University of Groningen Faculty of Economics and Business
Is the cost-to-serve method a solution for each firm?
A case study at Company X
Master of Science Business administration Organizational and management control
Name student: B.J. Veurink
Address: Watertorenweg 1
7688 PX Daarle Supervisor: Drs. D.J.J. Heslinga Co-assessor: Drs. J. Westra-de Jong Student number: 1718312
E-mail address: b.j.veurink@student.rug.nl
Executive summary
Company X has tried to implement a program (excellerate) with the cost-to-serve method as one of the elements however somehow, it failed. Despite the failure, the supply chain department of Company X still wants a better insight in the logistic service costs and wants to know if there are still possibilities to allocate these costs to the customer. This research was concentrated on the “allocation issue” which has lead to the following research question:
Why did the implementation of the cost-to-serve method fail and is it still possible to implement or what are the alternatives?
In this thesis the causes for the failure will be described. In addition, it will address if there are still possibilities to implement this method or if there are any alternatives for Company X.
To determine the causes for failure, first the theoretical backgrounds of the cost-to-serve and activity based costing method (the CtS method is based on ABC techniques) have been described. Moreover, in the literature several factors for a successful
implementation of these methods have been found and explained. These factors are on one hand “technical factors” and on the other hand “organizational & behavioral factors”. Through a case study, based on interviews, a deeper understanding of the problems with the CtS method at Company X has been gained. The results of the case study have been compared with the literature which has lead to several conclusions.
The failure of the excellerate program is caused by as well technical factors as
CtS method is very small. This, in combination with the effort to generate this additional information it wasn’t worth to keep this system up and running.
Looking at the organizational & behavioral factors it can be concluded that there was no sense of urgency. The project was launched from corporate and not initiated through the business unit itself. Also the literature address this point as one of the major reasons for failure. Besides, there was no internal need for additional information and therefore not really a support or incentive to implement the excellerate program. Moreover, the external team left before implementation. There was no guidance during the
implementation process to fine tune the program, role out inappropriate behavior etc.
Preface
The master thesis that is lying in front of you is the result of half a year research at Company X. I want to thank Company X for giving me the opportunity to conduct my research within their company. Especially thanks to Bart Oosterlee for the support during my research and, together with his colleague Thomas Bakker, for answering all my questions. Furthermore, I want to thank all the interviewees, the employees of the customer service center and other persons inside Company X who took the time and effort to help me conducting this research. In addition, I would like to express my acknowledgements to my supervisors Mr. Heslinga and Ms. Westra-de Jong for their assistance and recommendations. At last, I would like to say a word of thanks to my parents for their financial and motivational support.
Table of content
Executive summary ... 2 Preface ... 4 1. Introduction ... 6 1.1 Introduction Company X ... 6 1.2 Problem Company X... 6 1.3 Research questions... 7 2. Literature review ... 82.1 Introduction to ABC method ... 8
2.2 Introduction to CtS method... 9
2.3 Advantages and disadvantages of the cost-to-serve method... 10
2.4 Influence of indirect and direct costing on cost price methods ... 12
2.5 ABC and CtS into practice... 13
2.6 Factors for a successful implementation of the ABC method ... 14
3. Research methodology ... 22
4. Analysis... 25
4.1 Reason for implementing the excellerate program. ... 25
4.2 Evaluation of the implementation process. ... 25
4.2.1 Organizational and Behavioral factors... 26
4.2.2 Technical factors ... 28
4.3 What is still working from the excellerate program ... 30
4.4 Is it possible to allocate the supply chain service costs based on the CtS method? ... 30
4.4.1 Supply chain service costs at Company X ... 30
4.4.2 Suitability of the CtS method concerning the supply chain costs... 31
4.4.3 Advice concerning the supply chain service costs at Company X ... 31
4.5 Suitability of the cost-to-serve method for Company X... 32
5. Conclusion... 33
Limitations and further research ... 34
1.
Introduction
1.1 Introduction Company X
Company X is one of the many business units within Company X Group, a company who creates innovative products and services in “life sciences” and “materials sciences”. Company X is the leading, customer-oriented producer of polyester resins for powder coatings. The business unit serves a broad range of applications in its market. Company X is active in more than 50 countries and produces products for the industries:
“Automotive”, “Building and constructions”, “Furniture”, “Marine”, “Packaging”, “Sports, leisure and consumer goods” and “Transportation and mechanical engineering”.
1.2 Problem Company X
In 2008 Company X has implemented a program (excellerate) with several elements. One of the elements was the cost-to-serve (CtS) method (supply chain costs were not taken into account) to get a better balance between costs and customer service levels. However, somehow, the implementation of this method failed. Nevertheless, the supply chain department wants to get a better insight in the service costs and wants to know if there are possibilities to allocate these costs to the customer (CtS method). It is assumed that for some customers additional / hidden costs are made.
1.3 Research questions
Following from the research objective a general research question is formulated. This question is further specified in several sub-questions. A short content per sub-question is given and these questions will serve as a guideline for this research.
General research question:
Why did the implementation of the cost-to-serve method fail and is it still possible to implement or what are the alternatives?
Sub questions:
1: What is the cost-to-serve method?
