The paper is about two activity based approaches developed during the past twenty years, namely
Activity Based Costing (ABC), now upgraded to Time-Driven Activity Based Costing (TDABC) and
Contribution Based Activity™ (CBA).
That they both demonstrate positive outcomes is surprising, given the polarisation of methodology:
- TDABC treats operational expenses as fluid; CBA treats all expenses as fixed;
- TDABC assigns operational expenses to various activity drivers; CBA relates all expenses
plus profit to one activity driver.
- TDABC leaves a question mark over the ‘fluidity’ of assignable expenses, eschewing a cost
basis upon which mark-ups can be applied to cover non-operational expenses + profit; CBA
treats costs of goods sold plus freight as the only variables to which expenses + profit per
unit of activity are added to establish market price.
- TDABC establishes a standard time per minute of activity against which real time is
measured; CBA establishes a target average gross profit per unit of activity against which
actual gross profit per quote / price / product / job / order / sale / customer, is measured.
- TDABC diagnoses capacity utilisation, service, product and customer profitability in a
process that, depending on complexity, can take days or weeks; CBA completes the
diagnosis to an acceptable level of confidence, in minutes.
- Both TDABC and CBA reveal weaknesses in capacity utilisation systems and processes,
opening the door for a more in depth TDABC-type review.
Time-Driven Activity Based Costing from a Contribution Based Activity™ Perspective
A recent working paper by Kaplan and Anderson2 (K&A) presents Time-Driven Activity Based
Costing (TDABC) as a ‘new approach for implementing activity-based costing that is simpler, faster,
cheaper, more flexible and more easily maintained than the traditional approach’.
An example of the traditional ABC process will help. A customer service department performs
three activities, handling customer orders, processing complaints and credit checks. The cost of
operational resources performing these activities is $560,000 and there are 9.800 orders, 280
customer complaints and 500 credit checks. Based on the percentage of time absorbed by the three
activities the $560,000 is assigned as follows.
Orders per customer are accumulated for a period along with any complaints and credit checks
providing an overview of cost per customer. However, with no cost differential between small or
large, simple or complex orders, attempts to differentiate resulted in a potentially exponential
number of activities to which costs could be assigned. The process became unduly burdensome.
Moving away from a percentage apportionment of costs to activities, Time Driven ABC is based
on a cost per minute of personnel time per activity. For example, assuming that at 80% capacity
utilisation, activities costing $560,000 were calculated to absorb 700.000 minutes, the unit cost
would work out at $0.80c a minute. The $40 per order could then be adjusted depending on size
and complexity by adding or subtracting $1 a minute for additional personnel time. An added
advantage is the ability to more easily identify capacity utilisation by comparing assigned times to
total personnel time available. Assuming 10,200 orders, 230 complaints and 540 credit checks,
|Handle Customer Orders
|Perform Credit Checks
Once management is aware of under utilisation and cost per customer, action can be taken to
improve inefficiencies increase the size of small and unprofitable orders and so forth. Practical
examples of TDABC in action, have resulted in the positive outcomes indicated below:
- twenty-five percent of customers in one company were unprofitable
- the company could not make a profit on any order selling for less than 20 percent
gross margin (25% mark-up) - regardless of order size
- several entire distribution routes were unprofitable… with those less than 50 miles
away proving lot less costly than those 200 miles away.
- sales persons had been trying for years, unsuccessfully, to increase order volume with
apoints to their margin but by knowing which items to sell.
- One company was targeting a profit improvement of more than $700,000 annually
There are several points to be made about these positive outcomes:
- the application of time driven assignable expenses per activity appears to have had the
beneficial effect of focusing management on gross profit margins, without reference to
which, the positive outcomes could not be identified
- by extracting the key variable of goods plus shipping costs from the overall sale price
- unprofitable orders due to distant locations would have become obvious from the outset.
- intent on assigning expenses to activities, K&A exclude non-assignable (nonoperational?)
expenses as well as profit. And yet activities identified as ‘drivers’ must
ultimately bear the weight of both operational and non-operational expenses plus profit,
i.e. the gross profit of the company as whole.
