
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Why Do Customer-related Costs Matter? The Perfect Storm
# 3 - CRMs One-to-One Marketing Pepper & Rodgers have hailed technology as the enabler to (1) identify customer segments, and (2) tailor marketing offers.
# 4 - Power Shift The Internet is shifting power irreversibly from sellers to buyers.
32
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A Customer Profit & Loss Statement

CUSTOMER: XYZ CORPORATION (CUSTOMER #1270)
Sales
$$$
Margin $ (Sales - Costs)

$ xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx
Margin % of Sales
98% 50% 48% 46% 30% 28% 26% 24% 22% 10% 8% Productrelated costs
Product-Related Supplier-Related costs (TCO) $ xxx Direct Material Brand Sustaining Product Sustaining Unit, Batch* Distribution-Related Outbound Freight Type* Order Type* Channel Type* Customer-Related Customer-Sustaining Unit-Batch* Business Sustaining xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx
Channel & Customerrelated costs
Operating Profit
(Other ActvityAssignments traced based on informed (subjective) %s)
xxx
8%
* Activity Cost Driver Assignments use measurable quantity volume of Activity Output
34
Migrating Customers to Higher Profitability

Very Profitable
High (Creamy)
Product Mix Margin
Low (Low Fat)

Low High
Cost-to-Serve
Types of Customers
Very unprofitable
35
KPI Linkage of Customer Profits to the Scorecard

Very Profitable
High (Creamy)
KPI Target
Product Mix Margin
Low (Low Fat)

Low High
Cost-to-Serve
Types of Customers
Very unprofitable
36
Customer Value Management
Who is more important to pursue with the scarce resources of our marketing spend budget? Our most profitable customers? Or our most valuable customers? What is the difference? The customer lifetime value is intended to answer this question.
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Imagine you are pharmaceutical supplier.

Which Customer is more Important?
Dentist A
Dentist B
Sales = $750,000
profits = $100,000 Age 61
Sales = $375,000
profits = $40,000 Age 25
Which is more profitable? Which is more valuable?

38
Value Creation via CLV

Customer Lifetime Value $
After a CLV (or CP) is calculated and rank-ordered highest to lowest customer, then
Get more value from these
Protect these
Existing Customers
Source: Customer Equity Marketing; European Mgmt. Journal; Vol 20, No. 3; June, 2002
retain
develop, streamline
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Actions for each customer produces Profit-lift

Get more value from these
What actions will lift the profit curve?
Protect these; grow them
Existing Customers*
retain
develop, streamline * Ranked most to least valuable

40
Value Creation via CLV

Be selective pursing these Get more value from these
also, be prudent attracting new customers.
Protect these; grow them
Existing Customers
Possible New Customers

acquire do not acquire
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retain
develop, streamline
Here is a real companys CLV Formula

CLV I 0
t 0 T
( Rt kit ) Lt St
i 1
(1 d ) t
P t
Net Present Value of the Relationship (CLV)
Revenues
(R)
Cost of Product i
Sub. Maintenance - Retention (L) - Customer Care (S)
Cost of Acquisition
Probability for period t
Discount Rate
k i)
(P)
(d)
Probability for Churn
Cross/Up Sale
Willingness to expend more

42
My which-type how-much Hypothesis
The spending budget for sales and marketing is critical but it should be treated as a preciously scarce resource to be aimed at generating the highest long-term profits. This means answering questions like: Which type of customer is attractive to newly acquire, retain, grow, or win back? And which types are not? How much should we spend attracting, retaining, growing, or recovering each customer segment?
43
A Shift in the CFOs Emphasis
The CFO must now help Sales and Marketing to better target customers.
Segmentation, predictability, churn, offers, deals, risk and uncertainty must be understood in the language of money.
44
AGENDA
What is business analytics?