2: For which organizations is a cost-to-serve method appropriate? 3: How to implement the cost-to-serve method successfully? 4: Why did the implementation of the cost-to-serve method fail?
5: Is it possible to allocate the supply chain service costs based on the CtS method?
6: Is it still possible to implement the cost-to-serve method forCompany X or what are
the alternatives?
The structure of the report is as follows: the next chapter of this report contains a
literature review. The chapter will discuss the ABC and CtS method (including their pros and cons) and if the CtS method is appropriate for Company X. Furthermore, the
implementations steps of the ABC/CtS method will be described.
Chapter three describes the methodology which will be used for this research. The methodology is important for receiving and collecting exact and objective data.
2.
Literature review
In this section I will discuss the theoretical background of the CtS method. The CtS method is based on Activity Based Costing (ABC) techniques and therefore also the theoretical background of the ABC method will be explained. Moreover the advantages / disadvantages of both methods and the steps for a successful implementation will be described.
2.1 Introduction to ABC method
Since the mid-1980s the traditional costs methods have been attacked because these systems can lead to considerable distortions in product costing (Cooper & Kaplan, 1988, 1992; Rezaie, et al. 2008). Important decisions (pricing, cost control etc) and other decisions made by managers who are using these distorted cost information can lead to several problems in the future. According to Cooper & Kaplan (1992) traditional costs systems use volume-driven allocation bases, such as machine hours and direct labor hours to assign organizational expenses to individual products and customers. However, many resources (indirect costs) used by those products/customers are not proportional to the volume of units and hence, it isn’t possible to allocate those resources costs
accurately. Furthermore, in traditional cost accounting a part of the overhead costs (marketing, finance) are assigned to the period in which they are incurred or accrued and are not allocated to the products (Seat et al., 2006; Hardy, et al. 1992). This all leads to distorted cost information.
To avoid such sub-optimal decisions, firms can use activity-based costing, since ABC provides better information to decision-makers. According to Anderson (1995) ABC addresses inadequacies of traditional labor-based cost systems by using a two-stage method that attributes costs first to production and business activities, and then to
products on the basis of resource usage. In short, it assigns more indirect costs (overhead) into direct costs. Due to this, an organization is capable to estimate the cost of its
ABC can reduce costs because it gives a lot of information about the value of activities in the production process. Suppose that some activities generate no or less value, than it is possible to intervene and to adjust or eliminate some processes. The same information can be given on the product level, which subsequently can lead to adjustments or eliminations of product features or functions. On the other hand of course it can lead to more investments in features or functions which create value for the customer. In case of elimination, activities as control and moving/telling of products will be reduced. This will finally lead to a reduction of the total lead time. As such, ABC is an excellent tool for making strategic decisions such as outsourcing, pricing or identifying process
improvement initiatives.
Despite all those advantages of the ABC method, there aren’t so many success stories. Only a few firms have enjoyed significant benefits from it. One of the main reasons of failure is due to poor implementation (Ness and Cucuzza, 1995; Player and Keys, 1995; Pattison and Arendt, 1994)). Other critics on the ABC concept is that ABC is not suitable for making management decisions, especially for evaluating the performance of
departments based on this information (Armstrong, 2002). Moreover, it’s too complex and difficult to keep it up to date (Bruggeman et al., 2005). Additionally, it is difficult to define the activity pools and to use the right cost drivers (Innes & Mitchell, 1993). In conclusion, there are several disadvantages about the CtS method which maybe can explain why the implementation of the CtS method failed.
2.2 Introduction to CtS method
therefore it is critical to know what the CtS is. Moreover the costs of services are often dependent on the customer’s behavior, rather than that of the provider (Kaplan and Narayanan, 2001).
As already mentioned, traditional cost systems are not capable to allocate the overhead (service) costs to products accurately. Furthermore, Braithwaite and Samakh (1998) stated that traditional cost-determination systems do not permit an accurate analysis of individual customer performance. Therefore, it isn’t possible to find a balance between services on the one hand and costs on the other hand. The CtS method overcomes this problem. It gives, based on the ABC approach, a lucid description which customers and products matter most and how to manage them at the appropriate costs.
According to Sheth and Sisodia (1995) the ABC system can be used as an effective tool for achieving “effective efficiency” in this “commercial function”. Additionally, Kaplan and Cooper (1998) stated that the ABC system is, in theory, the most appropriate method for determining customer-service costs in companies with complex product, customer, and service requirements. Despite all those positive statements, it has taken a lot of time before ABC achieved greater acceptance as a tool for determining the logistics costs. ABC accounting has been focused traditionally on correcting the errors in overhead allocation to products. Due to continued development it became clear that ABC not only applicable was for areas inside the scope of cost accounting. Nowadays, areas such as logistics, marketing and supply chain are also using the ABC system.
2.3 Advantages and disadvantages of the cost-to-serve method.
Figure 1: The first 20% of customers account for 500% of profits, and the last 20% of customers destroy
400% of the profits from this market segment.
