Strategic Cost Management in the Airline Industry Finance... · · 2016-03-11can play a key role in maximizing shareholder wealth by providing relevant data for ... Marketing, Sales

STRATEGIC COSTMANAGEMENT IN THE

AIRLINE INDUSTRY

By: Anton van der Merwe and Christopher Jackiw

Originally published as “Strategic Cost Management in the Airline Industry” from the

Handbook of Airline Finance, McGraw-Hill Companies, Inc., 1999.

Strategic Cost Management in a Complex Service Industry 1

The Utopian vision of strategic management is a strategy that is pursued by everyone

throughout the enterprise and successfully executed, with management at all levels

leading and acting in unison. This vision is more easily attainable when the enterprise is

able to standardize and integrate business processes and has the capability to use the same

data, in concert, from the highest level to the minutest level of detail in the organization.

Until recently, this level of process and data integration was not possible. But real-time

integrated systems now make this level of integration a reality, so achieving the Utopian

vision a real possibility. It is important for an enterprise to achieve this vision since it is

only through repeatedly being successful in executing strategy that the enterprise can

ultimately maximize shareholder wealth. The strategic cost management system (SCMS)

can play a key role in maximizing shareholder wealth by providing relevant data for

supporting decision making and information for maximizing long-term profit, and by

accommodating essential business processes.

This chapter is essentially an argument for a management accounting system with

a strategic focus to assist the enterprise to maximize shareholder wealth. On the subject

of management accounting, it should be noted that management accounting is a discipline

in transition1. At this time innovative concepts abound. None of these concepts should

be ignored when one is covering this subject; their omission here is owing to a lack of

space and nothing more. Similarly, those concepts mentioned or introduced here should

also not be construed as deemed more important than others. The concepts explored in

this chapter were, however, considered more relevant in highlighting a practical approach

to aiding the accommodation and execution of a strategy using management accounting

principles on existing information technology (IT) and functionality.

What we will initially discuss in this chapter applies to any enterprise. The broad

principles are definitely generic, although the detailed examples are more specific to the

airline industry. This chapter is broken down into four sections. First we look at the two

basic requirements the enterprise needs to meet to be able to successfully execute

enterprise strategy: the efficient conversion of inputs to products and services and the

ability to effectively cope with a changing environment.


Next we highlight the importance of the management processes of planning,

controlling, and taking corrective actions to be effective in executing enterprise strategy.

Accommodating these management processes and providing relevant information for

making decisions about appropriate corrective actions lead into the next section of the

chapter.

In the next section we use detailed airline examples to illustrate the mechanics of

calculating and allocating costs, and we look at the underlying philosophies that should

constitute the foundation of the SCMS.

The chapter concludes with a limited representation of a possible Enterprise

Resource Planning (ERP) cost model for an airline, as well as practical illustrations of

how to use of the information provided by the proposed strategic cost model to make

decisions.

The Two Basic Elements Required to Successfully ExecuteEnterprise StrategyTwo elements are essential for the successful execution of strategy. The first is an

enterprise’s ability to mine the market for and invest in the right resources and to

effectively convert these resources input into sellable output. This process must be

optimized. The efficient and effective execution of the desired value chain configuration

will be referred to as optimized execution.

Second, an enterprise must react appropriately and in a timely manner to changes

in both the internal and the external environment and also strive to be proactive in

preempting change. The organization’s ability to appropriately evaluate, respond to,

adapt to, or preempt change within the shortest possible time will be referred to as

integrated organizational response.

Optimized Execution

As we have said, the conversion process consists of changing input resources into

products and services for use by the consumer. Optimizing the conversion process entails

analyzing and evaluating the entire conversion effort within the parameters of

organizational strategy. An analysis for the “entire conversion effort” must consist of


studying the internal and external components of conversion, from the resource market

and suppliers to the consumers of the finished goods or services provided.

The value chain is traditionally thought of as the group of processes/activities

within the enterprise. At first glance optimized execution might sound like Porter’s Value

Chain2, and in an ideal environment perhaps the value chain does extend beyond the

organization’s four walls, into the resource market, and to suppliers and consumers. This

expanded value chain concept has been suggested in the consumer products industry for

years. But to expand the value chain to this degree the enterprise has to share

information internally as well as with its suppliers and its consumers.

Evaluating the Macro and Micro Conversion Process

In Figure 8-1 one can see that according to the traditional definition, the conversion

process is contained within the enterprise walls. To achieve optimized execution, the

enterprise must extend its view of the conversion process beyond the traditional

enterprise, or “micro” view, to the “macro” view of conversion. The “macro” view,

shown in Figure 8-1, takes into account the suppliers/resources, the products and services

provided, and the customers and markets served.

The micro view is shown in more detail in Figure 8-2. The diagrams also

highlight that clear inputs and outputs exist for each of the views. For each input and

output, in turn, there are specific optimization requirements in which the SCMS has an

important role to play. Once an enterprise delves into each of these four areas, the

particular optimization requirements and solutions will be revealed.

In order to evaluate and present the opportunities of the SCMS, we will break

down each analytical area, either macro or micro, into input and output components of

analysis. For each of these resulting four components we will look at the optimization

requirements and highlight the demands of the SCMS.


Figure 8-1 The Enterprise Conversion Process – The Macro View.

Macro Conversion Optimization Optimizing the macro component of the

conversion process requires the ability to evaluate the environment in terms of resources

and resource alternatives as well as markets and market variations. As stated earlier, both

input and output perspectives need to be evaluated; further, for each component of the

analysis we need to determine efficiency (“doing activities right”) and effectiveness

(“doing the right activities”).

Resources Products/Services

Input Output

Micro ViewTargetMarket/MarketSegment

Purchasing,Conversion,Support, Distribution,

Marketing, Sales & Service

ResourceProduct/Service

Activity

Activity

Enterprise

M anufacturers

Suppliers

Customers


Figure 8-2 The Micro View of Conversion.

Macro Input In terms of macro-input efficiency, the enterprise must have the ability to

source the market and identify new technologies, techniques, resources, and methods that

will enhance the enterprise’s conversion process. The enterprise must be a “first finder”

and act quickly to bring these innovations to light, for evaluation by the enterprise, and

commercialize them ahead of its competitors. A similar set of activities/processes to find

new and existing suppliers and manufacturers to provide new raw materials and finished

Resource

Service

CustomerResource

Resource Product

Input Output Input Output

MarketSegment

Resource

Customer

Tier 1 Tier 2

SecondaryActivity

PrimaryActivity

PrimaryActivity


components must also be in place.

This evaluation of overall resource efficiency, in relation to the new options

available, should occur on a continuous basis. The SCMS must facilitate this

optimization analysis by supplying information on fully burdened resource costs for all

individual resources/resource pools. Fully burdened resource costs reflect a particular

resource pool and include the costs normally associated with the resources plus all costs

for internal services that are needed to support the resources in providing their output.

Detailed examples will be given later in the chapter. Included in this function is the

determination of the fixed and proportional costs (that is, the nature of costs) of resources

required to support capital replacement and resource outsourcing decisions. The SCMS

must also provide insight into the internally consumed resources and costs of all macro-

input activities/processes performed in determining the optimum solution from the

resource market (that is, prospecting the resource market).

When evaluating macro-input effectiveness, the focus is on the ability of the

enterprise to choose the right technology and input alternatives to maximize the

organization’s limited investment resources. The input goal is for the enterprise to invest

in resource alternatives that will provide for the lowest possible overall input costs

without sacrificing output quality.

To support optimization in the area of macro-input effectiveness, the SCMS must

provide for the evaluation of all business processes/activities, to enable the measurement

of process relevance. It must also provide the ability to optimize for the lowest possible

overall input cost (that is, to provide life cycle cost information, including costs for

research, evaluation, and acquisition and fully burdened operating costs of an

asset/resource).

Macro Output Macro-output decisions involve the outbound products and the markets

for those products and services. The macro-output efficiency component of the output

analysis refers to the enterprise’s ability to mine the market on a continuous basis,

exposing new markets for existing products as well as discovering the demand for new


and improved products. The goal is for the enterprise to be able to take advantage of

market and product opportunities ahead of its competitors.

The SCMS must provide vital information, on a per unit and cumulative basis, on

product revenues, cost and profit as well as on related down stream activities/business

processes so that management will be able to evaluate the profit potential for these new

opportunities. The SCMS must also provide for the valuation of all macro-output

business processes/activities, based on resources consumed, to ensure that the enterprise

can measure costs and can optimize for the lowest possible overall output cost.

In terms of macro-output effectiveness, the enterprise must be able to be effective

in applying and maintaining the appropriate product/service, and product/service mix in

the right target markets and market segments.

The SCMS must provide information, on a per unit and cumulative basis, for

product revenues, cost, and profit, and the system should present these in multi-

dimensional views that reflect the enterprise’s market segmentation. Each of these views

should accurately reflect full and proportional product costs as well as gross margins and

contribution margins. This information will aid in maximizing profitability and in

supporting specific strategies, for example, market penetration or product discontinuance.

Micro Conversion Optimization The study of the micro view of the enterprise

conversion process takes on a similar but more specific and focused analysis. Whereas

the macro view looks at the interaction of the enterprise with its external environment,

the micro view focuses within the enterprise. This analysis focuses on resources, the

outputs they provide into activities, and the resources and activities consumed by

products and services (both internal and external). Figure 8-2 depicts the two logical tiers

of inputs and outputs of the micro conversion process. When we look at internal

resources we see a variety of consumption patterns. For example, resource-to-resource

consumption, activity-to-resource consumption, and resource-to-product consumption.

The role of the SCMS is segmented along lines similar to the breakdown of the macro

view.

The micro view of conversion optimization, although similar in many ways to the

macro optimization scheme, contains many more permutations. The view can be limited


to a specific process/activity, or it can be broadened to include a group of processes

representing a chain of events. As a result of the varying levels of detail, many

components of analysis have to be considered. Optimization entails evaluating internal

resources, secondary activities, and primary activities.