Four barrier categories: technical, perceptions, design and organizational behavior 5 Design Barriers obstacles and impediments with measurements, accounting, customer value management, budgeting and their root causes.
How to overcome the barriers

What does enterprise performance management look like?
45
Why is the budgeting process broken?
The budget is typically a fiscal exercise by the accountants that is: -- disconnected from the executive teams strategy. -- not based on future driver volumes.
46
What are the Organizational Behavior Barriers?
Budgeting (and Rolling Financial Forecasts)

Excess power of managers with the loudest voice or strongest muscles and with sandbag padding expertise. Excel Hell. Tradition incremental / decremental cost center lineitem without cost driver interdependencies.
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Spreadsheet Budgeting Its Incremental !

a b c
1 2
3
4 5 6 7 8
Current Year Budget Year Wages $ 400,000.00 Formula = Column B * 1.05 Supplies $ 50,000.00 Rent $ 20,000.00 Copy down Computer $ 40,000.00 Travel $ 30,000.00 Phone $ 20,000.00 Total
Sheet 1
$ 560,000.00
Source: John Antos, The Value Creation Group
48
Match the Budget Method to its Category

Demanddriven
Integrated Budget
(Rolling Financial Forecasts)
Projectdriven
Source: Mike Tinkler; www.synerma.com
49
(1) Non-Recurring Expenses // Strategic Initiatives
Measurement Period;
1st Quarter Identify Projects, Initiatives, or Processes
Strategic Objective
KPI Measure
KPI Target
KPI Actual
comments / explanation
Executive Team Managers and Employees
X X X
X
their score
<----- period results ------->
Budgeting is typically disconnected from the strategy. But this problem is solved if management funds the managers projects.
50
(2) Recurring Expenses // Future Volume & Mix

ABC/M ABP
Past
Now
Future
Activity-Based Costing
- Historical & Descriptive - Starts with known: spending driver measures output quantities - Calculates costs
Activity-Based Planning
-
Predictive
Requires capacity analysis Starts with estimated outputs Applies ABC/M rates Solves for Resource expenses
51
Operational Resource Capacity Planning

inputs
Resources
Process Costs
Output & Outcome Costs
Resource expenses can be calculated with backwards ABC/M
Customers and Service-recipients

Start Here.
52
The Shift towards Predictive Accounting
ABC/M
ABP
Past
ABC/M
Now
ABP
Future
Known ?
resources work activities cost objects

53
Provides consumption rates
The Shift towards Predictive Accounting
ABC/M
ABP
Past
ABC/M
Now
ABP
Future
resources work activities cost objects

? ?
Estimated
54
Match the Budget Method to its Category

Budget method
Demanddriven
Recurring
expenses
volume & mix of drivers
production and ABP/B
Integrated Budget
(rolling financial forecasts)
Projectdriven
Non-recurring
expenses Strategic & risk mitigation projects
strategy map and risk grid
55
Linking Strategy and Risk to the Budget

Strategy Modeling
(by executives)
Strategy methods (e.g., SWOT) Managerial Accounting

knowledge (e.g., Activity-based Costing)
Define and adjust strategy and risk, and create strategy map Strategic objectives
Financial Modeling
Operational Modeling
(by employee teams)
Identify and manage strategic initiatives
priority projects and processes KPI dashboard feedback Driver volumes and mix Driver consumption rates Traditional and driver-based budgeting (e.g. PBB) Changes and responses
Manage and improve core processes Results and outcomes
Create balanced scorecard KPI targets Forecast drivers (e.g. sales) ; develop production plan
e.g., hours, Pounds, # employees
Approve strategy risk and capital budget (2) capital budget (3) strategy budget (4) risk budget
Capacity resource plan
Revise plan No
Acceptable?
(1) Operational budget
= financial information (e.g. $)
Derived budget (and rolling financial forecasts)
OK Yes
56
Historical versus Predictive Accounting

