Whitepaper Seriess
Mitchell Max
Managing Partner
The Performax Group
mmax@performaxgrp.com
www.performaxgrp.com
SOX + ABC = VALUE!
Whitepaper
pg_0002
The alignment of two seemingly unrelated stars in the Finance universe is creating a new
opportunity for CFOs. Recently, companies have invested heavily in documenting and
strengthening controls over business processes to support improved risk management in
accordance with requirements such as Sarbanes – Oxley (and, for financial services
organizations, Basel II), or to support process initiatives such as Six Sigma. At the same
time, a new and innovative approach to developing accurate and meaningful cost
information - Time-Driven Activity-Based Costing, has been evolving which directly
leverages process documentation, dramatically reducing implementation time and cost.
Organizations that have made early forays into Activity-Based Costing (ABC) have often
struggled to capture significant ongoing value from their ABC investments. Traditional
approaches to ABC rely heavily on surveys and estimates, and large staff groups to
maintain the systems, provide reports, and interpret the information for users. While few
question the value of the information, the cost of developing and maintaining it continues
to escalate. The rise of Time-Driven ABC, however, is beginning to provide CFOs with
better information at lower cost.
This paper explores some of the weaknesses of traditional ABC and demonstrates how
the new Time-Driven ABC overcomes many of these problems. At the same time, the
paper shows how Time-Driven ABC leverages existing process documentation to support
development of accurate and actionable cost information in a cost effective and timely
manner.
Limitations of Traditional Activity-Based Costing
Contrary to popular belief, costing is not an exact science. Traditionally, it relies heavily
on estimates and averages. For example, in an ABC study the practitioner will ask
employees to allocate their time across a number of pre-defined activities. The costs of
those activities are then assigned to products and/or customers based on average
consumption for those activities. This approach is appropriate in situations where
peoples’ roles remain relatively constant over time, and where the effort to service
customers is relatively consistent. In practice, the use of averages has been tolerated as
indirect costs have historically been less significant than direct labor (and material) costs.
Today, the opposite is the norm, as centralized costs significantly outweigh front-line
expenses in many organizations, particularly those with a service focus.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
1
pg_0003
Where averages and estimates were deemed to be inappropriate, practitioners introduced
different approaches. For example, if work effort changes significantly from period to
period, then surveys would be done more frequently (e.g., monthly). This requires a
significant investment in costing infrastructure to obtain and process updated time
surveys. In situations where consumption patterns differed, for example, based on ranges
of service complexity, complexity weightings would be estimated and established for
different products or customers.
These approaches are frequently inappropriate in today’s world. As organizations
centralize their business processes (with a corresponding increase in the level of visible
cost), potential variations in costing to meet the unique needs of customers have become
a much more evident.
Change in company operations is a constant. Centralized operational areas make wide
use of flexible work arrangements, shifting resources on an ongoing basis to match work
volumes, aided by cross-training and intelligent technologies. Allocation of effort on this
basis would require much more in-depth time tracking if a traditional ABC approach is
used.
At the same time, our experience continues to point that ‘average’ cost consumption by
products and customers has never been more inaccurate: wide variations from the average
are the new norm, based on the need to meet unique customer requirements to win
business (often with little impact on price).
What has the result been? Some companies have chosen to invest heavily in data
gathering in order to provide the necessary levels of accuracy. For many others, the
reliance on cost averages diminishes the accuracy and transparency of cost and
profitability information, which in turn creates skepticism around the output produced
and distrust of it for decision-making. For these reasons, Finance organizations have
difficulty justifying their ongoing use of the information other than for limited purposes,
and legacy systems are being targeted for “simplification”.
This need not mean that the baby is thrown out with the bathwater. Cost information –
even though expensive to produce - continues to be utilized for specific purposes: for
example, to provide relative product cost information or to support allocations. Few
organizations, however, have been able to make the transition to a comprehensive use of
cost information as the foundation for Performance Management.
The New Alternative
Against this backdrop, we began a search for a different approach which would allow
organizations to derive high value from cost and profitability information, but a
significantly lower cost of development and maintenance. Time-Driven ABC emerged as
a new approach that we have been able to employ in many of our client engagements.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
2
pg_0004
Described at length by Dr. Robert Kaplan and Steve Anderson
1
, Time-Driven ABC
provides a method which is both simple in concept and powerful in execution.
Coincidentally, our work led us to discover the synergies that exist between Time-Driven
ABC implementations and the use of existing process documentation. Recently,
organizations have spent significant amounts of cost and effort to document business
processes. This is a requirement, both for compliance with Sarbanes-Oxley or Basel II,
and also for analysis and ongoing measurement for process improvement initiatives such
as Six Sigma. Time-Driven ABC is able to capitalize on this investment by translating
process flow documentation into a cost flow model, and in turn by placing reliance on
process consistency as the basis for model building.
In essence, Time-Driven ABC works by understanding the amount of effort required to
process any given transaction, and by attaching cost to each specific transaction is able to
accurately measure costs by activity (process), products, customers (and/or segments),
and channels.
Consider a loan processing operation: (An illustrated example is provided later in this
article.) In a traditionally ABC approach, we would interview groups of personnel to
determine what types of activities they engage in (for example, application processing,
credit checks, loan fulfillment, etc.), and what portions of their time are spent in each
respective activity. We would then count the number of times they perform each of these
activities and use that as the basis for allocating activity cost to products, customers,
channels, etc.
In a Time-Driven approach, rather than interviewing personnel, we review existing
process documentation and determine, either through discussion or observation, the
amount of effort required to complete each stage of the business process. Where
complexity occurs, for example if additional steps are required for a given loan type, we
would seek to understand what attribute of the transaction would give rise to that
additional effort (e.g., a secured loan which requires additional documentation). The next
step is to use the operational transaction files themselves as the basis for calculating
costs. Rather than requiring separate extracts of transaction volume counts (or requiring
manual transaction counts by employees), we review the transaction’s attributes and infer
from that the work steps that would have been required to process the transaction. In the
example of a secured loan, we could assume that the required procedures were followed
to verify the loan security of each given type (i.e., drive-by, appraisal, legal review, etc.)
and compute the total amount of effort required from each resource as the basis for
computing cost.
This approach has several advantages over the traditional ABC methods:
1.
Costs are highly transparent and explainable to management. Rather than
indicating that costs are allocated, this is a true consumption model that is able to
1
Robert S. Kaplan and Steven R. Anderson, “Time-Driven Activity-Based Costing”, Harvard Business
Review, Nov 2004
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
3
pg_0005
show the amount of effort required by each product, customer, etc. As such it is
much simpler for management to understand, and facilitates an understanding of
the linkage between costs, activities and outputs. Particularly when cost is used
as a basis for pricing of customers based on the level of service they receive, the
ability to trace and explain costs based on the actual service volumes and costs is
a significant advantage in supporting effective communication. This approach
has provided many of our clients with the ability to significantly improve their
price margins with key customers.