- As the following example will show, management provided with a gross profit benchmark,
against which profitability of quotes or prices can be measured, would be immediately
alerted to the problems of small and unprofitable orders due to low gross margins.
Contribution Based Activity™ (CBA)
Assuming the same operational or assignable expense of $560,000 and adding $140,000 to cover
non-operational expense plus profit, the target gross profit would be $800,0000. Assuming a
target number of sales of 10,000, the target average gross profit per sale would be $80. Cba refers
to this $80 as the Target Average Rate Index or TARI® to emphasis its benchmark status and
distinguish it from a cost.
Based on 50 week year, the average number of sales would be 200 per week (10,000/50), giving a
Week no 3 for the period ending . . . .
average weekly gross profit target of $16,000 (200sales x $80). It then a matter of tracking each
invoice along the following lines.
||Cost of goods
|10 weeks for the period ending . . .
|Total to Date
On the grounds that it is possible to catch up on a poor week, but far more difficult to catch up on
a poor month, the number of orders and resulting average gross profit contribution are
summarised weekly and accumulatively for comparison with target.
The data invites the question, ‘why did 597 do so well and yet 600, an order of similar size do so
poorly?’ While the poor performance of 600 may be due to inept quoting, discounting, higher
shipping costs or bad buying, there is no evidence that even if TDABC were operative, internal
juxtaposition of costs to activities would have made any difference to the outcome. The addition
of $3 for more lines per invoice or $6 for difficult packaging or $200 to cover a credit check3, would have no impact on a gross profit based on the difference between market price and cost of
Tdabc doesn’t indicate how market price is calculated, but it is most unlikely it’s authors would
suggest adding $200 to the cost of goods for say, handling a complaint by the customer in
More important for management is the need to minimize repeats of 598 and 600 and optimize
orders such as 597/9.
The positive variance after 10 weeks is consistent with CBA experience at the coal face of
numerous businesses across the spectrum of resale, manufacturing, service or the professions.
Once management is provided with a clear focus such as TARI®, improvement flows in the first
instance from an increase in the gross profit per sale. Improvement in numbers of sales takes more
time, generally because more is involved in changing internal systems and processes. It is at this
point that a TDABC approach can play an important role in sorting out causes of inefficiencies.
The above example relates to businesses engaged in reselling activities, such as wholesale distribution
and retail, where the key driver is seen to be the number of sales and gross profit per
sale. Without a time factor however, capacity utilization is not so easily measured as in
manufacturing, trades, service, contracting, professions etc.
When time is the key driver
Apart from the clothing industry where time is measured in minutes, CBA identifies man or
machine hours as the key activity driver. There are 4 steps:
- Invoice analysis: identify the average gross profit per hour actually charged to jobs by
selecting a representative sample of at least 6 invoices (some prefer 10 invoices, others
50) and extracting the cost of materials plus any outsourced work.
work at cost
Apart from giving a close approximation of the average gross profit per hour, the sample
also reveals a wide range in contribution per hour, from $95 down to $28.
CBA experience across a wide spectrum of businesses indicates that the range of
contributions comes as a complete surprise to 98% of management. This is primarily due
to the method by which cost and prices have been developed over the years, varying from
standard manufacturing costs and percentage add-ons to material, to a multiple of 3 or 4
times hourly rates. The revelation is a point at which a process of re education often
To those commenting that higher contributions are due to mark-ups on jobs using more
material than jobs with little or no material input, we make the point that whatever costing
system they care to use, jobs with a higher than average contribution per man-hour
contribute more to the bottom line than jobs with lower than average. Providing
allowance is made in expenses for loss or damage, mark-ups on materials or goods has no divine mandate.