Micro Input Micro-input efficiencies can take on many forms. Input in the micro view

may be internal resource pools (tier 1) or activities either direct or indirect (tier 2). For

either input, the analysis is similar to that used in the macro environment. Is the

organization harvesting knowledge internally and ensuring the internal processes are

being performed in an optimal manner?

The organization’s internal resources are limited. Is the enterprise making the

most with these limited resources? In the tier 1, to address this question, the analysis may

be as simple as evaluating each resource pool and weighting the total inputs into the

resource pool against the output that the enterprise gains from the resource pool. The

SCMS must supply information on fully burdened resource output rates for evaluation of

overall resource efficiency. In the tier 2, the answer to the question lies in the quantity of

inputs (activities and or resources) required to produce products and services.

In evaluating Micro-input effectiveness the enterprise analyzes the value chain

configuration for its relevance when measured against strategy and the ongoing process

of adapting to changes in the internal and external environments. In other words,

management asks, Are the resources doing the right things? Does the internal

organization need and value the things that are being done? In this regard the SCMS

must assign a value to resources, activities, and supply product input details and costs.

To make the evaluation possible, the SCMS must accommodate all the activities and their

costs, making the business process transparent, for the purposes of improving processes,

evaluating the relevance of processes, and potentially eliminating unnecessary or

irrelevant processes.


Micro Output To optimize micro output, management looks to evaluate how well the

internal processes are being completed from the internal consumer’s perspective. The

internal consumer may be other activities or the end product or service. Micro-output

efficiency analysis addresses the specific activities executed by a resource pool, whether

those activities involve support, producing a product/service, distribution, marketing, or

serving the customer.

In the micro-output area the SCMS must supply information on resource output,

for example, resource utilization, resource capacity management information, and the

cost of excess idle capacity. Specific output units must be provided so that efficiency can

be measured, whether the output units were consumed to execute supporting activities or

to produce products and services. In this regard standard product costs are an important

measure of efficiency.

In evaluating micro-output effectiveness the enterprise looks at its ability to

produce the right products and services according to the strategic plan; therefore the

SCMS must supply product cost and quantity information. Additionally, the system

should enable the enterprise to evaluate “how” products and services are created,

produced, and delivered to the right markets at the right time (that is, are the outputs from

the micro conversion process the right outputs?). Relevant information in this instance

would be, for example, profitability by each class of passenger, segment, flight, route,

and geographical area. Effectiveness can also be measured by inventory turnover, excess

inventory, or excess/idle product capacity, and so forth.

Before concluding this section on optimized execution and its demands on the

SCMS, we must consider the different levels of management, taking into consideration

the various hierarchical levels of the value chain. Undoubtedly, information at the micro

level is necessary so that the enterprise can optimize operations. At the same time there

is also the need for more strategically oriented, aggregated information for top

management, as pointed out by Porter3, in his discussion of the overall value chain and its

ten major cost drivers. Therefore, the SCMS should be required to provide for alternative

activity/business process cost views. These alternative cost roll-ups can address dual

information requirements. On the one hand, activity-based costing (ABC) standards at


the micro level facilitate the detailed analysis of the micro and macro conversion views of

the enterprise. On the other hand, an aggregated value chain view of costs with multiple

drivers per process enables high-level strategic analysis of the value chain based on, for

example, economies of scale, location, interdependencies, and so forth.

In summary, through pursuing optimized execution an organization can be

effective and efficient in both its internal execution and its interaction with the business

environment based on a given strategy. An enterprise’s vision and strategy demand both

an internal optimization for given a configuration of the value chain as well as an external

optimization to extend the value chain concept to suppliers and consumers. In this sense

the traditional value chain shows its limitations in that it is essentially focused inward on

execution.4 The extended value chain, or the combination of the macro and micro views,

is necessary for true optimization.

Integrated Organizational Response

The second element required for an enterprise to be successful in implementing strategy

is the ability to react to but more importantly to preempt change in a timely and relevant

manner. The groundwork for such a forward-looking, proactive enterprise is laid

primarily by undertaking an integrated organizational planning process, that is, a process

consisting of integrating strategic, tactical and operational planning. The organization

must also have relevant and timely control, to highlight deviations from the plan so that

appropriate corrective actions will be triggered. Although engaging in the management

processes of planning, controlling and taking corrective action is key to achieving a

proactive organization, this is not the only work that needs to be done. Scrutinizing

managerial and organizational behavior is another important element.

The successful execution of strategy is not achieved in one step; it is a process.

The enterprise in itself is dynamic and subject to change just as the business environment

is. Management must therefore continuously communicate the enterprise’s vision, lead

in line with it, motivate workers, monitor operations and costs, and take the necessary

corrective action to ensure achievement of organizational objectives and strategy.

Everybody in the enterprise must have the same overall goals. There needs to be


alignment in terms of personal, departmental and corporate goals. Managers, as the

leaders in the enterprise, play a crucial role in this regard. Through their leadership,

managers, individually and collectively, shape and signal acceptable behavior.

A mechanism commonly used to shift focus and change behavior is Key

Performance Indicators (KPIs). A comprehensive, interrelated hierarchy of KPIs must be

developed to embody strategy, supply appropriate measures of performance throughout

the organization, and successfully motivate people through rewarding the right behavior.

Figure 8-3 The Building Blocks of Integrated Organizational Response.

The KPIs must fulfill the following criteria if they are to help managers work together to

achieve goals within the enterprise:

OrganizationalPlanning and

Control

Organizational Strategy

PerformanceMeasurement

RewardSystem

KPIs KPIs

KPI

s


The establishment of KPIs must emphasize the principles of the downward-cascading

organizational planning model, that is, first strategic planning, then tactical planning,

and then operational planning.

Key Performance Indicators must be specific to every individual managerial position.

The KPIs must be controllable measures that individual managers accept and can be

held accountable for.

The measurement of performance according to KPIs must be the primary driver of the

reward system of the enterprise.

Singleness of purpose and the congruence of goals therefore require the integration of the

enterprise strategy, the performance measurement system, the reward system and the

organizational planning and control processes.

The management processes of planning, controlling, and taking corrective actions

will be covered in the next section. With regard to integrated organizational response, the

management processes of planning and control are the key integrators of enterprise

strategy, performance measurement, and the reward system, as is illustrated in Figure 8-3.

The management planning and control process is also where standards are set that will

determine the enterprise’s response to changes in the business environment.

In summary, optimized execution of the value chain takes a broader view of

conversion and divides it into a micro and macro view. The aim is to optimize both of

these views, and in the process to place specific demands on the SCMS to supply

information that will make achieving optimized execution possible. Integrated

organizational response has as its vision the integration of various organizational and

management elements in an attempt to ensure an appropriate and timely response to

changes in the business environment. Management processes play a key role in both of

these elements. For optimized execution the standards define acceptable and

unacceptable deviations from company operating policy. For integrated organizational

response the management processes are the primary means for internalizing the


integration of strategy, performance measurement, and the reward system in the

organization.

Management Processes in the Strategic Cost Management System

It is interesting to note that in the earlier part of this century great strides were made in

the automation of manufacturing. The ERP system has similarly ushered in, although

much more quietly, the automation of business processes throughout the organization,

particularly in the back offices. But there seems to be a distinct shortcoming in

businesses’ failing to recognizing the need for explicit and integrated accommodation of

management processes. Before we look at management processes and their ideal place in

the strategic cost management system, it would serve us well to consider current practice

in two closely related subjects: the general state of current cost systems and the planning

and control roles managers currently fulfill in organizations. We will also consider the

consequences of these practices.

In practice one finds that organizational planning/budgeting systems are often

modified general ledgers that poorly accommodate planning, never mind that they do not

Man

agem

ent P

lann

ing

&C

ontr

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tegi

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Normative ManagementStructure

Simplified Organizational Structure

Man

age m

e nt P

lann

ing

&C

ontr

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S tra

tegi

cP

lann

ing

Ope

rat io

nal C

ontr

ol

Empirical Management

TopManagement

OperationalManagement

MiddleManagement

Figure 8-4 The Types of Management Structures.


reflect the full spectrum of management processes. Costing systems are often separate

from planning systems (ABC systems of the last decade are a good example); they are

stand-alone and in effect, actual cost systems only. Integrated activity-based budgeting

(ABB) systems are also not a reality yet5. The result is that the execution of management

processes is not optimized. Worse still, the relevance of data for making decisions is low

and data are dispersed, making it difficult for information to trigger the right actions.

Second, as far as managerial roles are concerned, one finds in practice that the

different levels of management devote varying amounts of time to planning and control

activities (see the left side of Figure 8-4).6 As can be seen in Figure 8-4, under the

empirical management structure, a disproportionate amount of time is spent on

operational issues and activities. As a result the organization is too internally focused

and is largely reactive to changes in the external environment.

On the other hand, under the normative management structure (pictured on the

right side of the diagram) there is an ideal division of time for each level of management

along three tiers of planning and control: strategic, management/tactical, and operational.

Within this normative management structure, top management is involved in operational

planning and control only in exceptional cases, as represented by the shaded triangle on

the right-hand side of Figure 8-4. The normative management structure also strives to

entrench a forward-looking, proactive enterprise whose managers can address change at

the earliest possible opportunity to ensure the successful execution of company strategy.

An organizational planning and control model based on normative management

principles will therefore encourage strategic, tactical, and operational planning and

control at the right levels in the enterprise and with the desired focus. Such a model will

also contain mechanisms for management to preempt change and actively seek to

influence the business environment, bridge performance gaps, and keep the organization

focused on achieving strategy.

Figure 8-5 represents an example of what such an organizational planning and

control model would look like (adapted from Schutte). 7 Following are the features of this

planning and control model:


Management processes are not viewed as distinct steps---planning, controlling, and

taking corrective action---but rather as one continuous, dynamic process of re-

planning, controlling, and taking corrective action.

