Activity Based Information Integrating Operations Strategy

ACTIVITY-BASED INFORMATION INTEGRATING THE OPERATIONS STRATEGY JOSÉ AUGUSTO DA ROCHA DE ARAUJO Production Engineering Department of the Polytechnic School at University of São Paulo [email protected]

REINALDO PACHECO DA COSTA Production Engineering Department of the Polytechnic School at University of São Paulo [email protected]

ABSTRACT In a global world the companies are looking for new operations strategies to guarantee success in the corporate world. This article analyzes the use of activity-based system as a tool for elaborating a global operations strategy focused on costs. We will present multiple cases about world-class companies in Brazil. Keywords: strategy; global operations; activity-based costing.

1. INTRODUCTION Nowadays’ world is watching the revolution in the production and capital systems, which work on globally searching for the most favorable environment to reach the corporate goals. This change is motivated by the new competitive logic, companies can source capital, goods, information from around the world and which considers technological leaps searching for ever-more global markets. In this context, the companies need to find their competing force in order to gain in new markets. The information about the profitability of several products and about the process’ activities’ costing in diverse markets helps the managers decision-making about the business profitability and about the opportunities in different countries, generating more ability to compete. The standardization of the manufacturing process and of the products themselves favors the production’s cost evaluation in different markets, through financial and nonfinancial indicators of the activities’ performance.

2. RESEARCHING PROBLEM At the present work, the researching theme is analyzing the suitability of the activity-based costing system for the development of a cost-centered global competitive strategy, as well as its efficacy for the integration between the global corporate strategy and the regionalmanufacture one. 2.1. RESEARCH METHODOLOGY In the present work, the literature on strategy-conceptualizing, global operations management and activity-based costing will be revisited. Multiple-case studies have been made in order to demonstrate the using of the activity-based costing system in real situations. The annex I contains the research questionnaire which was the data-collecting grounds at the analyzed companies. 3. GLOBAL OPERATIONS MANAGEMENT The companies have different strength and weak points, even when they produce similar goods, and they may choose several ways to stand out among their competitors. In other words, they need to choose among diverse production systems, to make decisions concerning the niches market, to define operational characteristics and, still, to adopt a standard system for production. That makes the manufacturing management’s mission to be the configuration of the production system through a series of consistent internal links and choices that represents the tacit priorities and the trade-offs of its competitive situation in its strategy. (Skinner, 1996). Global industrialization is the result of an integrated system of production and trade. So, the transnational and multinational companies, stimulated by the new global economic, are spreading over all countries, either through the setting of a new factory or through the acquisition of local plants. This resetting makes of these companies dynamic poles. According to the company’s strategic aim and to the host countries’ economic planning, the activities may develop abilities not only in the companies’ original countries, but in the developing countries too. This interaction between transnational companies and local ones means a new international division of the core competences (Fleury and Fleury, 2000).

The goal, clearly, is to develop and create sustainable competitive advantage, finding new ways to guarantee not only market share, but also opportunities that allow entrepreneurial growing and continuity. (Porter and Millar, 1979) Open international trade has encouraged nations to specialize in different branches of manufacturing and even in different stages of production within a specific industry. This new era of the globalized production is seen today as a strategy to create competitive advantages through the economy of scales, the rationalization, the standardizing of the project and of the product manufacturing. However, in order to be profitable in the global economy, the companies must know if their decisions creating competitive value for its clients that exceeds the cost of creating that value. Nowadays, we admit that cost information alone is not enough to improve profitability; managing methods make quality and flexibility as important as the cost information. There are global pressures to compete on several dimensions, such as costs, quality, flexibility and innovation, and to improve continuous. (Flaherty, 1996). Nevertheless, Bolwijn and Kumpe (1990) concluded, according to their researches, that the majority of the manufacturing companies studied by them show cumulative time evolution when applying their strategies. Firstly, the companies developed costing competence; then, they started their search to achieve the ability to compete in quality. Later, the answering time between manufacturing and the clients’ needs was equationed. After achieving a good competing parameter under these three criteria, the companies aimed at getting flexibility in their productive system and, finally, at becoming innovative. Sometimes the companies have just a few choices to determine their competing strategy. This happens when there are many entry barriers. The clients define the products, the needed services and they determine their value. The subsidiaries must, therefore, understand how its competitors are working and try to find new ways to stand out, but the companies must respect the regional politics and needs. Analyzing these concepts through the new point of view of the global competing environment, we can see that, for many of these companies, the initial development of a cost-centered strategy is a key factor for the new plant’s setting success, regardless of the ongoing stage of competition at the parent and sisters subsidiaries.

