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Adding Time to Activity-Based Costing


To improve any business, managers need to understand how much it costs to produce a profitable product. It seems a simple task, but the process of securing and analyzing the write my paper can be incredibly complex and organizationally taxing.

In Time-Driven Activity-Based Costing, Harvard Business School professor Robert S. Kaplan and Acorn Systems founder and chairman Steven R. Anderson (HBS MBA '95) introduce a system that calculates product, customer, and regional or branch P&Ls quickly and inexpensively. The work marries the Activity-Based Costing system developed by Kaplan and Robin Cooper in the 1980s, with time dimension modifications introduced by Anderson for clients of Acorn Systems.

We asked Kaplan to describe the problems with traditional costing approaches, the improvements made by TDABC, and how it works with the Balanced Scorecard developed by Kaplan and David Norton.

Sarah Jane Gilbert: What inspired you to develop the concept of time-driven activity-based costing?

Robert Kaplan: When Robin Cooper and I introduced ABC in the mid-1980s, we were strongly influenced by the approach taken by strategy consultants, who used interviews and surveys to assign the cost of employees to activities. We also wrote several cases where other companies, independently, relied on this interviewing approach.

These time surveys turned out to be the Achilles heel of ABC. They were time-consuming and expensive to perform, irritating to the employees who had to fill out the forms, and error-prone by using employees' subjective time estimates. Also, in the mid-1980s, we failed to fully understand the critical role played by capacity when estimating cost driver rates. The insight about the central role for capacity did not occur until about 1990.

Thus, while ABC still represented a definite advance over the arbitrary overhead allocations done by traditional standard cost systems, many companies abandoned ABC or updated their model only infrequently, because of the high time and cost associated with re-estimating the model, and its subjectivity and latent inaccuracies.

In the 1990s, many companies introduced ERP systems that captured data at the transaction level. It was natural to think how we could modify ABC systems to benefit from the ready availability of transactional data about orders, products, and customers. The stage was set for a major advance in the conceptual foundations of strategic costing systems.

The breakthrough came by combining a paper writing service I had while writing Cost & Effect with an innovation developed by Steve Anderson, an HBS MBA, who was a student in my second-year elective, Cost Measurement and Management. My insight was that you could build cost systems with only two parameters. One is the cost rate of supplying resource capacity (such as cost per minute for people and machine-driven processes, or cost per cubic meter per day in a warehouse). The second is an estimate of the demand made on resource capacity (typically time) by transactions, products, and customers.

Anderson, after graduation in 1995, worked at McKinsey where he got the idea for using time equations to estimate how the capacity demands by a transaction vary based on all the contingencies that introduce diversity into transaction time processing. Anderson left McKinsey to found Acorn Systems where he developed software to incorporate time equations into ABC. The software modeled how, for example, the time to process a customer order would vary depending on whether it was a standard or a custom order, a rush order or standard delivery, a domestic or an international order, and so on. Time equations handle complexity by simply adding terms with Boolean logic that test for the presence of a particular feature that adds or subtracts time to overall processing time, a simple and elegant technique. In one of the cases described in our book, a company used quite complex and multiple contingencies to reflect the factors that caused a particular transaction to be either fast or time-consuming to process.