Managers are not only challenged to be proactive and outward looking; they are

expected to make the intellectual tasks of planning and making action plans or taking

corrective actions as their primary entrepreneurial outputs, providing innovative and

new ways for the enterprise to respond to changes.

The Bridges of Performance Statement for action plans and corrective actions is

introduced at each level in the organization. A Bridge of Performance Statement

contains the monetary expression of each manager’s entrepreneurial action plans and

corrective actions. The monetary expression of these plans and actions consists of

quantified statements of what the dollar impact will be of each plan or action to

Strategic Plan- Critical

Assumptions- Strategic

Guidelines- Targets

UnitAssumptions

MechanisticForecast

AnalyticalForecast

SWOTAnalysis

Action Plans

Review

Action Plans

GapAnalysisReview

Bridge ofPerformance

Statement

UnitFinancial

Plan

StrategicGap

CorporateStrategic

ActionPlans

SummarizedBridge of

PerformanceStatement

CorporateFinancial Plan

Functional/Division

Level

BusinessUnit/

DepartmentLevel

CorporateLevel

Figure 8-5 An Example of the Organizational Planning and Control Model.


bridge the performance gap that is being addressed. The summary Bridge of

Performance Statement reflects all the action plans and corrective actions that will be

taken by the various levels of the organization, to ensure that the strategy is achieved.

The traditional management process of static planning, controlling (explaining

variances), and taking corrective actions (trying to make do with less or to scrounge

money somewhere else) is now replaced by a more dynamic process. Through a

continuous process of dynamic re-planning, controlling and taking corrective actions in

all three tiers of management, the organization fosters an external focus and a proactive

culture. The Bridges of Performance Statement is pivotal, because it is a quantified plan

with assigned responsibilities and time lines. It drives a proactive organizational attitude

and the entrepreneurial actions necessary to close gaps, work toward the realignment of

the organization, and achieve the organization’s strategy.

What are the implications of the normative management structure for the SCMS? To

answer this question we have to consider management planning and control in more

detail.

Planning

When we introduced KPIs, we argued for a very strong link between KPIs and

organizational planning and control. In this section, we are discussing the planning

component in more detail, but with a stronger focus of converting the strategic plan into a

monetary plan. It should be noted that we are not arguing for overtly quantitative KPIs.

Key Performance Indicators should be a sound balance of both qualitative and

quantitative measures that fully represent the enterprise strategy.

We focus on the monetary expression of the strategic plan here for the following

reasons:

The monetary planning or re-planning process is still the primary intellectual event in

an enterprise and should be exploited as such.


Management accounting is about computing cost and profit and should thus

accommodate the planning for these areas.

If the SCMS is to accommodate the management processes of planning and control,

the organization’s monetary strategic plan provides an excellent basis for

accomplishing this.

There is a need to periodically revisit and set standards periodically to keep the cost

model and measures for performance up to date.

Second, although we recognize the need for different planning horizons for different

purposes, for example, five-year strategic plans and day-to-day operational planning, the

focus here will be on planning that will reflect strategy for an appropriate time horizon.

In line with the recognition that the management processes are a continuum, an

appropriate time horizon should also be a moving window, which can be shorter or

longer than the traditional fiscal year. An appropriate time horizon must be established

after managers consider factors such as structural changes taking place in the industry,

economic trends, the competitive environment, and so forth. The primary aim of medium

term planning, the focus here, is to enable control and an integrated organizational

response to change. The longer-term strategic plan should serve as the more static

measure of how the enterprise is progressing along the path to achieving its strategy.

Within the framework just defined, monetary planning or re-planning is no longer just

a process whereby some dollar amount is agreed to for the planning period; rather it

becomes the first proactive step in focusing the enterprise on the road ahead. Therefore,

every plan will include entrepreneurial action plans and corrective actions that are

quantified and valuated in Bridges of Performance Statement, with explicit

responsibilities and time lines assigned to manage their accomplishment.

The organizational planning process is depicted in Figure 8-6. This is the process

whereby the vision, mission, and purpose objectives are converted into an investment in

resources with the desired quantity, quality, technology, skill, and training. Much is


being made of this cascading planning process in literature today, in particular the need

for ABB. However this is a question of method that we will return to later in the chapter.

Here we want to highlight the output from the organizational planning process, that is, the

establishment of the invested resource base, which has the following implications for

management accounting:

First, once this process has taken place, a number of the macro cost drivers of the

value chain will be determined, for example, economies of scale and location.

The initial inherent nature of cost, which the enterprise will have to deal with in

executing the desired value chain, is locked down. The initial inherent nature of cost

for the individual resources/resource pools are defined as the fixed and proportional

characteristics of the costs given the capacity, skill, technology, and so forth that are

invested in.

TopManagement

MiddleManagement

OperationsManagement

Resource Focus

Resource AcquisitionResource Application

Resource Utilization

Vision, Mission andPurpose Objectives

CapacitySkillLocation ScaleInitial Inherent Cost Characteristics

Figure 8-6 The Organizational Planning Process.


Initial capacity will be determined.

Finally, recognizing that change is inevitable, the futility of establishing a stagnant

dollar budget, for the purposes of effective control, becomes readily apparent. There is,

therefore, a need for the SCMS to convert planned activities and planned outputs into the

appropriate monetary values. The ability to adjust the monetary valuation for different

planning scenarios to determine likely outcomes, and to determine the deviation of actual

outcomes, should also be supported. Thus the SCMS must have a cost model based on

quantity structures where value follows quantity, and it must have quantity standards

reflecting causal relationships.

As regards quantity structures and quantity standards, it is important to note that the

resource drivers typically used in ABC will not suffice; for example, Full-Time

Equivalents (FTEs; that is, full-time productive people) will not suffice. Using FTEs as

resource drivers is a method of dividing a pool of dollars into portions; it is not a

quantity-based driver. Using a quantity structure to allocate the planned costs for a

passenger-handling department to its activities will be done using standard staff hours per

activity. Costs will be charged to the passenger-handling activity on a per hour basis, and

planned capacity information will be available for the passenger handling department.

More detailed examples of the quantity structure approach will be given in the section

where we deal with the basic building blocks of the SCMS.

Control

Within the normative management approach, control no longer involves measuring

performance against a static budget. Instead, if the control process is to sensibly support

performance measurement, the cost model must be able to adjust to the fluctuations of the

business environment. This means that the SCMS must be able to calculate authorized

expenses and profits, taking into account fluctuations in all relevant factors, for example,

product/service volume, mix, actual activity levels, increased complexity, and so forth.

Authorized reporting, therefore, is the practice whereby a particular budget associated


with a particular level of activity/output is adjusted up or down based on the fluctuation

(up or down, respectively) of the actual level of activity/output. Authorized expense then

is a new plan/budget calculated as relevant for the actual level of activity/output.

For example, consider the individual meal preparation time for two classes of

passengers. Product A, a business-class meal, requires 30 minutes of preparation time.

Product B, a coach meal, requires 12 minutes of preparation time. If the planned product

mix was 100 Product A and 800 Product B for the month, total planned meal preparation

time would be 12,600 minutes. But if the actual product mix is 120 of Product A and 770

of Product B, a reduction in total volume (from 900 to 890), the meal preparation expense

will increase to a dollar amount representative of 12,840 meal preparation minutes.

Assuming that one minute costs $1 and that all costs are proportional, a static budget

would compare actual meal preparation expenses with the $12,600 initially calculated.

But the authorized expense that would be calculated for the actual level of activity

incurred would be $12,840, a more relevant measure, since meal preparation actually

increased even though total meals produced decreased.

To facilitate this quantity-based approach and the calculation of authorized

expense, ERP systems with their real-time and integrated capabilities are ideally suited.

Tight integration means that operational system quantities are readily available to the

SCMS. Flight hours, cycles, the number of passengers per class, and other cost driver

data and consumption data are potentially available to support the calculation of

authorized expenses. Real-time operation of ERP systems ensures that standard costs and

profits are available immediately and authorized expenses can be calculated as soon as

the operational quantities are posted.

Also authorized reporting, as opposed to static budget, more accurately reflects the

current course of the enterprise. In this regard, it is important to note that because of the

various factors mentioned above, for example, changes in passenger mix and producing

more complex products and fewer simple products, different tiers of cost drivers in the

SCMS will react differently to these changes. For example, if sector lengths decrease and

there is no change in total flight hours, not only will direct maintenance costs increase

owing to an increase in cycles, but so will maintenance planning costs. Consider Figure


8-7, which shows five potential levels of fluctuations that might occur in an airline SCMS

under two scenarios. With causal relationships identified between the quantity-based

drivers, and costs at the different levels compounded with variance analysis, the course of

the enterprise can be influenced. Note that the scenarios pictured in the diagram are

obvious simplifications and that multiple layers with their own drivers actually exist.

Authorized reporting, because it utilizes the quantity-based drivers behind these cost

movements, will calculate the expected costs at each level and provide valid performance

measurement yardsticks at all levels.