Descriptive Predictive
Accounting Treatments and Behavior of Capacity (expenses)
Past
Now
Future
unused
Traceable to products, channels, customers, sustaining
sunk unused
fixed
(unadjustable)
used
variable
(adjustable capacity; avoidable)
57
International Federation of Accountants Report
Evaluating the Costing Journey: A Costing Levels Continuum Maturity Model By Gary Cokins, SAS
Most organizations are typically at lower levels of maturity in adopting progressive managerial accounting practices, methods and systems.
58
ACCOUNTING
Source data capture (transactions / bookkeeping)
Tax Accounting
Financial Accounting
Managerial Accounting
Non-financial data capture
Cost Accounting
Financial Reporting regulatory compliance
[e.g., GAAP, IFRS] Costs of goods sold Inventory valuation
Cost Measurement
Cost Reporting & Analysis
(feedback on performance)
Spending vs. budget variance analysis Profitability reporting Process analysis (e.g., lean, benchmarking, COQ) Performance measures Learning; corrective actions Fully absorbed & incremental pricing Driver-based budgeting & rolling financial forecasts What-if analysis Product, channel & customer rationalization Outsourcing & make vs. buy analysis
Decision Support/ Cost Planning
The Domain of Costing
History
Low value-add Modest value-add
Source: A Costing Levels Continuum Maturity Model by Gary Cokins published by the International Federation of Accountants, 2010 Copyright 2010, SAS Institute Inc. All rights reserved.
Future
High value-add
59
Costing Continuum / Levels of Maturity

(most companies are Level 4D and 0P)
(1) Descriptive Continuum

EXPENSE TRACKING, COST REPORTING and CONSUMPTION RATES
Improved Treatment of Indirect Costs Customer Demand Sensitive Unused Capacity Aware
(2) Predictive Continuum

DEMAND DRIVEN PLANNING with CAPACITY SENSITIVITY
8D
Unused capacity costs (estimate d) Pull Activitybased Resource Planning Timedriven ABC
Level #
7D
Improved Output Information/ Approximate Push Accuracy ActivityBased costing (ABC);
6D
Resource Consumptio n Accounting
Simulation
4P
Ultimate in consumptio n rates;
Output Visibility Blind Process Visibility
Level 6 with Channel and customer profitability Reporting; Cost-to-serve
3P
(RCA); Level 9 with proportional costing at direct and support depts.
1D
2D
3D
4D
5D
Product costs
% G/L acct. Incrementa l
2P
(TDABC); Forecast driver quantities X time consumption rates; Direct cost focus; Repetitive work conditions
1P
(ABRP); Forecast driver quantities X unit consumptio n rates; Driver based budgeting
process and bookkeeping Lean accounting
Direct costs without (3) and with (4) support costs to output groups
Standard costing to individual outputs; Project acct; Job order costing
0P
Source: A Costing Levels Continuum Maturity Model by Gary Cokins published by the International Federation of Accountants, 2010
60
AGENDA
What is business analytics? Four barrier categories: technical, perceptions, design and organizational behavior 5 Design Barriers obstacles and impediments with measurements, accounting, customer value management, budgeting and their root causes. How to overcome the barriers What does enterprise performance management look like?
61
Key questions
What? So what? Then what?
62
The Intelligence Hierarchy

Power of Information
Predictive Modeling Descriptive Modeling
(with analytics)
Optimization
$ROI
Raw Data
Ad hoc Reports & Standard OLAP Reports
Two types of software are like a brains two halves.
Data
Information
Knowledge
Intelligence
Transactional systems (e.g., ERP) the reptilian brain stem (breathing, blinking, digesting)
Business Analytics and Performance Management the cerebral cortex (thinking and decision making)
63
How Does It All Fit Together?
Strategy, Mission
Customer Satisfaction
ERP, etc.
CRM
Supplier Inputs Scorecards
Organizations Resources
(capacity)
ROI
$
Shareholders
64
In Summary first, we energize

with good managerial accounting.
Strategy, Mission Customer Satisfaction CRM Supplier Inputs ROI
$
ERP, etc.
Scorecards
Organization Resources
(capacity)
Shareholders
Managerial accounting
65
PM is Circulatory and Simultaneous

Shareholder Wealth Creation is not a goal. It is a result!
Strategy, Mission
Risk Mgmt., Strategy map, KPIs needs
ERP, etc.
Targeting
CRM
Order fulfillment
Scorecards
KPI Scores Feedback
(capacity)
ROI
$
Supplier Inputs Shareholders
66
PM is Circulatory and Simultaneous

