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| Mapping SAP Profitability and Cost Management to Value Chain Analysis |
Ever since the concept of the value chain was first introduced back in 1980's by M Porter in his book “Competitive Advantage: Creating and Sustaining Superior Performance” (Porter, 1985) companies have strived to map and analyse their value chain and model potential changes to seek competitive advantage.
Let's start with an understanding. The value chain originally proposed by Porter was a framework designed to help organisations analyse key activities through which firms could create value either through cost reduction (becoming more efficient) or competitive advantage (differentiation or value add). Understanding how your organisation creates value is fundamental to the health of your organisation. The more value an organisation creates by offering its goods or services at a value that exceeds the cost of the activities required to deliver them the more profitable it will be. Your competitive advantage will be delivered through the provision of this enhanced value and your customers’ understanding of this differentiation.
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Value Chain Analysis 101. In order to better understand the activities through which an organisation creates value, competitive advantage and therefore more profit Porter suggests we break the business value chain into primary and secondary (support) activities. Because the model easily pools distinct activities it makes it easier to visualise and identify opportunities for improved efficiency or competitive differentiation and as such it is a popular framework for businesses.
Porter essentially breaks activities down into five primary activity pools:Inbound Logistics, Operations, Outbound Logistics, Marketing and Sales, and Service functions. There are other ways of describing these, for instance: Develop and manage the business, Create demand, Replenish stocks, Make the product, Fulfil customer demand, Provide IT, HR, Finance and other support services. Whatever the chosen process model framework, the most important concept to establish in your business is to have a robust framework focusing attention on what the company “does” (activity) as well as what resources are spent (accounts) and by whom (cost/profit centres).
Once an organisation has identified all the major activities involved across the desired activity framework then the process of analysis can begin. With Porters’ framework we can see two approaches to the analysis the first is where can we create a cost advantage, the other is where can we create a competitive differential or advantage. Both are of course linked as, typically, increasing competitive advantage means increased costs, but as long as the customer is prepared to pay the premium to cover the extra costs, or the organisation is able to procure the resources required to create the differential at the same or lower cost, then profit will be positively impacted. An topical example of this at work is in budget airlines: over recent years check-in and baggage handling have been excluded from the cheapest fare offering, but if the passenger wants this service they can pay extra for this “gold” service!
Key to understanding the value chain activity framework though is ensuring you have grasped the inter-relationships between different activities and their causes (drivers). Increasing or decreasing an activity driver will typically have a knock on effect with the consumption of resources (held in cost centre/accounts). Analysis of costs in most companies in my experience rarely progresses beyond silo-based models which look only at functional costs such as marketing department or production costs.
How can SAP Profitability and Cost Management (SAP PCM) help?
“Cause and Effect” models maps business processes across functional organisation structures
Analysing the value chain with SAP PCM is an extremely effective way of bringing clarity on how to create or enhance value in each pool of business activities. The ability to analyse each key activity and cut across departmental silos will help to identify the inter relationships that exist between one area of your organisation and another. It is this understanding of the inter relationships between activities that will enable a more optimal, fact-based decision making process as to where the competitive advantage can be realised be it cost saving or increased differential advantage.
Easily Configured process automation tools (load-calculate-export results)
A large obstacle to using Cause and Effect models in the management information system is always that they are data hungry, often from multiple data sources. As a data source agnostic solution SAP PCM can be easily configured to import all data through automated processes, for instance from the GL, ERP, CRM systems (both SAP and non-SAP), Where data cannot easily be loaded automatically from a data source SAP PCM provides intuitive web-based data entry.
Best in class multi step allocation tool
Underpinning SAP PCM is a best in class activity based costing engine. Activity-based costing allows an organization to develop a valid economic cost model (“Cause and effect’) that reflects consumption of resource by activities and activities caused by delivering services and/or products to customers,. SAP PCM is an “activity-centric” solution and provides functionality for ABC, ABB and ABM.