The scenarios depicted in Figure 8-7 not only highlight the need to establish the

causal relationships between the quantity-based drivers and costs at the different levels;

they also show the need for variance analysis. Through variance analysis it will be

possible to identify controllable and uncontrollable variances and determine which areas

Flight Profitability Area:Flight AZ999

Flight Cost Area:Flight AZ999

Aircraft Type Cost Area:Aircraft Type A7X7

Hangar MaintenanceCost Area: Hangar 2

Maintenance Overhead CostArea: Planning Group A7X7

Figure G: Levels of Potential Fluctuations for an Airline

Scenario 1 Scenario 2

Flight profitability is downowing to competitive

pressure, for example, fewerpassengers

Flight cost is Higherowing to higher fuel

costs

Aircraft type cost higher owingto utilization pattern change:

shorter average sectors and totalflight hours decrease

The hangar maintenanceexpense is lower owing toless frequent larger checks

Maintenance planning costsare lower owing to fewerchecks being performed

Flight costs are lowerowing to lower

maintenance costs

The hangar maintenanceexpense is higher owingto bad troubleshooting

Less maintenance planningactivity is required owing to a

utilization pattern change

Flight profitability is up owingto better yield management

The aircraft type cost is lower,owing to a utilization pattern

change: longer average sectorsand total flight hours are

unchanged

-

-

-

-

+

+

+

+

+

+

Figure 8-7 Levels of Potential Fluctuation for an Airline.


within the organization are responsible for the variances. For example, the variance in

fuel price might not be the responsibility of route management, but bad trouble shooting

should be the responsibility of maintenance. In line with the classification of the input

and output areas we have already discussed, variances must be separated into input-side

and output-side variances. More specifically, price, quantity, resource usage, volume, lot

size, mix, and remaining variance categories must be supported.

It should be noted at this time that there are other factors that will influence the

effectiveness of the control process, for example, the handling of major maintenance

expenses. These factors will be addressed later when we discuss the potential

enhancement of the decision relevance of information for making decisions.

Taking Corrective Action

In the management planning and control process, standards need to be established for the

appropriate managers to respond to changes in the business environment, that is, to take

corrective action when necessary. Strategic cost management system design plays an

TopManagement

MiddleManagement

OperationsManagement

Resource Focus Shifts

Excess Idle CapacityResource OutsourcingResource RealignmentResource Redeployment

Resource OptimizationResource Short-term Application

Vision, Mission, andPurpose Objectives

Skill

Decisions

Figure 8-8 Levels of Management and Decision Making in an Organization


important role in decision support for managers; it ensures that information will be

available on an ongoing basis and that it will be tailored to meet individual managers’

needs. In this regard we will briefly consider managerial roles and the continuous nature

of the management process as they apply to taking corrective action.

As we saw in the section on organizational planning, the three tiers of

management have different responsibilities in converting the enterprise vision, mission,

and purpose objectives into a resource base that can execute strategy. Naturally when it

comes to taking corrective actions, responsibilities should align with the managers and

their planning outputs. Figure 8-8 gives examples of typical decisions/corrective actions

and the levels of management responsible for each of these decisions.

As one can see, information needs for different levels of management could be in

conflict. For example, in making an outsourcing decision, middle management may need

to consider fewer costs as being fixed, although more costs should be considered as being

fixed in normal operations by operational managers. Therefore the SCMS should address

these varying demands by supplying the necessary information.

The second aspect to consider is the continuous nature of the management

processes of dynamic re-planning, controlling and taking corrective action, as depicted in

Figure 8-9. Decision making as the primary intellectual task throughout this process is

also the primary entrepreneurial output and the focal point of management. Since

information is the primary input into decision-making, it is imperative that the SCMS

provide information that is relevant for decision-making purposes, in addition to fulfilling

the requirements already identified.

The relevance of the information supplied for decision-making purposes can be

characterized as follows:

The information reflects a timing dimension of costs and profits relevant to the

decision at hand.

The information is supplied in views that align with organizational responsibility, and

it is relevant for measuring performance and taking corrective actions.


Costs between internal suppliers and consumers are charged based on causal

relationships.

The initial inherent nature of cost is accurately reflected.

The changing nature of cost based on consumption is accurately accounted for. By

this we mean, in cases where services consumed are not proportional to the

consumers’ own output level, all costs for such services must become a fixed cost.

Detailed examples of this principle will be given in the next section.

Casual relationships are expressed in a flexible quantity structure to accommodate

authorized reporting, relevant variance calculation, and the appropriate corrective

actions.

Strategy

Figure 8-9 The Continuum of Management Processes.


The capability of the proposed cost model to provide relevant information for decision

making will be explored in the last section through decision scenarios.

The Basic Building Blocks of the SCM Model

We have identified the need to optimize execution, the need to preempt and adjust to

change, the centrality of the management processes, and the inevitable decisions that

must follow to keep the enterprise on track. Two basic building blocks constitute the

foundation of the SCMS and satisfy these needs: the mechanics used to do the

calculations and cost charges, for example, ABC or a more traditional full-absorption

approach, such as direct conversion cost plus a percentage for overheads. Second, the

philosophical approaches adopted to enhance the relevance of information, for example,

the timing of expense, the normalization of expense, or the incorporation of industry-

specific characteristics in the strategic cost model.

In this section we will first propose the mechanics for satisfying the demands on

the information to be supplied by the SCMS, and then we will look at the philosophical

approaches available to enhance, in particular, the relevance of information for making

decisions. The development of the strategic cost model will be based on the storyboard

shown in Figure 8-10, which is a limited representation of an airline with the

departments, products, and consumption flows of services indicated by the arrows.

The Mechanics for a Strategic Cost Management System

The resources of the enterprise are the basis of the SCMS mechanics. There are many

reasons why resources are important, for example, for purposes of departmental learning

and optimization and resource specialization. Resources are also paramount in planning,

in that resources and their costs are the outputs from the strategic enterprise planning

process, as we have already indicated. Resources are the basic building blocks of the

value chain, as we saw in the section on micro efficiency, and therefore they are key

elements in execution optimization, as well as in changing and adapting the organization


to meet its strategy. For these reasons, resources will be the foundation for the proposed

strategic cost model.

We have already pointed to the need for an entirely quantity-based cost model and

the need for resource costs to be fully burdened, in both their fixed and their proportional

components, these being some of the requirements to be fulfilled by the SCMS.

In explaining the details of the SCMS mechanics and highlighting how these

requirements are met, we will build the cost model from the ground up, starting with such

basic concepts as the origin of the quantity structure, the initial inherent nature of costs,

fully burdened resource costs, and the changing nature of cost on consumption. Having

laid the foundation, we will expand the cost model into a model consisting of a standard

cost system, capacity management, and ABB.

HumanResources

FlightProfitability

Catering

Purchasing

- Jet Fuel- Landing and Parking

Cabin Crew

ApronHandling

HangarMaintenance

Flight: ZZ999- Business Class- Coach Class

Aircraft Types:- A7X7- A7Y7

Figure 8-10 A Limited Storyboard.


The Origin of the Quantity Structure and the Initial Inherent Nature of Costs

Resource Consumption Accounting (RCA) is an approach to the calculation and

assignment of resource costs based entirely on a quantity structure and direct causal

relationships. This approach results in fully burdened resource costs and specific

treatment of the nature of costs.

The quantity structure approach starts with the quantity of resource output. For

each resource pool, this output is used to calculate the resource output rate. As we

indicated in discussing micro input, the resource output rate is an important parameter in

determining the initial efficiency of converting inputs into outputs for each

resource/resource pool. The resource output quantity and output rate together are the

mechanism whereby costs are charged to the consumers of resources.

Resource Consumption Accounting also recognizes that the resource pool is the

primary determinant of the initial inherent nature of costs. That is to say, once the airline

has decided to invest in a specific mix of resources involving a specified level of skill and

technology, the nature of the costs required to achieve the strategy is fairly well locked

down. Take, for example, the option of using a highly automated cargo-handling system

as opposed to a labor-intensive cargo-handling department.

Given these two basic principles, the annual plan for the Purchasing Department

in the storyboard could be as reflected in Table 8-1. The expenses shown in this example

are only those expense accounts for which the department is directly responsible. We will

classify these as primary expenses. Primary expenses are then further broken down and

classified into their fixed and proportional components. The resource output rate for the

inputs is also shown in the table.


Table 8-1 The Initial Inherent Nature of Costs and Resource Output

Purchasing Department Planned Resource Output: 8,000 Purchasing Man-Hours

Primary Expenses Fixed Proportional Total

Supervisory Salary $ 60,000 - $ 60,000

Purchasing Clerk Salaries - $ 152,000 $ 152,000

Office Supplies - $ 8,000 $ 8,000

Depreciation – Furniture $ 20,000 - $ 20,000

$ 80,000 $ 160,000 $ 240,000

Resource Unit Output Rate $10 $ 20 $ 30

It is important to recognize that this approach will result in the determination of

very specific rates for each individual resource pool. This means that purchasing

departments in different locations will have not only different rates but also different

ratios of fixed and proportional costs. For example, because of relatively high social

costs in Europe, not only will purchasing in Europe be more expensive, but its fixed cost

component will be higher than, for example, the same type of purchasing function in

Asia.


RCA and ABC The quantity structure approach also serves as a perfect compliment to

ABC. Consider Table 8-2, which is an example of the airline’s Catering Department,

showing the planned primary costs and the activities that Catering performs, namely,

“Prepare Business Class Meal” and “Prepare Coach Class Meal”. Note first of all how

the quantity structure is used to allocate costs from the Catering Department to its

activities. Note also how the inherent nature of the Catering Department’s costs is

transferred to its activities, since with each unit of resource output consumed, for a given

level of invested capacity, a fixed and a proportional component of cost is incurred on

every activity. More specifically, the number of Catering hours (0.5 hours), needed to

prepare a business-class meal (Activity 1) is multiplied by the resource output fixed rate

($ 12.00 per hour) to arrive at the fixed cost for the activity: $ 6.00. The resource output

proportional rate ($ 19.00 per hour) is also multiplied by the consumption quantity (0.5

hours), resulting in the $ 9.50 of proportional costs assigned to the activity. Note that we

are assuming, at this stage, that quantities being consumed by the processes/activities are

not fixed; that is to say, if an activity is eliminated, all of the resource output hours

consumed will become available to perform other activities. This assumption is an

obvious simplification and will be revisited later when we consider the changing nature

of costs on consumption.