Source: (http://www.sas.com/resources/whitepaper/wp_5073.pdf)
This example shows that approximately 20% of the customers are responsible for 500% (cumulative) of the profit. The next 60% doesn’t contribute to the profit (breakeven) and the final 20% destroy 400% of the profit. Kaplan (1989) research shows similar results. Therefore, CtS literature addresses often the well-known 80/20 rule, that is, 80% of the profit is created by 20% of its customers while the remaining 20% profit come from 80% of its customers.
Based on this information a more commercial policy can be adopted per customer. The company can develop innovations and strategies to enhance the profit per customer without reducing the satisfaction. Factors who can affect the profitability obtained from individual customers are “purchase behavior”, “delivery policy”, “accounting
procedures” and “inventory levels” (Smith and Dikolli, 1995).
improve their core business processes, namely if the cost structure is transparent,
inefficiencies can be quickly identified and addressed. Traditional accounting completely hides this kind of information.
The disadvantages of the ABC method are automatically the disadvantages of the CtS method. However, Johnson (1992) addresses another more cost-to serve related disadvantage. Johnson claims that the answer to competitiveness and long-term profitability is not to do a comprehensive ABC analysis. He states that activity
information undoubtedly improves many companies’ efforts to cut costs, however it does not show how work is done or how it will contribute to customer’s total satisfaction (e.g. responsiveness to customers and flexibility in processes). If for example a customer really wants frequent deliveries in specific packaging and an alternative supplier can deliver on these specific terms, then an activity analysis can be confusing for the supplier. Johnson argues that in order to stay competitive, don’t persuade customers to purchase what the company now produces at lowest costs, but give the customers what they want.
2.4 Influence of indirect and direct costing on cost price methods
As already addressed in the former paragraph, the distinction between the traditional methods and the ABC/CtS method is the allocation of the indirect costs. As a conclusion from the literature, the following model can be given:
Indirect cos ts D irect cos ts
S upply chain s ervice cos t C ompany X
D ifferences in alloca tion between traditional methods and the A B C method
No differences in alloca tion between traditiona l methods and the A B C method
The model shows that if the supply chain service costs are indirect, the service costs can be allocated, based on different methods, to the customer. In this case, it is possible to choose between traditional costs methods are the ABC/CtS method.
If the supply chain service costs are direct then it doesn’t matter if you choose between a traditional cost method or the ABC/CtS method. The direct costs will be allocated by both methods on exactly the same way.
2.5 ABC and CtS into practice
To explain the ABC and CtS methods into practice, consider the following example. Company X sells resins with a 25-percent gross margin to two customers. One customer orders three times per week a less than truck load (LTL), is inefficient in its receiving and often badly organized, products must be delivered in specific packaging, and is a slow payer.
A second customer orders large quantities once a week in a full truck load (FTL), is well organized and efficient in its receiving, products can be delivered in standard package, provides a longer lead-time, and uses electronic ordering and payment.
In this case, the second customer can provide of course a higher profit contribution vs. the first customer, when you factor in order size, real ordering costs, delivery frequency, the difference in delivery time and efficiency and the savings from better planned manufacturing and distribution operations.
2.6 Factors for a successful implementation of the ABC method
There could be several reasons to adjust a current accounting system, e.g. to improve the quality, quantity or accuracy of management information. Another reason could be to improve the speed of access to / producing information. However, a new desired accounting system isn’t always suitable. For determining the suitability of the CtS method for Company X, a quick scan for ABC has been used (figure 2). This scan contains 10 financial relating questions and is filled in together with the internal
controller of Company X. The answers are, among others, based on the following facts:
- Company X makes over more than 100 different resins
- The cost price of a resin consist for about 75% out of raw material costs
- 20% of the customers of Company X are responsible for about 80% of the profit. - Company X makes use of a traditional cost method.
- Price changes for resins are mostly caused by fluctuations in raw material costs - Company X is able, based on margins, to determine the profitability per
customer/product.
Quick scan ABC
In case you do agree with a statement, you fill in a 1 under "Agree" and a 0 under "Disagree". In case you don't agree with a statement, you fill in a 0 under "Agree" and a 1 under "Disagree".
Agree Disagree
Question 1 We don't now exactly which customers, orders, products
and/or services contribute to our profit 0 1 Question 2 We have a major diversity in our customer-, order-,
products-and/or services portfolio 1 0
Question 3 We don't know how are competitor can sell his products for
that particular price. 1 0
Question 4 Are selling price is based on the integral cost price 1 0 Question 5 We steer, qua decisions, strong on the impact of these
decisions on the cost price. 0 1
Question 6 We work with average surcharges, and/or quote's and/or
shares by determining the cost price. 1 0 Question 7 We don't know for sure if we have to source out internal
facility services 1 0
Question 8 We have to put a lot of effort each time in allocating changes
in our customers, orders, products and/or services portfolio. 0 1 Question 9 We think that the indirect costs do have a relative big share in
the total costs. 0 1
Question 10 We have a feeling that the indirect departments can grow apparently unrestrained and don't have control about their costs.
