Using activity-based costing to assess channel/customer profitability: better understanding of your customers' profitability picture is imperative for survival in today's competitive environment. Here the CFO of an employment services company used ABC to analyze the company's profitability picture at the customer channel- and individual customer-level

Management Accounting Quarterly, Wntr, 2004 by DeWayne L. Searcy

"With better information and accounting systems, firms are beginning to disaggregate revenues and costs to customer or account level. This analysis often reveals previously hidden subsidies across customers, products, and markets." (1)

Most firms are well aware of the 80/20 rule in which a small fraction of customers accounts for a large share of revenues and most of a firm's profits. As the above quote states, that small fraction of profitable customers subsidizes the firm's other unprofitable or, at best, breakeven customers. Instead of accepting the 80/20 rule, firms should strive to identify those subsidized customers and work with them in either altering the servicing of those customers (including pricing) to a more equitable arrangement or outsourcing the servicing of those customers altogether.

Temp Employment Company, Inc. (TEC), a firm in the employment services industry, used Activity-Based Costing (ABC) in assessing the profitability picture in order to better understand which customers were profitable and which were subsidized. This article describes the journey of TEC's chief financial officer through the ABC implementation and subsequent analysis. (Note: The name of the actual company has been changed and the financial data altered to protect the company's confidentiality.)

ABC AND THE FIRM

TEC is a multi-office employment services firm offering temporary employment and permanent placements. The temporary employment division represents over 70% of TEC's business and is the focus of this article. Before covering how TEC used ABC information to assess its profitability picture, TEC's ABC implementation will be briefly discussed. Table 1 summarizes the four-step process TEC completed in transforming its cost management system.

Step 1. Develop the activity dictionary.

In the first step, TEC was divided into activities. It would have been possible to divide TEC into several activities, but it was important to develop a simple, yet meaningful, system. Three activities were defined as relevant to the operations of the firm: 1) filling work orders, 2) hiring temporary employees, and 3) processing payroll/billing.

The filling work orders activity begins once an order is received from a customer and ends when the customer is provided with the name(s) of the temporary employee(s) assigned to work for them. The hiring temporary employees activity involves the process of hiring employees for temporary assignments. This activity begins when an application is completed and ends once the employee is debriefed on company polices and entered in the system. The last activity, processing payroll/billing, involves the weekly payroll and customer billing process.

Step 2. Determine how much the organization is spending on each of its activities.

Once the activities were identified, the CFO assigned the direct costs associated with each one. Any resource that could not be directly traced to an activity was initially assigned to a general overhead account. Once the directly traceable resources were assigned to each activity, the general overhead was allocated. Table 2 summarizes the results of assigning the costs to the three activities of TEC. The general overhead was allocated to each activity on the basis of the directly traceable costs of each activity to total directly traceable costs.

Step 3. Identify the organization's products, services, and customers.

As mentioned earlier, TEC offers two services, temporary employment and permanent placements. Within each service offering, TEC's customers are separated between two channels, industrial and clerical, depending upon the job classification of the position they are seeking to fill. Industrial customers hire temporary employees to fill touch-labor positions (such as assembly, machine operator). On the other hand, clerical customers seek to hire office positions (such as receptionist or secretarial).

Step 4. Select activity cost drivers that link activity costs to the organization's products, services, and customers.

The goal of identifying a cost driver for an activity is to determine the source that causes the consumption of that activity--what drives the activity. The cost driver identified must be quantifiable and reasonably accessible. The three activities and the related cost drivers are discussed next.

FILLING WORK ORDERS

The first activity identified was "filling work orders." As stated earlier, customer service coordinators begin to fill work orders once a customer calls in a request for a temporary employee. If a customer does not call in an order, there is no work order to fill. It makes sense then that the cost driver for the "filling work orders" activity is the number of temporaries ordered by customers. This is used as the cost driver instead of the number of orders generated because an individual order can be for more than one temporary employee. The more temporaries on an order, the more servicing of the account is required. Thus, the number of temporaries ordered is a better indicator of resources consumed by the activity than the number of orders.