146 Understanding the Numbers
reside within another in the chain. For instance, the driver for the
ETN/ W customer sale cost pool was the technical sophistication of
the potential customer. Those that did not understand the costs of
transaction processing and what ETN/ W could provide were much
more difficult to sell, and more costly. Once ETN/ W understood this,
it developed a short video that explained the transaction processing
side of e-commerce and the cost and complexity of performing this
function internally. This video made the selling process much easier
for those customers—and less costly.- Once the industry-level value system is understood, prepare a process
map for your company. Identify what value pieces of the overall sys-
tem your company contributes. Although most people assume that ev-
eryone “knows what we do,” this is most often not the case. Like the
Hindu parable of the blind men trying to describe an elephant by feel-
ing only one piece—trunk, ear, leg—few managers within an organiza-
tion truly understand how all processes are integrated across the firm. - Prepare a detailed activity analysis for each internal process—exactly
what steps are taken, who does them, and with what resources. Since
this will be the basis for determining your cost pools, activities must
first be identified at a granular level—if you are too fine you always can
aggregate them later.^9 Activity identification can be done from a histor-
ical perspective or by studying the activity real time. In either case
this stage will require discussion with those people responsible for the
process to identify the activity steps. Since these steps often are per-
formed by many functions within an organization, it is sometimes
necessary to gather all participants such that a true cross-functional ac-
tivity map be drawn and agreed upon. - Estimate the cost pools for each activity and identify their behavior—
variable or fixed. If an activity has both fixed and variable costs, use
two pools for that activity. Often secondary support functions such as
payroll and human resources are first “allocated” to primary ledger ac-
counts such as manufacturing labor or sales salaries accounts before
being traced to activities.^10 At the end of this step a reconciliation
should be performed. All of the costs from the general ledger should be
traced to activity pools using the activity map. Typically some costs
such as corporate administration and R&D do not get traced to activity
pools since they have little to do with current operations. This is ac-
ceptable, and the key parameter one looks at is what percentage of over-
all costs is ultimately charged to activity pools. Rather than being
discouraged by the 10% to 20% of costs not traced to any activity pool,
focus on the 80% to 90% of which you now have a better understanding.
To reiterate, this analysis is a strategic one; the acceptable percentage of
unknowns is dependent on how good your rivals’ cost systems are. - Select drivers for each pool—that is, the method to be used to transfer
the costs from the pool to the object we wish to cost. Note the different