1. Should ABC analysis be appropriate tool for not-for-profit organization (NFPO)? Does the goal of cost-efficiency conflict with the objective of a NFPO? ABC analysis is an appropriate tool for a NFPO. It is an important first step. In these types of organizations especially it is important to use funding wisely and justify costs/activities to the taxpayers. The city of Indianapolis was already in trouble prior to this initiative because they didn’t understand their activities and costs and were wasting taxpayer dollars.
In this case there was no previous system for understanding activities or costs. In the case of the Dept. of Transportation, a budget of $61M was said to be required. Year-after-year, a percentage increase was requested with no justification for the increase. ABC/ABM provides the appropriate processes for analyses. The objective of an NFPO, such as a city government, is to provide services to the citizens. It is not organized for profit so it must use its net proceeds (taxpayer dollars) to maintain, improve, and/or expand its operations. To make the best use of its taxpayer dollars, it must be cost efficient.
2. Calculate the bids the city workers will issue for fixing potholes in the Northwest quadrant. Should the city have allowed the municipal employees to see the ABC estimates? Originally, the city had no detail as to what activities were required to perform the service of pothole repair. Before ABC, the city would have estimated that hourly wages accounted for 80% – 90% of the total cost to provide this service. During the initial ABC process, the following activities were identified resulting in a preliminary estimate of $739,448.
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Figure 1 – Preliminary Costs However, as the city applied ABM through the use of ABC methods/software they were able to further adjust the pothole services and revise costs downward. The following figure describes the revised cost estimates and the subsequent bid of $330,587 placed by the city: Figure 2 – Revised Costs (Bid) An interesting point about the city’s analysis is that they used a volume-based cost driver ($ per ton) for all identified activities. Overall, the city may be able to further reduce their bids by identifying additional, non-volume-based cost drivers that more closely follow typical ABC cost pools (Facility Level, Batch Level, etc.).
If the city is too low with its bid, then other city activities would end up subsidizing the filling of potholes. Long term, this would be a problem as it would result in consistent overspending much like the case that led the city to require a more accurate, cost-based accounting of their activities. If the city is too high with their bid, they risk losing the bid to private contractors who more than likely are using ABC/ABM methods for calculating their estimates.
As far as letting the municipal employees see the city’s estimates, I have mixed feelings since I believe that eventually the city would be at a disadvantage once their bid information leaked out to the private sector. Private contractors do not have to share their bid information with anyone and keeping it secret prevents some of the undercutting that would surely ensue. I think the playing field should be kept as level as possible by having both the city and the private sectors following the same rules.
3. Comment on whether the city has accomplished the goal of privatization? Could the initiatives apply to the private sector’s outsourcing decisions on service functions? Although the city’s goal was not to privatize its services it was able to accomplish the effect of privatization and change the behavior of city workers. This was accomplished directly through the use of the derived ABC activities and cost data. Once the ABC system highlighted the amount of overhead the city had, especially in management, and took steps to reduce this overhead by dismissing half of the supervisors, the union employees were motivated differently. They suddenly realized that their jobs were at stake if they didn’t bid competitively.
Additionally, the work crews started multi-tasking on other city activities during downtimes in the pothole filling processes thus further reducing the unproductive time charged to pothole filling. This was another work behavior modification as a result of the ABC system. The whole outsourcing initiative was encouraging efficiency. These ABC system initiatives can and do apply to the private sector’s outsourcing decisions on service functions. In fact, that is where the whole concept originated. The free market effectively encourages competition. This competition and privatization requires cost information provided by ABC methods. The private sector will continue to innovate and provide the latest in competitive advantage.