- Time charged to jobs: divide the average gross profit per hour into overall gross profit to
get a close approximation of the hours charged to jobs/products:
||Sales for past period
||Materials/purchases at cost
|C (A - B)
||Gross Profit (72%)
||Average gross profit per hour
|E (C / D)
||Approx. hours charged to jobs
- Capacity utilization: divide the hours charged to jobs by the hours available to be
charged. Available hours will normally be hours paid less time for breaks and vacation
etc. Multiplying percentage productivity by 8 hours will give a more meaningful results
of hours charged out per person per 8 hour day, eg:.
||Hours available for charging
|H (G x 8 hrs)
||Charged hours per person per 8hr day
- Looking ahead: target ongoing performance following the same process as for
wholesale/distribution, using target chargeable hours instead of number of sales/orders. In
this case, we would target additional net profit as well as an increased number of
chargeable hours to deliver a TARI® very close to the average gross profit of $53.50
|Target gross profit
|Target chargeable hrs (70% x 20,000hrs)
|Average weekly target (14,000 / 50wks)
||$53.50 x 280 hr
Practical Application of CBA
The following 5 examples demonstrate the application of CBA in both resale and time related
With $50m turnover and 19% gross profit margin, 12 branches and 60 sales representatives,
the company showed nil profit at the time of a management buy-out.
In response to a query about ‘average sale’ management was of the opinion there was no such
thing in a company that supplied the QE2 with $150,000 orders and a tugboat with $50 of
bread and milk. However, accepting that it would difficult to improve an unknown amount,
management cooperated by analysing a random sample of sales to reveal an average sale of
$5000, which divided into $50m indicated approximately 10,000 sales. Given a 19% gross
margin, the average gross profit per order was $950.
The immediate objective was to improve the gross margin from 19% to 25%, and target an
average gross profit (TARI®) of $1250.
Sales representatives were made responsible for costing their own orders, a task previously
carried out by office personnel. Branches were instructed to transmit weekly reports showing
the number of sales made along with the gross profit per sale and per representative.
Quarterly meetings of branch managers focused on ways and means of improving product
mix and adding value per order. One branch, using brochures from a local jeweller sold opals
to ships’ crews, adding value to the food and other supplies. Another branch arranged a deal
with a local video outlet and sold videos.
By the end of the financial year, 10.5 months following the management buy-out, net profit
had blossomed from nil to $2.5m. (Equivalent in effect, to 10,000 sales x $250 added value
The jeweller was persuaded to maintain weekly reports of the sales, gross profit and number
of sales as recorded on the cash registers.(A cash ring-up of several items counted as one
sale). A CPA processed the reports and handed back a weekly comparison of the average
gross profit per sale with TARI® as well as a comparison of the number of sales with target.
Profit increased from a break-even situation to a net of $80,000 within 6 months. In response
to our request for what the jeweller had to say, he sent us the following:
- he liked the idea of having a benchmark by which to gauge performance on a
- it helped identify whether the contribution was above or below the TARI®
benchmark when developing product mix
- it provided immediate feedback on the effectiveness of advertising
- it gave more understanding of the cycles impacting his business.
The ensuing three illustrations demonstrate the application of time based drivers.
Kitchen Utensil Plant - customer contribution.
The CEO had recently spent $500,000 on an IBM AS400 plus consulting input on a full
blown costing system. Given the profusion of information pouring out of the system, he felt
unable to see the wood for the trees and with a gut feeling all was not well, called for help. In
the conference room of the plant, in answer to the writer’s questions, the following was
written up on the white board:
A Annual Gross profit - $20,000,000
B Man-hours charged to jobs - 250,000 hrs
C = A/B) Average GP.per hour (TARI®) $80
A sample of invoices from a customer buying 55% of the output revealed the following:
By taking 55% of the output at a average gross profit per hour of $32, the major customer
contributed only $4.4m of the $20m gross profit. It was highly unlikely the required
contribution of $15.6m could be achieved from the remaining 45% of customers.
The simple analysis took less than 20 minutes and would have taken less, had the information
been more easily accessible.
Leading Furniture Manufacturer - product contribution.
An international consulting group had been working with this company for six months,
concentrating on production and marketing. Knowing the consultant in charge of the
assignment, the writer asked if they had tried CBA? The answer was no, because the company
was well set up with standard costing and able to identify any variances arising, Apart from
that, productivity was running hot at 75%, due mainly to a newly designed suite that was in
great demand on the continent.
