Summary by Darin Didier
Master of Accountancy Program
University of South Florida, Summer 2001
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Cost Management Main Page
The purpose of the article is to explain why many ABC systems have failed to date, and give conditions present in companies that successfully implemented the system.
Why ABC systems have failed?
Many companies heard about the wonders of activity-based costing and quickly tried to put the system into use at their companies. Frustration and displeasure was generally the result and the ABC backlash began. The authors explain the reasons for failure are rather obvious. Companies receive results from their new costing system, but either wouldn’t or couldn’t implement them. Organizations are simply resistant to change. Whether because of internal or external barriers, managers have difficulty applying the results to the company in order to improve operations. Difficulties with implementation include:
Too many or too few identified activities and cost drivers;
Overly complex system design;
Reciprocal cost allocations; and
Lack of technical expertise in the identification and analysis of activities.
Internal barriers exist due to the inherent nature of the business. The infrastructure of a company, or hierarchy, contains interdependent departments that work towards the common goal. Unsuccessful attempts stem from focusing on the processes and the belief that departments are independent of each other. Plus, companies have trouble distinguishing between profit increases from normal operations and those attributable to ABC. The following is a list of complications companies run into in separating profit sources:
Controlling for other concurrent changes in the organization;
Determining the appropriate time period of study (e.g. When should the profits appear – by the end of one month, six months, one year?);
Modeling a company’s "expected" profitability against which to compare realized profitability after an ABC implementation; and
Controlling for the degree and breadth of ABC implementation and integration throughout the firm.
The authors give an example showing that implementation has been the problem. The company received results from the ABC system showing a possible $750,000 increase in profits. When the report followed-up with the company, little action had been taken and many unprofitable products still were being produced. The example helps explain why ABC has failed in many companies. Organizations believe by simply getting more useful information that change will naturally follow. They think that a new cost system will drive the production system, but the opposite is actually true. The authors believe ABC’s main role is to "reflect correct measurements of the current production processes and, thus, provide measurements that may indicate areas for readjustments within the current production model or function" (26).
Steps to successfully implement ABC
A non-traditional view must be taken in order to understand how ABC will be effective. Perfect conditions and information don’t exist. Therefore, a realistic approach must be grasped. Sufficient motivation and a practical change strategy must be present for success. For example, high-volume companies have highly structured organizational forms that contain interdependent departments. ABC will best serve companies such as these, but because so many different units must be involved, change is nearly impossible unless total commitment is given.
Certain factors are necessary to help ABC succeed no matter what company is involved. These factors along with a short explanation are given below:
Interdependent environment – the environment should have a preexisting process-oriented improvement program. A disposition towards internal change will help move the implementation along.
Security – employees will fear replacement if their unit is found to be unprofitable, but assurance that their job is safe and their assistance is necessary will help the change.
Legitimacy – senior operating management needs to lead the implementation to show employees the commitment to the effort.
Critical timing – users need timely reports in order for successful implementation.
Coordination and integration – involving various departments in decision-making will ease the implementation process.
Incentive alignment – making incentives based on ABC information instead of traditional means pushes personnel towards focusing on successful implementation.
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Related summaries:
Anderson, S. W., J. W. Hesford and S. M. Young. 2002. Factors influencing the performance of activity based costing teams: A field study of ABC model development time in the automobile industry. Accounting, Organizations and Society 27(3): 195-211. (Summary).
Cooper, R. 1990. Implementing an activity-based cost system. Journal of Cost Management (Spring): 33-42. (Summary).
Cooper, R. and R. S. Kaplan. 1992. Activity-based systems: Measuring the costs of resource usage. Accounting Horizons (September): 1-13. (Summary).
Cooper, R., and R. S. Kaplan. 1998. The promise - and peril - of integrated cost systems. Harvard Business Review (July-August): 109-119. (Summary 1, Summary 2).
Gosselin, M. 1997. The effect of strategy and organizational structure on the adoption and implementation of activity-based costing. Accounting, Organizations and Society 22(2): 105-122. (Summary).
Hughes, S. B. and K. A. Paulson Gjerde. 2003. Do different cost systems make a difference? Management Accounting Quarterly (Fall): 22-30. (Summary).
Ittner, C. D., D. F. Larcker and T. Randall. 1997. The activity-based cost hierarchy, production policies and firm profitability. Journal of Management Accounting Research (9): 143-162. (Summary).
Jones, T. C. and D. Dugdale. 2002. The ABC bandwagon and the juggernaut of modernity. Accounting, Organizations and Society 27(1-2): 121-163. (Summary).
Kaplan, R. S. 1990. The four stage model of cost systems design. Management Accounting (February): 22-26. (Summary).
Krumwiede, K. R. 1998. ABC: Why it's tried and how it succeeds. Management Accounting (April): 32-34, 36, 38. (Summary).
Landry, S. P., L. M. Wood and T. M. Lindquist. 1997. Can ABC bring mixed results? Management Accounting (March): 28-30, 32-33. (Summary).
Mangan, T. N. 1995. Integrating an activity-based cost system. Journal of Cost Management (Winter): 5-13. (Summary).
Martin, J. R. Not dated. Chapter 7: Activity Based Product Costing. Management Accounting: Concepts, Techniques & Controversial Issues. Management And Accounting Web. Chapter7.htm
Mecimore, C. D. and A. T. Bell. 1995. Are we ready for fourth-generation ABC? Management Accounting (January): 22-26. (Summary).
Palmer, R. J. and M. Vied. 1998. Could ABC threaten the survival of your company? Management Accounting (November): 33-36. (Summary).
Ruhl, J. M. and B. P. Hartman. 1998. Activity-Based Costing in the Service Sector. Advances in Management Accounting (6): 147-161. (Summary).
Sandison, D., S. C. Hansen and R. G. Torok. 2003. Activity-based planning and budgeting: A new approach. Journal of Cost Management (March/April): 16-22. (Summary).
Troxel, R. and M. Weber. 1990. The evolution of activity-based costing. Journal of Cost Management (Spring):14-22. (Summary).
Turney, P. B. B. 1990. Ten myths about implementing an activity-based costing system. Journal of Cost Management (Spring): 24-32. (Summary).
West, T. D. and D. A. West. 1997. Applying ABC to healthcare. Management Accounting (February): 22, 24-26, 28-30, 32-33. (Summary).
Zeller, T. L. 2000. Measuring and managing e-retailing with activity-based costing. Journal of Cost Management (January/February): 17-30. (Summary).