Table 8-2 Charging Costs, Using a Quantity Structure, Quantities Consumed,

and Rates

Catering Department Planned Resource Output: 12,000 Catering Man-Hours



Chefs’ Salaries - $ 228,000 $ 228,000

Fringe Benefits $ 60,000 - $ 60,000

Depreciation – Equipment $ 4,000 - $ 4,000

$ 144,000 $ 228,000 $ 372,000

Resource Unit Output Rate $ 12 $ 19 $ 31

Catering Activities

Process/Activity 1: Prepare Business-Class Meal Quantity: 1

Resource Output Quantity Required

0.5 catering man-hours

Activity Fixed Costs

$ 6.00

Activity Proportional Costs

$ 9.50

Process/Activity 2: Prepare Coach Meal Quantity: 1

Resource Output Quantity Required

0.2 catering man-hours

Activity Fixed Costs

$ 2.40

Activity Proportional Costs

$ 3.80


Fully Burdened Resource Costs A requirement for the SCMS is that it should

supply fully burdened resource costs, so that the enterprise can optimize in the area of

macro input. The SCMS should support outsourcing decisions, capital replacement

decisions, and the valuation of products and services with the fully burdened resource

cost information.

Figure 8-11, is a graphic representation of the step-down method - the dominant

method of cost allocation in today’s advanced cost management arena. This step-down

method of allocation generally does not recognize the fact that processes/activities should

be allocated back to the resource pools, that is, the real consumers of support activities.

An appropriate example from the storyboard (see Figure 8-10) would be, for instance, if

the Purchasing Department had to purchase furniture or office supplies for the Human

$

Process/Activity

Departments/ Cost Centers

Process/Activity

Process/Activity

$ $

CostObject

CostObject

$ $C

ostFlow

$ $

Figure 8-11 The Step-Down Allocation Method.


Resources Department. Within the step-down logic, the cost of this purchase order is not

charged back to the Human Resources Department, but some allocation relationship is

derived to allocate the costs to products/services directly.

Table 8-3 Fully Burdened Resource Costs

Hangar Maintenance Planned Resource Output: 40,000 Hangar Maint.Hours


Supervisory Salary $100,000 - $ 100,000

Technicians’ Wages - $ 600,000 $ 600,000

Uniforms and Clothing $ 3,000 - $ 3,000

Depreciation Tools $ 10,000 - $ 10,000

Secondary Expenses Fixed Proportional Total

Human Resource (HR) Costs $3,000 $ 12,000 $ 15,000

Purchasing Costs $ 4,000 $ 28,000 $ 32,000

$ 120,000 $ 640,000 $ 760,000

Resource Unit Output Rate $ 3 $ 16 $ 19

Table 8-3 shows the fully burdened resource costs for a resource pool of aircraft

maintenance technicians. Note that the costs from the Human Resources Department and

the Purchasing Department, that is, the services that maintenance consumes, are charged

to this resource pool to obtain its fully burdened resource costs. These consumption-

based charges are classified as secondary costs. The method of cost allocation in

resource consumption accounting is therefore not a step-down method but rather an

iterative method of allocation, since all resource pools will reflect support and reciprocal

services as secondary consumptions.9 The secondary costs, for the moment, reflect the


fixed and proportional components of the resources supplying the services (the

calculation details are not shown in the table).

Resource Consumption Accounting and the Changing Nature of Costs

We demonstrated earlier how fixed costs are transferred from the supplying activity or

resource to the consumer (refer to the section on ABC and the secondary-cost examples).

An important factor in determining the type of cost that must be accommodated by the

SCMS is that the nature of costs can change upon consumption. The initial nature of

costs is determined by the characteristics of the invested resources, that is, the supplying

resource pool. But in cases where the service consumed is not related to the output of the

consuming resource or activity, the quantity of service consumed, and thus the costs for

that particular service, must be considered as fixed to the consumer.

An example, mentioned before, is that of the Purchasing Department buying

furniture for the Human Resources Department. Clearly, this expense does not relate to

the output of the Human Resources Department, in terms of human resources man-hours,

in the same way that the purchase of office supplies would, the latter being proportional

to the output generated by the Human Resources Department. Table 8-4 shows how the

nature of cost changes at consumption in the case of furniture purchased for the Human

Resources Department. First the costs, as incurred on the purchasing activity/process, are

shown, and then the costs, after consumption by the Human Resources Department, are

shown.

Using the Purchasing Department information from Table 8-1, five purchasing

man-hours are charged to the activity “Purchase Asset”. Note that the five hours

consumed by the activity is proportional, but that $50 of fixed cost (5 hours x $10

resource output fixed rate) and (5 x $ 20) results in the fixed and proportional costs for

the activity, respectively.


Table 8-4 The Changing Nature of Costs on Consumption

Purchasing Activity

Process/Activity 1: Purchase Asset Qty: 1

Fixed Resource Output

Quantity Required

-

Proportional Resource

Output Quantity

Required

5.0 purchasing man-

hours

Activity

Fixed

Costs

$ 50

Activity

Proportional

Costs

$ 100

Human Resources Planned Resource Output: 10,000 Human Resource Hours

Primary Expenses Fixed Cost Proportional

CostTotal Cost

Supervisory Salary - - $ 30,000 - $ 30,000

Human Resources Clerk

Salaries - - - $ 90,000 $ 90,000

Depreciation: Furniture - - $ 8,000 - $ 8,000

Secondary ExpensesFixed

Qty.

Prop.

Qty.Fixed Cost

Proportional

CostTotal Cost

Purchase Orders: Assets 10 - $ 1,500 - $1,500

$ 39,500 $ 90,000 $ 129,500

Resource Unit Output Rate $ 3.95 $ 9 $ 12.95


The ten purchase orders, planned for equipment to be provided to the Human Resources

Department, are planned as a fixed quantity consumption, because the purchase orders

will be raised regardless of the level of output of the Human Resources Department.

Note that using the fixed-quantity consumption method results in all of the costs for

purchasing becoming fixed for the Human Resources Department and being included as

such in the human resources output rate. The purchasing cost for the Human Resources

Department is calculated as follows: 10 purchase orders (fixed) multiplied by the hours

per purchase order (5) multiplied by the resource output rate fixed ($10) for purchasing,

or 10 x 5 x 10 = $500. We add this result to the ten purchase orders (fixed) multiplied by

the hours per purchase order (5) multiplied by the resource output rate proportional ($20)

for purchasing, or 10 x 5 x 20 = 1,000. After adding the results of the previous equation

we get $1,500, the total fixed purchasing expenses. Thus we illustrate how value follows

quantity.

The Need for a Standard Costing System The enterprise must be able to

effectively plan and control its path to achieve its strategy. The SCMS must be based on

a standard cost approach. Standards should be quantity standards, and values should

follow quantities. The reasoning behind the standard cost approach for the SCMS was

given earlier in the chapter.

Another reason for the use of a standard costing approach is the need for

timeliness. Although real-time ERP systems strive to enhance the timely availability of

information, it is not practically possible. Quantities are fairly well available to the

SCMS at the time that they are posted in the logistics modules, but expenses cannot be

gathered with such consistency. Within the ERP system the monthly payroll run is still a

periodic processing event. Normal expenses are still received only after the service or

product has been consumed; for example, the monthly invoicing for jet fuel or the invoice

for landing and parking fees comes in after the fuel was uploaded and landing and

parking have occurred. The situation gets worse when charges for reciprocal services or

code-share revenues arrive at the airline via an IATA clearinghouse.


Timely monetary reflections of the airline’s activities and outputs can be provided

by a standard cost system that uses the real-time quantities available via the ERP system.

On a real-time basis, managers can evaluate the impact of actual activity and output

levels on planned profit and costs. They can take appropriate steps at an early stage to

address any deviations. Yet they will be able to make a detailed variance analysis of

actual expenses only after all relevant expenses have been collected.

Capacity Management Another important requirement that is fulfilled by the

combination of the quantity structure approach and the standard cost system is that of

capacity management. A primary responsibility of middle management is the monitoring

and realignment of the deployed resource base (refer to Figure 8-8). Excess/idle capacity

information is an important input into this process.

The proposed SCMS will not only enable middle managers to monitor resource

utilization during the process of execution; it will also help them to make capacity

management decisions during the planning stage. In cases where resource skill or

technology dictates the use of practical capacity during planning, the financial

implications of this decision will be known up front. For example, when aircraft

maintenance technicians will not be fully used for a planning period, the decision is made

not to reduce the number of technicians. This decision is rightfully based on the fact that

these highly skilled personnel require four to six years of training to work independently

and can therefore not be replaced at will. A resource output rate based on practical

capacity, as the resource pool output quantity, and the planned product consumptions of

this resource will result in the resource pool showing a dollar amount of costs that are to

be under-recovered. This amount is a clear expression of the financial implication of the

decision.

In a similar vein, excess/idle capacity variances during execution will be an

indication to middle management that changes have occurred in the business environment

and must be addressed. It is important to note that the use of the quantity structure and

standards in white-collar areas, such as human resources and purchasing, provides for an

effective tool to apply capacity management principles in these historically elusive areas.


The presence of excess/idle capacity variances in the SCMS means that

activities/processes are not fully burdened with expenses for a given accounting period,

as would be the case in most existing ABC systems. Although not allocating this

variance bodes well for the accuracy of product costs and the relevance of information for

making decisions, it does have an implication for alternative strategic cost rollups. The

total costs of all activities/processes are now no longer a reflection of total enterprise

expenses. The excess/idle capacity variance must therefore be added into the relevant

macro level of the value chain to ensure that all costs are included in the strategic cost

analysis.

Finally, attempts have been made to incorporate capacity management into activity-

based costing.10 But the proposed strategic cost model takes the RCA view and bases it

on the following considerations:

The invested resource base is the output from the strategic planning process, and at

this time initial capacity has been determined.

The primary capacity measure in the model is the resource output quantity, which is

established through the quantity structure approach.

The domain of capacity management is wholly contained within the resource base.

