Technovation 25 (2005) 523–533 www.elsevier.com/locate/technovation
Performance measurement and costing system in new enterprise A. Gunasekarana,*, H. James Williamsb, Ronald E. McGaugheyc a
Department of Business Administration, University of Illinois at Springfield, One University Plaza, Springfield, IL 62703-5407, USA b School of Business, North Carolina Central University, Durham, NC 27707, USA c Department of Management Information Systems, The University of Central Arkansas, Conway, AR 72035-0001, USA
Abstract In this paper, we describe a framework for measuring costs and performance in new forms of business organization that are evolving to meet the competitive challenges of the 21st century. A literature review on cost management and performance measures in advanced manufacturing and service organizations provides the basis for our framework. The framework emphasizes measurement of costs and performance in the virtual enterprise and along the supply chain to enhance competitiveness in global markets. Investing in knowledge capital and information technology plays an important role in improving organizational competitiveness in the 21st century, yet the measurement of performance in these important areas is at best, imprecise. Managing and controlling costs and performance in new forms of organization poses challenges. We hope this article will encourage research that will help practitioners meet the challenges of performance measurement in the 21st century. q 2003 Elsevier Ltd. All rights reserved. Keywords: Cost accounting system; Performance measures; Virtual enterprise; Supply chain; New enterprise
1. Introduction In the 21st century, firms need not just operate in different countries, they must develop global strategies to coordinate their operations at all phases of the value-adding chain (D’Amours et al., 1999). Coordination of the supply chain has become strategically important as new forms of organization, such as virtual enterprises, global manufacturing and logistics networks, and other company-to-company alliances, evolve. The Japanese are often praised for the way they use information sharing to improve supply chain competitiveness. Information exchange has become a key component in their manufacturing strategies (Dyer and Ouchi, 1993). Companies in all sectors are examining ways to reduce costs, shorten product development times and manage risks. The transactions between companies in supply chains are characterized by adding value up through the chain and incurring costs (and consequent payments) down the chain. Supply chain management aims to reduce costs, risks and leadtimes associated with these transactions, thus releasing value. There is limited research on supply chain management in the low-volume Engineer to Order (ETO) sector. This is in stark contrast to the extensive literature on high-volume sectors, * Corresponding author. Tel.: þ 1-217-206-7927; fax: þ1-217-206-7543. E-mail address:
[email protected] (A. Gunasekaran). 0166-4972/$ - see front matter q 2003 Elsevier Ltd. All rights reserved. doi:10.1016/j.technovation.2003.09.010
particularly the automotive sector (Hicks et al., 2000). Performance measurement is critical to the success of any “for-profit” organization because it creates understanding, molds behavior, and improves competitiveness. World-class firms recognize the central role measurement plays in their success and are often compulsive about their performance measurement efforts (Fawcett and Cooper, 1998). Manufacturers are looking to their suppliers, with increasing frequency, for modules and systems, not just components. This is particularly true in the automotive industry where the industry’s procurement and engineering activities provide lessons about selling modules and systems applicable to virtually any other manufacturing industry (Henke, 2000). Briers and Chua (2001) sought to illustrate how an organization’s accounting system could be changed by a heterogeneous actor-network of local and global actors and actants. Four types of boundary objects were identified for this type of accounting system: data repositories, visionary objects (conceptual objects with high levels of legitimacy within a particular community), coincident boundaries and standardized protocols. Activity Based Costing (ABC) is a product costing technique that has gained attention. Turney (1996) defined ABC as a method of measuring the cost and performance of activities and cost objects. It assigns costs to activities based on their consumption of resources and then allocates costs to cost objects based on their required activities. The focus of ABC is
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on accurate information about the true cost of products, services, processes, activities, distribution channels, customer segments, contracts and projects. ABC helps identify problems and opportunities and formulate solutions to problems or ways to take advantage of opportunities. It does so by providing financial and non-financial information about activities and cost objects. Numerous articles address the design and implementation of ABC systems (Shank and Govindarajan, 1993; Alan, 1995; David and Robert, 1995; Booth, 1996). According to Innes and Mitchell (1990), ABC provides process control information. A measure of the volume of each activity (cost driver) is used to generate a cost rate for estimating production cost, and as a performance measure for the activity concerned. In practice, most applications of ABC make arbitrary allocations of common costs. The search for the activities which connect costs to products and processes, and for the cost drivers which proxy for them, involves compromise between accuracy and manageability. The result is that some indirect costs are excluded from the cost-pools associated with a practical set of cost drivers (Armstrong, 2002). Strategic performance measurement defines the focus and scope of management accounting. Specifically the requirement is that management accounting practice recognize and reflect choices made in organizations for management accounting to be relevant (Atkinson, 1998). For the purpose of strategic performance measurement, the organization’s objective can be entirely financial, social, or a mix of both financial and social objectives. It is widely believed that the large-scale use of EDI leads to improvements in the communication infrastructure between organizations, and that this, in turn, strengthens the economy of a nation and possibly a group of nations. It is also widely recognized that EDI enables