ABC Cost Drivers: 'Weighty' Decisions

While it makes sense from an ABC perspective,
is it right to charge customers by weight?
Source: directline-holidays.co.uk

In industries that are highly competitive, an understanding of costs is crucial. Identification and analysis of a business's cost drivers are key to achieving lean operations, through a more accurate understanding of how costs are generated through an organisation's value chain.

An understanding of costs is imperative in the airline industry, where competition is intense, and where industry conditions have been hit hard by the fallout from the Global Financial Crisis. In 2012, overall airline profits totalled $7.6 billion. While this sounds like a lot, this only boils down to about $2.56 per passenger (Source: IATA). This makes an accurate understanding of costs crucial, and acting on activity-based information to improve margins by finding opportunities to reduce costs or accurately pass customer-generated costs is important.

But can there inappropriate activity-based actions to improve a company's bottom line? Consider the recent decision by Samoa Air to become the first airline in the world the charge passengers based on their weight. You can watch and read more about their decision here and here.  From a business standpoint this makes sense. People are charged accurately for the cost burdens they place on the airline (weight adds to a plane's fuel requirements, and a larger person may take up and extra seat that might have otherwise been available for another passenger). The CEO of Samoa Air indicated that, from their perspective, this is the fairest way to charge customers, because "a kilo is a kilo is a kilo." However, does this seem fair in the court of popular opinion? Many would argue that this discriminates against larger people, many of whom may be unable to help their situation. Some may also argue that it also sends out the wrong image regarding body image.

What do you think?

School-Based Management: Can decentralisation work in government schools?

School-Based Management: does it add up?
Source: ecenglish.com

School-Based Management is one of the hot issues in NSW public schools at the moment. Generally speaking, school-based management is defined as the transfer of authority for many matters (e.g. managing school budgets, hiring staff) from the central government authority to the school level. Since first promised as part of their 2011 NSW state election platform, Barry O'Farrell and Coalition government have been moving to make such an initiative a reality for NSW government schools.

To date, the NSW government schools system has operated in a relatively centralised fashion. The NSW Department of Education has largely retained centralised responsibility for school recruitment, staffing and finances. many arguments are put forward to decentralise these responsibilities, and allow schools to make decisions for themselves. Advocated reasons for such moves correlate strongly with conventional arguments for decentralised decision-making authority in large organisational settings. Can you recall what these conventional arguments are and how they may relate to improving the quality of schools and education? You can read an evaluation of school-based management here and an assessment of pilot testing of school-based management in the NSW here. 

However, not everybody is happy about this development, and there is strong criticism about the possibility of decentralised schools. What do you think the bases for their criticisms might be?

What's your view? Do you think school-based management is a good thing? Or do you think maintaining centralised control of government schools is in the best interests of public eduction? Let me know your thoughts.

Update: The Coalition Federal government announced in February 2014 a $70 million proposal to train school principals and leadership boards as part of a plan to help 25% of government schools across Australia become 'independent' by 2017. Read more here.

What drives cost? The case for ABC

Activity-Based Costing (ABC) delivers more accurate costs - this is the mantra pushed by advocates of this costing approach. How so? Here's we draw on a few practical examples to help bring clarity to this claim.

Example 1: Nanosolar

Our first example will consider the high-level production activities of Nanosolar, a leading manufacturer of solar cells and panels. (You can read more about the company here.) There are 4 high-level steps in nano-solar's solar panel production process: (i) production of nanoparticle ink, a fundamental ingredient in a solar panel's energy capturing potential; (ii)  printing nanoparticle ink onto propriety aluminium foil; (ii) cutting foil and assembling them into solar cells; and (iv) assembling cells together to form solar panels (the finished product). Watch the process in action here.

After reading through the basic production process and watching the associated video, Think about the following:

• What are the significant costs incurred in this process? (Specifically identify as many as you can.) 
• What proportion of these costs are likely to be directly traceable to eachpanel produced (high/low)?
• For the indirectly traceable costs, what proportion is likely vary with each panel produced (high/low)? 

Example 2: Fine Dining

Have you ever bemoaned the cost of eating out, particularly when it comes to fine dining? Many have difficulty reconciling menu prices with what they receive on the plate. Amusingly, some people I know go as far as to sprout the theory that the price of a meal is inversely related to the amount of food one receives on the plate! Of course, this theory is based on the limited view that the cost one can see on the plate (the physical ingredients to the actual meal) accounts for all the costs. Some investigative journalism by the Sydney Morning Herald (see articles here and here) highlighted that there are many overheads that need to be taken into account, and that the margin being made on each meal may be far less than one thinks. Take for example the following meal from Canberra's Aubergine restaurant:

Would you pay $36 for this meal? (Source: Sydney Morning Herald).

