The Texas Pilot Project
For years, the plumbers, painters, carpenters and maintenance people who worked for the Texas General Services Commission (GSC) shuttled back and forth between the departments administration building, located in Austins Capitol Complex, and its parts warehouse, about seven miles to the east. While everyone knew this was an inconvenience for the painters and carpenters, it wasnt clear that these trips were costing the agency a considerable amount of money. "It was a pain to have to constantly drive from one building to the other," one employee told us, "but we just assumed that was the way it had to be."
But it wasnt. And now those 14-mile round trips are gone for good.
In Spring 2000, GSC decided to include capitol maintenance services in an activity-based costing (ABC) analysis to learn the true, fully-allocated costs of these activities. The analysis demonstrated, among other things, that the location of the warehouse was costing the department a lot of money that could be spent better elsewhere.
By management estimates, GSCs plumbers, painters and carpenters logged more than 48,000 miles driving between the two locations in 1999. Including salaries for drive times, gasoline, and indirect and administrative costs, the ABC analysis found that GSC could save more than $51,000 a year simply by moving the warehouse to its administration buildings basement. Within weeks, GSC did so.
This experience illustrates the benefits the state can realize from ABC. The tremendous opportunities offered by ABC analyses were discussed in the Comptrollers 1999 Texas Performance Review report, Challenging the Status Quo: Toward Smaller, Smarter Government. In response to recommendations in that report, the 1999 Legislature adopted Article IX, Section 9-6.43 of the General Appropriations Act, creating an ABC management team of representatives from the Governors Office of Budget and Planning, State Auditors Office, Legislative Budget Board, and the Comptrollers office. This team was directed to oversee an ABC pilot project and report to the Legislature on its results no later than January 15, 2001. The process followed to fulfill this directive is discussed in detail in this report.
ABC assigns costs to all of the activities in a given process, based on the resources they consume. Activities are the steps necessary to convert resources into a product or service; under ABC, all costs of activities, including overhead, are traced to the product or service for which the activities are performed.
Most governments do not have a clear idea of all the costs associated with their own in-house operations. Some researchers have estimated that governments routinely underestimate the true costs of in-house operations by as much as 30 percent, typically because they omit many indirect costs when determining the total costs of performing any function.1
ABC provides a more accurate picture of costs than traditional accounting methods. Both ABC and traditional accounting consider items such as fringe benefits, labor, supplies and possibly depreciation. ABC, however, traces the full range of direct and indirect costs to each product or service, allowing organizations to determine the full amount of resources consumed by each activity and make business decisions accordingly.
Below is a glossary of terms that will aid understanding information contained in this report.
Glossary of Key Terms Activity-Based Costing (ABC) A methodology that measures the full cost and performance of activities, resources and cost objects. Resources are assigned to activities, and activities are assigned to cost objects based on their purpose.
Activity-Based Management (ABM) A discipline that focuses on the management of activities to maximize the profit from each activity and improve the value received by the customer. This discipline includes cost-driver analysis, activity analysis and performance measurement. ABM draws on ABC as its major source of information.
Activities The functions that an organization performs to fulfill its missionits reason to exist. For example, mowing a lawn, trimming trees, edging and blowing leaves are all core activities of a landscaping company.
Task A specific set of actions that generally involve the completion of one step in a process. Filling the gas tank of a lawn mower is one of many tasks performed in landscaping.
Process A series of activities linked to perform a specific objective. For example, mowing involves filling the lawnmower with gas; starting the lawnmower; pushing the lawnmower over grass; stopping the lawn mower engine; detaching the clippings bag; emptying the bag; and putting away the lawn mower.
Cost Drivers Any factor that causes a change in the cost of an activity.
Resources Anything consumed in the performance of an activity, such as salaries, rent, insurance and supplies.
Non-Value-Added Activity An activity that does not contribute to customer value or the organizations needs. A good example of a non-value-added activity is the effort exerted to correct an error.
Cost Objects Any customer, product, service, contract, project or other work unit for which a separate cost measurement is desired. For example, the service "Business Machine Repair" is a cost object at GSC. Managers typically set targets for these products and track their organizations performance against the targets. In the private sector, the target may be to achieve a particular profit level; in the public sector, it may be recovering the full costs of an operation through fees.2
Activity-based management (ABM) takes the concept of ABC one step further, drawing on ABC data to identify ways to make processes more effective and efficient, generate meaningful performance measures, set and evaluate goals, and meet or exceed changing customer needs. ABM provides the tools necessary to view processes in new ways, and therefore lends itself to making improvements that will increase customer satisfaction, maximize resources and/or decrease costs. ABM provides the information needed to distinguish between activities that contribute to the organizations mission and those that do not. It equips managers and employees to make sound business decisions based on in-depth knowledge of the activities performed to produce a unit of output.