Shareholder Wealth Creation is not a goal. It is a result!
Strategy, Mission
Risk Mgmt., Strategy map, KPIs needs
ERP, etc.
Targeting
CRM
wasted resources
Order fulfillment
Scorecards
KPI Scores Feedback
(capacity)
ROI
$
Supplier Inputs Shareholders leakage (waste)

67
Less productivity reduces Shareholder Wealth
A 30 Minute Webcast of points made during this presentation
http://videoplayer.nlps.com/?FMN_SEPT09_SEG2
By www.smartpros.com Financial Management Network
68
The Complete Vision of Analytics-based Performance Management
Make the RPM of the PM and BA gears spin better, faster, cheaper and smarter
69
From Theory to Practice
Your success depends on how well and how fast the right information and intelligence gets to the right people.
70
Thank You
Visit our corporate Web Site: www.sas.com
Or feel free to contact:
Gary Cokins, CPIM

SAS Performance Management www.sas.com 919 531 2012 gary.cokins@sas.com
71

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Key Questions for ABC What? So what? Then what?

About Gary Cokins

Of 151 ABC titles, ranked by bestselling volume ..

Gary Cokins 2001 book ranks #1

Gary Cokins 1996 book ranks #2

SAS is the Worlds Largest Privately-Held Software Company

2010 - 2011 Best Company to Work for Fortune Magazine

43,000+ customer sites in 112 countries

Copyright 2010, SAS Institute Inc. All rights reserved.

Who will benefit from this presentation?

Copyright 2010, SAS Institute Inc. All rights reserved.

What? So what? Then what?

Copyright 2010, SAS Institute Inc. All rights reserved.

Six Eras of Managerial Accounting

Stage Of Costing Maturity

Rocks and stone piles.

Copyright 2010, SAS Institute Inc. All rights reserved.

Will our young managers herald the BA era?

Copyright 2010, SAS Institute Inc. All rights reserved.

Mistrust of the managerial accounting system

A simple explanation of ABC

Copyright 2010, SAS Institute Inc. All rights reserved.

Multiple-Stage Cost Assignment Tracing

Copyright 2010, SAS Institute Inc. All rights reserved.

ABC/M Cost Assignment Network

Phone, Travel Supplies

Rent, Interest, Tax

Costs Measure the Effects

Final Cost Objects

(1) Demands On Work Costs (2)

Products, Services Suppliers Customers Business Sustaining

Copyright 2010, SAS Institute Inc. All rights reserved.

More important than a better costing method are its results.

$ 30 sales - 28 expenses = $ 2 profit

Unrealized profit revealed by ABM

Copyright 2010, SAS Institute Inc. All rights reserved.

Activity Costs pile up into outputs.

each activitys driver quantity

unit activity driver cost

Processes: Six Sigma, Lean Management, and Value Stream Mapping

Supplier (direct material)

Copyright 2010, SAS Institute Inc. All rights reserved.

Rapid Prototyping with

Each iteration enhances the use of a PM system.

Copyright 2010, SAS Institute Inc. All rights reserved.

ABC Error has Offsetting Properties

Final Cost Objects

Contribution View Many-toOne

Copyright 2010, SAS Institute Inc. All rights reserved.

Balancing Levels of Accuracy with Effort

Accuracy of Final Cost Objects

World Class ABC System Design

0% Little Modest Great

Level of Data Collection Effort

Copyright 2010, SAS Institute Inc. All rights reserved.

Proof of error dampening from academics

A Simulation Analysis of Interactions among Errors in Costing Systems

Copyright 2010, SAS Institute Inc. All rights reserved.

Correlation Analysis of Activity Drivers

Why are some customers more profitable than others?

Copyright 2010, SAS Institute Inc. All rights reserved.

Recursive Partitioning / Decision Trees

Copyright 2010, SAS Institute Inc. All rights reserved.