Within this view activities/processes have no capacity in and of themselves; they are

individually and collectively consumers of capacity output. The consumption quantities

that activities/processes consume reflect resource utilization, not capacity. Utilization

and capacity can always be equal only in a closed and perfectly balanced system.

The Quantity Structure and Activity-Based Budgeting

For the cascading organizational planning process, shown in Figure 8-6, one needs a

reliable method for calculating both the resource quantities and the associated dollars

necessary to support a given strategy. This planning process is typically a reverse flow of


the standard cost model; the quantity-based cost model is ideally suited to this process

because it is geared to generating accurate planned dollar values.

For example, Table 8-5 gives details, as per the storyboard (see Figure 8-10) of

the cabin crew and their utilization on the two aircraft types for the current period and the

current flight timetable. Note that the A7Y7 is a larger airplane that requires more cabin

crew per flight. The total expense for the cabin crew is $4,000,000.

Table 8-5 Basic Data for an Activity-based Budgeting Example

Cabin Crew UtilizationAircraft Type:

A7X7 (10,000 FlightHours)

Aircraft Type:A7Y7 (5,000 Flight Hours)

Cabin Crew Time 80,000 hours (40 FTEs) 120,000 hours (60 FTEs)

Cabin Crew

$ 4,000,000

Aircraft Type: A7X7$ 1,600,000

Qty: 10,000

Basis of the Calculation

Activity-Based Budgeting Result

Aircraft Type: A7Y7$ 2,400,000

Qty: 5,000

Cabin Crew

$ 5,120,000


Qty: 8,000

Aircraft Type; A7Y7$ 3,840,000

Qty: 8,000

Dollars

Figure 8-12 Activity-Based Budgeting without a Quantity Structure.

40 FTEs

60 FTEs

Dollars


In Figures 8-12 and 8-13 we show the differences in deriving a budget using activity-

based budgeting without a quantity structure versus using resource consumption

accounting with a quantity structure. Using the current approach to ABB, the budget that

would be generated for 8,000 planned flight hours for both aircraft types is shown in

Figure 8-12. In the top half of the diagram the FTEs from Table 8-5 are used to split the

$4,000,000 of cabin crew expense between the two aircraft types. This results in the

values $1,600,000 and $2,400,000 as shown. These numbers are then used to calculate a

new budget, given the planned flight hours. Because it is common practice to consider

all costs in ABC as variable, the calculated costs for A7X7 and A7Y7 will be $ 1,280,000

and $ 3,840,000 respectively (refer the bottom half of Figure 8-12). The total calculated

planned expense for cabin crew is then $5,120,000.

Table 8-6 Fully Burdened Resource Costs for the Cabin Crew

Cabin Crew Planned Resource Output: 200,000 Cabin Crew Hours

Primary Expenses Fixed Cost Proportional Cost Total Cost

Supervisory Salaries $ 190,000 - $ 190,000

Crew Salaries - $ 2,900,000 $ 2,900,000

Uniforms and

Clothing $ 200,000 - $ 200,000

Secondary Expenses Fixed Cost Proportional Cost Total Cost

Human Resources

Costs $ 170,000 $ 60,000 $ 230,000

Aviation Medical $ 320,000 $ 40,000 $ 360,000

Facilities Costs $ 120,000 - $ 120,000

$ 1,000,000 $ 3,000,000 $ 4,000,000

Resource Unit Output $ $ 5 $ 15 $ 20


On the other hand, using resource consumption accounting and the quantity

structure, one would first come up with the resource pool plan. Cost would be classified

as primary and secondary as well as fixed and proportional. The plan for the cabin crew

is shown in Table 8-6. (Note that because of the complexity of the table, the detailed

secondary quantities are not shown here. But these consumption quantities would be

assigned to the cabin crew resource pool using the quantity-based principles previously

introduced.)

Next, using the resource output quantity as the primary consumption link, we

arrive at the dollar value for each aircraft type (see the top half of Figure 8-13). Note that

we are assuming no planned excess/idle capacity, and thus the amounts calculated are the

same as when FTEs were used. Given the planned utilization for each aircraft type, new

demand for cabin crew hours is calculated as 64,000 hours for the A7X7 and 192,000 for

the A7Y7, which results in total planned cabin crew hours of 256,000 as shown in the

bottom half of Figure 8-13.

Cabin Crew$ 4,000,000


Qty: 10,000

Basis of the Calculation

Activity-Based Budgeting Result

Aircraft Type: A7Y7$ 2,400,000

Qty: 5,000

Cabin CrewPlanned Qty: 256,000

Corresponding Value:$ 4,840,000

Aircraft Type: A7X7

Qty: 8,000

Aircraft Type; A7Y7

Qty: 8,000

80,000 Hours

120,000 Hours

64,000 Hours

192,000 Hours

Figure 8-13 Resource Consumption Accounting Using a Quantity Structure.


The hours demanded are converted to the dollar amount that would be required

using the resource pool unit standards. Total hours (256,000) multiplied by the

proportional cost rate ($15) gives the total planned proportional expense ($3,840,000).

Add to this the $1,000,000 of fixed costs and we arrive at the total planned expense for

cabin crew: $4,840,000. This number is $280,000 less than the amount calculated using

activity-based budgeting with no quantity structure.

The following limitations of this example should be noted. The example

highlights only the error that current ABB practices will cause owing to the fact that fixed

primary and secondary costs of the resources are ignored. The error would be even larger

if the example had included fixed quantity consumptions on the activities/processes.

Second, both scenarios used the same total expense for cabin crew ($4,000,000).

Because, in practice, resource consumption accounting includes the secondary costs and

an iterative method of allocation, this method will give a more accurate reflection of total

cabin crew costs. Further, it would be possible to use the secondary quantities calculated

(detail not shown in Figure 8-6) for the Human Resources Department, the Aviation

Medical Department, and the Facilities Department to derive their budgets in a similar

fashion. The process of deriving these support budgets will, like the process used for cost

charging, be iterative.

Philosophical Approaches Affect the Relevance of Management

Information

The mechanics of the SCMS are just one of the basic building blocks of the system. The

other is the philosophies adopted with respect to each of the following: the timing of

expense, the allocation of fixed costs, the normalization of expense, and the consideration

of industry-specific characteristics.

As alluded to in the introduction to this chapter, the information that the SCMS

supplies is essential for the maximization of profit over the life of particular assets that

are deployed, over the life cycle of a product, or the strategic horizon under

consideration. The product information supplied, for example, must reflect the inherent

characteristics of applicable assets and the full and marginal costs and profits of products.


Therefore the information needs to be transparent and should intuitively highlight the

underlying principles of applicable assets, the nature of costs, and the appropriate time

line. The choices the enterprise makes with regard to the following four areas are crucial

to successfully executing strategy.

The Timing of Costs The aggregate nature and lack of relevance of financial

information for management decisions are well documented. Although the need for

financial information and the rules governing financial accounting are well recognized,

the SCMS clearly has a management focus. Enterprise Resource Planning systems now

afford companies the best of both worlds by allowing the sharing of common data and by

providing additional functionality to satisfy management accounting needs. The example

that will be used here to highlight the opportunities provided by ERP systems and the

influence of the timing dimension on cost information is depreciation.

Depreciation constitutes a large portion of airline expense and therefore has a

major impact on the cost of a ticket11. Figure 8-14 depicts the operating costs of an

aircraft. The shaded area between years 0 and X represents the operating costs and

depreciation costs while financial depreciation is in force. From year X onward the

airplane is fully depreciated, and the shaded area represents operating expense without

depreciation. For the sake of simplicity and because operating expense is not key to this

illustration, operating expense is assumed to be constant over the life of the airplane. The

two horizontal dashed lines represent the price the market will bear for a coach ticket on

two flights, ZZ999 at $410 and flight ZZ998 at $190.

Using financial depreciation for decision making in this instance would bring about the

following circumstances:

Flights with a ceiling price below that of the initial expense of the equipment, up until

year X, would likely not be provided; that is, both flight ZZ999 and ZZ998 would not

be provided.


After year X both flights are likely to be provided since as of that point they would

appear profitable.

Simply stated, using financial depreciation results in inadequate information for making

strategic decisions.12 It is important to recognize that it is very difficult to determine

which products will be truly profitable in the long run.

200

400

600

Dol

lars

Years

Flight ZZ999 Price $ 410


X Z0

Figure 8-14 Product/Service Costs with Financial Depreciation.


We would propose that the SCMS should use cost depreciation. Cost depreciation is

calculated as the replacement value of the airplane divided by its economic life, for

example, year Z in the diagram. In Figure 8-15 we show the operating cost for the

airplane depicted in Figure 8-14, but figuring in cost depreciation. The following points

should be noted regarding the potential use of cost depreciation:

Current IT functionality is able to simultaneously support financial depreciation for

the general ledger and cost depreciation for the SCMS, while maintaining all required

integrity.

The argument is often raised that the lives and costs involved are too difficult to

estimate. It should, however, be borne in mind that on a period-by-period basis, for

example annually, the lives and values should be adjusted to reflect the latest insights.

In this sense, the graph in Figure 8-15 is not a true reflection of the new cost curve.

200

400

600

Dol

lars

Years



X Z0

Figure 8-15 Product/Service Costs with Cost Depreciation.


From a purely capital cost perspective the curve will in fact increase periodically by

small increments.

As Figure 8-15 illustrates, the longer-term view of product profitability shows that

Flight ZZ999 could be operated profitably with the airline type under consideration, but

Flight ZZ998 could not. The use of financial depreciation-based cost information could

potentially lead to inconsistent product and profitability decisions. If this statement is

true, there is a whole range of other implications that follows as a result of this

information, namely:

New, more efficient equipment will potentially be underutilized or not utilized to its

fullest potential.

Potentially profitable products/opportunities will be turned away, for example, Flight

ZZ999 in Figure 8-14 from year 0 to year X.