organizations to redesign their processes significantly, because of its main capabilities: high speed, reliability and ease of data capture (Sheombar and Wagenaar, 1991). Hoogeweegen et al. (1998) describe a comprehensive approach for evaluating the value of various courses of action involved in implementing EDI. The first relies on ABC and quantifies the costs and benefits that are to be expected from the information processing when EDI is being used. The second uses discrete-event computer simulation to quantify the costs and benefits to be expected in the physical logistic processes. In advanced manufacturing/service environments, companies often operate in a physically distributed environment. They rely more on business network partners (Partners in a Virtual Enterprise) and suppliers for services and goods required to make final products/provide services in a networked economy. Traditional costing systems may not be suitable for a virtual enterprise or integrated supply chain management. Since most activities that add value, manufacturing and/or service activities, are outsourced to suppliers or partners, the application of ABC seems inappropriate. In the virtual enterprise, value adding activities may be less visible, except for the activities of strategic alliance, information sharing, and payment that takes place face-to-face, online, or
using other paperless means. Traditional costing and ABC are, however, useful for external financial reporting purposes and controlling the utilization of resources for producing goods and services at the factory of suppliers and partners (Cousins, 1999; Croom et al., 2000; Green and Flentoy, 1991; McCutcheon and Ian Stuart, 2000). In addressing performance measurement within a virtual enterprise or supply chain, due emphasis should be given to knowledge and information technology management costs. Unfortunately, there is limited research on this challenging problem area. Most organizations do not have suitable performance measures, metrics and costing systems for “new enterprise” models like the virtual enterprise, fully integrated supply chain, and physically distributed operations environment. The organization of the paper is as follows: Section 2 deals with the new operating environment and corresponding need for new cost accounting systems and performance measurements. Section 3 describes new approaches and new enterprises for the 21st century. Section 4 describes the steps involved in creating a Performance Based Costing system. Section 5 presents a conceptual framework describing the PBC system and the measures and metrics that can be used to assess performance in the “new enterprises” of the 21st century. Section 6 presents a brief summary and conclusions.
2. Need for a new costing system and performance measurements Global competition is leading companies towards a renewed commitment to excellence in manufacturing. Attention to the quality of products and processes, inventory levels, and workforce improvement has provided a competitive edge for insightful companies striving to become world class. In the advanced manufacturing/service environment, it is difficult to see (monitor) some important activities because they are mostly outsourced. In such cases, costing becomes more an assessment of the cost of buying products/services. Information sharing, communication, and trust play major roles in improving the performance of virtual enterprises and integrated supply chains. Most companies operating within the context of these new business models still use the same traditional costing and management control systems that were developed decades ago for a dramatically different environment (Cooper and Kaplan, 1991). New systems and approaches are needed and the reasons are as follows: (i) traditional costing systems do not provide sufficient nonfinancial information, (ii) existing product costing systems are inaccurate, (iii) current costing systems do not encourage improvements, and (iv) overhead costs are predominant. In the virtual enterprise there is a need for new costing systems based on performance. Such a system should identify critical success factors (CSFs), develop measures and metrics that assess performance in those key areas, and use those measures to plan and control operations to improve organizational performance and, thus, competitiveness.
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Mouzas and Araujo (2000) discuss the implementation of programmatic initiatives in manufacturer – retailer networks. They define a programmatic initiative as a complex and hybrid innovation problematizing a particular domain of activity and supplying a set of ready-made solutions to tackle those problems. They focus on one programmatic initiative, “Efficient Consumer Response (ECR)”, a radical program of change designed to achieve cost savings and speed up business processes throughout manufacturer – retailer supply chains. Information/transaction costs make it necessary to decentralize some decision rights in organizations and in the new economy. Decentralization, in turn, requires solving the control problem that results when self-interested persons do not behave as perfect agents. The following functions are critical: (1) allocating decision rights among agents in the organization, (2) measuring and evaluating performance, and (3) rewarding and punishing individuals for their performance (Jones and Thompson, 2000). Improvement should focus on the work that pertains to value creating activities of the organization; however, traditional costing does not report useful information about those activities that have the most potential for improving overall performance. Traditional costing provides information about salaries and depreciation at the department level. Such functional overhead reports do not provide information about the effectiveness of the work done, nor do they capture and describe the contribution of each worker. Traditional cost systems are dominated by functional classification. This functional classification is accompanied by the use of cost variance as a key performance measure. Traditional measures and metrics often cause behaviour that improves functional performance at the expense of overall performance of a company (Miller, 1996). Functional classification appears to be fading because of the integration of functional areas using information technologies and the increasing prevalence of networked partnering firms. In either case the integration of partners with suitable information systems and knowledge becomes critical. Knowledge