2.
Costs (and profitability) are accurately captured in all dimensions (product /
customer / channel etc.) at the same time. This makes it much easier to model and
analyze cost behaviour and profitability dynamics.
3.
In a traditional model, the costs of the entire resource group are allocated to all
users of that resource. In the Time-Driven approach, only the costs of time (or
effort) expended are assigned to outputs. The cost of unused capacity is not
automatically assigned, but is explicitly reported and made available for
management purposes. In a world with significant fixed levels of capacity, the
ability to better manage the available capacity is critical to profitability. In one of
our clients, this has provided millions of dollars of benefits and has been
recognized as a key driver of their strengthened profitability.
4.
In a similar manner, Time-Driven ABC explicitly recognizes the distinction
between fixed and variable costs, allowing an understanding of actionable cost
can be developed. For example, when developing re-engineering plans, it is
critical to identify the true variable impact on costs. This approach also supports
the utilization of cost information for driver-based planning and forecasting
purposes, and enables effective simulation and what-if analysis based on
underlying changes to business volumes.
5.
Development and maintenance are significantly reduced, in a number of areas:
a.
The use of existing process documentation reduces the need to interview
and map effort;
b.
Since process work levels only change when systems or processes
themselves are changed (i.e., re-engineered), updates to effort levels are
not required on a regular basis. Volume changes dynamically drive
changes to the levels of effort and corresponding costs;
c.
There is significantly less need for time-tracking on an ongoing basis,
except for situations where time is the only driver and the amount of effort
is not predictable (i.e. advisory work); and
d.
System extracts are simplified, as the tools themselves determine the
volumes based on the transaction logs, instead of custom-built systems
queries.
In a practical measure, our experience has allowed us to model business areas and
generate actionable information in significantly less time – and at lower cost - than ever
before. We are building high-quality models in as little as 2-3 weeks with minimal
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
4
pg_0006
operational interference, dramatically improving our ability to drive action in
organizations and “strike while the iron is hot”.
Some organizations have employed detailed time-engineering statistics or “time-wands”
as the basis for costing. Our experience is that, while we can use this information as the
basis for a Time-Driven model, the level of granularity is too detailed to be maintained
effectively. A higher level of analysis, combined with a better understanding of the
sources of process differentiation, can provide the desired level of accuracy at a lower
cost.
Time-Driven ABC may not be appropriate in every situation within a company. In areas
where there is little differentiated complexity or work effort, costs are relatively fixed or
the outputs are homogeneous, (for example, a group responsible for data input or
managing a copy facility) a simple allocation may provide sufficient accuracy. Similarly,
for situations where the amount of time cannot be effectively predicted, such as advisory
work or consulting, a more formal time-tracking system may be required. It is important
that users select a costing system which has the flexibility to adapt to use the most
appropriate method in each situation within the same model.
Leveraging Your Finance Investment
Over the past few years, Finance organizations have made considerable investments in
their infrastructure. While most CFO’s value the information that a good ABC system
can provide, the appetite for yet another project with its associated funding is hardly
appealing.
Based on our client work, we would encourage CFO’s to consider the synergies that
exist, from two perspectives:
First, utilize ABC information to satisfy other business requirements. ABC can provide
new or improved information for other purposes, such as:
Cost allocations for Line of Business reporting;
Performance Measures (KPIs) for operational scorecards;
Process cost information to support re-engineering and continuous improvement
measurement
Too often, the value of ABC information is viewed in a silo. In the past, practitioners
urged their clients to choose between strategic ABC information (e.g., product or
customer segment profitability) and operational ABC information (e.g., process cost and
performance management). Traditional systems necessitated that these two views could
not co-exist in the same application, as the level of detail required for the latter would
make it cumbersome to produce the former. Our experience with Time-Driven ABC is
showing that these two different approaches can – and in fact should – be incorporated in
the same model. Thus, it is truly practical for ABC to be built from the bottom-up and
yet still be used to serve strategic cost analysis. A bottom-up build is critical for
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
5
pg_0007
supporting cost allocation models on a basis that satisfies the need for information
transparency within the organization.
Second, as we have discussed, ABC information can be directly developed based on the
process maps and controlled information systems that are being developed to help
organizations comply with Risk Management and/or Six Sigma requirements. We have
been able to demonstrate a repeatable process that directly leverages this investment to
rapidly produce an accurate and transparent ABC model.
In particular, we have found that this methodology is directly aligned with the
management processes and metrics that operational managers use daily in running their
business, and as such they can easily begin to leverage the information in their
operational management programs. For example, operational managers explicitly
manage productivity measures such as the number of applications per hour that can be
directly translated into the effort component in a cost model. This builds quick buy-in
outside of Finance and ensures that consistent information is used across the business.
Conclusion
We have been excited by the ability to leverage our clients’ investments in risk
management process documentation and control to develop and use cost information
quickly and cost-effectively, by applying Time-Driven ABC. This methodology creates
higher value than traditional methods by providing improved accuracy and transparency,
and has a significantly lower cost of development and maintenance. For those
organizations that have abandoned ABC, we encourage you to use this opportunity to re-
evaluate. For those that have not yet embarked on an ABC program, the cost of entry is
now much less than ever before. We encourage you to seek new ways to derive value
from your Finance investments.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
6
pg_0008
Applying Time-Driven ABC – An Example
ARN Financial Corporation undertook an ABC study for the Line of Credit origination
process. Before commencing the study, the ABC team obtained and verified a process
map which had been prepared for the department, and obtained time estimates (in
minutes) for each major step in the process. The process map is shown in Figure 1:
Figure 1
Department: LOC Processing
EXPENSES
GL $
SALARIES AND BENEFITS
PERSONNEL COSTS - FULL TIME 300,000
PERSONNEL COSTS - HOURLY
40,000
BENEFITS
119,000
FACILITIES
80,000
COMPUTER COSTS
130,000
TELECOM COSTS
44,000
POSTAGE, COURIER & FREIGHT
23,000
STATIONERY, SUPPLIES AND REPAIRS 6,000
TRAVEL & ENTERTAINMENT
4,000
OTHER
2,000
748,000
$
FTE's
82
Capacity [21 days @ 7.5 hrs/day]
12,915
Capacity Hours @ 80%
10,332
Cost per Minute @ "Normal" Capacity
1.21
$
The first step was to calculate the cost per
minute for time worked. In this example, we
elected to treat all costs as a single cost pool for
purposes of illustration. Further, all costs were
assumed to be variable. Figure 2 shows the
calculations. Based on a workday of 7.5 hours,
and assuming normal utilization at 80% of
capacity, we calculated a total cost per minute
of $1.21.
