Many companies continue to use inappropriate cost management approaches which distort cost and profitability reporting and provide often counter-intuitive and completely misleading information to support commercial decision-making.  Given the proliferation of now relatively mature costing methodologies, it is extraordinary that so many executives are prepared to accept cost management information which is not based on the fundamental principle of cause and effect.  Whilst the debate will continue as to the respective roles of financial and management accountants, it is clear that adoption of new cost management methodologies is an issue of cultural change.

One of the more subtle reasons for avoiding change is the perceived complexity of new methodologies and the effort required to implement and sustain a new approach.  Leading an organisation deploying Activity-Based Costing systems for over 12 years has provided some insight as to where managers are getting it wrong.  My belief is that cost models should be as simple as possible and as complex as necessary.  It is my experience that many managers or consultants who are tasked with constructing models often lose perspective in layers of detail and the effort required is totally disproportionate to the organisational benefits.

Often the first complexity-related problems are technological.  Financial managers’ and consultants’ proficiency with spreadsheets has led some to believe that anything can be modelled, manipulated, calculated and analyzed this way.  The reality is different.  There are any number of cost modelling software tools available which can assist organisations in developing multiple-stage cost assignment models, ranging from standalone desktop applications to enterprise-wide systems.  In all but the most simple models, the limitations of spreadsheet become quickly apparent:  the lack of visibility, the complexity of cell formulas, the conversion of all driver quantities to percentages, the inability to trace cost flow and analyse cost contribution and the inflexible nature of spreadsheet models (how do I add another period, scenario, product or customer?) requires Herculean efforts to build and maintain them.  Experience of replacing spreadsheet-based systems with dedicated software can dramatically simplify the modelling process and provide a much more powerful analytical platform.  A real-life example comes from a customer whose costing team had developed over 600 linked workbooks with an average of 10 worksheets in each.  A 5-man team struggled to update this model on an annual basis and provided very basic results and analysis for the business.  A single cost model is now updated on a monthly basis with the same team spending most of their time on analysis and planning.

Technology is not, however, a silver bullet which will automatically solve all cost management problems.  In some instances, the very fact that technology is capable of handling vast amounts of data can lead to overly-complex cost models.  Here’s a test which has proved effective with a number of clients who have needed to simplify their cost models:  for each cost driver in your model, calculate the total cost for which it forms the basis of allocation.  Rank these cost drivers by their total cost and evaluate the level of effort that goes into the collection of data for calculating those driver quantities.  For many service-based organisations People, IT and Occupancy costs will collectively represent 85%+ of operating expenses.  Make sure that the effort expended in the collection of quantitative driver data is proportional to the impact on cost flow and consequent model accuracy.  Activity-Based Costing is a continual process of division where inaccuracies tend to get smoothed out through the model as opposed to compounded.  The greatest impact on cost flow in a model is the logic which connects costs, activities and outputs (i.e. where you are allocating cost) whilst the absolute precision of driver quantities is less important.

In the final analysis, any progressive costing methodology must support managers in making decisions which have a positive commercial impact.  Collecting data to support a level of detail which does not change the decisions that management make may simply be wasted effort.

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