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The Wise Use of Resources

As demands grow and resources become increasingly scarce, associations and non-profits must be more innovative in how resources are allocated and costs managed.

I would argue that the vast majority of organizations do not know the real cost of their various products and services. This lack of knowledge may lead them to mistakenly increase their focus on one product or service in the belief that it delivers a high financial contribution. The reality may be the opposite.

And for those organizations that set prices based on cost (a massive mistake in my view, and the basis for a future article), an inaccurate cost determination and the overly low price that results could be disastrous in the long run. 

Some organizations have attempted to deal with this situation by allocating overhead costs. To do this, they typically pick a basis on which to do the allocation. Unfortunately, that allocation usually will result in wildly inaccurate costs.

Such inaccurate costs also affect the organization's ability to cut costs or downsize in a manner that limits impact on member value, choose between competing products or services, budget accurately, measure organizational financial performance, and determine the package of services to provide to members as part of their membership.

I believe the time is right to consider a different approach. The approach that can provide the cost accuracy required is a concept called Activity-Based Costing. It started out in the manufacturing sector, and has been growing in popularity over the past fifteen years.

What is Activity-Based Costing (ABC)?

The basic premise of ABC is that a product or service (e.g. a seminar) consumes activities (e.g. registration data entry), the activities consume overhead resources (e.g. admin staff time), and the consumption of these resources is what drives costs (e.g. the number of registrations entered). Understanding this relationship is key to effectively managing costs.

Why Consider ABC?

The benefits of ABC are that it is a more accurate approach to cost management, it focuses on overhead (i.e. indirect costs), it traces these costs to a product or service rather than allocating them to the product or service, and as a result, makes indirect expenses into direct expenses.

Associations are good candidates for ABC because they generally have a wide variety of products and services, and overhead (admin and governance) is high. In addition, the cost of errors can be high given that many organizations operate on a break-even basis (plus a potential contribution to surplus).

How Does ABC Work?

The steps in implementing ABC are as follows:

• Identify the activities

• Determine cost for each activity

• Determine cost drivers

• Collect activity data related to all product and services

• Calculate product or service cost

It is important to incorporate the use of capital assets in the calculations by following a similar approach -- calculating capital costs, a capital cost rate, the usage level of the asset, and including that in the cost calculation. 

The Possibilities

By using ABC, it would be possible to accurately calculate the costs of recruiting a new member, retaining/maintaining a member, and each program and service. In addition, the true cost of supporting the board and governance could be determined, and I expect that this would be a shocker for most organizations.

This cost information would revolutionize the budgeting process, and the allocation of resources. Huge consumers of resources could not be justified unless they delivered an equally huge measure of value. Performance would be more easily measured.

Best of all, the information gleaned from an ABC process when combined with member value research would enable the organization to maximize value within set resource constraints.

Where To From Here?

Generally, current financial information is inadequate for effective organizational strategic and operational management. Decisions lead to uncertain results, because the decision-makers have incomplete information. Organizations can continue operating with partial cost and performance information, or they can embark on an exciting and revelatory new process. It is as simple as ABC!

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