Using actual volumes for each step in the study
period, we (1) determined the total minutes of
time consumed by the resources for each step,
(2) multiplied the minutes by the cost per
minute, and (3) calculated the amount of used
and unused capacity (Figure 3):
Figure 2
Task
Time Volume Minutes Cost Unit Cost
Request LOC
2 30,000
60,000
72,396
$
2.41
$
Receive LOC via Fax 6 6,000
36,000
43,438
7.24
$
Receive LOC via W eb 1 15,000
15,000
18,099
1.21
$
Receive LOC via Phone 8 9,000
72,000
86,876
9.65
$
Manual check
3 6,000
18,000
21,719
3.62
$
Perform rush request 5 4,500
22,500
27,149
6.03
$
Perform credit check 10 27,000
270,000
325,784
12.07
$
Setup new customer 5 9,000
45,000
54,297
6.03
$
Complete LOC
2 22,500
45,000
54,297
2.41
$
583,500
704,055
$
Actual Cost
748,000
$
Difference (unused capacity)
43,945
$
Time-Driven Analysis
In our example, although costs
in aggregate are $748,000,
only $704,055 can be directly
attributable to work performed.
The balance of $43,945
represents unused capacity
which is available to handle
additional work volumes.
Figure 3
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
7
pg_0009
Next, each the activity costs are applied to each loan transaction. For illustration, we
have pre-aggregated the transactions. ARN’s interest is in analyzing costs by Product
and Channel. The volumes for each product/channel combination are costed out
separately (Figure 4). In addition, we segregated the loans into two groups: funded loans
and those which dropped out as they moved through the origination process.
Unit Cost 2.41
$ 7.24
$ 1.21
$ 9.65
$ 3.62
$ 6.03
$ 12.07
$ 6.03
$ 2.41
$
Total Vol 30,000
6,000
15,000
9,000
6,000
4,500
27,000
9,000
22,500
Product Channel Loan $
Secured Direct
-
$
2100 600 1200 300 600 300 1200 0 0 32,216
Secured Direct 703,107,000
$
4500 1800 2100 600 1800 660 4500 1200 4500 115,110
Secured Broker
-
$
900 0 900 0 0 120 300 0 0 7,602
Secured Broker 731,231,280
$
3900 0 3900 0 0 540 3900 3600 3900 95,563
Unsecured Direct
-
$
2700 2400 0 300 2400 180 1500 0 0 54,659
Unsecured Direct 600,547,200
$
4800 1200 1800 1800 1200 840 4800 900 4800 124,160
Unsecured Broker
-
$
1200 0 1200 0 0 300 900 0 0 17,013
Unsecured Broker 474,807,630
$
3300 0 3300 0 0 240 3300 3300 3300 81,084
Overdraft Direct
-
$
600 0 0 600 0 120 600 0 0 15,203
Overdraft Direct 38,940,000
$
6000 0 600 5400 0 1200 6000 0 6000 161,444
30000 6000 15000 9000 6000 4500 27000 9000 22500
2,548,633,110
$
704,055
$
Figure 4
Finally, we summarized the costs and
the originated loan values by Product
and Channel, and determined a number
of key metrics associated with this
process (Figure 5). As a result, vastly
different unit costs and cost per dollars
of loan originated are apparent under
each product / channel combination. In
addition, recall that the cost of unutilized
capacity has not been applied to these
dimensions, but is reported separately
for management.
Product
Direct Broker Total
Cost of Sales 147,327 103,165 250,492
Unit Cost
$32.74 $26.45 $29.82
Cost/Rev 0.0210% 0.0141% 0.0175%
Cost of Sales 178,819 98,097 276,916
Unit Cost
$37.25 $29.73 $34.19
Cost/Rev 0.0298% 0.0207% 0.0258%
Cost of Sales 176,647
176,647
Unit Cost
$29.44
$29.44
Cost/Rev 0.4536%
0.4536%
Cost of Sales 502,793 201,262 704,055
Unit Cost
$32.86 $27.95 $31.29
Cost/Rev 0.0374% 0.0167% 0.0276%
Total
Channel
Secured
Unsecured
Overdraft
Figure 5
When examining any particular cost, it is completely transparent to understand which
activities and costs gave rise to any particular item by referencing the associated volumes.
This facilitates a proactive discussion of the opportunities available to better manage cost,
and ultimately profitability.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
8
SOX + ABC = VALUE!
Whitepaper Seriess
Mitchell Max
Managing Partner
The Performax Group
mmax@performaxgrp.com
www.performaxgrp.com
SOX + ABC = VALUE!
Whitepaper
pg_0002
The alignment of two seemingly unrelated stars in the Finance universe is creating a new
opportunity for CFOs. Recently, companies have invested heavily in documenting and
strengthening controls over business processes to support improved risk management in
accordance with requirements such as Sarbanes – Oxley (and, for financial services
organizations, Basel II), or to support process initiatives such as Six Sigma. At the same
time, a new and innovative approach to developing accurate and meaningful cost
information - Time-Driven Activity-Based Costing, has been evolving which directly
leverages process documentation, dramatically reducing implementation time and cost.
Organizations that have made early forays into Activity-Based Costing (ABC) have often
struggled to capture significant ongoing value from their ABC investments. Traditional
approaches to ABC rely heavily on surveys and estimates, and large staff groups to
maintain the systems, provide reports, and interpret the information for users. While few
question the value of the information, the cost of developing and maintaining it continues
to escalate. The rise of Time-Driven ABC, however, is beginning to provide CFOs with
better information at lower cost.
This paper explores some of the weaknesses of traditional ABC and demonstrates how
the new Time-Driven ABC overcomes many of these problems. At the same time, the
paper shows how Time-Driven ABC leverages existing process documentation to support
development of accurate and actionable cost information in a cost effective and timely
manner.
Limitations of Traditional Activity-Based Costing
Contrary to popular belief, costing is not an exact science. Traditionally, it relies heavily
on estimates and averages. For example, in an ABC study the practitioner will ask
employees to allocate their time across a number of pre-defined activities. The costs of
those activities are then assigned to products and/or customers based on average
consumption for those activities. This approach is appropriate in situations where
peoples’ roles remain relatively constant over time, and where the effort to service
customers is relatively consistent. In practice, the use of averages has been tolerated as
indirect costs have historically been less significant than direct labor (and material) costs.
Today, the opposite is the norm, as centralized costs significantly outweigh front-line
expenses in many organizations, particularly those with a service focus.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
1
pg_0003
Where averages and estimates were deemed to be inappropriate, practitioners introduced
different approaches. For example, if work effort changes significantly from period to
period, then surveys would be done more frequently (e.g., monthly). This requires a
significant investment in costing infrastructure to obtain and process updated time
surveys. In situations where consumption patterns differed, for example, based on ranges
of service complexity, complexity weightings would be estimated and established for
different products or customers.