Moved by this necessity, some transnational and multinational companies are developing and projecting activity-based costing systems aiming at supplying new tools for the global strategic cost-managing in order to create the rules and the patterns to coordinate the global production activity, the establishment of new products, the products’ mix, the improvement of the process, the activities that aggregate value to the products, the by-product profitability, the regional profitability, and also in order to set the managing and the global performance indicators, among other decisions. 4. GLOBAL COSTING STRATEGY The development of a competitive strategy is, essentially, the development of a general formula for the way the company will compete. (Porter, 1991). It is very important that the company defines its network, and that it identifies its competitive force, plans the tasks for each force, besides roughly fore-planning each required resource and defining its goals before building a composed chart of the likely profitability. (Porter, 1979). The company has to worry about creating consistent solutions that stand halfway between the clients’ needs and the organizational practice. Skinner (1996) identified, as the practical aspects of the competitive advantage, the setting of performance measures, such as quality, the production or the attending speed, accountability, flexibility and costing. Buffa (1985), however, believes that in order to formulate a manufacturing strategy, it is important to consider every aspect of the operational decisions, which he qualifies into six large components: •

Positioning of the production system;

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Capacity/Location decisions;

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Product and process technology;

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The work force and job design;

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Strategic implications of operational decisions;

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Suppliers and vertical integration .

These components are the basic elements for formulating the production strategy, once they supply a wide scenario to choose feasible alternatives. Each one of them will have its long-

term effect in the company’s competing environment and will also cause an impact upon the costs, the quality, the products’ feasibility and the flexibility. Therefore, the development of a corporate strategy is the optimizing and the interlacing of the various activities that will be maintain to competing capacity. All the abilities, in consequence, have to be considered when formulating the different internal settings such as the producing and the costing strategies. The strategic costing management, on the other hand, regards the cost management for the financial analysis and the products’ profitability as well as for the verification and the profitability’s evaluation of the long-term and short-term business. To achieve these goals, a costing management that is both, efficient and effective, is needed, and in order to achieve a sustainable competitive advantage, that such management must be added to the business strategy. The strategic costing management also contributes significantly to the efficiency concerning the shareholder’s value analyzes, the changing of the organizational behavior and the minimization of the effects of company-adverse economic and political decisions. Porter (1996) discusses the subject identifying the company’s need to evaluate the performance of the competitors and to establish a difference that is able to be preserved. In other words, besides doing what the competitors do, the company needs to aggregate a higher value from the point of view of the client or to create something similar, but with lower costs. The essence of the strategy lays in the activity – choosing the company’s performance to be different of the competitor’s one. Through the critical analyzes of the activities, the companies should identify which are the performance indicators that will have to be monitored, allowing trade-off decisions and assuring the advantage to facilitate the exploitation of the market’s opportunities and modifications. Or, still, the companies should choose the different activities and set up the required performance, aiming at doing them better that the competitors. Yet, the majority of the great companies seem to acknowledge that their costing systems don’t correspond to the nowadays competitive environment; the current methods to evaluate the costs of the products are irretrievably obsolete. (Kaplan, 1984).