0 1
5 5
Score Score
Category A No reason to implement ABC/M 0 10
Category B Consider ABC/M seriously, execute an attainability study 1 - 4 9 - 6
Category C Start as soon as possible with the implementation of the
ABC/M, however develop first a business case. 5 - 10 5 - 0
Figure 2: Quick scan ABC Results
Instructions:
Score
In paragraph 2.1 is already discussed that due to poor implementation only a few firms have benefit from the ABC method. According to Ness and Cucuzza (1995) only 10% of the companies who wanted to implement activity-based costing are using it now. The other 90 % didn’t succeed due to several factors. Furthermore is already discussed the disadvantages from the ABC/CtS method. Among others, it takes too much time to implement, too complex and it’s difficult to keep it up to date. However, implementation failures are mostly caused by other factors. An important reason is that firms weren’t focused on behavioral and organizational factors (Cooper et al. 1992; Hankinson and Lloyd 1994; Argyris and Kaplan 1994). In addition, Krumwiede (1998) argued that implementation issues are more related to organizational factors than contextual factors. Shields (1995) stated that ABC literature describes in detail the technical aspects of implementing an ABC method however little attention is being given to human issues which in the end determine the general and long-term success of an ABC system. Shields and Young (1989) mentioned in their research that ABC is an administrative innovation in organizations. Based on this assumption, they argue that implementation is determined more by specific behavioral and organizational variables. Seven behavioral and
organizational variables are identified by them, namely:
1) Top management support: management determines which resources (e.g. money, time and talent) can be used and can reduce resistant through political support. 2) Linkage of the cost management system to competitive strategies (particular
quality and speed strategies), performance evaluation and compensation: to motivate and reward employees to use ABC information which finally lead the company in a more competitive position.
4) Sufficient internal resources (e.g. employee time): creating believes among employees that an ABC initiative is not pressuring them to do more without adequate support.
6) Non-accounting ownership: also non-accounting departments should be involved to minimize resistance and because they have to provide input for the ABC method.
7) Consensus about and clarity of the objectives of the cost management systems: to ensure that ABC information is produces efficiently and effectively used.
Most of the factors described above are factors to create a readiness for change. Cooper (1992) research shows that the most successful projects occurred in firms who prepared their organization for change. Anderson (1995) identified 21 factors which influenced the ABC implementation process executed at General Motors. He used a model, which also was based on the organizational change theory, to determine the influence of several factors on the implementation of ABC (figure 3).
Figure 3:A Factor-stage Model of Information Technology Implementation
organizational change (unfreezing, change, and re-freezing), one of the earliest models of planned change. John Kotter (2006), another well-known guru in the leadership and change management, defines 8 steps to create a successful change (figure 4).
Figure 4: eight steps to successful change.
1) Establish a sense of urgency: addresses the need and importance for change. 2) Create a guiding coalition: create a powerful team with among others, leadership,
communication and analytical skills.
3) Develop a clear shared vision: make clear what will change in the future and how it will be reached.
4) Communicate the vision: communicate the vision from the start and make sure that people will understand and accept the vision.
5) Empower people to act on the vision: reduce resistance and barriers as much as possible.
6) Create short term wins: create some visible, unambiguous successes as soon as possible (stimulation).
7) Consolidate & build on the gains: continue and press harder and faster after the first successes.
Issue Issue Description Solution / Measurement to be taken 1a 1b 1c 1d 1e 1f
The system was over designed with detail
Keep it simple
Table 1: The major reasons
The major reasons (show stoppers)
There is an underestimated degree of employee resistance to change and of organizational disbelief with the new costs
The project should be launched from operations with support from all the departmens involved
Train/ Inform all parties involved to get them more familiarized with cost
Define upfront a clear scope and objective of the project
Make sure the systems are linked so that differences between the two systems do not occur and a track & trace is possible Explain and investigate all the results in-depth to help the users to understand the data
The project was launched from finance, not pulled through from operations
Cost accountings is outside most everyone's comfort zones
The system was installed like a field of dreams, without a predefined problem for the data to solve and with no stated objective
It runs with the official regulatory accounting system as a parallel and off-line information system
Issue Issue Description Solution / Measurement to be taken 2a 2b 2c 2d 2e
Table 2: The user rejections
Acting on the data involves pain -refocused strategies usually require some different people, implying job eliminations
This is not always the case; be clear about this! If needed, try to communicate carefully about the consequences for some people
Sales and marketing people get a different bonus or reward at the end of the year by the introduction of CtS
In the transition year the bonus or reward must be calculated for both circumstances (with and without CtS) and they should receive the highest of the two
CtS/ ABC does not provide all the information needed to make customer decisions.
Define upfront a clear scope and objective of the project
CtS/ ABC competes with other improvement programs without integration
Align and integrate the CtS system with the other projects and make clear how the different projects relate to each other The user rejections
Sales and marketing people do not know how to react with the new profit winners and losers.
Train sales and marketing people and involve them from the start of the project. Keep also the system transparent.
Issue Issue Description Solution / Measurement to be taken
3a
3b
3c
3d
3e
Table 3: The organizational obstacles
CtS / ABC's reputation is perceived as too costly to maintain or as a wrong tool
Define upfront a clear scope and objective of the project
There is minimal customer diversity, resulting in little change in customer
Do a pilot first to determine if there is a need for such a project
The organization has a lack of cost management expertise.
Train the organization The organizational obstacles
The project loses initial management buy-in by not maintaining a brisk pace and momentum.