The above example shows the many indirect (otherwise known as shared or overhead) costs associated with this meal. Think about the following:

• What are the implications of this high proportion of overhead costs? 

• Are there further implications from the fact that many of these overhead costs would not vary with each meal served?

The value of ABC

Reflecting on the above examples, the value of ABC comes in being able to identify more specific and robust logics for how overhead costs should be apportioned to things we want to estimate the cost of. This is particularly so where overhead is a higher proportion of total costs; many of those costs are driven by something other than volume of output (e.g. batches run, product lines maintained, or general facility-related concerns), and where, in a multiple product/service provision setting, different products/service draw on proportionately different levels of resources. 

On the flip-side  ABC can be quite expensive and resource intensive to implement. And it brings its own problems, uncertainties and motivational issues. What are your experiences with organisational uses of ABC systems. Have they been of benefit? What problems were encountered? 

Costing or Caring? Activity Based Funding in Australian Hospitals

The Activity-Based Funded future for hospitals?
(Source: The Health Roundtable)

Since 2008, negotiations between the Australian Commonwealth and State governments have been progressing towards the implementation of a nationally consistent system of Activity Based Funding (ABF) for Australian hospitals. Basically, ABF is a system for allocation health funds based on the activities/treatments they undertake. Consequently, funding allocations are driven by activity type, quantity of activity by type, and standardised cost per activity type (cost). 

ABF is not a new idea, Notwithstanding this, introducing a nationally consistent ABF framework represents a significant national health reform. Driving this reform is a desire to better understand and control rising health care costs driven by new treatments, an ageing population, and increasing rates of chronic and preventable diseases. The overriding fear is that: 

Without this reform, state and territory government budgets will be overwhelmed by their rising health spending obligations ... Projections show that by 2045-46, health spending alone would be more than all revenue collected by state and local governments (Source: yourhealth.gov.au).

What would be the benefits of ABF be to addressing these fears? How would it help to better understand, allocate and control health expenditure? Read more here and here.   

Although there are many supporters of the initiative, there is also vocal opposition to the introduction of ABF. Consider the following quote from Greens NSW MP John Kaye:

Activity-Based Funding turns hospitals into factories and patients into products. It will undermine outcomes, further demoralise professional health staff and hit the elderly and mental patients particularly hard (Source: John Kaye Media Statement).

The core of this criticism is a deemed incompatibility between costing and caring in the health sector. What would be the grounds for this deemed incompatibility? Particularly, how does recourse to activity-based methods potentially inflame these criticisms?

What do you think about this use of ABC? Is this a well founded reform? Or is this a case of business methods overreaching into the administration of important government services? You decide. 

The Economist: Cost behaviour driving change in the airline industry

Airline margins are tightening.
Capacity management is crucial

(Source: Airline World and Clay Bennett)

Airlines around the world are feeling the squeeze. The fierce price-based competition, the GFC, rising fuel prices, and greater uncertainty in travel demands have increased pressure on airline bottom lines. When times are tight, airlines focus heavily on capacity management. In part, this is focused on 'getting bums on seats'. Increasingly, as a 2012 Economist article highlights, airline are also increasingly giving thought to how they should best source their aircraft fleet.

Essentially the question airlines confront on the matter of sourcing aircraft is should they buy or rent? Traditionally, airlines have owned their aircraft. This is fine in a steady or growing travel market. But ownership ties up resources and commits expenditure for long periods of time What happens if the market turns or demand fluctuates? What if demand in new routes is relatively untested? What if the airline is new, or otherwise lacks sufficient financial stability to responsibly commit to the long term financial demands of ownership? Such questions are particularly important in the relatively uncertain market conditions airlines now face.

The market response, according to The Economist article (which can be read here) has been the rise of "airlines with no passengers" - aircraft leasing companies. Given current market conditions, airlines are warming to this development - over a third of the world's airline fleet is now leased, according to the article. This brings added flexibility to the cost management of a key airline resource (their fleet of aircraft). Leases can be made for desired durations, brought in and removed as needed. Responsibility for the cost management of unused aircraft falls back to the lessor.

However, an airline's decision to own or lease, and by how much, is not always an easy decision. There are likely to be a host of positive and negative considerations to take into account (both financial and non-financial). Some are briefly outlined in the article. Can you think of others? Do you think it is likely to reach a point where most aircraft are leased? Do you have any other comments on this industry development? Let me know your thoughts.