Due to the difficulty of identifying precisely the costs of the products through the traditional costing models, a large amount of the companies abstain from including their costs to their corporate strategies as an strategic matter. This is a serious problem: in the new competitive environment set by globalization, the clients’ behavior has changed, and now they define what products and services have to be produced or offered. Thus, it has become necessary to develop new cost-evaluation tools, having in view to guide the corporate strategy. This means that an exact information on costs, in a very simple way, may afford to the company a competitive advantage. The management of the costs, for a long period of time, became a forgotten island for the corporate strategy. In recent years, however, the cost-evaluation sector has been able to get its strategic importance increased in terms of organizational modifications, of development of operational capacity and of exploitation of external opportunities. The strategic management of costs offers a higher understanding about the processes applied to administrate expenditures for the financial performance decisions, as well as for the identification of competitive advantages. (Grundy, 1996) Tayles and Walley (1997) believe that the information systems should be developed and projected aiming at fulfilling the needs that are identified by the strategic view of the intended goals. This way, they would help to determine the goals and to emphasize the efficacy of the costing-system and of the result indicators. This implies directly that the interface between the marketing, production and accountability management sectors should acquire the knowledge about the organization of the production, so the costs and performance indicating systems become relevant. Many diverse factors may influence the project of the costing system. It is not simply the degree of competition that influences the project, but the nature of the competition, which, theoretically, is determined by the choosing of the competitive strategies. In a strategy focused on costs leadership, the costing system must be projected and developed to identify the areas that provide a potential cost reduction. The competitive strategy influences directly the standards of the operations. In this case, low costs are achieved through the efficiency of the material, the low level of wasting in the process and the minimization of the overproduction of the rework process. The costing system should

be able to help the managers with effective informations, facilitating the decisions and allowing the company to achieve its goals. Regardless of the company’s competing in costs or in any other priority explained above, knowing the costs is important for the inner strategy analyzes and its setting up and for the evaluation of the external competitive advantages. Furthermore, the cost analysis may generate rules to determine the companies, the markets, the market’s and the products’ segments, which are important factors for the global operations’ success. This information, associated with the data concerning each productive process, demonstrates the company’s profitability scheme and allows it to define the best competitive strategy for different markets and different countries in order to achieve the regional goals and to maximize the global corporate results. 5. ACTIVITY-BASED COSTING (ABC) The activity-based costing was brought about aiming at helping the manager in the new competitive environment introduced by the new production technologies and by the clientfocusing. Kaplan ( 1997 ) related that the costing models used up to then weren’t equipped with accuracy and control mechanisms able to guide the companies through the decision making process, concerning: •

Design products and services that both meet customers’ expectations and can be produced and delivered with profit;

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Signal where either continuous or discontinuous (reengineering) improvements in quality, efficiency, and speed are needed;

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Assist front-line employees in their learning and continuous improvement activities;

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Guide product mix and investment decisions;

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Choose among alternative suppliers;

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Negotiate about price, product features, quality, delivery, and service with customers; and

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Structure efficient and effective distribution and service processes to targeted market and customer segments.

The new activity-based costing system aims thus at including the very important costs information into the new competing panorama, creating a tool to serve the corporate strategies decisions. The ABC has grounds on the evaluation of every necessary activity in the process, from the production (manufactured or service) to the offering, identifying the resources consumed by these activities through different costing guides, giving value to each individual product. So, in the ABC system the cost of a product equals the cost of all activities required to produce it ( Aderoba, 1997 ). In this method, it is fundamental to have a knowledge of the entire producing process besides being aware of how the system aggregates value to the products. The ABC system is based more upon the activities’ resources than upon quantity and price standards for material and labor, that are obviously included into those activity resources, besides indirect labor, equipment, tools, auxiliary tools, indirect materials, advertising, government taxes, etc, consumed by specific activities. This way, the system, besides supplying strategic information, which helps the continuous improvement of the process, offers data concerning the activities that do not aggregate any value, monitors the quality, presents tools to make decisions about