Keep the project on the agenda of the management team for the first year (at a minimum)
There is no true profit and loss responsibility at the pilot site.
Issue Issue Description Solution / Measurement to be taken
4a
4b
4c
4d
Table 4: The smallest reasons / nuances
The scope is too limited, not all costs are included
Define upfront a clear scope and objective of the project.
The wrong cost drivers are selected for the activities and cause the outcome of the CtS system to not be credible.
Make sure the most appropriate cost drivers are used. This can be accomplished with in-depth interviews with the responsible departments and come to an agreement over the cost drivers to be used. After on year, review the system totally and adjust the drivers where needed.
Relevant or detailed data are unavailable
Create standard accessible reports for all relevant data (in most cases this involves activity cost drivers)
The smallest reasons / nuances Training was inadequate and failed to include the right level of people
Train people on various levels of the organization for their use of or contribution to the CtS system
3.
Research methodology
In this chapter the methodology of this research project will be discussed. The different types of methodology will be described and the choice of research method will be explained.
3.1 Type of research
Creswell (2003) stated that there our three types of research, namely: quantitative, qualitative and a combination of both methods. The main difference between those methods is that qualitative research isn’t based on statistics results / analyses. Qualitative research delves more deeply into people’s motivation, interpretations, understandings etc. and gets finally an in-depth understanding of a situation. For qualitative research data of different sources can be used such as people, organizations, objects etc. Criticism on qualitative research is that it can be subjective and it is sensitive for human errors.
This research will be executed at the business unit Company X. It wasn’t allowed to execute this research at other business units inside Company X Group. Besides, the limited timeframe in which this thesis should be conducted, it isn’t even possible to perform this thesis within other business units of Company X Group.
3.2 Data collection
This research consists of two parts: a literature study and a case study. The purpose of the literature study is to describe first the theoretical background of the ABC / CtS methods with their pros and cons and finally how these methods should be implemented. The data used for this part is based on books and scientific articles. The results of the literature study will be used as the basis for the case study.
As already mentioned, observations, interviews and documents can be used as data for a case study. These items will be described beneath separately.
Observation
Observation is a useful method to get information about behavior (Baarda en De Goede, 2001, p. 252). The intention of this research is not to observe the employees and to register their behavior. However, due to the fact that the researcher have been for about 6 months internal he has got a good impression about the behavior of the employees and the organization. For example, are they open for change programs?
Interviewing
Another way of collecting data is by interviewing the employees. The advantages of interviews is that the interviewer can get a lucid and detailed picture of the meanings, expectations and feelings of the interviewee. It’s suitable for open and difficult questions and it’s possible during the interview to switch from direction. The disadvantages of interviewing are that it’s time-consuming, not easy to organize, not anonymous and it is sensitive for social desirability (Baarda en De Goede, 2001, p. 222-229). To overcome the problem of social desirability partly, the interviews are one-on-one conversations. This, to ensure that the interviewee is set at ease and therefore express themselves more openly.
excellerate project. On average, the duration of the interviews was about an hour. All the interviews were recorded which makes it possible to put the results of the interviews as precise as possible on paper. The content of the interview was for each participant different. The interview started with some general questions and specified later on to the duty of the participant during the implementation of the project. The following persons were interviewed, namely:
• The global business director of Company X during the start of the excellerate project: introduced the excellerate program within “Company X” and became later and still is the current director of the excellerate program.
• Business director Company Y & Company X (Europe). The business director of Company Y became later (during the excellerate program) business director Company X (Europe).
• Account manager Company X. The first task of this new account manager “Company X” was to implement the excellerate program about six months after the external excellerate team left.
• Controller Company X (Europe). The controller had to supply the external excellerate team with accounting data on which finally the pricing model have been build up.
• Manager supply chain planning Company Y. The supply chain planner must also supply the external excellerate team with (logistic) data to determine service levels etc.
Documents
Besides the books and scientific articles, also internal documents of Company X were used for this research. The internal documents were analyzed and which were useful have been selected. Through the selected documents, the researcher gains a more detailed picture of the organization and the internal issues.
4. Analysis
4.1 Reason for implementing the excellerate program.
The excellerate program (a pricing tool) is executed within the business unit “Company X” on behalf of Company X Group. Pricing is a continuous cycle, where price
performance has to be monitored against ‘targeted price’ vs. ‘realized price’. It is the reflection between the return a business expects for the value they create, with how much the market is rewarding them for it.
In setting prices, the relative price level of competitors and price movements due to market changes need to be taken into account. Not only the raw material price changes, but the importance of the value created as well. With these insights,Company Xis able to proactively manage and anticipate price changes instead of being reactive. These thoughts are embedded in the excellerate program.
The excellerate program creates a customer segmentation model (based on value drivers) which can be used to differentiate between customers in terms of strategy, service levels, contract/sales agreements and price. Furthermore, it develops a costs model where the consistency of prices and profitability will be checked across customers, products or market segment. In addition, the costs of serving customers will be analyzed. This part is based on a CtS analysis (see e.g. paragraph 2.4). The profitability per customer will be assessed and if necessary, it will result in policy actions, i.e., the customer will receive a surcharge or less service.