management should be a key concern. Knowledge management involves various activities that add value. That being the case, like any other activities that take place in an organization, knowledge management could be evaluated with a performance based costing system. Good information about activities helps to focus effort on improving overall performance. It helps to set improvement priorities and provide feedback about progress. Moreover, a traditional cost system does not report the activity information needed to gain insight into how to improve the performance. The last decade brought forth increased development of crosscompany relationships, alliances, and more complex business networks. Tomkins (2001) examines fundamental concepts that relate to the need for information, including accounting information, in these interactive structures. It considers, initially, some consequences for accounting when planning and control is to be exercised across organizational boundaries, but the main thrust of the research is to focus on the fact that all relationships depend on trust to some extent. Likewise, planning
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and control depend on accurate, timely, useful information. Activities that create, disseminate and apply information add value. All such activities could be costed with a PBC system. The cost profile of manufacturing has changed over the last thirty years (Marrow, 1992). Production overhead and non-production overhead have increased in importance as more resources have been committed to the organisation and management of production and quality and to providing value adding services to the customer. For example, the cost and complexity of logistics and shipping have increased rapidly in new enterprises, especially when those engaged in e-commerce. This highlights the importance of developing cost and performance measures and metric in logistics. Inventory management is a major challenge in a networked economy, wherein firms must meet market demand in a timely fashion. The nature of overhead costs has changed from predominantly labor cost influenced by output volume, to a composition determined largely by complexity and diversity of production (Kaplan, 1984). Increasingly, overhead costs arise from the quest to exploit economies of scope as well as economies of scale. Knowledge workers, particularly engineers and software specialists, have displaced much of the direct labour force in many plants. In some cases, overhead outside the plant associated with engineering, marketing and distribution has increased to the point where it exceeds direct labor cost. The costing process has become very challenging, especially in virtual enterprises where the cost of purchasing, logistics and overhead now dominate total product cost. Regarding performance measures and metrics in supply chains and in Virtual Enterprises, one should recognize the importance of knowledge and information technology management, the development of trust, and the establishment of strategic alliances with suppliers or partners. All of these add value to products, ultimately providing value to the customer. Companies are making fundamental changes in the organization of and technology employed in their manufacturing operations, but they ignore their costing systems. It seems clear from the literature that the information available from a traditional costing system or ABC is not sufficient for the continuous improvement programs that are essential to competitiveness in rapidly changing market environments. Neither a traditional costing system, nor ABC provides accurate information about the consumption of different resources and activities. The ABC system is an information rich costing system useful in companies that perform value adding activities within, but not for the virtual enterprise where value is added by partners. ABC could be suitable for a manufacturing supplier. For a virtual enterprise or supply chain, because of their distributed nature, a simple costing system that uses purchasing/logistics cost plus overhead costs could be more suitable. Now we will turn our attention to new business models.
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3. New pressures, approaches and enterprises for the 21st century Supply Chain management (SCM) is now recognized as one of the best means by which enterprises can make instant improvements to their business strategies and operations (Kaihara, 2001). During the last few years, the focus has shifted from the factory level management of supply chains to enterprise level management of supply chains. This change of focus is due to the increasing global presence of companies. The physical flow of products amongst the nodes of the supply chain is studied intensively in effective SCM. Supply chains consist of several layers of business units. Resource allocation is a quite important operational criterion at the workshop level of SCM, but as the number of potential business units in the supply chain increases, the effective management of product distribution plays a more important role—it is a more dynamic environment (Kaihara, 2001). Markets are naturally distributed and agents make their own decisions about how to bid, based on the prices and their own utilities of the goods. Communication is limited to the exchange of bids and a process involving agents and the market. Issues of concern include the following: † How much the agent’s work contributes to the principal’s marginal profits; † The extent that ‘noisy’ (incomplete) information, distorts the principal’s ability to accurately monitor the agent’s performance; † Factors which reward or penalize behavior that is required or not--there is a need to develop optimal costing models based on agency theory and employment contracting; † Assessment of the optimal value of the agent’s contribution for the principal, having considered the extent that the agent is averse to carrying risks (Cullen and Hickman, 2001). Cullen and Hickman (2001) examine relationships developed in the UK’s defense branch of the aerospace supply chain. Comparisons are made between economic and formal contractual relationships. Major customers tend to develop complex and legalistic contacts with their suppliers and use the threat of enforcement when problems arise. This requires development of guidelines for the establishment of contracts between suppliers and customers in a virtual enterprise environment. A different type of costing system seems warranted. Perhaps transfer-pricing mechanisms could be used for costing products in a supply chain or virtual enterprise environment. Mabert et al. (2001) argue that most companies are pleased with their enterprise Resource Planning (ERP) systems. Although many expect the useful life of the system to be in excess of ten years, routine upgrades are required over time. Companies believe that ERP systems enable and enhance e-commerce initiatives, primarily by providing accurate, integrated, transaction processing capabilities for a firm. The conduct of business in the e-commerce environment demands accurate information and the ability