Benefits of ABC/ABM Knowing the cost of activities can help organizations make decisions that save money and improve the quality of services. Examples of how ABC and ABM can help include the following:
Benchmarking. Knowing the true costs of activities helps agencies decide whether to perform those activities in-house or to contract for them with another entity. The Iowa Department of General Services Micrographics area, for example, once processed rolls of 35mm film at a cost of $15 per roll. After identifying its own costs, the department compared them to private sector rates, which varied from $7 to $9 per roll. This information led the department to stop performing the work in-house in favor of the cheaper alternative.3
ABC also is useful to benchmark costs across regions. Indianapolis uses ABC to analyze all types of city services, from trash pickup to pothole repair. The citys snowplowing operations, for instance, were divided into 13 regions and analyzed via ABC to determine the costs of each activity associated with snowplowing in each region. The city found that the costs of plowing snow varied considerably across the city; the total cost of plowing one mile of snow was $39.96 in the citys southeast region but $117.59 in its southwest region.4 Such information prompts managers to look deeper into the reasons for such differences, adopt the best practices of cost-effective areas and correct problems within their control.
Reengineering Operations. ABC/ABM encourages employees to "map," or describe in detail, their business processes. Mapping such activities helps identify bottlenecks and other work steps that do not add value to the overall process. Reengineering those processes can result in lower costs and improved services.
In 1992, Mobil Oil implemented an ABC program focusing on the firms US lubricants business. "Mobil wanted to know what was making moneywhich products, which customer relationships, and which production plants," recalls Thomas Kang, who expanded the ABC program globally for Mobil. The investment in ABC unearthed thousands of unprofitable product lines and an antiquated approach to the use of suppliers. The US lubricants division has since reduced the number of its products from around 12,000 in the late 1980s to less than 5,000, and cut the number of suppliers it uses from more than 2,000 to around 500. That, in turn, helped its after-tax profit rise from zero in 1990 to $150 million today.5
Measuring Performance. ABC also can enhance an organizations performance measurement process. It can help organizations set reasonable performance targets based on the acceptable amount of time needed to perform each activity.
Cost Recovery. Professional licenses, permits to build or operate, and applications for governmental service are just a few of the areas requiring accurate fee-setting. Many agencies are required by law to recover the costs of their services, yet may lack the data or expertise needed to ensure the sufficiency of the fees they charge. ABC/ABM can provide the data they need to set fees at a level sufficient to recover costs.
Exhibit 1 lists the agencies that participated in the ABC/ABM pilot project, the processes reviewed and the potential savings identified.
Summary of Review Areas
Total Program Costs and Gross Potential Savings
General Services Commission Business Machine Repair $1,602,140 $188,680 11.7% Leasing 928,891 125,425 13.5% Capitol Zone Maintenance 5,123,168 169,480 3.3% Total GSC $7,654,199 $483,585 6.3% Department of Transportation Voucher Processing- Central only $3,088,249 $414,735 13.4% Map Sales 518,283 308,182 59.4%* Total TxDOT $3,606,532 $722,917 20% Texas Workforce Commission Controller $2,141,086 $71,160 3.3% Unemployment Insurance Collections 2,053,916 226,460 11% Austin Tax Office 957,890 89,400 9.3% Out of State Unit 366,900 40,950 11.1% Total TWC $5,519,792 $427,970 7.7% Texas Cosmetology Commission All Areas $2,452,353 $546,710 22.2% Total TCC $2,452,353 $546,710 22.3% Texas Water Development Board Loan Servicing: D Fund II Program $6,557,745 $257,732 3.9% Total TWDB $6,557,745 $257,732 3.9% Texas Department of Economic Development Finance $1,265,480 $113,050 8.9% Internet Clearing House 1,133,670 172,360 15.2% Total TDED $2,399,150 $285,410 11.9% Comptroller of Public Accounts Revenue Processing $11,106,521 $2,772,956 24.1% Account Maintenance 12,323,182 2,180,895 19.4% Revenue Refunds 6,835,098 837,900 11.1% Revenue Accounting 9,478,357 372,456 3.9% Total CPA $39,743,158 $6,164,207 15.5% Total All Agencies $67,932,929 $8,888,530 13% * $116,039 of revenue from increased price of maps not included.
The consultants estimate that if participating agencies implement 100 percent of the recommendations, the state could save almost $8.9 million. Since this figure does not include the costs to implement the recommendations, agencies were asked to estimate implementation costs.
The agencies support some recommendations but disagree with others. For the recommendations the agencies deemed feasible, the potential savings were estimated at $7.9 million before implementation costs. Agencies estimated that it would cost $6.9 million to implement these recommendations, for a total of about $1 million in initial net savings to the state. Because many of the implementation costs are one-time expenses, the state could expect to realize significant savings in subsequent years.