A framework for integrating activity-based costing and the balanced scorecard into the logistics strategy development and monitoring process

INTRODUCTION

Activity based costing (ABC) systems and the balanced scorecard have generated extraordinary interest in corporate America recently. One can find numerous firms, small and large, that have or are implementing both of these methodologies which are designed to help relate the economic value or worth of current and potential actions, strategies, and plans to the firm and its stakeholders. Overall, one can view these systems as two elements in a firm's kit of decision support tools. They are perceived as valuable ways to improve and clarify decision making and to monitor progress against goals. Given the current effort and investment devoted to them, the question arises of how, if at all, these two initiatives may complement each other.

This paper demonstrates how a company can use its ABC system and balanced scorecard in a complementary fashion. In addition our framework introduces an approach for linking the key performance measures of a balanced scorecard directly to the firm's overall goals or objectives. Specifically, it illustrates how the analytical hierarchy process (AHP), a multi criteria decision-making technique, can facilitate that linkage.

This paper demonstrates the potential synergies between an ABC system and a balanced scorecard by showing how the two methodologies can provide input to a firm's distribution channel strategy. Briefly, we review how an ABC system can reveal critical insights into the current and future profitability of alternative distribution channels and thus help fashion an effective channels strategy. At the same time, we discuss how a firm can employ the key performance measures of a balanced scorecard to monitor that strategy as well as progress toward overall firm goals.

The paper begins with an overview of ABC and an example highlighting the differences between actual and perceived channel profitability as indicated by an ABC and a traditional accounting system.1 This example illustrates the key role an ABC system can play in the development of a distribution channels strategy. Next a brief review of the balanced scorecard considers how its performance measures facilitate monitoring a firm's progress toward overall objectives.2 Finally we propose an approach that facilitates formal, quantitative links between those performance measures and a firm's overall mission and objectives, and specific strategies, such as its distribution channels strategy. The approach uses the AHP technique.3

ACTIVITY -- BASED COSTING

ABC evaluates the costs of a firm's activities based upon the actual resources and time consumed in performing them. One can (and ideally should) apply ABC to all major processes and activities of an organization, and certainly to all elements of the supply chain. One of the first areas in which ABC gained prominence was product costing for manufacturing operations.4 Traditional manufacturing cost systems typically allocated costs to products using only a few standard cost bases: labor hours, machine hours and/or material dollars consumed. However, as more firms began to view manufacturing operations as a series of linked activities, it was increasingly recognized that these limited traditional bases did not accurately depict the true costs of production. Firms began to expand the number of cost bases or drivers to include such activities as the number of setups and changeovers, the number of receipts and shipments, the number of orders, and so on. Thus, many conventional volume-based costing systems gradually evolved toward ABC. (The interested reader is referred to Cooper,5 Cooper and Kaplan,6 and Pohlen and Lalonde.7)

ABC AND DISTRIBUTION CHANNELS

When firms use ABC to evaluate distribution channels, they often find a significant change in the perceived profitability. The picture given by a traditional accounting system, which employs only a few volume-focused bases, may differ dramatically from the detailed ABC view. Consider, for example, the costing of warehouse operations. Assume that a firm's traditional costing system allocates warehouse costs based upon either the total dollars or weight shipped to each customer and channel. Typically, however, customers, channels and products do not consume warehouse resources (such as labor and machine time) proportionately to their dollar or weight volume, so a traditional cost accounting system will distort the true costs. Suppose a warehouse has a mix of low-valued to highvalued products with a wide range in the dollar value per pound, and it receives, stores, and ships products in everything from individual eaches (e.g., pharmaceuticals) to pallet quantities (e.g., bulk consumer products). In addition, there are small pick lines (for eaches), automated conveyor lines (for cases), and forklifts (for bulk pallets) to move product from inventory storage to the shipping dock. Finally, there is a separate pick area to serve the special requirements of the three largest customers, and all modes of transport are used, from truckload to ground parcel to next-day air. An ABC view of costs at this facility would differ substantially from that of a traditional volume-based perspective. Table 1 shows the difference in the net profit generated by three different distribution channels as calculated by traditional, volume based accounting and then by an ABC approach. While a "volume-driver" based traditional accounting system may use only sales dollars and/or weight shipped to assign costs, an ABC system employs many more drivers. For example, a warehouse may use a case pick operation to serve small retailers and a bulk pick operation to serve wholesalers and mass merchandisers. An ABC system would accurately calibrate the different costs of serving customers using the two different operations. It also would evaluate the costs of all other major components (such as order management, transportation, and sales force activities) involved in serving customers. In this fictitious case, one can observe that small retailers provide the smallest margin, while the mass merchandise and wholesale channels yield a higher return. The example illustrates the altered cost and profitability picture produced by ABC systems.8 These insights can be critical in developing a distribution channel strategy.