to measure impact instantaneously. ERP provides the digital nerve system to allow the backbone in an organization to respond swiftly to customers and suppliers. To meet the ever-changing business environment, many ERP vendors have upgraded their systems to operate on the Web. Aptel and Pourjalali (2001) highlight the differences between variables in hospital logistics, including the following: (1) the extent of responsibility given to the logistics department with respect to items like purchasing, physical supply, receiving, inventory management, internal distribution to medical departments, and management information systems; (2) the manner of distribution of supplies (such as central warehouse vs. direct vendor distribution); (3) the quantity of medicine distributed; (4) the degree of partnership between the hospitals and their vendors and other hospitals, and (5) the past efforts of logistics departments in improving supply-chain management and future plans for improving logistics functions. The study by Aptel and Pourjalali describes an interesting situation, wherein a new cost accounting system was developed to improve the overall performance of medical services and, hence, organizational competitiveness. Adoption of electronic commerce (EC)-enabled interorganizational systems (IOS) has become increasingly important for organizations to remain competitive in this era of globalization. Many organizations have established partnerships to develop new strategies jointly (for example JIT, QRM, ECR) based on EC and other enabling information technologies to improve the competitiveness of their supply chains (Kurt Salmon Associates, 1995; Holland, 1995; Johnston and Lee, 1997). Adoption of such systems, however, has proved to be extremely difficult since they span organizational boundaries. Adoption of IOS involves simple and sometimes complex interactions with external entities (such as trading partners, regulators and third parties) that normally have different and conflicting interests. The model developed by Kurnia and Johnston (2000) for the “first-order” model of Efficient Consumer Response (ECR) adoption in Australia included factors found to be associated with ECR adoption. Lamming (2000) describes a new order wherein Japanese suppliers are developing highly competitive, technical, realtime, market driven configurations of products, without the need to hold stocks in their supply chains and distribution channels. This suggests that companies will need to produce goods/services based on customer requirements. Burgess and Gules (1998) divide advanced manufacturing technologies into two types: hard and soft. Hard technologies are biased towards the use of hardware such as robotics while soft technologies, e.g. TQM, rely more on organizational procedures and management methods. It has been proven that supplier collaboration is more closely linked to the level of soft technology implementation than to that for hard technology. This should be taken into account in developing performance measures and costing systems in a supply chain/virtual enterprise environment. The new costing system should focus on purchasing, supplier development, knowledge management, information technology and logistics.
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Table 1 Differences between traditional and networked organizations Areas
Traditional organizations
Networked organizations
Strategy formulation
Focused on narrow market, centralized operations, Limited competitive performance objectives, Longlife cycle of products, horizontal organizational structure Aggregate Production Planning, Accurate Forecasting, Stable Master Production Scheduling, and Make or buy decisions. Make to stock, Pull/push scheduling, Quality assurance control systems, Large lot production Domestic market, Less intensive competition, Lack of focus on logistics, Focus on cost and not customer service, Lack of communication and IT applications Knowledge workers, Less IT skills, Lack of Innovation, Less investment in knowledge capital, Human resource management CAD/CAM, Legacy systems, Functional integration, Investment in IT is internally focused
Strategic alliances, Global market, Global outsourcing, Multiple competitive performance objectives, ECommerce, Vertical Organizational Structure, Shorter product life cycle Purchasing of goods and services, Enterprise resource planning, Selection of partners/suppliers, Partnership formation, Information productivity Agile Manufacturing/services, Scheduling of deliveries with Partners, Distributed inventory control Contract, Negotiations, Agility, e-Market, Timeliness is important, Reverse logistics, Customer service, Supplier development
Tactical decisions
Operational controls Purchasing and logistics
Knowledge management
Information technology
Summarizing the characteristics of new enterprise, the following are the key observations that should influence efforts to develop new performance measurements, metrics and cost accounting systems: † Activities are difficult to trace because of the distributed nature of the virtual enterprise or supply chain environment; † Many indirect costs will become direct costs and many direct costs will become indirect costs; † Logistics costs are a major portion of the total cost; † Many costs are hidden, and thus difficult to measure; † Knowledge management and information technology costs will be major costs in the virtual enterprise or supply chain environment; † A complex cost system will not likely work with the supply chain/virtual enterprise—a cost system similar to backflush costing may be suitable for new enterprise models. Different approaches to conducting busin ess have evolved in response to pressures created by a rapidly changing business environment. Businesses must be proactive if they expect to prosper, or at least reactive in order to survive. Table 1 highlights some key differences between traditional and networked organizations that can be gleaned from the discussion above.