These approaches are frequently inappropriate in today’s world. As organizations
centralize their business processes (with a corresponding increase in the level of visible
cost), potential variations in costing to meet the unique needs of customers have become
a much more evident.
Change in company operations is a constant. Centralized operational areas make wide
use of flexible work arrangements, shifting resources on an ongoing basis to match work
volumes, aided by cross-training and intelligent technologies. Allocation of effort on this
basis would require much more in-depth time tracking if a traditional ABC approach is
used.
At the same time, our experience continues to point that ‘average’ cost consumption by
products and customers has never been more inaccurate: wide variations from the average
are the new norm, based on the need to meet unique customer requirements to win
business (often with little impact on price).
What has the result been? Some companies have chosen to invest heavily in data
gathering in order to provide the necessary levels of accuracy. For many others, the
reliance on cost averages diminishes the accuracy and transparency of cost and
profitability information, which in turn creates skepticism around the output produced
and distrust of it for decision-making. For these reasons, Finance organizations have
difficulty justifying their ongoing use of the information other than for limited purposes,
and legacy systems are being targeted for “simplification”.
This need not mean that the baby is thrown out with the bathwater. Cost information –
even though expensive to produce - continues to be utilized for specific purposes: for
example, to provide relative product cost information or to support allocations. Few
organizations, however, have been able to make the transition to a comprehensive use of
cost information as the foundation for Performance Management.
The New Alternative
Against this backdrop, we began a search for a different approach which would allow
organizations to derive high value from cost and profitability information, but a
significantly lower cost of development and maintenance. Time-Driven ABC emerged as
a new approach that we have been able to employ in many of our client engagements.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
2
pg_0004
Described at length by Dr. Robert Kaplan and Steve Anderson
1
, Time-Driven ABC
provides a method which is both simple in concept and powerful in execution.
Coincidentally, our work led us to discover the synergies that exist between Time-Driven
ABC implementations and the use of existing process documentation. Recently,
organizations have spent significant amounts of cost and effort to document business
processes. This is a requirement, both for compliance with Sarbanes-Oxley or Basel II,
and also for analysis and ongoing measurement for process improvement initiatives such
as Six Sigma. Time-Driven ABC is able to capitalize on this investment by translating
process flow documentation into a cost flow model, and in turn by placing reliance on
process consistency as the basis for model building.
In essence, Time-Driven ABC works by understanding the amount of effort required to
process any given transaction, and by attaching cost to each specific transaction is able to
accurately measure costs by activity (process), products, customers (and/or segments),
and channels.
Consider a loan processing operation: (An illustrated example is provided later in this
article.) In a traditionally ABC approach, we would interview groups of personnel to
determine what types of activities they engage in (for example, application processing,
credit checks, loan fulfillment, etc.), and what portions of their time are spent in each
respective activity. We would then count the number of times they perform each of these
activities and use that as the basis for allocating activity cost to products, customers,
channels, etc.
In a Time-Driven approach, rather than interviewing personnel, we review existing
process documentation and determine, either through discussion or observation, the
amount of effort required to complete each stage of the business process. Where
complexity occurs, for example if additional steps are required for a given loan type, we
would seek to understand what attribute of the transaction would give rise to that
additional effort (e.g., a secured loan which requires additional documentation). The next
step is to use the operational transaction files themselves as the basis for calculating
costs. Rather than requiring separate extracts of transaction volume counts (or requiring
manual transaction counts by employees), we review the transaction’s attributes and infer
from that the work steps that would have been required to process the transaction. In the
example of a secured loan, we could assume that the required procedures were followed
to verify the loan security of each given type (i.e., drive-by, appraisal, legal review, etc.)
and compute the total amount of effort required from each resource as the basis for
computing cost.
This approach has several advantages over the traditional ABC methods:
1.
Costs are highly transparent and explainable to management. Rather than
indicating that costs are allocated, this is a true consumption model that is able to
1
Robert S. Kaplan and Steven R. Anderson, “Time-Driven Activity-Based Costing”, Harvard Business
Review, Nov 2004
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
3
pg_0005
show the amount of effort required by each product, customer, etc. As such it is
much simpler for management to understand, and facilitates an understanding of
the linkage between costs, activities and outputs. Particularly when cost is used
as a basis for pricing of customers based on the level of service they receive, the
ability to trace and explain costs based on the actual service volumes and costs is
a significant advantage in supporting effective communication. This approach
has provided many of our clients with the ability to significantly improve their
price margins with key customers.
2.
Costs (and profitability) are accurately captured in all dimensions (product /
customer / channel etc.) at the same time. This makes it much easier to model and
analyze cost behaviour and profitability dynamics.
3.
In a traditional model, the costs of the entire resource group are allocated to all
users of that resource. In the Time-Driven approach, only the costs of time (or
effort) expended are assigned to outputs. The cost of unused capacity is not
automatically assigned, but is explicitly reported and made available for
management purposes. In a world with significant fixed levels of capacity, the
ability to better manage the available capacity is critical to profitability. In one of
our clients, this has provided millions of dollars of benefits and has been
recognized as a key driver of their strengthened profitability.
4.
In a similar manner, Time-Driven ABC explicitly recognizes the distinction
between fixed and variable costs, allowing an understanding of actionable cost
can be developed. For example, when developing re-engineering plans, it is
critical to identify the true variable impact on costs. This approach also supports
the utilization of cost information for driver-based planning and forecasting
purposes, and enables effective simulation and what-if analysis based on
underlying changes to business volumes.
5.
Development and maintenance are significantly reduced, in a number of areas:
a.
The use of existing process documentation reduces the need to interview
and map effort;
b.
Since process work levels only change when systems or processes
themselves are changed (i.e., re-engineered), updates to effort levels are
not required on a regular basis. Volume changes dynamically drive
changes to the levels of effort and corresponding costs;
c.
There is significantly less need for time-tracking on an ongoing basis,
except for situations where time is the only driver and the amount of effort
is not predictable (i.e. advisory work); and
d.
System extracts are simplified, as the tools themselves determine the
volumes based on the transaction logs, instead of custom-built systems
queries.
In a practical measure, our experience has allowed us to model business areas and
generate actionable information in significantly less time – and at lower cost - than ever
before. We are building high-quality models in as little as 2-3 weeks with minimal
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
4
pg_0006
operational interference, dramatically improving our ability to drive action in
organizations and “strike while the iron is hot”.
