As the world economy shifts away from the more conventional product focus and towards a services-based economy, so it becomes increasingly difficult for businesses to use their traditional enterprise resource planning (ERP) systems to cost their operations accurately.
This is because ERP functionality, particularly the general ledger (GL), is structured in such a way as to provide a view of costs that meets statutory and financial reporting requirements, rather than delivering the level of granularity required for costing in the new services-focused world.
According to Ronald Laxton, General Manager at Keyrus, the growth in popularity of shared services as an organisational means of creating more efficient service delivery is a direct response to the services-based economy. Shared services allow for costs to be reduced through outsourcing or through economies of scale from centralisation of services. However, the calculation, the allocation and the reporting of these costs to the relevant business units can be difficult.
“When it comes to truly understanding costs, the shared services environment is extremely complex. For example, in a financial services organisation, how do you cost the contribution IT or HR makes to enabling your business to offer a particular product such as a home loan? Yet in providing products such as this, it is vital the company knows it is done profitably, which means it is critical to understand these costs,” Laxton says
“This is what the discipline of cost transparency is designed to address. The result of effectively implementing such transparency is that it enables you to attribute costs more accurately. It also enables people responsible for specific areas of the business to understand which costs they are able to control, as well as which levers they can pull to effect changes in these.”
Cost transparency trumps cost allocation
Up until recently, cost allocation was the standard approach from organisations with regard to the different shared services within a business, explains Laxton.
“The trouble with this way of doing things is that it treats shared services with a simplistic approach, by merely working out a percentage allocation of budget for each business unit, which is not only inflexible, but ultimately ends up with such cost allocations being seen as sunk costs to the business. This is because the lack of visibility around what constitutes the cost means there is less motivation to find ways to optimise spend, so the business units just learn to live with things the way they are.”
“Cost transparency, on the other hand, is designed to provide business, finance and shared service owners with detailed and meaningful insights into their respective areas. It creates both visibility and understanding of the costs and volumes of their entire shared service product and service portfolio, enabling the organisation to make informed and fact-based strategic and tactical decisions concerning its shared service investments.”
Moreover, he adds, no less an entity than Gartner has suggested that the effective implementation of the discipline of cost transparency will save an organisation around 10 per cent to 15 per cent of its shared services costs, year-on-year.
And it is not only limited to costs either, continues Blake Davidson, Head of Delivery for Magic Orange platform, who indicates that cost transparency is equally adept at helping businesses to improve performance and increase efficiencies.
“In effect, you achieve not just a clearer view of costs, but also the ability to do something about them in such way as to increase performance. For example, granular knowledge of what services are being run on which servers may demonstrate to a business unit that multiple servers are only running at 50 per cent capacity. This will enable them to consolidate in this area, reducing costs and increasing efficiencies at the same time,” Davidson suggests.
“Thus, the best cost transparency strategies move beyond simply cost savings and into the arena of optimisation. In the end, it is about transforming the conversations between what the business unit needs and what the shared service provides. Instead of, say, the IT shared service simply delivering an application to the business,
it can now demonstrate the value it is delivering via the application.”
Ultimately, he says, cost allocation only discusses what is delivered, while transparency is able to quantify the value obtained from such a delivery.
Acceptance can be difficult
Implementing effective cost transparency is very much a journey, Davidson continues, and is thus not something that can or should be implemented via a big bang approach.
“Typically, we follow a recognised framework which focuses on delivering the most value in the shortest time. Tackling this low-hanging fruit not only delivers significant value, but also provides more time to drive the relevant behaviour through the organisation as well. Sometimes, ensuring that the people within the business accept and adopt the new approach is more difficult than implementing the actual discipline.”
Laxton agrees, indicating that a critical part of cost transparency is the educational process required to drive the mindset change among those who will be using this approach.
“Nonetheless, with the right solution, it is possible to democratise the responsibility for costs and empower people across the business units to manage their costs on a broader basis. Remember that if you have a large group of people thinking about costs and how to reduce them – as opposed to merely a few key people from the finance department – the opportunity to gain deeper insights is exponentially increased.”
“Moreover, with the right tool, one which is able to deliver truly granular detail, people will be able to understand what the costs are in detail and where these are found in the value chain. Thus it becomes possible not only to understand how much it costs to manufacture a product or provide a service, but ultimately to determine what it costs to support the entire ecosystem, from delivery and support through to infrastructure and marketing. Magic Orange is that tool,” he concludes.
Rodney Weidemann, Ronald Laxton, Blake Davidson, Magic Orange (opens in new tab)
Image source: Shutterstock/MaximP