price flexibility,

controls the costs, the profitability and the performance of the products, giving to the company that works on this system basis a sustainable competitive advantage if compared to the traditional costing system. (Kaplan and Cooper, 1991; Kaplan and Cooper, 1997; Gunasekaran et al, 1998; Chalos, 1992; Grundy, 1996; Nakagawa, 1994). This costing system has, nowadays, been used by transnational companies having in view the use of a management and control tool to determine the cost-centered global competitive strategy. This comes to happen through the standardization of processes, of activities, of common costs control, through the regulation of decisions about material purchasing and its suppliers, through the tax planning on different countries and through the evaluation of the production capacity usage according to the global corporate strategy, identifying the competitive priorities and the business opportunities in each market. Strategic information on costing indicates if the company’s activity is efficient in the cost field if compared with the alternatives outside the company. Furthermore, it helps the sold product’s mix’s management, checking the activity efficiency and leading to the most profitable path. The world-class companies need, therefore, suitable costing information

added to quality and flexibility indicators in order to achieve the world-class standards through the waste management and the activity costing. Consequently, combining the information given by the non-financial indicators of the activities’ control with the activity-based costs may compose a map about the profitability, the activities and the products in every market occupied by the company. In the nowadays competitive world, the performance information and the activity-based costing data are the way to the continuous improvement of the business profitability. 6. CASE-STUDIES Three case-studies in transnational companies placed in São Paulo, Brazil, have been made, having in view the establishment of parameters for an evaluation between the operations and the global costs strategies, analyzing how the costing systems help the integration of the regional strategic decisions and the global corporate ones. 6.1 CASE-STUDY 1 The first case-study is about a company working on the chemical area which produces raw material that will serve to the manufacturing of tires. At the present time the company is the world-market leader and it is positioned in the national market’s second place, with about 30% of the market. The regional goal is to keep the leadership, achieved through quality and cost-oriented strategies. As a second goal, the company is increasing its activities volume in the country buying new businesses, aiming at increasing the products mix and the flexibility of the producing process without jeopardizing the current market share. The company owns factories in 25 countries and sales branches in 112 countries. The regional operations don’t compose a global management, which leaves the responsibility of choosing the corporate and the producing strategies completely to each local CEO. The headquarters sets the business goals to each subsidiaries and controls them through reports of non-financial indicators. The financial results are charged as royalties and shares. Nowadays, modifications in the internal markets competition are expected due to the coming of a strong world competitor, which has begun its production, in 2002, with a hightechnology industrial plant.

The production process happens with the high-temperature combustion of different kinds of oils and additives, according to the specific characteristics of the intended product. Consequently, the processes’ costs are variable, and can be higher or lower depending on the quantities and the specifications of the final product. The final product is a certain amount powdered and the control indicators are determined in kilograms, such as quality measures, process performance and wasting control. The operations systems management and the costing ones are integrated. The company set up the costing system through absorption (full cost), which must be chosen due to the brazilian taxing system in order to determine the taxable profit. This traditional costing system uses apportionments to allocate the fixed and indirect costs to the products, usually taking the amount of machine-hours and direct labor-hours as a reference. The company, however, creates, through electronic charts, a budget-report and an economic management report aiming at identifying the profitability of the products and of the business, and the data that is generated by the costing system through absorption are the data-base for these reports. The applied costing system fulfills the needs it was developed to fulfill: stockpile control concerning taxing implications; however, the regional directing board is concerned about the competing modifications and needs new alternatives to form the product’s selling price, which the implanted system is not able to present. 6.2. CASE-STUDY 2 The analyzed company works in the chemical area and it is a paint producer. It is the market leader in the U.S. and the world’s largest paint producer. In Brazil, it oscillates between the third and the fourth places. The regional goal is to enlarge its market share, consolidating its profitable groups of products and to reduce the costs. The company owns factories in North, Central and South Americas, besides its British factory. The regional operations integrate the strategic management of global operations; the holding company keeps information on each market occupied by the company and determines goals and strategies for each group of products. The responsibility of each regional branch’s CEO is to guarantee the efficiency of the operations and of the strategies defined by the holding. In this case, different financial and non-financial indicators are used to control the business,