Some organizations have employed detailed time-engineering statistics or “time-wands”
as the basis for costing. Our experience is that, while we can use this information as the
basis for a Time-Driven model, the level of granularity is too detailed to be maintained
effectively. A higher level of analysis, combined with a better understanding of the
sources of process differentiation, can provide the desired level of accuracy at a lower
cost.
Time-Driven ABC may not be appropriate in every situation within a company. In areas
where there is little differentiated complexity or work effort, costs are relatively fixed or
the outputs are homogeneous, (for example, a group responsible for data input or
managing a copy facility) a simple allocation may provide sufficient accuracy. Similarly,
for situations where the amount of time cannot be effectively predicted, such as advisory
work or consulting, a more formal time-tracking system may be required. It is important
that users select a costing system which has the flexibility to adapt to use the most
appropriate method in each situation within the same model.
Leveraging Your Finance Investment
Over the past few years, Finance organizations have made considerable investments in
their infrastructure. While most CFO’s value the information that a good ABC system
can provide, the appetite for yet another project with its associated funding is hardly
appealing.
Based on our client work, we would encourage CFO’s to consider the synergies that
exist, from two perspectives:
First, utilize ABC information to satisfy other business requirements. ABC can provide
new or improved information for other purposes, such as:
Cost allocations for Line of Business reporting;
Performance Measures (KPIs) for operational scorecards;
Process cost information to support re-engineering and continuous improvement
measurement
Too often, the value of ABC information is viewed in a silo. In the past, practitioners
urged their clients to choose between strategic ABC information (e.g., product or
customer segment profitability) and operational ABC information (e.g., process cost and
performance management). Traditional systems necessitated that these two views could
not co-exist in the same application, as the level of detail required for the latter would
make it cumbersome to produce the former. Our experience with Time-Driven ABC is
showing that these two different approaches can – and in fact should – be incorporated in
the same model. Thus, it is truly practical for ABC to be built from the bottom-up and
yet still be used to serve strategic cost analysis. A bottom-up build is critical for
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
5
pg_0007
supporting cost allocation models on a basis that satisfies the need for information
transparency within the organization.
Second, as we have discussed, ABC information can be directly developed based on the
process maps and controlled information systems that are being developed to help
organizations comply with Risk Management and/or Six Sigma requirements. We have
been able to demonstrate a repeatable process that directly leverages this investment to
rapidly produce an accurate and transparent ABC model.
In particular, we have found that this methodology is directly aligned with the
management processes and metrics that operational managers use daily in running their
business, and as such they can easily begin to leverage the information in their
operational management programs. For example, operational managers explicitly
manage productivity measures such as the number of applications per hour that can be
directly translated into the effort component in a cost model. This builds quick buy-in
outside of Finance and ensures that consistent information is used across the business.
Conclusion
We have been excited by the ability to leverage our clients’ investments in risk
management process documentation and control to develop and use cost information
quickly and cost-effectively, by applying Time-Driven ABC. This methodology creates
higher value than traditional methods by providing improved accuracy and transparency,
and has a significantly lower cost of development and maintenance. For those
organizations that have abandoned ABC, we encourage you to use this opportunity to re-
evaluate. For those that have not yet embarked on an ABC program, the cost of entry is
now much less than ever before. We encourage you to seek new ways to derive value
from your Finance investments.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
6
pg_0008
Applying Time-Driven ABC – An Example
ARN Financial Corporation undertook an ABC study for the Line of Credit origination
process. Before commencing the study, the ABC team obtained and verified a process
map which had been prepared for the department, and obtained time estimates (in
minutes) for each major step in the process. The process map is shown in Figure 1:
Figure 1
Department: LOC Processing
EXPENSES
GL $
SALARIES AND BENEFITS
PERSONNEL COSTS - FULL TIME 300,000
PERSONNEL COSTS - HOURLY
40,000
BENEFITS
119,000
FACILITIES
80,000
COMPUTER COSTS
130,000
TELECOM COSTS
44,000
POSTAGE, COURIER & FREIGHT
23,000
STATIONERY, SUPPLIES AND REPAIRS 6,000
TRAVEL & ENTERTAINMENT
4,000
OTHER
2,000
748,000
$
FTE's
82
Capacity [21 days @ 7.5 hrs/day]
12,915
Capacity Hours @ 80%
10,332
Cost per Minute @ "Normal" Capacity
1.21
$
The first step was to calculate the cost per
minute for time worked. In this example, we
elected to treat all costs as a single cost pool for
purposes of illustration. Further, all costs were
assumed to be variable. Figure 2 shows the
calculations. Based on a workday of 7.5 hours,
and assuming normal utilization at 80% of
capacity, we calculated a total cost per minute
of $1.21.
Using actual volumes for each step in the study
period, we (1) determined the total minutes of
time consumed by the resources for each step,
(2) multiplied the minutes by the cost per
minute, and (3) calculated the amount of used
and unused capacity (Figure 3):
Figure 2
Task
Time Volume Minutes Cost Unit Cost
Request LOC
2 30,000
60,000
72,396
$
2.41
$
Receive LOC via Fax 6 6,000
36,000
43,438
7.24
$
Receive LOC via W eb 1 15,000
15,000
18,099
1.21
$
Receive LOC via Phone 8 9,000
72,000
86,876
9.65
$
Manual check
3 6,000
18,000
21,719
3.62
$
Perform rush request 5 4,500
22,500
27,149
6.03
$
Perform credit check 10 27,000
270,000
325,784
12.07
$
Setup new customer 5 9,000
45,000
54,297
6.03
$
Complete LOC
2 22,500
45,000
54,297
2.41
$
583,500
704,055
$
Actual Cost
748,000
$
Difference (unused capacity)
43,945
$
Time-Driven Analysis
In our example, although costs
in aggregate are $748,000,
only $704,055 can be directly
attributable to work performed.
The balance of $43,945
represents unused capacity
which is available to handle
additional work volumes.
Figure 3
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
7
pg_0009
Next, each the activity costs are applied to each loan transaction. For illustration, we
have pre-aggregated the transactions. ARN’s interest is in analyzing costs by Product
and Channel. The volumes for each product/channel combination are costed out
separately (Figure 4). In addition, we segregated the loans into two groups: funded loans
and those which dropped out as they moved through the origination process.
