Service companies are quickly catching up to manufacturers when it comes to implementing activity-based management. Their focus is on using ABM to increase customer profitability and identify non-value-added services.

Do the principles of activity-based management (ABM) change from industry to industry? No. That’s one of its attractions. It’s universally applicable. However, there are special areas of emphasis within ABM that are more pertinent to some types of companies than others. Those within the service sector, for example, often find different applications for ABM than companies in the manufacturing sector. If your company works within the services sector, you may be able to improve your use of the ABM tool by understanding some of these basic differences.

In general, ABM appears to be developed at a more sophisticated level among manufacturing companies than among services companies. That may be due to the fact that ABM grew up in the manufacturing sector. Its roots trace back to collecting cost information on a product by analyzing activities related to the production process.

Another basic distinction is that service companies are less numbers-intensive than manufacturing companies. Cost accounting textbooks use manufacturing companies, not service companies, as examples simply because a company like General Motors tends to have more cost accounting than a company like CitiBank.

"ABM kept us from bringing on new customers that we might have lost money on."

Dorothy Brown,
Field Operation
Accounting Manager,
Multifoods Distribution Group

"Manufacturing companies generally have more ABM data than service companies, and they tend to have more automation to collect that data," says John Antos, president of the Value Creation Group, an international group of ABM consultants located in Dallas. "So service companies often end up collecting ABM data through a manual process for projects such as time studies, as opposed to collecting the information electronically." As a result, ABM data collection among service-oriented companies may often require more people hours than in manufacturing, since there’s less automation available at service companies to speed up the process.

There are fewer ways to measure the performance of activities in services than in manufacturing, according to Antos. "In particular, there tends to be less performance measurement in support areas and the operations areas of service-oriented companies than among manufacturing companies," Antos says.

On the other hand, ABM data collection tends to be easier for service companies. "In services, you’re looking at activity costs tied to people, things like the number of cubicles and computers people use, whereas in manufacturing you’re looking at activity costs tied to equipment, where there can be tremendous capital assets usage [to track]," says Antos. "For instance, one person in manufacturing could be responsible for six or seven machines."

Boiled down to basic terms, service companies are more people-intensive, while manufacturing companies are more equipment-intensive. So, there’s less need for service-oriented companies to concentrate on traditional product costing and more urgency to use ABM as a growth-enabling tool for purposes such as customer profitability and identifying non-value-added services.

"In manufacturing, depreciation is usually a much larger percent of total cost than in services," says Antos. "For instance, 50 percent to 75 percent of a service company’s total costs may be taken up by salary and wages."

As service companies increase the number of products they offer, the interest and need for more detailed, accurate costing information increases. The services sector has been the largest and fastest-growing area of the U.S. economy. It’s not surprising, then, that service companies are quickly catching up to manufacturing companies when it comes to implementing ABM.

Cost to Serve

In the service arena, determining and lowering the cost to serve is a prime objective for using ABM. The challenge is to make the less expensive service also the preferred service among customers. Banks, for instance, can provide basically the same services either through a teller or an automated teller machine (ATM). The ATM is cheaper for banks, and generally the service option of choice among customers.

"It costs about $2 for a teller to process a transaction versus about 50 cents per transaction for the ATM," says Mitchell H. Max, a senior manager in Arthur Andersen’s Business Consulting practice in Toronto who specializes in services industries. "The fact that more people may prefer the ATM drives home the point that you have to look at value to customer when using ABM, and not get caught up entirely on cost." In looking at how to execute transactions through the most efficient channels, focus on volume of demand and relative customer demand as well, says Max.

Developing a shared services process within your company by consolidating specific operations in one location can also reduce cost to serve. For Mutual Life of Canada, the second-largest retail insurance company in Canada, the challenge was to use ABM to improve understanding of costs within their internal shared services departments, which service a number of areas including finance, corporate affairs, strategic development, human resources, legal, maintenance and information technology.

"Before we began ABM, our costs for shared services were significant, representing one-third of the total non-sales-related costs of the company, and there was a lack of understanding of those costs," says Andrew Beacom, manager of ABM for Mutual Life of Canada. "In addition, internal customers were saying, ‘Prove to us the value of your shared services area.’ The introduction of ABM came as a response from our business units to reduce costs."

"Our goal was to review all customers to determine which customers were profitable and which were not."

David Arney,
Divisional Controller,
Trans Union Corp.

Beacom went through an activity identification process and then mapped those activities to products provided; for example, mapping payroll activity to the payroll product. But more detail was required, according to Beacom. ABM revealed where activities could be combined, eliminated or outsourced. As a result of the ABM effort, service-level agreements were set up with internal customers, along with monthly invoices to bill back to business units for services provided.

Combining services for greater efficiency is a prominent ABM theme in the services area. That concept was also the answer for Healthspan Transportation Services (HSTS) in St. Paul, Minn., a business unit of Allina Health Systems. HSTS offers a range of ambulance services, from 911 responses to wheelchair transportation, to 75 communities.