Optimize Costs and Profitability:
It is the ability to reflect the inter-relationships between activities and the drivers of those activities that gives the SAP PCM analyst the tools and functionality to optimise costs and profitability. With SAP PCM we can very easily do a number of different analyses to identify profitability improvement opportunities
- cost to serve i.e. the cost of customer and/or channel driven activity
- cost of processing including cost of process failure, often required by Total Quality Management.
- cross charging of secondary (support) activities as identified in Porters value chain framework. Activities such as “Support IT infrastructure”, can be charged to the customer and product driven activities to give a more realistic view of the contribution from customer/product combinations. More complex scenarios are also possible for example the ability to manage multi pass allocations where as an HR uses IT activities, but in turn needs to recharge these to the primary activities.
- Time-driven ABC With SAP Profitability and Cost Management you can make use of the best costing methodology for the situation. For instance this could be: time driven for specific responsibility centres that carry out a high number of repetitious activities such as pick and pack operations and customer contact centres; time splits for the others such as Marketing, Legal and Finance where the allocation of activities is based on a proportion of time being consumed by the primary activities or other secondary activities; and/or direct allocation for costs such as product marketing where these costs need to be allocated directly to the products benefiting from the expenditure. Where a more finessed approach is required to the allocation of activities SAP PCM has a sophisticated rules engine embedded in it. Provided with a front end wizard for easy and rapid modelling of more complex business rules or for calculating “derived drivers”
Planning and Budgeting Resources: The ‘Cause and Effect’ model created in SAP PCM is effectively a driver-based costing model. This driver-based model can be used us to create ‘What-if?’, Budget, Forecast and Plan scenarios. At its simplest all that is required is to change the driver volumes to a plan, budget or forecast data set. These data sets can also include changes to future pricing, unit rates, costs and factors. More complex conditional or step relationships can be modelled using the Rules Engine
Capapcity management: SAP PCM has capacity functionality and rules which can be used to set capacity targets or constraints. These can be used to identify for instance where further investment is required to fulfil a growth forecast. . Measuring and Monitoring: Automated drill through of KPIs for cost, profitability and other performance metrics, variance analysis of actual vs budget and/or plan are all delivered through a single user interface with all the data stored in a single open database
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Conclusion
In conclusion, we regularly see a management cycle described as starting with setting a strategy, it is our view that having a fact based understanding of what activities are utilising what resources and whether those activities are adding or diluting value is the most critical thing to understand before you can define a strategy based on facts. It will be these facts that allows you to devise mechanisms to drive and deliver more value added activities and reduce, redefine or in fact remove activities, customers, products that bleed your resources and dilute your P&L statement.
Glossary:
ABC
If we take cost through activities to cost objects such as products and customers and then bring in the revenue at the same level of dimensionality, we can develop a detailed understanding of profitability – which is what ABC is all about.
ABB
But having developed a logical model of what driver cost inside the organization, we can then begin to play with it – changing driver volumes and assumptions and “back calculating” the model to forecast new levels of activities and line item expenses. This is ABB or driver-based budgeting.
ABM
Many of the drivers will be key performance indicators and monitoring and managing these is Activity Based Management.
The Author: Mike Weeks
About:
Helping Clients Meet their Digital Transformation Goal through Supply Chain Management
Customer centric business development with over 25 years experience in both direct and indirect channels across industries such as Digital Imaging, Mobile Telecoms and Software. Helping customers understand their value chain and enabling them through technology to exploit opportunities in enhanced efficiency is what makes me get out of bed. Currently engaged in the rewarding experience of customer acquisition for itelligence UK, one of SAPs largest global VARs and part of the NTT Data group of companies. iTelligence is a global player with a local presence. The Analytics division is focused on the sales and implementation of SAPs Business Analytics Technology solutions.
I have responsibilities for both developing the EPM footprint at itelligence through both licence and services consulting along with managing the relationship with named accounts. The role includes marketing liaison and the consideration of propositions and accelerated implementation models through the utilisation of consulting IP. Previous employment challenges have involved the break up of a distribution market in Republic of Ireland and the creation of an entire new channel market for a new entrant in to the mobile telecoms sector in the UK. Specialties: Enterprise Performance Management Software and Consulting expertise across many industries gained over the last 12 years My other passion is photography (when I get the time)
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