Unit Cost 2.41
$ 7.24
$ 1.21
$ 9.65
$ 3.62
$ 6.03
$ 12.07
$ 6.03
$ 2.41
$
Total Vol 30,000
6,000
15,000
9,000
6,000
4,500
27,000
9,000
22,500
Product Channel Loan $
Secured Direct
-
$
2100 600 1200 300 600 300 1200 0 0 32,216
Secured Direct 703,107,000
$
4500 1800 2100 600 1800 660 4500 1200 4500 115,110
Secured Broker
-
$
900 0 900 0 0 120 300 0 0 7,602
Secured Broker 731,231,280
$
3900 0 3900 0 0 540 3900 3600 3900 95,563
Unsecured Direct
-
$
2700 2400 0 300 2400 180 1500 0 0 54,659
Unsecured Direct 600,547,200
$
4800 1200 1800 1800 1200 840 4800 900 4800 124,160
Unsecured Broker
-
$
1200 0 1200 0 0 300 900 0 0 17,013
Unsecured Broker 474,807,630
$
3300 0 3300 0 0 240 3300 3300 3300 81,084
Overdraft Direct
-
$
600 0 0 600 0 120 600 0 0 15,203
Overdraft Direct 38,940,000
$
6000 0 600 5400 0 1200 6000 0 6000 161,444
30000 6000 15000 9000 6000 4500 27000 9000 22500
2,548,633,110
$
704,055
$
Figure 4
Finally, we summarized the costs and
the originated loan values by Product
and Channel, and determined a number
of key metrics associated with this
process (Figure 5). As a result, vastly
different unit costs and cost per dollars
of loan originated are apparent under
each product / channel combination. In
addition, recall that the cost of unutilized
capacity has not been applied to these
dimensions, but is reported separately
for management.
Product
Direct Broker Total
Cost of Sales 147,327 103,165 250,492
Unit Cost
$32.74 $26.45 $29.82
Cost/Rev 0.0210% 0.0141% 0.0175%
Cost of Sales 178,819 98,097 276,916
Unit Cost
$37.25 $29.73 $34.19
Cost/Rev 0.0298% 0.0207% 0.0258%
Cost of Sales 176,647
176,647
Unit Cost
$29.44
$29.44
Cost/Rev 0.4536%
0.4536%
Cost of Sales 502,793 201,262 704,055
Unit Cost
$32.86 $27.95 $31.29
Cost/Rev 0.0374% 0.0167% 0.0276%
Total
Channel
Secured
Unsecured
Overdraft
Figure 5
When examining any particular cost, it is completely transparent to understand which
activities and costs gave rise to any particular item by referencing the associated volumes.
This facilitates a proactive discussion of the opportunities available to better manage cost,
and ultimately profitability.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
8
SOX + ABC = VALUE!
Whitepaper Seriess
Mitchell Max
Managing Partner
The Performax Group
mmax@performaxgrp.com
www.performaxgrp.com
SOX + ABC = VALUE!
Whitepaper
pg_0002
The alignment of two seemingly unrelated stars in the Finance universe is creating a new
opportunity for CFOs. Recently, companies have invested heavily in documenting and
strengthening controls over business processes to support improved risk management in
accordance with requirements such as Sarbanes – Oxley (and, for financial services
organizations, Basel II), or to support process initiatives such as Six Sigma. At the same
time, a new and innovative approach to developing accurate and meaningful cost
information - Time-Driven Activity-Based Costing, has been evolving which directly
leverages process documentation, dramatically reducing implementation time and cost.
Organizations that have made early forays into Activity-Based Costing (ABC) have often
struggled to capture significant ongoing value from their ABC investments. Traditional
approaches to ABC rely heavily on surveys and estimates, and large staff groups to
maintain the systems, provide reports, and interpret the information for users. While few
question the value of the information, the cost of developing and maintaining it continues
to escalate. The rise of Time-Driven ABC, however, is beginning to provide CFOs with
better information at lower cost.
This paper explores some of the weaknesses of traditional ABC and demonstrates how
the new Time-Driven ABC overcomes many of these problems. At the same time, the
paper shows how Time-Driven ABC leverages existing process documentation to support
development of accurate and actionable cost information in a cost effective and timely
manner.
Limitations of Traditional Activity-Based Costing
Contrary to popular belief, costing is not an exact science. Traditionally, it relies heavily
on estimates and averages. For example, in an ABC study the practitioner will ask
employees to allocate their time across a number of pre-defined activities. The costs of
those activities are then assigned to products and/or customers based on average
consumption for those activities. This approach is appropriate in situations where
peoples’ roles remain relatively constant over time, and where the effort to service
customers is relatively consistent. In practice, the use of averages has been tolerated as
indirect costs have historically been less significant than direct labor (and material) costs.
Today, the opposite is the norm, as centralized costs significantly outweigh front-line
expenses in many organizations, particularly those with a service focus.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
1
pg_0003
Where averages and estimates were deemed to be inappropriate, practitioners introduced
different approaches. For example, if work effort changes significantly from period to
period, then surveys would be done more frequently (e.g., monthly). This requires a
significant investment in costing infrastructure to obtain and process updated time
surveys. In situations where consumption patterns differed, for example, based on ranges
of service complexity, complexity weightings would be estimated and established for
different products or customers.
These approaches are frequently inappropriate in today’s world. As organizations
centralize their business processes (with a corresponding increase in the level of visible
cost), potential variations in costing to meet the unique needs of customers have become
a much more evident.
Change in company operations is a constant. Centralized operational areas make wide
use of flexible work arrangements, shifting resources on an ongoing basis to match work
volumes, aided by cross-training and intelligent technologies. Allocation of effort on this
basis would require much more in-depth time tracking if a traditional ABC approach is
used.
At the same time, our experience continues to point that ‘average’ cost consumption by
products and customers has never been more inaccurate: wide variations from the average
are the new norm, based on the need to meet unique customer requirements to win
business (often with little impact on price).
What has the result been? Some companies have chosen to invest heavily in data
gathering in order to provide the necessary levels of accuracy. For many others, the
reliance on cost averages diminishes the accuracy and transparency of cost and
profitability information, which in turn creates skepticism around the output produced
and distrust of it for decision-making. For these reasons, Finance organizations have
difficulty justifying their ongoing use of the information other than for limited purposes,
and legacy systems are being targeted for “simplification”.
This need not mean that the baby is thrown out with the bathwater. Cost information –
even though expensive to produce - continues to be utilized for specific purposes: for
example, to provide relative product cost information or to support allocations. Few
organizations, however, have been able to make the transition to a comprehensive use of
cost information as the foundation for Performance Management.
The New Alternative
Against this backdrop, we began a search for a different approach which would allow
organizations to derive high value from cost and profitability information, but a
significantly lower cost of development and maintenance. Time-Driven ABC emerged as
a new approach that we have been able to employ in many of our client engagements.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
2
pg_0004
Described at length by Dr. Robert Kaplan and Steve Anderson
1
, Time-Driven ABC
provides a method which is both simple in concept and powerful in execution.