4. Design of a Performance Based Costing (PBC) system A PBC system focuses on performance (in terms of financial and non-financial) rather than activities themselves, which avoids distorted product cost information produced by the application of traditional costing systems in the virtual enterprise/supply chain environment. PBC provides more
Invest in knowledge capital, Encourage to innovate, Training and educating employees to work in virtual enterprise, Multi-skilled workers Integration of supply chain, ERP, Extended enterprise integration, Invest in IT. Select suitable IT system matching Business models, Investment in IT has both internal and external focus
accurate cost information. The basic principle of PBC is to identify the business areas that add value to an organisation and to calculate direct materials, direct labour, overhead, etc., for the purpose of accurately estimating product cost. The product cost depends on the value added and costs incurred in those areas. Fig. 1 presents the steps involved in establishing a PBC system. The accuracy of product cost depends upon the costs of value creation areas and corresponding drivers. Based on this principle, the steps required to design a PBC system are explained. 4.1. Step 1: Develop objectives for the performance based costing system A PBC system may be desirable for a number of reasons. A company must carefully define the purpose of the system in terms of system objectives. Basic objectives of a PBC system include the following: (a) encourage proactive rather than reactive responses to markets, customers, and partners, (b) promote agility, and (c) create wealth (maximize profits). Other objectives would of course be necessary and would reflect organizational needs as well as the business environment. 4.2. Step 2: Develop PBC team The second step in designing a PBC system is to develop a team, which should include members from several disciplines and perhaps from different organizations in a virtual organization or supply chain environment. Team size depends on the organization’s size, urgency of completion of projects and the availability of staff. The team members should have the full support of top management, which is only possible if top management is convinced that a new
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4.4. Step 4: Identification of value-adding areas and CSFs
Fig. 1. Steps in PBC systems.
cost system is better than the old system, they should be dedicated to the success of the system, and they should have the required knowledge and experience to make a significant contribution to system success. 4.3. Step 3: Address issues of organization A PBC system affects many aspects of an organization and its partners. The potential impact of the new system, especially in terms of its effect on people and organizational relationships, should be considered. Many of these organizational impacts of a PBC system are not directly quantifiable, but to ignore them for that reason would be to ignore some of the most important issues, costs, and benefits (Lyne and Friedman, 1996). The particular nature and circumstances of an organisation are highly pertinent to an assessment of how suitable would be the adoption of the PBC methodology.
The Value Creation Area (VCA) is where a set of processes or procedures add value to products and services (value from standpoint of customers) and hence to an organisation. They are aggregations of tasks (whether performed by people or machines) to satisfy the needs of customers (whether they are internal or external) (Miller, 1992). The identification of the critical success factors (CSFs) for a PBC system is a basic step because it sets the structure and scope of the system. CSF identification forces the accountant to determine what is actually happening in the relevant areas of a business and ensure that the costing system is built on reality (Innes et al., 1994). It is to be noted that an “Area” can be defined as a set of activities that occur to create value to customers”. The identification of VCAs and corresponding CSFs involves finding out where in an organization the most value is created for customers. The approach to this task must be systematic to ensure that all relevant areas are considered. The “relevant” areas may differ in type and location from one company to another due to the technology, size and company approach. For a small company, quality control is an important value creating area, but for a big company quality control involves many areas that have broad scopes. Quality control responsibility in world class manufacturing is the job of all employees. The identification of micro and macro value creating areas is important for a PBC system. The micro areas are focal points of improvement efforts. The micro areas are used to cost the macro areas, which are the aggregation of related micro activities. The primary purpose of a Micro value area is to facilitate reporting of accurate product cost (Turney and Stratton, 1992). Visiting all the departments of a company, interviewing staff members, and listing the work done in each department can identify macro and micro areas. Business process reengineering is a valuable methodology that can assist in identifying macro and micro value areas. Clearly, a decision is required on the number of areas, including CSFs, to be used in the PBC system. The decisions should be based on the degree of CSF relevance (potential to impact CSFs) associated with each area, the level of detail required to give acceptable cost visibility to management, and the degree of accuracy required for product cost planning and control. Common activities in organizations include purchasing, customer order processing, quality control, material handling, production control, inspection, distribution, and maintenance (Miller, 1996). Most of these activities exist, and there are others that should be the focus of VCA/SCE (Supply Chain Efficiency) in the virtual enterprise/supply chain environment. 4.5. Step 5: Identification of CSF drivers in areas A CSF driver is a factor that has a direct influence on cost and performance pertaining to the CSF or VCA. It provides the best explanation of why costs in a CSF cost pool change over
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time (Kennedy, 1996). A CSF/VCA driver can be defined as any factor that causes a change in the cost of a VCA. The primary cost drivers are the link between resources and activities. They relate cost from the general ledger to the activities (Berliner and Brimson, 1988). The accuracy of a product cost depends on CSF drivers. The cost of each area is an aggregation of the costs of primary drivers, and “product cost” is an aggregation of the costs of areas. These CSF drivers actually indicate how many specific resources an area consumes. Different types of resources are required to perform in each area; therefore, every area should be analyzed in detail to create a list of all the primary CSF drivers. The estimation of cost for each driver should be very accurate. 4.6. Step 6: Critical success factors cost pools A CSF cost pool is the total cost associated with a particular CSF. Each type of CSF has drivers that become cost elements in a CSF pool. If all the costs of a CSF are identified by cost drivers, then the costs can be directly charged to the CSF cost pool. If some resources are shared by several CSFs, then some measure of apportionment will be necessary. The basis of apportionment should reflect as closely as possible the extent to which each activity consumes the shared resource. The best estimation of the apportionment rate does not adversely affect the accuracy (Keegan and Eiler, 1994). There are two views of categories of costs that should be included in a CSF cost pool. The first view is that all traceable costs should be included to create a fully absorbed CSF cost pool. This is attractive conceptually, in that all resource consumption is taken into account in the area (CSF) cost, and so all the resources are therefore managed at the area level. In practice, fully absorbed CSF costs become very complex and create a hierarchy of cross charging which distorts the understanding of cost behaviour (Marrow, 1992). The second view is that the costs included in a CSF cost pool should be those relevant to the decision being made and provide decision relevant information. A good rule is to strike a balance between excessive system complexity and the approach that suits the circumstances, information needs and requirements of an organisation. The area cost pool is traced to the cost object via secondary cost drivers.