Based on these models a price setting model can be developed. As result, it is possible to price products not only at product level and customer level but also specific to a customer based on the different costs that are unique for that customer (cost-to-serve).
4.2 Evaluation of the implementation process.
4.2.1 Organizational and Behavioral factors.
The implementation process will be evaluated according to the 8 steps of Kotter (1995). In addition, several other organizational & behavioral factors will be added which weren’t embedded in the eight steps.
1) Establish a sense of urgency. According to Kotter (1995) this step is very essential because getting a transformation started requires the aggressive cooperation of many individuals. More of 50% of the companies Kotter analyzed failed in this phase. The last few years before the start of the excellerate program were very profitable. From this starting point it’s hard to convince people of the need for change. Besides, the last few years several pricing tools have been tried to develop however none of them succeed. In addition, the project was launched from corporate and not initiated through the business unit itself. Cokins (1996) stated that this is one of the major reasons (show stopper) for failure. There was no internal need for extra information. All these factors didn’t
contribute to the change process and in this way the message for addressing the need and importance for change failed. However, business units have to obey the rules of corporate which have led to the execution of this program.
2) Create a guiding coalition: several authors (Kotter, 1995; Anderson, 1995; Shields, 1995) address the importance of a team. They stated among others that a major change is impossible unless the head of the organization is an active supporter. Due to the fact that it was a corporate program there were adequate resources available. An external and internal team was created to build the pricing and customer segmentation models. In addition, the project was a discussion point during each management team meeting and the project approach was serious and professional. This was also driven by the fact that it was an expensive project.
3) Develop and communicate the vision: the communication of the project was good and professional. Through several presentations the whole company was communicated about the new upcoming project, the vision and objectives. Employees who had to participate in the project received additional information and had to follow extra courses. Moreover, account managers, the final users of the whole program, received coaching in which communication tactics could be used to communicate the new service levels to their customers.
4) Empower people to act on the vision: in this phase it is important to reduce resistance and barriers as much as possible. According to the business unit director the most resistance came from the account managers. This is of course not weird because: 1) the account manager has to tell the customer that he has to pay a surcharge for additional services or receives less service and in the meanwhile the account manager have to ensure that it won’t damage their relationship; 2) the CtS method creates more transparency about the performance of an account manager; 3) through more transparency, it is possible for other persons, e.g. a BU director, to intervene in the relationship between account manager and customer. This can result in other account plans than the account manager had in mind, which will lead to less satisfaction.
In addition, the fact that the last few years several pricing tools (without success) had past by gave some resistance. Furthermore, little resistance came from employees who were busy and also had to participate in the project. By addressing the advantages of the program during presentations, resistance have been tried to reduce.
program. As already addressed before, management determines which resources (e.g. money, time and talent) can be used and can reduce resistant through political support. Therefore, the support of management is in important factor which can influence the success of failure of an implementation process.
Furthermore, according to some of the interviewees the external team only mentioned how to implement but weren’t there during the implementation to fine tune the program, to evaluate, to rule out inappropriate behavior, give it attention and a follow-up. These issues are also addressed as one of the causes for the failure of the excellerate program.
As can be concluded from above, the failure causes were; no sense of urgency, the external excellerate team left before implementation, no top management support and changes in management team.
4.2.2 Technical factors
One of the questions in the quick scan for ABC is: “We think that the indirect costs do have a relative big share in the total costs”. The controller disagreed on this question. The indirect costs (including service costs) are a small part of the total costs. The raw material costs are with distance the main costs item. For example, price increases caused by fluctuation in raw material costs are a lot higher than the price a customer must pay for additional service. As a result, interviewees addressed that it is difficult and meaningless to steer on such small differences. Account managers mentioned that the selling prices in the powder market are always under pressure and that for commodity products it is easy for buyers to switch (switching costs are relative low) to competitors. Hence it’s hard to charge extra costs for specific services.
Another disadvantage of the ABC/CtS system is that it is too complex and difficult to keep it up to date (Bruggeman et al., 2005). Company X defines their current target margins on five volume segments, about 7 different regions and 17 product values. This means that they have about 600 different target margins. The excellerate program also added different service levels per customer. As result, the pricing model which
to update and to understand. As already mentioned, the service costs were only a small part of the total costs. With this in mind, the interviewees claimed that it wasn’t worth to keep this system up and running in comparing with all the effort it costs.
The interviewees mentioned furthermore that excellerate generates target prices. However, the market is very dynamic and should therefore be steered on gross margins instead of target prices. In addition, account managers addressed that excellerate doesn’t take into account the risks of increasing prices. It doesn’t tell by which price level customers will leave or stay. Besides, it doesn’t make a risk analysis per product e.g. based on switching cost.
Moreover, the program doesn’t tell how to communicate to customers that they have to pay more for additional services. Account managers received training on this subject however that is not a guarantee that the customer will pay. Finally, each product and/or customer has its own story.
Despite all these negative aspects, the director of the excellerate program stated that it is important to know what the service costs (profitability) per product or customer are. Even if these costs are only a small part of the total costs. Because, based on this information it is possible to differentiate and make a segmentation between customers which finally is a proper way to deal with pricing.