such as production-controlling tools, waste indicators, processes timing, IRR calculation, present value, discounted payback and cash flow. The model doesn’t supply, nevertheless, information, already available in other factories of the group, about the products’ variation of costs due to quality programs, about modifications in the producing process or about modifications of the product itself. The producing process is relatively simple and consists of the manufacturing of paint through the mixing of chemical components and additives, once each, according to the consistency and the quality intended to be reached, but uses imported raw materials that have a great influence on the costs of the products. This process’ cost is also variable, depending on the volume and the final specifications of the final product. However, due to the fact that the competitors compete with quality and low prices concerning the basic product, the company chose to stand out in the market competing through diversifying and innovating. This strategic option demanded a great increase of the fixed and indirect manufacturing costs, which enlarged the expectations about the development of a new structure to evaluate the activities’ cost, aiming at understanding the true costs of the new products. At the present time, the brazilian branch is starting to project a new model to evaluate the activity-based costs. The expectations are to be able to gather all information about the physical performance of the activities and the costing ones, having in view to supply data for the quality management and parameters for the decision taking about the selection of new products and the flexibility of the process. 6.3 CASE STUDY 3 The third case-study has been done through the analysis of a company that works on the nourishing area, producing and commercializing ice-cream. It occupies the brazilian market, exports to Argentina and to Uruguay, and forms a transnational group that acts in different markets and in diverse business. The current goal is to increase the profitability of the business, focusing on the client’s satisfaction and the integration with the suppliers. The regional operations gather up in a global management of operations; the corporate strategy is defined by the headquarters which keeps, besides the macro-economical view of the countries where it has a share of the market, all the information of the markets, the costs of

the regional processes, the activities, the investment opportunities, the factories’ logistics, the international laws and the capacity of production among other data that lead the global competitive strategy. The subsidiaries communicates its operations through global standard-form reports so the headquarters can evaluate the business’ risk and the operating conditions of the producing plant, defining the regional corporate strategy and manufacturing strategy. The success of such operation is due to evaluations and analysis about the production resources, identifying the financial and the non-financial performance indicators for the control of the activities and of the processes, which is made feasible through the implementation of an activity-based costing system. The goal of this operation is clearly to create competitive advantages through standardizing the activities, the processes and the products, looking for efficiency in the production, in the economy of scales and the rationalization of the projects. The production process follows world suit, divided into 10 steps: raw materials stockpiling; mixing; homogenizing; pasteurization; exposure to cold and air; barreling; freezing; paletting; final product’s stockpiling. In this process, there are variable costs concerning the volume and the producing time besides the fixed costs such as stockpiling. The activity-based costing system was developed aiming at the standardization of the activities. The process has been worldly divided into steps (e.g. paletting), and drivers have been determined for the distribution of the consumed resources, (e.g.amount of pallets). This allows alikeness in every activity of the process, which are analyzed and monitored by each subsidiary’s CEO, concerning the regional performance inserted into the global context. The responsibility centers and the accountable bills are gathered, and they aggregate values in the same costing model and are done according to parameter to establish the performance criteria and the system’s indicators. This way, the productive activities are detailed and structured in a global way, aiming at identifying the steps of the process, the activities’ costs and the need for resources, which are set according to the performance standards, monitored in a uniform manner in every similarly-producing plant. The system identifies the variations detected in the process, shows data about modifications in the activities and judges the results of these changes, besides recognizing periodically the activities that need to be modified in order to increase

the ability to compete, not only regionally but also in a global scale. The system runs a performance check list on the regional activities and compares it to the benchmark’s performance, making new solutions feasible and multiplying the learning of the process. The system suppliers data for the decision taking on the price formation in diverse markets, selection of countries and factories for the manufacturing of a specific product, it leads the gathered regional actions, aiming at the costs reduction and it swells the business opportunities besides establishing the regional corporate strategies maximizing the global results. The activity-based costing system has, in this company, a great influence on the logistic deployment model between Brazil, Mexico and Chile, identifying the best operating conditions in terms of costs reduction, tax encouragement, and available technologies. However, the information about the operation conditions in each country depend on the result of many factors: governmental and economic policies, natural resources and economical growing, which change constantly, making the trade-off decisions harder. 7. CONCLUSIONS This paper has confirmed, through case-studying and specific literature-reviewing on the strategy concepts, as well as on the global operations management and on the activity-based costing system, the feasibility of the creation of a cost-centered global strategy and the activity-based costing system’s suitability as a tool that supplies sustainable competitive advantage. It has been concluded that the activity-based costing system has a methodology that fulfills the need of information to unite global corporate strategies and regional strategies, once this method presents in its structure financial and non-financial measuring of the performance and of the activities’ costs. However, the efficacy of this method’s usage depends on the relevance of the activities’ costs data for to the corporate strategic formulation, represented by Graph 1.

