As a veteran of more than a couple of Warehouse Activity Based Costing projects, I’d like to share some of the insights I’ve gathered along the way.
First, I am a whole-hearted believer in Activity Based Costing (ABC) in virtually all forms. The old adage of “you can’t improve what you can’t measure” I feel needs a special adjustment for ABC in that “you don’t improve that what you don’t cost.” When ever you “peanut butter” spread the costs, you lose the visibility to the drivers of cost.
I’ve seen it time and time again, warehouse costs (or any other cost center) are spread evenly over all products. As a result, the overall warehousing number becomes the only number that matters and it only matters to the warehousing leadership. All of the daily activities that can drive costs are kinda, sorta, not really, cared about. Why? Because the impact of the decisions doesn’t hurt/help the person who is making the decision. Let’s look at some real world examples…
Example 1: Bob
Bob is a procurement manager, his key metrics that most impact his job are out of shelf items and overall pricing. He knows that he can get lower prices and reduce the risk of out of shelf by buying larger quantities. Bob knows, his target is 2 months of supply. So, he buys 3 months (which will, by the time it is gone, average less than 2 months.) The extra storage costs? Not part of Bob’s consideration, even if it goes into outside storage. Sure, as a good corporate citizen he “cares”, but really, he feels that managing the costs is why there are warehouse leaders. What does Bob care most about? Bob, naturally.
Now, let’s add activity based costing in, and suddenly Bob is in a whole new world. Because the Activity Based Costing dings his products P&L at the end of every day with a “storage” charge, the over purchase now cuts into Bob’s P&L. Cutting into Bob’s P&L with pricing has Bob’s attention. Bob stops over purchasing.
Example 2: Sue
At another company, there was a Sue. (Yes, these are real situations but not real names.) Sue bought half pallets on a regular basis. Because they were being backhauled, her trans costs were negligable AND she was helping her friend in the transportation team by boosting their KPI of percent backhaul loads. This is also a great example where a KPI makes bad behavior look like good behavior – costing beats KPIs every time. Add a little magic of ABC and suddenly Sue’s warehouse costs are higher than average. Two trips to put stuff away shows Sue that her procurement scheme was not without a downside.
Now, I’m not saying that every time that ABC is turned on that magically the entire organization wakes up to all of the behaviors that are costing extra money and suddenly fixes them. I’m just saying that when the costs and the consequences are clear, people care a lot more than they did when it was part of someone else’s KPI / P&L.
BUT (and you better have expected a but), there are some downsides, and it is important to be aware of them prior to committing to an ABC project.
The big one is political, there will be winners and there will be losers. One company I worked with, when they shifted from peanut butter to ABC, they completely upended the marketing department. One product group that was previously seen as the “sexy” one to be part of and, due to internal name recognition and overall margin, was the team to be on if you wanted to get promoted. Suddenly, the product group was no longer the rocket to propel a career but was re-classified as a “cow” (to be milked for cash). The ambitious head of that marketing team was none to pleased that some wonks in warehouse accounting killed his ticket to the big time. The ABC model stuck but so did the organizational scars. The lesson is simple, make sure that even before results are in, that the possible impact gets communicated at the highest levels.
The second counter point is subtle but pervasive. All allocation methodologies, whether activity based, peanut butter or some other method, inherently contain the biases used to make them. Let’s go back to Bob. I slipped in the example the fact that his products got charged a “housing” fee for every night. A housing fee is very common, I’ve seen it done as a daily, weekly, or monthly charge. Usually, this charge is based on the overhead (non-activity) of the warehouse. The thinking being, you are in the rack, you pay rental for that rack.
But here is the thing with that allocation, if Bob reduces the inventory he holds, until the overall inventory profile is in such a state where the warehousing footprint can be changed, Bob doesn’t actually reduce anything to the bottom line. The money Bob is “saving” doesn’t directly save anything. All that happens is that the costs just get allocated next month across fewer cases. All Bob did was make the other people’s storage more expensive. And since warehouse footprints can’t be changed on a dime, are you creating a situation where Bob is incentivized to play games with inventory in a manner that doesn’t drive costs to the bottom line?
I’d argue that without everyone pulling in the same direction, you can’t achieve that dramatic step in cost saving. But, at the same time, adding “games” to a company’s measures is a sure way to get people who are only really good at the game. Meanwhile, the company may never see a single dime in benefit. Like I said, all allocations contain biases, the trick is to understand the behavior that each bias can drive.
Lastly, experience counts. That example of the company that unexpectedly upended the marketing department, that was from my first ABC rodeo. The subtle issue of overhead allocation, that came after multiple bites of the same apple. Warehousing is a great place to now do ABC because almost all warehouses have good transactional systems that can be a feeder for ABC activities. But there are big and small questions that need to be answered along the way. Do you do a full P&L integration? Do you do a report or two that is shared to help fix the biggest cost issues? What is a Rate/Vol/Mix report and why do we recommend them? Is the cost difference enough to actually change behavior?
Hopefully, this provides food for thought for those thinking of a warehouse ABC project. I do recommend Warehouse Activity Based Costing strongly. (I also strongly recommend Transportation Activity Based Costing, but that is another post.) Behaviors change for the better when costs are reflected most accurately. But I also strongly recommend an experienced partner like Cabri Group. We can talk the strategy of why, the tactics of how, and can even turn the knobs that can get you live.