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the underlying reasons for cost. In choosing the secondary cost driver, the following criteria should be considered: (i) the cost driver selected should have a strong correlation with cost level in the CSF cost pool, (ii) the variable should be quantifiable and homogeneous, (iii) minimize the number of unique drivers (cost and complexity are directly correlated with the number of drivers), (iv) select cost drivers that encourage improved performance, and (v) select cost drivers that are already available and/or have a low cost of collection. In practice, it may be possible that a number of cost drivers exist for the same cost pool, and in these circumstances, the exercise of professional judgement involving the application of the above criteria to a given situation will be necessary. For example, purchasing activity’s cost pool can have different cost drivers, such as the number of orders, number of suppliers and number of parts ordered. The objective is to pick the right number and the right type of cost drivers. Enough of the right types are needed to report accurate cost. Too many of them may be costly and create a system that is too complex to understand. These cost drivers differ greatly from the basis for overhead cost allocation in conventional cost accounting systems. They are the linkages between products and activities that represent opportunities for improvement in product or process design (Turney, 1996). It may not be possible to identify all cost drivers at the same level—they may span multiple organizational levels/units and even multiple organizations. In the traditional costing system, cost drivers are identified at the unit level and at the facility level. 4.8. Step 8: Cost object
A secondary cost driver is a measure of the frequency and intensity of demands placed on activities by a cost object (Miller, 1996). It is used for assigning the cost of a CSF to a cost object. A cost driver is a variable used as the denominator in rates used to apply CSF costs to product or cost objects (Innes et al., 1994). The cost driver rate can be calculated as follows:
A cost object can be any customer, product, service, contract, project or other work unit for which a separate cost measurement is desired. The cost object resides at the bottom of the cost assignment view of the PBC system. Most companies have two hierarchies of cost objects, one for products and another for customers (Turney, 1996). The ideal cost object is ‘products’ that are sold to customers. Linking the cost of a CSF/ VCA directly to areas and activities that affect the cost of products is the basis for a product cost under a PBC system. To operate effectively selected cost drivers should be clearly identified with specific products (Innes et al., 1994). If this does not occur, then the cost driver is effectively joint to several VCAs and may have to be split amongst them equally on based on some proportional assignment. Now the question is how to allocate overhead costs. Perhaps one could use the value added, contribution to CSF and overall performance of an organization. The allocation of such costs to products remains arbitrary even under a PBC system (Maurice and Nibbelin, 1992).
Cost driver rate
4.9. Step 9: Implementation
4.7. Step 7: Secondary cost drivers
¼ CSF cost for period=cost driver volume for period: Selecting appropriate cost drivers is a creative process in the sense that it goes beyond traditional analyses in the search for
The costing of a product with a PBC system should be compared with that of the traditional costing systems (one already in use). There is a risk of increasing the cost of a product due to an
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increase in the cost of measurement. If the system is very detailed, then the accuracy of the system will increase, but at the same, the time measurement cost will increase. The cost of implementing and maintaining a complex system can become excessive. If the product cost is higher using this new system than with the traditional costing systems (due to measurement cost and complexity of system), then PBC system should be reexamined, starting with identification of value creating areas. A simple solution for reducing system cost is a reduction in area details, but this reduction should be made carefully as it will affect the accuracy of product cost. For the successful implementation of a PBC system, management must be convinced of the need to change. A PBC system will be quite different from the existing system. When a PBC system becomes available, a group of managers and engineers should assemble to analyse the results. A well prepared PBC team can convince them of the PBC system’s value by presenting results for at least one major product for which they are responsible. PBC measures differ significantly from those reported by a company’s existing cost accounting system. The design and function of the PBC system should be explained to managers so they can understand how the new cost system differs from the existing one (Cooper, 1991). The users should be educated so that they understand the information available from the PBC system and how that information should be used in decision making. The primary aim of the new system is not to create an elegant and technically robust solution, but rather to provide a solution that will change behavior, particularly decision making behavior, thus allowing management to improve the performance of the business (Marrow, 1992). The design of a PBC system requires a detailed analysis of the already available information and collection of information that is not available from the present system. The identification of CSFs, value creation areas, and value creation activities and levels is critical to the design of a PBC system, because the cost of the system and the accuracy of product costs depend on it. The steps explained above can be applied to any organisation (service industry or manufacturing industry). A simple, but focused emphasis on value creating areas as the basis for allocating cost would improve the utilization of resources in the production of quality goods and services. 5. A framework for measuring performance in new enterprise In today’s information age, and with the development of e-businesses, the technology is transforming industry after industry, as well as creating new industries. Hidding (2001) argues that Sustainability Analysis (SA) assesses strategic advantage from the product perspective. It starts from the premise that no advantage lasts forever; the question is how quickly the advantage will erode. SA recognizes that product advantages come and go with different speeds, in