Older, fully depreciated but less efficient equipment will be utilized more since it

does not negatively impact currently “profitable” products, for example, Flight

ZZ998 from year X to year Z in Figure 8-14.

Practices like those mentioned in the preceding items have a negative impact on the

operating expense of the enterprise. The identification of this situation was also

alluded to earlier when we discussed macro input and mentioned the need for

determining the “life cycle cost” of an asset.

Finally, it is worth noting that depreciation is not the only big-ticket financial cost that

could be handled in a more decision-oriented way using the SCMS. Interest on capital is

another item that is highly relevant to this industry.

The Allocation of Fixed Costs A traditional full absorption approach to cost

accounting would allocate all fixed costs at the product level13, that is, to the class of

passenger in the storyboard (see Figure 8-10). Because we are proposing a standard cost


approach, the liquidation of the excess/idle capacity variance is the primary fixed cost

that must be considered for allocation in the SCMS.

We would propose a stepped allocation of this variance as represented by the

simplified stepped contribution report in Table 8-7. Two excess/idle capacity variances

are allocated in this example. The variance for cabin crew staff is allocated to the Flight

Business level. The variance for the Human Resources Department is allocated to the

Enterprise Result level.

The variance for excess/idle capacity is allocated in the stepped recovery method for

the following reasons:

In line with the principles of controllable and uncontrollable variance identification,

the excess/idle capacity variance should not be spread out among the lowest-level

products, that is, passenger classes.

For the sake of visibility and to clearly delineate responsibility for the variance, it is

allocated to an appropriate, higher level in the stepped recovery report.

Not spreading the variance to the individual product level enhances the relevance of

the data for decision making.


Table 8-7 Product Stepped Gross Margin Report

Business-Class Passengers:

Passenger RevenuesPassenger-Related Costs:MealsCabin CrewPassenger Handling

Gross Margin 1: Business-Class Passengers

Planned

(50,000)

5002,0002,500

(45,000)

Actual

(45,000)

4802,0002,400

(40,120)

Flight ZZ999:

Passenger Class MarginsFlight-Related Costs:Jet FuelLanding and ParkingAircraft Maintenance

Gross Margin 2 : Flight ZZ999

(150,000)

15,0008,0006,000

(121,000)

(165,000)

16,0008,0006,000

(135,000)

Route: Europe/Asia:

Flight MarginsRoute-Related Costs:Lounge CostsMarketing Costs

Gross Margin 3 : Route Europasia

(2,250,000)

55,000800,000

(1,395,000)

(1,975,000)

50,000910,000

(915,000)

Flight Business:

Route MarginsFlight Business-Related Costs:Flight Business OverheadExcess Capacity – Cabin Crew

Gross Margin 4 : Flight Business

(10,800,000)

1,700,000-

(9,100,000)

(6,300,000)

1,500,000100,000

(4,700,000)

Enterprise Result:

Business Units’ MarginsEnterprise-Related Costs:Corporate OverheadExcess Capacity – Human

Resources Department

Enterprise Operating Result

(27,900,000)

3,000,000-

(24,900,000)

(18,100,000)

3,200,00080,000

(14,820,000)


Normalized Expenses The same principles we have mentioned in relation to

accounting for the cost of assets also apply to certain expense items in the airline

industry. The cost for major aircraft maintenance is an expense that would have a similar

effect on margins. Figure 8-16 represents the typical actual cost curve for a modern

jetliner14 . Clearly, from perspective of managing the margins, the spikes in costs shown

in the graph cannot be afforded. From an organizational planning and control

perspective, it should be noted that these cost spikes are also not related to the ongoing

activities and outputs that form the basis of planning and authorized reporting

We therefore propose that major maintenance expenses be charged to flight

costing as a normalized expense. Costs that could be included in the maintenance

category are, for example, the costs of major airframe checks, engine overhauls, landing

Cos

t

Years in Operation

Introduction Mature Aging

Figure 8-16 Actual Cost Curve for Typical Jetliner.


gear overhauls, and Auxiliary Power Unit (APU) overhauls. The total maintenance

charges to flight costing will then be broken down into a regular maintenance charge per

flight hour, a regular maintenance charge per cycle, and a standard major maintenance

charge per flight hour. This smoothed cost curve for total maintenance cost is

represented by the horizontal dotted line in Figure 8-16.

Apart from the benefits for managing margins, the process of normalizing

expenses has some very specific implications for organizational planning and control.

Planning must now be done for two time horizons. First of all, a long-term plan must be

established for major maintenance costs to be incurred per category. This information is

used to determine the standard major maintenance rate by dividing the total planned costs

by the planned flight hours. These calculations and standards should be updated on a

periodic basis. This rate is charged to the cost of the flight and used to build a reserve for

Cabin Crew

Flight: ZZ999- Business Class- Coach Class

Catering

HumanResource

Purchasing

- Jet Fuel- Landing and Parking

ApronHandling

FlightProfitability

HangarMaintenance Major

MaintenanceEvents

Aircraft Types:- A7X7- A7Y7

MajorMaintenance

Reserve

Figure 8-17 A Revised Storyboard Representing an SCMS Model.


future major maintenance expenses. Regarding the acceptability of this practice for

financial accounting purposes, it should suffice to say that current ERP functionality

allows for parallel treatment of the major maintenance expenses to satisfy both financial

and management accounting demands in cases where the airline does not have to

capitalize the reserve.

Second, since major maintenance will now be controlled for each period as actual

events occur, management needs to determine the planned number of each type of major

maintenance event. These events are individually budgeted and controlled when they

occur, and at completion the costs are accounted for against the reserve that has been

built using the standard rate.

The normalization of large expense items will necessitate an adjustment to the

storyboard (Figure 8-10) to more accurately reflect our proposed SCMS model. The

revised storyboard is shown in Figure 8-17.

Adjustments for Industry-Specific Characteristics

We indicated previously that the invested resources determine the initial inherent nature

of costs. But at least one other factor need to be considered in this regard - the inherent

operating cost characteristics of the resources/assets.

It is a well known fact in the airline industry that operating costs are to a large

extent a function of equipment utilization patterns, the operating environment, and fleet

age, and so forth, for example, the fuel efficiency of the equipment.15 The airline industry

is, of course, not unique in this regard; these factors holds true for any transportation

enterprise. But because of the cost of the equipment used in the airline industry, this

industry is more sensitive to these factors than most.

We have not been oblivious to this fact as we have gone along in this chapter. As

far as the influence of equipment utilization patterns, operating environments, and fleet

age, among other considerations, on the inherent nature of costs is concerned, there is

clearly a need to evaluate the specific airline’s position. This process must take into


consideration the utilization pattern, the status of the equipment in terms of the overall

equipment life curve and cost curve, and it must adjust the fixed and proportional nature

of the costs of certain assets. This also implies the need to make periodic adjustments to

standards as the fleet ages or as utilization patterns change.

In conclusion, it is important to note that the primary purpose of the SCMS is to

accommodate the management processes of planning and control, and the provision of

information that is relevant for making decisions within the time frame that the strategy

must be achieved. The reflection of the proportionality of costs is therefore driven

primarily by the strategic view, but within the framework of the airline’s position in

terms of industry-specific cost characteristics. Both views must be combined in the

SCMS to enable accurate planning and valid control measures as provided by authorized

reporting.

Evaluating the Output of the Proposed SCMS Model

In this section we illustrate how the output from the SCMS can be used in everyday

management tasks and decisions. We present three examples: an outsourcing decision,

illustrating how middle management will use information from the SCMS; an authorized

report for a resource pool that incurred a higher than planned activity level; and, finally,

to illustrate the support of more strategically oriented decisions, entry into a new market

using data from the SCMS.

An Outsourcing Decision and the Alternate Views of the Nature of Costs

As we have pointed out already, the information demands of different levels of

management could result in conflicting information needs. This is well illustrated when

we compare the information typically supplied by the management accounting system

with the information needs of managers who need to make an outsourcing decision. For

decisions of this kind, middle managers must consider fewer costs fixed than what they

are typically presented with.


It is important to realize that the proposed SCMS model is based on what is

considered to be a viable strategic plan. No organization plans for failure. Adjustments

to the resource base, for example, outsourcing, can therefore only be incremental steps to

the plan, triggered by change in the environment. The embodiment of the plan,

optimizing execution and enabling control, is a primary objective of the SCMS. The

SCMS must therefore supply data with primarily an operational flavor.

But on those occasions when outsourcing decisions must be made, the SCMS

should also supply information that is relevant for making this kind of decision. Consider

Table 8-8, an example of the fully burdened resource costs for the Catering Department

of an airline; note that this is an expansion of Table 8-1, which showed only the primary

expenses. The view is often held that all costs are variable at this level of decision

making. We would propose that this is not the case, and in this regard the classification

of costs into their primary and secondary categories is crucial. In particular, the

secondary costs should be more carefully considered.

The classification of primary fixed and proportional costs, although essential for

making short-term operating decisions, is not relevant in the case of outsourcing

decisions. If the catering function is to be outsourced, clearly all of the primary expenses

will no longer be incurred, and therefore middle management will need to consider none

of these costs to be fixed.

But this is not the case for the secondary expenses. In the event that catering is

outsourced, the proportional secondary expenses will result in excess/idle capacity for the

providers of these services. For the Human Resources Department, Water and Energy

Department, and the Facilities Department, subsequent management actions are required

to ensure that the resultant excess/idle capacity is addressed and the cost savings realized.

It is more difficult to turn the secondary fixed costs, highlighted in Table 8-8, into cost

savings. These costs typically include fixed costs, not only those from the suppliers of

service - in this instance Human Resources Department, the Water and Energy

Department, and the Facilities Department - but also the fixed costs for those services

that suppliers of the service consume in providing their service. Those making the

outsourcing decision therefore cannot be oblivious to these costs, which will clearly not


go away when the Catering Department is outsourced. As this scenario illustrates, the

SCMS can supply information that is relevant to tactical management in cases where

these managers are required to take corrective actions, as well as information that is

relevant to operational decisions.