4.3 What is still working from the excellerate program
As already mentioned, the current BU director uses only a few elements of the excellerate project. The target prices which excellerate generated were based on product class, volume, markets and service levels. Company X currently steers at minimum target margins based on the same factors excluding the factor service levels. It still makes use of the customer segmentations and their different service levels however it doesn’t influence the margins. It only makes distinctions which customers can receive which service. For example, if a customer doesn’t have a high ranking it won’t receive technical support. Or a plant has reached its maximum capacity; customers with a high ranking will be supplied first. The ranking is based on among others volume, importance of the customer and profitability per customer. Furthermore, customers with a high growing potential are also an important factor.
4.4 Is it possible to allocate the supply chain service costs based on the CtS method? As mentioned in the introduction, also the supply chain department wants to get a better insight in the service costs and wants to know if there are possibilities to allocate these costs to the customer (CtS method). Furthermore, it is assumed that for some customers additional / hidden costs are made. The next part will focus into this subject.
4.4.1 Supply chain service costs at Company X
Concerning the supply chain service costs, the following costs items have been identified: Transport costs: it appears that the selling price per kg resins included transport cost based on a full truck load. However, the order patterns of most of the customers are far below the required amount of a full truck load. This results in higher transport costs per kg for Company X.
two BB (2 x 500 BB) instead of one BB (1000 kg BB). In this case, Company X has to use two BB instead of one BB which lead to higher packaging costs per kg.
Besides the costs of packaging itself, specific packaging generate also additional transport costs. Due to different packaging, it isn’t always possible to load a truck to its maximum capacity (23000 kg). For example, it isn’t possible to staple a 600 kg BB and therefore its maximum capacity is lower than 23.000 kg.
4.4.2 Suitability of the CtS method concerning the supply chain service costs. As already addressed, the main advantage of the CtS method is that it is capable to allocate the overhead (service) costs to products accurately. Furthermore, it can generate an accurate analysis of individual customer performance. However, the supply chain service costs (transport and packaging) which have been identified can be seen as direct variable costs. These costs can be easily and conveniently traced to the particular cost object, the customer. Looking at the model described in paragraph 2.4, I can conclude that it doesn’t matter if you use a traditional cost method or the ABC method. Each method will handle these costs exact in the same way. The choice for an traditional costs method or the ABC/CtS method is therefore not dependent on the supply chain service costs.
4.4.3 Advice concerning the supply chain service costs at Company X.
4.5 Suitability of the cost-to-serve method for Company X
The cost-to-serve literature address many advantages and positive results and therefore this method can definitely be a solution for many firms. However, if we look at the technical factors above and at the situation at Company X there is only one conclusion possible: the cost-to-serve method is not suitable for Company X. The CtS method is more suitable for products with higher fixed costs. Besides, in a less competitive and complicated market it’s easier to give customers a surcharge and to steer on target prices. In addition, it makes the CtS method less complex. Furthermore, the specialty of the products is important. Around 80% of Company X product portfolio contains commodity products. The costs for the customer to switch between these products are low which makes it hard to ask a higher price.
Moreover, approximately 20% of Company X customers generate 80% of the sales. Losing one of these customers caused by prices increases (surcharges for services) do have a major impact. In case a customer is important it will automatically receive more attention which of course lead to higher service costs. However, this is taken for granted. Kaplan (1992) addressed also that some customers shouldn’t be retained of services in case they are potentially non-profitable customers:
1) New and growing customers who promise more profitable business in the future. 2) Those who provide qualitative learning benefits (rather than financial benefits). 3) Those who are acknowledged as leaders in their market or specialty area.
Kaplan (1992) stated that in case a customer isn’t profitable it doesn’t mean that he or she should be eliminated or necessarily persuaded to accept negotiation terms that reduce the customer’s satisfaction level.
5.
Conclusion
In this paragraph the research question will be answered:
Why did the implementation of the cost-to-serve method fail and is it still possible to implement or what are the alternatives?
The implementation failure of the cost-to-serve method (excellerate) is caused by as well “technical” as “organizational & behavioral” factors. The technical factors for failure were: 1) the complexity of the system. Due to the fact that Company X has a lot of products and customers it makes it very difficult and complex to determine exactly the service costs per customer/product; 2) because of this complexity it makes the system difficult to keep it up to date. To make a few adjustments takes a lot of time; 3) in addition, the indirect costs are a small part of the total costs. Therefore, the impact of the additional information received from the CtS method is very small. This, in combination with the effort to generate this additional information it wasn’t worth to keep this system up and running.
Looking at the organizational & behavioral there was: 1) no sense of urgency. The
project was launched from corporate and not initiated through the business unit itself. The literature also address this point as one of the major reasons for failure. Besides, there was no internal need for additional information and therefore not really a support or incentive to implement the excellerate program; 2) the external team left before
implementation. There was no guidance during the implementation process to fine tune the program, role out inappropriate behavior etc.
almost the same analysis can be made in comparison with the excellerate program. In addition, it doesn’t matter which cost price method will be used for the supply chain service cost. These costs are direct variable and will be handled by each costs method on exactly the same way. In this way, there is no need for an alternative system.