different environments known as “ecologies”. Different ecologies imply different strategy paradigms, regarding for example critical resources and key metrics. This is the basis for developing a new set of performance measures, metrics and costing systems. Alvarado and Kotzab (2001) suggest that there is need for integration of logistics and marketing. SCM orchestrates activities between firms. Efficiency requires strategic supplier partnerships and advancing relationships through mutual interests. Implementing ECR principles tend to be the greatest challenge for supply chain partnerships. Nevertheless, as Jenkins (1994) has insisted, it remains critical that managers be able to adopt and employ ECR principles. Following are several reasons why ECR is important for managers working in the grocery industry: † The push strategy does not work † Both suppliers and distributors have to work towards consumer satisfaction † Trust and compromise are better than power plays † The competitive environment does not allow growth based on sales only (Alvarado and Kotzab, 2001). Many of the activities and processes involved in ECR cross-functional boundaries as well as organizational boundaries. ABC and traditional cost accounting methodologies lack the capability to capture the value of some of the value creating activities involved in ECR. On the other hand, there is nothing inherently rigid in the PBC system that would preclude assignment of costs to activities or areas and ultimately to products for value creation areas and activities that crossfunctional and organizational boundaries. Table 2 provides examples of value creation areas, critical success factors, performance measures and CSF drivers. It is our framework for relating value creating areas to CSFs and CSF drivers, and to performance measures. This framework does not, and could not possibly contain all value creating areas, CSFs, performance measures, or CSF drivers, because they are likely to vary from firm to firm, and from business model to business model. Organizations could develop their own matrices for relating the elements of PBC-matrices based on their unique needs. Interorganizational teams of Virtual business partner employees or from supply chain partners could use this methodology to develop PBCs for assessing value system performance from end to end. Such a system wide approach to PBC could provide a starting place for the internal PBC of individual partners.
6. Conclusions Holistic and proactive concepts, such as Lean Production, Just-In-Time, Total Quality Management, Concurrent Engineering and Supply Chain Management have become important for companies seeking lean processes
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Table 2 A framework for measuring performance in new enterprise Value creation areas
Critical success factors
Performance measures
Networking
Experience, Education, Conferences, New Initiatives, Joint Projects
Investment in Skilled workers, Support for exhibitions and Product promotions, New products Investment in KM workers, Investment in IT, Training and Education in Virtual Enterprise Investment in training and education, Strategic alliances with high tech companies, Investment in knowledge capital Business strategy, agility focused, E-commerce enabled SCM, Global manufacturing, Global outsourcing, Global market Number of years in business, IT Strategic alliances, ERP, investment, Past performance, Constant meetings between Repeat orders, Delivery partners, Long-term business performance contracts, Technological support Selection of partners for logistics Warehousing operations strategy, service and suppliers for goods, Outsourcing of logistics service, Time to deliver products, Logistics Number of partners/suppliers, cost, Time to Process orders Number of products, IT in purchasing and logistics Time to respond to customer Invest in IT and KM systems, enquiries, CRM system, Budget Training and Eductaion, Strategic for training and education, Number alliances to facilitate better CRM, of meetings, Workshops, Incentives Invest in communication technologies, Incentives for good job
Partnership formation
Knowledge management
Information technology
Trust creation
Purchasing & logistics
Drivers of CSF
Knowledge workers, Number of conferences or meetings attended, Number of joint projects, number of new products introduced Communication, Trust, Data mining, Data Warehousing, Infrastructure, Past performance, Number of partners/suppliers, Selection of business strategy, B2B Training and Education Information technologies (Internet, Number of IT trained Managers, EDI, WWW), Training and The age of the website, Integration Education of B2C and B2B, ERP, BPR, E-Commerce Selection of suitable IT, Number of Software, Number of Integration of suppliers/partners, PCs, Budget for IT training and Eductaion, ERP system, and Investment in IT Long-term relationship, Transparency, Good communication, Meetings and Contracts Inventory control, Warehousing, Shipping and Transportation
Customer Relationship Management (CRM) B2C, Customer service, Good IT skills, Communication skills, Knowledge of Products and Services, Knowledge about technical content of the product
with short throughput time and zero defects. In most plants, the physical equipment is susceptible to failure through breakdown, deterioration in performance through age and use, and to obsolescence due to improvements in technology. The rising importance of “Streamlining” the processes and achieving process control and flexibility has raised the cost of disturbance, and, thus, increased the need for reliable and consistent equipment without quality problems (Jonsson, 2000). Likewise, there is a need for reliable and consistent performance measurement methodologies to meet the needs of businesses operating in our ever changing and increasingly competitive global business environment. In this paper, we described pressures and approaches that characterize the 21st century global business environment. We described some characteristics of new enterprise models like the virtual enterprise. From those descriptions we speculated about the nature of appropriate performance measurements, metrics and costing systems that will be required to improve the competitiveness of new enterprises in the 21st century. A performance based costing system was discussed, highlighting its capability to measure performance in such areas as knowledge management and information systems, as well as performance across functions and organizations. The steps for setting up that