Table 8.8

Catering Department Planned Resource Output: 12,000 Catering Man-Hours



Chefs’ Salaries - $ 228,000 $ 228,000

Fringe Benefits $ 60,000 - $ 60,000

Depreciation – Equipment $ 4,000 - $ 4,000

Secondary Expenses Fixed Proportional Total

Human Resources $ 40,000 $ 15,000 $ 55,000

Water and Energy $ 8,000 $ 25,000 $ 33,000

Facilities $ 20,000 - $20,000

$ 212,000 $ 268,000 $ 480,000

Resource Unit Output Rate $ 17.67 $ 22.33 $ 40.00

Finally, this scenario highlights another interesting point about the nature of costs

- namely, that there is never really a business for which all costs would be variable, an

approach generally maintained in ABC today. For any given strategy, considering the

investment base and support services being provided, certain fixed costs will always be


present. The conclusion on the nature of cost within any going concern would therefore

have to be that the only time all costs would be variable would be if it is the enterprise’s

strategy to go out of business.

Organizational Control with Authorized Reporting

A primary objective of the SCMS is to enhance organizational control by providing valid

yardsticks for performance measurement in spite of changes in the business environment.

Table 8-9 shows the original plan and actual expense for the period for the Apron

Handling Department. Note that this table covers ground-handling equipment and does

not include labor costs; the latter would be treated as a separate resource pool with its

own output in the SCMS.

The rates charged by the secondary services in this example are shown in Table 8-

10. Note that the actual output level for the period was higher than planned. A fair

amount of the input variances shown here should therefore be attributed to the increase in

volume from 10,000 hours to 11,000 hours. This distinction is provided by the

authorized report shown in Table 8-11.

The total input variance for apron-handling equipment is now $ 4,780 as opposed

to $11,750 in Table 8-9, and this variance is the responsibility of the apron-handling

supervisor. Functionality typically allows for the primary cost variances to be broken

down into price, quantity, resource usage and remaining variance (details not shown in

the table). Note that authorized secondary costs are based on authorized secondary

quantities. The monetary secondary cost variances shown reflect the quantity variances

only. Since the SCMS is a standard cost system, no price variances for secondary costs

are provided.


Table 8-9 Planned Output and Costs To Be Used for Authorized Reporting

Plan/Actual/Variance Report

Department: Apron Handling

Output: Equipment Hours

Planned Quantity: 10,000 Actual Quantity: 11,000

Primary Costs Plan

Fixed

Plan

Prop.

Actual Variance

Oil and Lubricants 100 1,000 1,270 170

Diesel Fuel - 5,000 6,000 1,000

Consumables 50 200 260 10

Depreciation 25,000 - 25,000 -

QuantitiesSecondary Costs

Plan

Fixed

Plan

Prop.

Actual

Maintenance 10 1,000 1,377 10,250 15,000 34,425 9,175

Plan & Schedule - 400 433 6,000 8,000 15,155 1,155

Purchasing - 100 112 500 1,500 2,240 240

41,900 30,700 84,350 11,750

Table 8-10 Secondary Service Outputs and Rates

Service Description Output Fixed RateProportional

Rate

Equipment Maintenance Hours 10 15

Equipment Plan and Scheduling Hours 15 20

Equipment Purchasing Purchase Orders 5 15


Table 8-11 Authorized Report for Apron Handling

Authorized Report

Department: Apron Handling

Output: Equipment Hours

Planned Quantity: 10,000 Actual Quantity: 11,000

Primary Costs Authorized Actual Variance

Oil and Lubricants 1,200 1,270 70

Diesel Fuel 5,500 6,000 500

Consumables 270 260 (10)

Depreciation 25,000 25,000 -

QuantitiesSecondary Costs

Authorized Actual

Maintenance 1,200 1,377 30,000 34,425 4,425

Plan and Schedule 440 433 15,400 15,155 (245)

Purchasing 110 112 2,200 2,240 40

79,570 84,350 4,780

Considering Entry into a New Market

The following scenario illustrates how the information that the SCMS provides enables

the evaluation of macro output efficiency.

A regular scheduled airline wants to get into the no-frills travel business. The

company has identified a popular vacation destination as a potential target market into


which to introduce its product, initially to be offered from the airline’s primary hub only.

It is also estimated that some traffic will be attracted from the large retired population in

the state, with travel patterns complimentary to vacation travelers. The plan is to serve

the route with older aircraft with a single-class configuration that is being phased out of

normal scheduled operations. Management also wants to ensure that the business

remains profitable once the airplanes come up for replacement, particularly since this is a

very price-sensitive market.

Market research has indicated that the route is not very thick. The airline has,

however, proven that with its name, image, and safety record in the market, it is normally

able to attract passengers fairly quickly on new routes. Initial route density is estimated

at one thousand passengers per week. This translates to a 60 percent load factor on an

initial service offering of two flights per day. It is also assumed that current support

service capacity will be able to absorb this initial level of increase in throughput without

any incremental investment. It is estimated that route density will increase to two

thousand passengers per week. The ceiling price on this service is currently $ 79. The

thought is to follow an aggressive market penetration strategy, the two major prongs

being aggressive pricing and a corresponding advertising campaign to raise market

awareness. Management has asked the management information analyst (MIA) to

prepare an estimate of the product costs for this venture. The MIA used data form the

airline’s newly implemented SCMS to provide the information shown in Table 8-12.

The analysis of the data shows that the flight will not make an overall profit.

Given the initial route density, the full-cost column indicates a loss of $2,120. Although

the flight would make a contribution to fixed costs, it was decided that this was not going

to be incremental business since this venture would have dedicated airplanes. Break-

even occurs at a load factor of 86 percent (99 passengers) - a level that is attainable

should the route density increase as forecasted. But the information supplied by the MIA

was based on the assumption that increase in traffic would not require any additional

investment in support areas. After investigating capacity utilization in maintenance,

cabin crew, flight crew and apron handling, the airline decides not to pursue the venture

any further since the incremental investment that would be required to facilitate a fully


developed route would increase the fixed costs to a level where the venture would no

longer be profitable.

Table 8-12 Profitability of the Venture at Initial Route Density

Estimated Product Profitability Report: Flight ZZ1111

Passenger Information:

# of Passengers

Passenger Revenues

Passenger Related Costs

- Passenger Handling

- Cabin Crew

Passenger Contribution Margin

Passenger Gross Margin

Marginal Cost

70

($ 5,530)

$ 210

$ 280

($5,040)

Full Cost

70

($ 5,530)

$ 560

$ 770

($ 4,200)

Flight Information:

Flight Related Costs

- Fuel

- Landing and Parking

- Maintenance

- Flight Crew

- Apron Handling

- Interest

- Depreciation

Flight Contribution Margin

Flight Gross Margin

$ 2,500

$ 800

$ 350

$ 60

$ 100

-

-

(1,230)

$ 2,500

$ 800

$ 790

$ 200

$ 280

$ 250

$ 1,500

2,120


Conclusion

Clearly managers need a system that can accommodate their processes and that has the

ability to supply information that supports them in guiding the enterprise to achieving its

strategy. Such a system should thus utilize a common set of data and supply information

that is relevant to all managerial levels for decision making. The ability to immediately

support decisions at all levels of management is critical in maximizing the enterprise’s

efficiency and effectiveness.

A primary objective of the proposed SCMS is that it supports proactive decision

making better than what traditional prescriptive reporting does. Changing to this new

system means migrating the organization from historic reporting to the ability to address,

adjust to, and even preempt change in the business environment. Achieving this vision

means converting from the traditional management accounting view into a strategic cost

management view. The power of real-time integrated systems makes this vision and the

maximizing of shareholder wealth attainable.


Endnotes

1. D.H. Drury and C.S. McWatters, “Management Accounting Paradigms in

Transition,” Journal of Cost Management 12, no. 3 (1998): 32-40.

2. Michael E. Porter, Competitive Advantage. Creating and Sustaining Superior

Performance (New York: The Free Press, 1998), p. 37.

3. Ibid., p. 70.

4. Drury and McWatters, “Management Accounting Paradigms in Transition,” pp. 32-

40.

5. Robin Cooper and Robert S. Kaplan, “The Promise-and Peril- of Integrated Cost

Systems,” Harvard Business Review (July- August 1998): 109-119.

6. Grant F. Schutte, Integrated Management Systems (Durban, South-Africa:

Butterworths, 1981), p. 13.

7. Ibid., p. 96.

8. Wolfgang Kilger, Flexible Plankostenrechnung und Deckungsbeitragsrechnung

(Wiesbaden, Germany: Gabler, 1993), p. 946.

9. A. van der Merwe, “Plaut Activity-based Costing: An Evaluation of Its Relevance in

Multi-Product Companies” (an empirical research project presented as a thesis for the

master’s degree in business leadership at the School of Business Leadership,

University of South-Africa), p.75.

10. Robert S. Kaplan, ABC Seminar Presentation. Frankfurt, Germany, June 11, 1996.

11. The Airplane Economics Group, BOEING. Airframe Maintenance Cost.

Methodology and Application. (BCAG Marketing Department) (Seattle, Wash.:

BCAG, 1994), p. 8.

12. John K. Shank and ijay Govindarajan, Strategic Cost Analysis: The Evolution from

Managerial to Strategic Accounting (Homewood, Ill.: Richard D. Irwin, 1989), p.

131.


13. Charles T. Horngren and George Foster, Cost Accounting. A Managerial Emphasis

(New Jersey: Prentice-Hall, 1987), p. 107.

14. Jean-Pierre Poubeau, Direct Maintenance Costs: Art or Science? Maintenance Costs

Group, Airbus Industrie, France, p. 17.

15. The Airplane Economics Group. BOEING. Airframe Maintenance Cost.

Methodology and Application, p.4.

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