Limitations and further research
A limitation of this research is that the findings are relative subjective of nature. This is, among others, caused by the fact that most interviewees didn’t had positive experiences with the cost-to-serve method. Besides, due to the fact that the excellerate program is executed a few years ago, the number of employees who could be interviewed and supported the cost-to-serve method were limited.
References
• Anderson, S.W. (1995), “A framework for assessing cost management system changes: The case of activity based costing implementation at General Motors”, 1986-1993, Management Accounting Research, 1995, Vol. 7, pp. 1-64.
• Argyris. C . and Kaplan, R., (1994), “Implementing new knowledge: The case of activity based costing”, Accounting Horizons, Sep 1994, pp. 83-105.
• Armstrong, P. (2002), "The costs of activity-based management" Accounting, Organizations and Society, Vol. 27, pp. 99-120.
• Baarda, D.B. and De Goede, M.P. (2001), “Basisboek Methoden en Technieken; Handleiding voor het opzetten en uitvoeren van onderzoek”, Groningen/Houten, Stenfert Kroese.
• Braithwaite, A. and Samakh, E. (1998), “The cost-to-serve method”, International Journal of Logistics Management, Vol. 9, issue 1, pp. 69-84.
• Bruggeman, W., Everaert, P., Moreels, K. en Lowyck, T. (2005), "Time-Driven Activity-Based Costing: een nieuwe doorbraak In Management Accounting", Accountancy en Bedrijfskunde,Vol. 25, No. 7, pp. 15-23.
• Cobb, I.., Innes, J. and Mitchell, F. (1992), “Activity-Based Costing: Problems in Practice”, London, CIMA.
• Cokins, G. (1996), “Activity-Based Cost Management, making it work”, McGraw-Hill.
• Cooper, R. and Kaplan, R.S. (1988), “Measure Costs Right: Make the Right Decision”, Harvard Business Review, Vol. 66, issue 5, pp. 96-103.
• Cooper, R. and Kaplan, R.S. (1992), “Activity-Based Systems: Measuring the Costs of Resource Usage”, Accounting Horizons, Sep 1992, Vol. 6, issue 3, pp. 1-13.
• Creswell, J.W. (2003), “Research design: Qualitative, Quantitative and Mixed Methods Approaches”, Lincoln, Sage.
• Hankinson. H., and Lloyd, S., (1994), “Change management”, Handbook of Cost Management,New York: Warren Gorham Lamont.
• Hardy, J.W. and Hubbard, E.D. (1992), “ABC revisiting the basics”, CMA Magazine, Nov 1992, Vol. 66, issue 9, pp. 24-29.
• Innes, J. and Falconer, M. (1993), "Activity-based costing: A review with case studies”, London: CIMA;
• Ittner, C.D., (1999), “Activity-based Costing Concepts for Quality Improvement”, European Management Journal, Vol. 17, No. 5, pp. 492-500.
• Johnson, T.H., (1992), “It’s time to stop overselling activity-based concepts”, Management Accounting,pp. 26-35
• Kaplan, R.S. (1989), “Kanthal (A)”, HBS Case, 9-190 007.
• Kaplan, R.S. (1992), “In defense of activity-based cost management”, Management Accounting (US), pp. 58-63.
• Kaplan, R.S. and Narayanan, V.G. (2001), “Measuring and managing customer profitability”, Cost Management, Vol. 15, No. 5, pp. 5-9.
• Kotter, J., (1996), “Leading change”, Harvard Business School Press. • Lewin (1952), Group decision and social change”, In Readings in Social
Psychology,edited by T. M. Newcomb and E. L. Hartley. New York.
• Lillis, A. and Mundy, J. (2005), “Cross-sectional field studies in management accounting research - Closing the gaps between surveys and case studies”, Journal of Management Accounting Research, 2005, Vol. 17, pp. 119-141. • Ness, J.A. and Cucuzza, T.G. (1995), “Tapping the Full Potential of ABC”,
Harvard Business Review, July/August 1995, Vol. 73, issue 4, pp. 130–138. • Norek, C.D. and Pohlen, L. (2001), “Cost knowledge: a foundation for improving
supply chain relationships”, International Journal of Logistics Management, Vol. 12, issue 1, pp. 37-51.
• Player, R.S. and Keys, D. (1995), “Lessons from the ABM Battlefield: Getting Off to the Right Start”, Journal of Cost Management, Spring 1995, pp. 26–38. • Rezaie, K., Ostadi, B., and Torabi, S.A. (2008), “Activity-based costing in
flexible manufacturing systems with a case study in a forging industry”,
International Journal of Production Research, February 2008, Vol. 46, issue 4, pp. 1047-1069.
• Seal, W., Garrison, R.H., & Noreen, E.W. (2006), “Management accounting”, London: McGraw Hill
• Shields, M. D. (1995), “An empirical analysis of firms’ implementation experiences with activity-based costing”, Journal of Management Accounting Research,Vol. 7, pp. 148-166.
• Shields, M., and Young, S. M., (1989), “A behavioral model for implementing cost management systems”, Journal of Cost Management, pp. 17-27.
• Sheth, J. and Sisodia, R.S. (1995b), “Feeling the heat – Part 2”, Marketing Management, Vol. 4, issue 3, pp. 19-33.