Coincidentally, our work led us to discover the synergies that exist between Time-Driven
ABC implementations and the use of existing process documentation. Recently,
organizations have spent significant amounts of cost and effort to document business
processes. This is a requirement, both for compliance with Sarbanes-Oxley or Basel II,
and also for analysis and ongoing measurement for process improvement initiatives such
as Six Sigma. Time-Driven ABC is able to capitalize on this investment by translating
process flow documentation into a cost flow model, and in turn by placing reliance on
process consistency as the basis for model building.
In essence, Time-Driven ABC works by understanding the amount of effort required to
process any given transaction, and by attaching cost to each specific transaction is able to
accurately measure costs by activity (process), products, customers (and/or segments),
and channels.
Consider a loan processing operation: (An illustrated example is provided later in this
article.) In a traditionally ABC approach, we would interview groups of personnel to
determine what types of activities they engage in (for example, application processing,
credit checks, loan fulfillment, etc.), and what portions of their time are spent in each
respective activity. We would then count the number of times they perform each of these
activities and use that as the basis for allocating activity cost to products, customers,
channels, etc.
In a Time-Driven approach, rather than interviewing personnel, we review existing
process documentation and determine, either through discussion or observation, the
amount of effort required to complete each stage of the business process. Where
complexity occurs, for example if additional steps are required for a given loan type, we
would seek to understand what attribute of the transaction would give rise to that
additional effort (e.g., a secured loan which requires additional documentation). The next
step is to use the operational transaction files themselves as the basis for calculating
costs. Rather than requiring separate extracts of transaction volume counts (or requiring
manual transaction counts by employees), we review the transaction’s attributes and infer
from that the work steps that would have been required to process the transaction. In the
example of a secured loan, we could assume that the required procedures were followed
to verify the loan security of each given type (i.e., drive-by, appraisal, legal review, etc.)
and compute the total amount of effort required from each resource as the basis for
computing cost.
This approach has several advantages over the traditional ABC methods:
1.
Costs are highly transparent and explainable to management. Rather than
indicating that costs are allocated, this is a true consumption model that is able to
1
Robert S. Kaplan and Steven R. Anderson, “Time-Driven Activity-Based Costing”, Harvard Business
Review, Nov 2004
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
3
pg_0005
show the amount of effort required by each product, customer, etc. As such it is
much simpler for management to understand, and facilitates an understanding of
the linkage between costs, activities and outputs. Particularly when cost is used
as a basis for pricing of customers based on the level of service they receive, the
ability to trace and explain costs based on the actual service volumes and costs is
a significant advantage in supporting effective communication. This approach
has provided many of our clients with the ability to significantly improve their
price margins with key customers.
2.
Costs (and profitability) are accurately captured in all dimensions (product /
customer / channel etc.) at the same time. This makes it much easier to model and
analyze cost behaviour and profitability dynamics.
3.
In a traditional model, the costs of the entire resource group are allocated to all
users of that resource. In the Time-Driven approach, only the costs of time (or
effort) expended are assigned to outputs. The cost of unused capacity is not
automatically assigned, but is explicitly reported and made available for
management purposes. In a world with significant fixed levels of capacity, the
ability to better manage the available capacity is critical to profitability. In one of
our clients, this has provided millions of dollars of benefits and has been
recognized as a key driver of their strengthened profitability.
4.
In a similar manner, Time-Driven ABC explicitly recognizes the distinction
between fixed and variable costs, allowing an understanding of actionable cost
can be developed. For example, when developing re-engineering plans, it is
critical to identify the true variable impact on costs. This approach also supports
the utilization of cost information for driver-based planning and forecasting
purposes, and enables effective simulation and what-if analysis based on
underlying changes to business volumes.
5.
Development and maintenance are significantly reduced, in a number of areas:
a.
The use of existing process documentation reduces the need to interview
and map effort;
b.
Since process work levels only change when systems or processes
themselves are changed (i.e., re-engineered), updates to effort levels are
not required on a regular basis. Volume changes dynamically drive
changes to the levels of effort and corresponding costs;
c.
There is significantly less need for time-tracking on an ongoing basis,
except for situations where time is the only driver and the amount of effort
is not predictable (i.e. advisory work); and
d.
System extracts are simplified, as the tools themselves determine the
volumes based on the transaction logs, instead of custom-built systems
queries.
In a practical measure, our experience has allowed us to model business areas and
generate actionable information in significantly less time – and at lower cost - than ever
before. We are building high-quality models in as little as 2-3 weeks with minimal
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
4
pg_0006
operational interference, dramatically improving our ability to drive action in
organizations and “strike while the iron is hot”.
Some organizations have employed detailed time-engineering statistics or “time-wands”
as the basis for costing. Our experience is that, while we can use this information as the
basis for a Time-Driven model, the level of granularity is too detailed to be maintained
effectively. A higher level of analysis, combined with a better understanding of the
sources of process differentiation, can provide the desired level of accuracy at a lower
cost.
Time-Driven ABC may not be appropriate in every situation within a company. In areas
where there is little differentiated complexity or work effort, costs are relatively fixed or
the outputs are homogeneous, (for example, a group responsible for data input or
managing a copy facility) a simple allocation may provide sufficient accuracy. Similarly,
for situations where the amount of time cannot be effectively predicted, such as advisory
work or consulting, a more formal time-tracking system may be required. It is important
that users select a costing system which has the flexibility to adapt to use the most
appropriate method in each situation within the same model.
Leveraging Your Finance Investment
Over the past few years, Finance organizations have made considerable investments in
their infrastructure. While most CFO’s value the information that a good ABC system
can provide, the appetite for yet another project with its associated funding is hardly
appealing.
Based on our client work, we would encourage CFO’s to consider the synergies that
exist, from two perspectives:
First, utilize ABC information to satisfy other business requirements. ABC can provide
new or improved information for other purposes, such as:
Cost allocations for Line of Business reporting;
Performance Measures (KPIs) for operational scorecards;
Process cost information to support re-engineering and continuous improvement
measurement
Too often, the value of ABC information is viewed in a silo. In the past, practitioners
urged their clients to choose between strategic ABC information (e.g., product or
customer segment profitability) and operational ABC information (e.g., process cost and
performance management). Traditional systems necessitated that these two views could
not co-exist in the same application, as the level of detail required for the latter would
make it cumbersome to produce the former. Our experience with Time-Driven ABC is
showing that these two different approaches can – and in fact should – be incorporated in
the same model. Thus, it is truly practical for ABC to be built from the bottom-up and
yet still be used to serve strategic cost analysis. A bottom-up build is critical for
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
5
pg_0007
supporting cost allocation models on a basis that satisfies the need for information
transparency within the organization.
Second, as we have discussed, ABC information can be directly developed based on the
process maps and controlled information systems that are being developed to help
organizations comply with Risk Management and/or Six Sigma requirements. We have
been able to demonstrate a repeatable process that directly leverages this investment to
rapidly produce an accurate and transparent ABC model.
