Costing System Starts with ABC

A management accounting method that has won high praise in many industries is finding its way into the printing industry. Activity-based costing (ABC), first introduced 15 years ago, provides a means of accurately assigning support or "soft" costs to product manufacture that includes the administrative resources that a job actually consumes, not just labor, machinery, and materials.

The ABC approach calls for mapping all of a company's workflows and processes so that each activity that contributes to costs is identified and traced through the system.

This basis of activity-based costing gives managers a detailed perspective on the business side of their operations, which should sound familiar. Why? Because while many printing companies use such approaches to improve their manufacturing efficiencies, they have largely ignored the tactic for improving their business operations.

To spread the gospel about use of activity-based costing in the printing industry, three graphic arts consultants are undertaking a two-phase campaign—awareness, then implementation—to introduce the method to owners and managers of U.S. printing companies.

Included are G. David Dodd, founder and principal, Southern Consulting, a strategic management and marketing consultancy based in Nashville, Tenn.; William K. Lavelle, senior analyst, Point Balance, Inc., a management consulting firm in Harvard, Mass.; and Stuart W. Margolis, president of H.R. Margolis Company, certified public accountants, Bala Cynwyd, Pa. The combination of their individual specialties—strategy, process, and accounting—should enhance their efforts, they note.

Their first step is the release of 26-page white paper, "Driving Improved Profitability With Activity-Based Costing," available for download from pointbalance.com or hrmargolis.com.

If the "awareness" paper generates interest—already, Dodd terms the interest "overwhelming"—the three plan to release a detailed implementation guide for printers, followed by a seminar series.

"Activity-based costing is a time-tested management accounting system," explains Margolis. "Since its introduction, activity-based costing has proven its value in an extraordinarily wide variety of both large and small organizations, including manufacturing and service businesses, nonprofit organizations, and even governmental entities. What has been missing is a way to apply these principles to printing companies. We can now provide that methodology."

As a mature industry facing slowing growth rates, printing is primed for the ABC approach, the three consultants contend.

Three factors are at work, they add: (a) managers' understanding of the cost dynamics of all facets of the business has never been more critical to survival, (b) the old accounting systems that focus primarily on hourly press costs are difficult to apply to many of the new services being offered, and (c) with the industry's new focus on workflows, the process mapping step will be easier.

In researching the benefits of ABC for printers, Dodd, Lavelle, and Margolis analyzed the annual Ratio Studies, which are compiled by H.R. Margolis Company and offered by the Printing Industries of America.

They discovered that the industry's profit-leading companies incurred significantly lower support expenses—that is, for administrative activities, marketing and sales, estimating, customer service, purchasing, and scheduling—for each dollar of earnings produced, compared to most printers.

Activity-based costing, they realized, could provide managers with a better way to identify those "soft" costs and understand their impact on profits. By comparison, the consultants reason, traditional budgeted hourly rate (BHR) cost systems are not really designed to provide the information that managers need to better manage and control support expenses.

To improve support activity efficiency, says Lavelle, a printing company's management team must be able to identify what specific support activities the company is performing, describe in detail how it is performing those activities, and establish how much it is spending on those activities.

He holds that BHR costing provides little if any insight into the cost of specific support activities and processes.

BHR systems put support costs into a pool that is distributed across production cost centers, a procedure that the consultants say can distort the true cost of a job. For example, an order that requires 10 estimates and 10 sales calls is assigned the same support cost as a job that didn't required any estimate or sales call.

The three consultants concede that use of budgeted hourly rates is ingrained in the printing industry. "Yes, we know that many printers use budgeted hourly rates as a pricing tool rather than as a cost management tool," says Dodd. "The BHR system may be easy to use for pricing, but it doesn't yield prices that make sense."

He goes on to say that activity-based costing is more about process improvement and managing those things that cause cost to occur than it is about coming up with a price, even though it can be used as a tool for pricing.

In their white paper, Dodd, Lavelle, and Margolis note, "Companies in other industries using ABC systems to assign costs to customers have discovered that customers can vary greatly in the demands they make on a company's resources. But few customer-driven inequalities are reflected in the pricing.

"When companies start to use accurate measures of the costs incurred in serving customers, managers realize that the company typically earns a great deal of profit on the winners [the most profitable customers] but gives up much of those profits because of the losers."

Implementing an ABC system will require a new kind of thinking by printing managers, says Margolis. "BHR costing addresses the question—how to allocate all costs to production cost centers, then to individual print jobs—but ABC systems ask much different questions of companies."

These include:

• What activities are being performed by its resources?
• How much does it cost to perform organizational activities and business processes?
• What is needed to perform specific activities and business processes?
• How much of each activity is required to produce individual print jobs, to produce and/or deliver non-print services, and how much of each activity is required to serve specific customers?

Lavelle anticipates that one likely point of opposition will be whether support costs are fixed or variable. He says, "While support costs may seem fixed because you have to pay the staff that performs those activities, you can direct how employees spend their time to gain efficiencies and enhance profitability. The idea is to better utilize resources, not squander them."

He also feels that proper implementation will counter another possible objection, that activity-based costing requires support staff to keep detailed records of how they spend their time.

Lavelle concludes, "We are not saying that activity-based costing can solve all of a company's problems, just that it is a heck of a lot better than what you are doing now."