"When we started our ABM efforts, we focused on our two areas of business: emergency room calls and scheduled calls," says Lynn Sexter, the company’s director of finance. "We recognized by analyzing our data that when our scheduled call service was busy, our emergency room service was often idle, so we used the emergency room service to respond to scheduled calls. That increased our usage efficiency. We went from 50 percent usage of service resources to 75 percent usage, which enabled us to improve profits by $600,000."

Companies are also concentrating more on the cost to serve potential new customers. ABM reveals information about whether a new client prospect will provide the profit margins the company requires.

"ABM kept us from bringing on new customers that we might have lost money on," says Dorothy Brow, field operation accounting manager for Multifoods Distribution Group in Denver, a division of International Multifoods Corp., a Fortune 500 company. Brow’s company is a food service provider to fast-food chains. It used Sapling’s NetProphet software to create what-if scenarios to anticipate and analyze distribution needs. "Our cost to serve is based largely on our transportation costs, so we rank customers in terms of potential profit from zero to 250 miles, 250 miles to 500 miles, and 500 to 1,000 miles. Our potential for new business growth is greatest in rural areas, but we had to be selective because those are also the most remote areas for us to deliver."

ABC Pizza

Where do companies go wrong in their use of ABM? For service companies, it’s often in using ABM as a costing mechanism rather than as a management tool. John Antos, president of the Value Creation Group, an international group of ABM consultants located in Dallas, explains: "Let’s say you’re in the pizza delivery business and you want to determine your cost per pizza. So you define your activities and then relate the results to product costing. You determine it costs you $1 per pizza. That’s not useful information. You need to define your output in terms of process, not product. Your question shouldn’t be ‘What’s my cost per pizza?’ It should be ‘What’s my cost per delivery?’ That’s where your major costs lie. Now that you’ve asked the right question, you can focus on trying to reduce the number of minutes it takes to deliver, on improving delivery accuracy by finding ways to get the right address more often."

Brow’s company is merging with a sister company, which means she’ll have to go back to the ABM drawing board. "As of August, our ABM models will be obsolete because of our merger," says Brow. "ABM isn’t too flexible when the company changes its major systems of operation. We’ll have to go back and add more activities and do more studies on cost per transaction."

Brow also pointed out that although ABM has the full support of senior management, in her opinion it’s a conservative tool. "We could occasionally see reasons to serve a customer where ABM said it wouldn’t be worthwhile," Brow says. "That’s due in part to the nature of our business. While we shoot for a certain percentage of net income from each customer, the distribution business is so competitive that we may try to make up in volume what we lack in profit potential by focusing on customers to whom we can deliver a full truckload or standard delivery rather than an odd-weight delivery. Those kinds of deliveries improve our warehouse efficiency."

Unbundling Services

Today there’s a strong compression on profit margins among service companies as competition heats up and customers face more and more service choices. Unbundling service packages has proven effective in improving value to customers as well as growing a customer’s use of a company’s services. ABM information can help determine which set of services are in greater demand and which ones within a standard packaged offering are less attractive to customers.

"Offering more customized service packages that may, for example, leave out one or two services from the usual service package can increase appeal for a greater number of customers than merely making only one standard choice available," says Max. "Allowing for greater flexibility in service choice alternatives can help bring in customers you might otherwise not get."

Customization is a two-way street, however. Some companies find they’re willing to answer requests for customized services if those requests can be made more reasonable. That’s one of the things David Arney discovered when he set out to implement ABM at his company.

"Our goal was to review all customers to determine which customers were profitable and which were not," says Arney, divisional controller of Trans Union Corp., a Chicago-based provider of consumer credit information with over 3,400 employees. "We have traditionally provided customized services for some people, and we found we could frequently increase that part of our business by asking them to change or simplify their criteria. This strategy allows us to work within ranges where we can build more profit into our customized service and still accommodate the request, and we’ve found customers are often willing to make that compromise."

Technology can provide remarkable insights into customer profitability. Some companies can now identify each caller going through their phone system by account number, phone number or by other means. The process is called intelligent sorting. If the intelligent sorting system recognizes a caller as someone who has historically bought more services when they talk to a live person, it moves that person ahead of other callers waiting to speak to someone. So the company is making it more convenient for this customer to get on the line with a live person, realizing that customer is more likely to buy more services than if they’re relegated to automated phone routing. ABM can provide the performance measurements that determine how to use technological innovations in this manner.

Perhaps the greatest challenge facing service companies is finding a way to differentiate themselves from the stream of competitors who appear to offer basically the same kinds of services. While that sounds like a marketing task, ABM can deliver information to aid decision-making on how to service the most lucrative customers better and more efficiently. It may even lead you down a path toward greater specialization, focusing on a more specific group of customers who not only provide the greatest profit potential, but also fit your strongest business areas.

Tad Leahy is a Tampa, Fla.-based business writer.