Defining Business Activities for Activity-Based Cost

One requirement when creating an Activity-Based Cost model is refining activities. A few simple criteria help the new model builder accomplish this requirement. However, the actual activity definition is the less consideration at this stage of model building.

A prime consideration in implementing Activity-Based Cost is to create and maintain support from operations personnel. With this in mind, a bottoms-up approach to activity identification works better than a top down approach. Start with the lowest organizational level at which expenses are collected. These are departments or cost centers. (The name of the organizational type varies business to business.)

With a team of employees representing the department, brainstorm about the work they do. They will come up with an extensive list and need a break. This is a great time for short discussions:

  1. The first discussion concerns the level of detail. Explain that some items that they have listed are very low level tasks; others are very summary; still others may only represent objectives. Explain that the low level tasks can make up an activity and that usually only four to eight activities are required to represent the work done in a department.
  2. Briefly discuss tools versus work. Invariably, they will have "answering email" or "answering telephone" and "attending meetings". Explain that these are tools we use to do our work. Rarely are they the ultimate work that needs to be accomplished.
  3. Help them identify and discuss their principal outputs. This will help them create appropriate summary activities.

Then ask the team to group task level items into summary activities and then to create a name for each activity. A great rule of thumb is to use a verb + noun object template for all activities. The "ing" form of a verb helps describe the work. Examples are Moving Materials, Calling Customers, and Purchasing Supplies. Keep all the task level items with the activity. They are valuable as a reference in describing the final activity. Resist verbose activity names. Rather, use the task detail for clarification but not in the name.

Before finalizing the activities, have the team estimate the time spent on each activity within their department. If the total percent of time spent is less than four or five percent of the total time, then have them look for opportunities to consolidate small activities into more meaningfulful summary activities.

The advantage of this approach is that the team immediately relates to the activities as defined. They created the list and understand all the detailed tasks. Allowing them to list detail tasks validates their work and their importance to the company's operations. Then they will allow appropriate summarization. Otherwise, they will fight for extreme detail.

Whatever you do later, do not change these activities. While upper management may want more summary activities, further grouping and summarization will cost you the buy-in you've worked hard to create. Rather than forcing new activity definitions onto operating teams, map operational activities to summary level activities for management reports with software. This preserves the best of both worlds: Detail for operations and summary for upper management.

In my first ABC implementation, we interviewed managers and teams in operations to define activities. Then, our consultant convinces us to summarize the activities to a higher level for management reports. Later, when we took the activity reports back to review with operating personnel, they did not recognize the activities and wanted what they had already defined. Consequently, we lost their buy-in. It would have been much better to use software to map operating activities to management level activities and reserve the hard won buy-in.

Too often, ABC implementation teams fail to consider the needs of operations personnel. ABC is new and potentially scary until they and their managers get familiar with it and adapt. The actual list of activities is only a small part of the real implementation work. The broader scope is to help the business understand and to adapt to new and better cost management. A little more time working with operations personnel pays healthy dividends later.