In particular, we have found that this methodology is directly aligned with the
management processes and metrics that operational managers use daily in running their
business, and as such they can easily begin to leverage the information in their
operational management programs. For example, operational managers explicitly
manage productivity measures such as the number of applications per hour that can be
directly translated into the effort component in a cost model. This builds quick buy-in
outside of Finance and ensures that consistent information is used across the business.
Conclusion
We have been excited by the ability to leverage our clients’ investments in risk
management process documentation and control to develop and use cost information
quickly and cost-effectively, by applying Time-Driven ABC. This methodology creates
higher value than traditional methods by providing improved accuracy and transparency,
and has a significantly lower cost of development and maintenance. For those
organizations that have abandoned ABC, we encourage you to use this opportunity to re-
evaluate. For those that have not yet embarked on an ABC program, the cost of entry is
now much less than ever before. We encourage you to seek new ways to derive value
from your Finance investments.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
6
pg_0008
Applying Time-Driven ABC – An Example
ARN Financial Corporation undertook an ABC study for the Line of Credit origination
process. Before commencing the study, the ABC team obtained and verified a process
map which had been prepared for the department, and obtained time estimates (in
minutes) for each major step in the process. The process map is shown in Figure 1:
Figure 1
Department: LOC Processing
EXPENSES
GL $
SALARIES AND BENEFITS
PERSONNEL COSTS - FULL TIME 300,000
PERSONNEL COSTS - HOURLY
40,000
BENEFITS
119,000
FACILITIES
80,000
COMPUTER COSTS
130,000
TELECOM COSTS
44,000
POSTAGE, COURIER & FREIGHT
23,000
STATIONERY, SUPPLIES AND REPAIRS 6,000
TRAVEL & ENTERTAINMENT
4,000
OTHER
2,000
748,000
$
FTE's
82
Capacity [21 days @ 7.5 hrs/day]
12,915
Capacity Hours @ 80%
10,332
Cost per Minute @ "Normal" Capacity
1.21
$
The first step was to calculate the cost per
minute for time worked. In this example, we
elected to treat all costs as a single cost pool for
purposes of illustration. Further, all costs were
assumed to be variable. Figure 2 shows the
calculations. Based on a workday of 7.5 hours,
and assuming normal utilization at 80% of
capacity, we calculated a total cost per minute
of $1.21.
Using actual volumes for each step in the study
period, we (1) determined the total minutes of
time consumed by the resources for each step,
(2) multiplied the minutes by the cost per
minute, and (3) calculated the amount of used
and unused capacity (Figure 3):
Figure 2
Task
Time Volume Minutes Cost Unit Cost
Request LOC
2 30,000
60,000
72,396
$
2.41
$
Receive LOC via Fax 6 6,000
36,000
43,438
7.24
$
Receive LOC via W eb 1 15,000
15,000
18,099
1.21
$
Receive LOC via Phone 8 9,000
72,000
86,876
9.65
$
Manual check
3 6,000
18,000
21,719
3.62
$
Perform rush request 5 4,500
22,500
27,149
6.03
$
Perform credit check 10 27,000
270,000
325,784
12.07
$
Setup new customer 5 9,000
45,000
54,297
6.03
$
Complete LOC
2 22,500
45,000
54,297
2.41
$
583,500
704,055
$
Actual Cost
748,000
$
Difference (unused capacity)
43,945
$
Time-Driven Analysis
In our example, although costs
in aggregate are $748,000,
only $704,055 can be directly
attributable to work performed.
The balance of $43,945
represents unused capacity
which is available to handle
additional work volumes.
Figure 3
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
Page
7
pg_0009
Next, each the activity costs are applied to each loan transaction. For illustration, we
have pre-aggregated the transactions. ARN’s interest is in analyzing costs by Product
and Channel. The volumes for each product/channel combination are costed out
separately (Figure 4). In addition, we segregated the loans into two groups: funded loans
and those which dropped out as they moved through the origination process.
Unit Cost 2.41
$ 7.24
$ 1.21
$ 9.65
$ 3.62
$ 6.03
$ 12.07
$ 6.03
$ 2.41
$
Total Vol 30,000
6,000
15,000
9,000
6,000
4,500
27,000
9,000
22,500
Product Channel Loan $
Secured Direct
-
$
2100 600 1200 300 600 300 1200 0 0 32,216
Secured Direct 703,107,000
$
4500 1800 2100 600 1800 660 4500 1200 4500 115,110
Secured Broker
-
$
900 0 900 0 0 120 300 0 0 7,602
Secured Broker 731,231,280
$
3900 0 3900 0 0 540 3900 3600 3900 95,563
Unsecured Direct
-
$
2700 2400 0 300 2400 180 1500 0 0 54,659
Unsecured Direct 600,547,200
$
4800 1200 1800 1800 1200 840 4800 900 4800 124,160
Unsecured Broker
-
$
1200 0 1200 0 0 300 900 0 0 17,013
Unsecured Broker 474,807,630
$
3300 0 3300 0 0 240 3300 3300 3300 81,084
Overdraft Direct
-
$
600 0 0 600 0 120 600 0 0 15,203
Overdraft Direct 38,940,000
$
6000 0 600 5400 0 1200 6000 0 6000 161,444
30000 6000 15000 9000 6000 4500 27000 9000 22500
2,548,633,110
$
704,055
$
Figure 4
Finally, we summarized the costs and
the originated loan values by Product
and Channel, and determined a number
of key metrics associated with this
process (Figure 5). As a result, vastly
different unit costs and cost per dollars
of loan originated are apparent under
each product / channel combination. In
addition, recall that the cost of unutilized
capacity has not been applied to these
dimensions, but is reported separately
for management.
Product
Direct Broker Total
Cost of Sales 147,327 103,165 250,492
Unit Cost
$32.74 $26.45 $29.82
Cost/Rev 0.0210% 0.0141% 0.0175%
Cost of Sales 178,819 98,097 276,916
Unit Cost
$37.25 $29.73 $34.19
Cost/Rev 0.0298% 0.0207% 0.0258%
Cost of Sales 176,647
176,647
Unit Cost
$29.44
$29.44
Cost/Rev 0.4536%
0.4536%
Cost of Sales 502,793 201,262 704,055
Unit Cost
$32.86 $27.95 $31.29
Cost/Rev 0.0374% 0.0167% 0.0276%
Total
Channel
Secured
Unsecured
Overdraft
Figure 5
When examining any particular cost, it is completely transparent to understand which
activities and costs gave rise to any particular item by referencing the associated volumes.
This facilitates a proactive discussion of the opportunities available to better manage cost,
and ultimately profitability.
©
2005 Mitchell Max and The Performax Group – All Rights Reserved.
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