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Activity-based costing, government and business intelligence

"An activity-based costing approach provides transparency in allocating costs back to processes and expended resources, and thus allows for analysis of the drivers and comparison of the resources used."

This article originally appeared on the BeyeNETWORK.

In tight times, it becomes extremely important to have a good grasp of where one’s resources are going. Well, these are tight times for most federal agencies as a result of two key factors. First, the cost of the war has imposed significant budget constraints on everyone outside of the Department of Defense; second, the Continuing Resolution (CR) is now into the third month of this new fiscal year that runs from October 1, 2007, through September 30, 2008.

A CR, to remind you folks outside the Washington Beltway, is just the legislative mechanism that allows the Executive Branch to actually spend money when a formal budget has not been approved by Congress at the beginning of a new fiscal year. It is an actual law that takes the form of a joint resolution of Congress and provides temporary funding for government to operate but at a substantially reduced level. This is just a way to get around shutting down government altogether as happened during the Gingrich-Clinton standoff in 1995-96 when major parts of the Executive Branch were closed down for several weeks.

Hence, being able to perform efficiently is a key consideration throughout government these days. That is one of the reasons why there has been so much attention paid to Six Sigma, balanced scorecards or activity-based costing (ABC) approaches.

Activity-based costing, in particular, has been adopted in a number of federal settings over the last few years. While there are many questions that still need to be answered about the fitness of ABC in government, it is also clear that it has moved the ball forward in several agencies where it has been implemented.

At the heart of an ABC is the need to allocate costs as accurately as possible in order to provide managers with a potentially better way to make decisions. Should we buy a software package or develop the application in house? Should we use airplane Model A or Model B to transport this cargo? How many anesthesiologists should we hire in this hospital to handle the increased volumes in surgery?

Like any methodology, activity-based costing is not magic, nor is it a “silver bullet.” There are a number of challenges and potential pitfalls. First, it requires a conscientious definition of all activities performed and the associated resources used. Furthermore, the output from the process is only as good as the data that goes in. This last point can be particularly frustrating in cases where the detailed capture of time is required through too granular a timecard or timesheet. (There are some industries, however, such as healthcare, where software tools have been developed to take advantage of libraries of cost coefficients by procedure. This preempts the need to do much detailed capture of labor data and relies purely on these coefficients that have been defined based on years of research.)

But activity-based costing goes beyond determining the cost labor driver in each process. Hence, dictionaries have to be developed with cost coefficients for all potential factors that affect the cost of a process.

An ABC approach, in principle, is able to provide transparency in allocating costs back to processes and expended resources, and thus allows for analysis of the drivers and comparison of the resources used. We are able to much better estimate the return on investment (ROI) of a piece of hardware, a professional resource or a real property asset and, hence, can improve the management of these resources and enhance an organization’s performance.

This approach utilizes a process that starts by identifying resources involved in any business (compensation, rent, machinery, etc.) and mapping them back to the activities those resources carry out. The analysis permits management to view cost based on the activity performed (e.g., dollars per operation) rather than on the resource itself (e.g., salaries paid). As a result, activity drivers are applied to specific resources in order to be able to answer the key question, “What do things cost?” And depending on the line of business, a “thing” may be a pilot, an airplane, a patient, a clinical procedure, a weapon, an office or a piece of furniture.

In government, while there may be some areas that are difficult to map to the classical ABC approaches, there are others that are rife with opportunity. If we look across the lines of business that government performs and dive down to specific functional activities, we find a potential mother lode. Just take transportation, for example, throughout the public sector and consider the considerable advantages of understanding, for example: what specific equipment to use in order to minimize the expense of a transaction; the true cost of operating a given truck, or automobile or airplane; the return on investment of hiring one additional pilot, mechanic or engineer; or being able to reduce the operating costs of a dispatch center.

Or take healthcare. This is an activity that, at the federal level at least, is carried out in multiple agencies. The Army, Navy and Air Force all run healthcare systems, so does the Department of Veterans Affairs; the Department of Health and Human Services runs many clinics as well as the National Institutes of Health, etc. Well, it becomes particularly important in a hospital, for example, to be able to understand what the costs are of operating cardiac rhythm device 1, 2 or 3 in order to decide which one to buy; or what the cost of a surgical procedure is when it is performed by Surgeon X or Y as opposed to Surgeon Z.

It’s about at this point where we business intelligence (BI) mavens start to feel our juices flowing because we can see that in order to make an ABC truly effective, you must couple it with a robust BI capability. Having an ABC system and not being able to query for specific responses, or without allowing it to simulate given scenarios, or without enriching it with relevant statistical and financial functional libraries would be a dire underutilization of the resource.

In my opinion, the future of ABC systems in government is very promising. There is certainly significant need. But it is critical that this methodology be looked at carefully in conjunction with the decision support and business intelligence systems deployed within each line of business in each agency. Without this, activity-based costing could become one more way in which taxpayer dollars are spent without getting enough value in return.

Dr. Barquin is the President of Barquin International, a consulting firm, since 1994. He specializes in developing information systems strategies, particularly data warehousing, customer relationship management, business intelligence and knowledge management, for public and private sector enterprises. He has consulted for the U.S. Military, many government agencies and international governments and corporations.

Dr. Barquin is a member of the E-Gov (Electronic Government) Advisory Board, and chair of its knowledge management conference series; member of the Digital Government Institute Advisory Board; and has been the Program Chair for E-Government and Knowledge Management programs at the Brookings Institution. He was also the co-founder and first president of The Data Warehousing Institute, and president of the Computer Ethics Institute. His PhD is from MIT. Dr. Barquin can be reached at rbarquin@barquin.com.

Editor's note: More government articles, resources, news and events are available in the BeyeNETWORK's Government Channel. Be sure to visit today!

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