HIGH STRATEGIC

DECISION SUPPORTING

Competitive Strategy OPERATIONAL CONTROL LOW LOW

Costing systems

HIGH

Source Authors: Graph 01 – Degree of dependence on the costs data for the formulation of the competitive strategy

The impact of this information will be greater depending on the competitive priorities and on the costs’ importance for the competition. Therefore, three levels of dependence are identified: •

Strategic – a company positioned at this level has its cost-evaluation system considered as a critical activity. The system’s projecting and developing have great relevance, once the corporate success depends on them. The data about the activities’ costs and performances, the profitability and the mix of the products, the increase of the indirect and fixed expenses’ volume, among others, may change the nature of the competition.

•

Decision Supporting – at this level, the company has its evaluation system of costs focused on the supply of information about the development of products, the changes that occurred in the process by organizational programs (e.g. quality), and the furnishing of data for the formation of the sale price besides assessing the productive efficiency.

•

Operational control – the company positioned at this level may be considered dependent on the costing system for the day-by-day operational information. The

system, thus, fulfills the needs of stockpiles control and judgement of the taxable profit, but is it not focused on the supporting and strategic decision making. It is concluded that the companies should evaluate the nature of the competition and the competitive priorities, having in view to identify its dependence on cost information to define which costing system fulfills the decision-making needs, having in mind that a simple correct information about the cost of the activities may supply a competitive advantage. 8. BIBLIOGRAPHY 1. ADEROBA, A. A generalised cost-estimation model for jobs shops. International Journal of Production Economics, v. 53, pp. 257-263, 1997. 2. BOLWIJN, P.T.; KUMPE, T. Manufacturing in the 1990’s: productivity, flexibility and innovation. Longe Range Planning, v. 23, n. 4, p. 44-57, 1990. 3. BUFFA, E.S. Meeting the competitive challenge with manufacturing strategy. National, 1985. 4. CHALOS, P. Managing cost in today’s manufacturing environment. Englewood Cliffs, N.J., Printice Hall, 1.992. 5. COOPER, R.; KAPLAN, R.S. Measure costs right: make the right decision. Havard Business Review, v. 66, n. 5, p. 96-103, sep./oct.,1988. 6. COOPER, R.; KAPLAN, R.S. The design of cost management systems. Englewood Cliffs, N.J., Prentice Hall, 1991. 580 p. 7. FLAHERTY, M. T. Global operations management. Mc-Graw Hill Books, 1996. 8. FLEURY, A.; FLEURY, M. T. Estratégias empresariais e formação de competências: um quebra cabeça caleidoscópio da indústria brasileira. São Paulo, Editora Atlas, 2.000. 9. GHAURI, P.; GRONHAUG, K.; KRISTIANSLUND, I. Research methods in business studies: A practical guide. s.l.,Hardcover, 1994.

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ANNEX I RESEARCH QUESTIONNAIRE 1. Historic Data. 2. What are the organizational goals: globally and regionally. 3. Description of the producing process. 4. Description of the costing systems and how they go with the global strategy. 5. Description of the costing system’s implantation process. 6. What are the global and regional competing strategies. 7. What are the tools that help the strategies to work. 8. Are there influences of the headquarters on the regional strategies? 9. Are people familiarized with the costing system and can the easily use it? 10. Does the costing system use non-financial performance measurements? 11. What is your analyzes about the influence of the costing system on the global strategy? 12. How are the information about costs and about the activities’ performance consolidated and integrated between the headquarters and the subsidiary company? 13. What are the indicators of the global operations?