PBC system were described. Finally, a framework describing the relationship among PBC system components was presented in the hope that it would provoke more thought on and development of the concept. Management practices and methods have changed and organizations are moving from managing vertically to managing horizontally. PBC and Performance Based Management (PBM) provide cost and operating information that mirrors the horizontal view. We believe that the PBC system can provide accurate cost information and Activity Based Management can use this information to initiate performance improvements. We, like many other researchers and practitioners, recognize the limitations of traditional costing methods when applied to business models that have evolved over the last decade of the 20th century and the early years of the 21st century. ABC helped to bridge the gap (address measurement problems) when businesses, particularly manufacturers were undergoing fairly dramatic changes in the 80s and 90s. It appears now that limitations inherent in ABC, as well more traditional costing systems, make them less than perfect measurement approaches for evolving business models. PBC systems may or may not be the solution to performance measurement challenges faced by organizations in the 21st century, but the time has come
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to examine new approaches. This is precisely why we have presented our ideas on the PBC system. We believe more research is needed on performance measurement tools for 21st century business models. Specifically, we believe future research directions should include: (1) development of a more precise framework based on the ideas presented for developing a PBC or similar system and (2) empirical testing of the performance measures and metrics that would comprise a PBC or similar system. Action research and longitudinal case studies would seem appropriate methods for studying the implementation of PBC systems as well as their effectiveness over time. Whatever the method, we hope to see more research on this important area in the near future.
Acknowledgements The authors are most grateful to the Editor, Dr. George Hayward for his constructive and helpful comments on the paper.
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Dr. Angappa Gunasekaran is a Professor of Business Administration in the College of Business and Management at the University of Illinois-Springfield. Prior to joining the UIS, Dr. Gunasekaran was on the faculty of the Charlton College of Business, University of Massachusetts (Dartmouth) since 1998. He has held academic positions at Brunel University (UK), Monash University (Australia), the University of Vassa (Finland), the University of Madras (India), and the University of Toronto, Laval University, and Concordia University (Canada). Dr. Gunasekaran has a PhD in Industrial Engineering and Operations Research from the Indian Institute of Technology (Bombay). He has over 150 articles published in 40 different peer-reviewed journals. He has presented and published about 50 papers in conferences and given a number of invited talks in more than 20 countries. Dr. Gunasekaran is on the Editorial Board of 20 refereed journals. He is involved with several national and international collaborative projects that are funded by private and government agencies. Dr. Gunasekaran has organized several international conferences in the emerging areas of operations management and information systems. He has edited books that include, “Agile Manufacturing: The 21st Century Competitive Strategy” and “Knowledge and Information Technology Management: Human and Social Perspectives”. Dr. Gunasekaran is the Editor of Benchmarking: An International Journal, Associate Editor of the Integrated Manufacturing Systems: The international Journal of Manufacturing Technology Management and the Regional Editor of the Supply Chain Management: An International Journal. Dr. Gunasekaran has received Thomas J. Higginson Award for Excellence in Teaching within the Charlton College of Business. He has edited several special issues for well known journals. Dr. Gunasekaran is currently interested in researching benchmarking, e-commerce, performance measures, logistics and supply chain management. He has been serving on over 25 committees at the department, college and university level committees that include the university curriculum committee, general education committee, and faculty evaluation committee. Recently, Dr. Gunasekaran has received an outstanding paper award from Managerial Auditing Journal for the year 2002.
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Dr. H. James Williams is Dean of the School of Business, at North Carolina Central University, located in Durham, North Carolina. He earned the following degrees: B.S. Degree in Accounting, at North Carolina Central University (1977); a M.B.A. Degree in Accounting at the University of Wisconsin (Madison) (1979); a Ph.D. Degree in Accounting, at the University of Georgia (Athens) (1982); and J.D. and LL.M. (Taxation) Degrees, at Georgetown University Law Center (1988 and 1990, respectively). Dean Williams is also a Certified Public Accountant and a Certified Management Accountant, with a wealth of practical experiences, having worked in the public accounting profession and in the legal profession (as a corporate and tax lawyer). Currently, in addition to his responsibilities as Dean, Dr. Williams is very active in the community, serving on a number of corporate and community boards.
Dr. Ronald E. McCaughey (Ph.D., Auburn University) is an Associate Professor of Information Systems at the University of Central Arkansas. His research appears in the Journal of Systems Management, Information and Management, International Journal of Production Economics, International Journal of Computer Integrated Manufacturing, the Journal of Information Technology Management and in other journals and conference proceedings. He is the Internet Editor for the Benchmarking: an International Journal and serves on the editorial board of other journals. He has practical experience in industry. His current research interests include manufacturing strategy, Benchmarking, E-Commerce, and the use of computers by the elderly.
