Exploiting hidden profits through Activity-Based Costing, Management

At a recent breakfast hosted by SAS Institute, international industry expert Peter Turney, CEO of Cost Technology, explored customer profitability as the hidden opportunity for sustainable bottom line growth.

During his presentation Turney spoke about hidden opportunities to increase profits, the reasons many companies do not exploit these hidden profits and smarter ways to increase profits using tools such as Activity-Based Costing (ABC) and Activity-Based Management (ABM).

He also offered a five-step guide towards sustainable bottom line growth.

According to Turney, hidden profit may be up to as much as 400% of a company's current profits. But one of the major reasons organisations cannot see these opportunities and cannot take advantage of them is because of a conventional reliance on the financial system to provide information for decisions on profit and costs.

“Financial systems are used for regulatory and statutory reporting, and within the limits of generally accepted accounting principles, can be used for the reporting of aggregate profit or loss. However, financial systems were never intended to provide information about the sources of profit and cost,” Turney explains.

“The limitation of financial systems in this regard is that if they are used for internal profit management purposes, they provide inaccurate or incomplete costs of products and services. They also fail to attribute the costs of market-facing activities and business support costs, so do not report customer profitability and cost of serving customers, channels, segments etc. They also cannot be easily modified to reveal the impact of complexity and diversity, and costs are reported by account rather than by process or objective,” he adds.

Activity-Based Costing, on the other hand, gives not only a traditional view of costs but also a cost view of resources, activities and cost objects, as well as a process view of cost drivers leading to activities, enabling performance measures.

On top of this, ABM solutions such as the Activity-Based Management system from SAS, then give insight into the cost of business support services and cost to serve activities, the cost of services, and deeper information around the cost of customers. This enables organisations to develop customer economic profit reports and gain a far better idea of how profitable customers really are.

From this it can be seen where hidden profits may lie, as organisations can see who the profitable customers are, what the profitable products are, and can exploit opportunities to increase these profits.

ABM can help organisations develop reports around profit by channel, activity costs per channel, and cost analyses, as well as allowing companies to forecast optimal future media mixes and the resources required for this media mix, and creating budgets based on forecasts and resource changes.

According to Turney, any organisation can follow five simple steps to get them on the path towards increased profits and sustainable bottom line growth.

1. Identify the most important areas for improving profitability
These areas may include market segments, channels, customers, product mixes, pricing, marketing initiatives or buckets of cost. Areas can be selected based on current performance, competitive conditions, strategic direction and so on. High-level analysis may identify obvious targets, but in some cases a more detailed analysis may be necessary.

2. Evaluate how decisions are made
Organisations need to ask themselves several questions regarding their decision-making process. What are the limitations of existing financial information? Do decision makers have the tools to make decisions? Is analysis done on a timely basis with up to date information? Can managers easily access information, tools and analyses? Is there time to analyse the profit impact of decisions? Depending on the answers to these questions, organisations may need to alter how these processes are run.

3. Close the decision gap
Decision-makers need to be able to access information from data sources and systems in a usable and relevant manner. In order to do this organisations need to have data services and solution integration that feeds this data into automation and reporting tools that deliver useful information to decision-makers in a timely fashion.

4. Change the performance management system
Performance management systems need to be aligned with new costing and management models. Profitability management solutions such as the offering from SAS help to reflect performance based on profit rather than performance based on revenue, which may give a skewed picture of the true profitability of the company.

5. Track the results
This is an important step as it validates the success of the profitability management initiatives and encourages ongoing investment in profitability management. It also helps to focus on measuring changes that may account for up to 80% of the profit gains.

Increasing profits does not necessarily mean increasing market share, says Turney. In order to increase profits organisations need to understand the true cost to their business of providing customers with goods and services.

By implementing ABM and profitability management systems, companies can get a clearer understanding of exactly how much profit, as opposed to revenue, is generated, and where these profits originate from. In this way, hidden opportunities for increasing profits can be identified, and organisations can begin a journey towards creating sustainable bottom line growth.