However the consultant did agree to cooperate in pinpointing the average gross profit
contribution per hour, which turned out to $130:
Because the costing system did not give the gross profit per hour for each product, it was
necessary to write a simple program to extract that information. With the data processing
section employing 26 staff, all busy with other projects, it was a good two weeks before it
was possible to review the range of contributions from each of 150 products.
The gross profit contribution per hour ranged from $225 to $57, with the product in high
demand and driving productivity showing up at $81. Noting with some alarm that the
products contributing $225 and $195 were in fact disused, the consultant claimed there must
have been an undetected change in product mix. It was to his credit that he immediately
referred the findings to senior management.
A meeting of key players spent the following days brainstorming how to improve the
contribution from the $81 product along with several other low contributors, primarily by
improving efficiency and reducing material usage without impacting quality. Cba software
was installed to monitor progress.
Within three months, the downturn in the bottom line began to level out and within six
months it was on a steady rise. It proved to be a salutary lesson for all concerned. From that
time on, all new designs had to pass the contribution test before proceeding.
Fabricator - job contribution
Posting a loss of $133,000 for the previous financial year and $80,000 for the seven months
to January 31, the company commenced applying CBA. Later that year, the CPA who had
introduced them to the concepts, told us that from February through September, the firm had
made a net profit of $138,000. The writer asked the accountant to find out what his client had
to say about this dramatic turnaround. He came back with the following:
“I developed confidence in quoting - because I knew the contribution compared with TARI®
I got my weekly results each Friday and monthly results in four days instead of six weeks”.
- positive outcomes relating to customer and product profitability described by K&A are
substantially available to all business, large or small without the installation of a timedriven
activity based costing system, helpful though that process may be as a means of
improving efficiency and capacity utilisation.
- the assumption underlying TDABC4 that the majority of expenses are fluid and can be assigned to time driven activities appears to (i) fight shy of non-assignable expenses and
profit, (ii) overlook the basis of cost upon which mark-ups are applied in those cases
where no market price already exists and (iii) bypass the fixed nature of assignable
expenses such as complaints (eg $176 each) and the need to spread them across total
available time. The sum of which, calls into question the extent of ‘fluidity’ of assigned
expenses and the consequent impact on profitability.
- the only expenses treated as ‘fluid’ in CBA are the cost of goods/materials sold plus any
obviously direct variables such as shipping costs and outsourced work. While not
excluding any overtly direct costs that may from time to time occur, all other expenses
are, for all practical purposes, treated as fixed, to be adjusted up or down as expenses rise
or fall. Whilst these findings run contrary to the basic tenets of TDABC, the advantages
become apparent in the application.
- TDABC calls for a categorisation of activities and an assessment of time per category in
order to get a close approximation of time-driven costs. It is a process that depending on
complexity, could take days and even weeks. Once established, several more weeks may
be required to assess capacity utilisation.
- by comparison, CBA is able to establish capacity utilisation along with an overview of
contribution of services, products and customers, in a matter of minutes from a sample of
- the target average rate index, TARI® in conjunction with a targeted volume lies at heart
of CBA. Along with a weekly comparison of results with targeted gross profit, the two
together provide a focus at the point of quoting / pricing / invoicing and a benchmark for
monitoring performance that provides early alert for relevant and timely correction.
- application of CBA, in no way excludes the need for TDABC once it becomes apparent that
capacity ultilisation and expenses need more in-depth attention.
Copyright Keith N. Cleland1 - April 2004
- The author is founder of the concepts underlying Contribution Based Activity
- Time Driven Activity Based Costing, a Working Paper, Robert S. Kaplan & Steven R Anderson, Nov 2003
- “For example, at Maines Paper and Foodservice, the algorithm for Customer Service adds three minutes for special orders, another three minutes if a credit memo is required…” Ibid p10.
- “I believe that all but a very small portion of organization expenses are not ‘fixed’ and indeed can be assigned rationally and meaningfully to products, services and customers. This is the entire foundation of activity-based costing….” excerpt from correspondence to the author by Robert Kaplan, 12/11/03