05 Jul 2006Working Paper Summaries

Time-Driven Activity-Based Costing

by Robert S. Kaplan and Steven R. Anderson

Activity-based costing (ABC) has become popular in business writing and management circles. (An example of an activity would be process customer complaints.) However, calculating baselines for activities, developing the model, and retesting the model once it is implemented is time-consuming and costly. Kaplan and Anderson developed improvements in the process through what they call time-driven ABC. Time-driven ABC decreases the amount of data needed, and only requires estimates of two things: (1) the practical capacity of committed resources and their cost, and (2) unit times for performing transactional activities. Key concepts include:

Building an accurate time-based algorithm in one facility will typically serve as a template that can be easily applied and customized to other plants, or even other companies in an industry.
Time-driven ABC requires less time and resources to implement. At one company cited, it took two people two days per month to load, calculate, validate, and report findings, compared to the ten-person team spending over three weeks to maintain the previous (traditional ABC) model.

Author Abstract

The traditional ABC model has been difficult for many organizations to implement because of the high costs incurred to interview and survey people for the initial ABC model, the use of subjective and costly-to-validate time allocations, and the difficulty of maintaining and updating the model as (i) processes and resource spending change, (ii) new activities are added, and (iii) increases occur in the diversity and complexity of individual orders, channels and customers. Time-driven ABC requires estimates of only two parameters: (1) the unit cost of supplying capacity and (2) the time required to perform a transaction or an activity. A time-driven ABC model:

can be estimated and installed quickly
is easily updated to reflect changes in processes, order variety, and resource costs
can be data fed from transactional ERP and CRM systems
can be validated by direct observation of the model's estimates of unit times
can scale easily to handle millions of transactions while still delivering fast processing times and real-time reporting
explicitly incorporates resource capacity and highlights unused resource capacity for management action
exploits time equations that incorporate variation in orders and customer behavior without expanding model complexity

The paper uses simple numerical examples to articulate the fundamentals of time-driven ABC and provides several examples of companies that have implemented the approach and enjoyed rapid and significant profit improvements.