Activity Based Costing: What’s the Return on it?

Student Data: Man looking at a chart

Photo: Len Brazisby Len Brazis, Director of Strategic Planning and Analysis,
Embry-Riddle Aeronautical University

Here at Embry-Riddle, the adoption of Activity Based Costing (ABC) principles has been an evolutionary process that began on one of our residential campuses in the Fall of 2010. That campus had just finished a fiscal year with a negative operating margin of $3.3 million. A new Chancellor was installed and had been charged by the President to cut about 100 positions, eliminate at least 5 unprofitable degree programs, and cut costs operationally wherever he could to turn the campus around.  He tapped me immediately to fly out and provide him with guidance that would enable him to accomplish his charge and return to our President at the time with a strategy to turn the campus around.

Understanding that I could never overcome in short order our established accrual-based accounting process, I immediately set out developing a standalone model that was grounded in ABC principles. After three days of nearly around-the-clock work, we had a new model that provided so much clarity for the new Chancellor that he immediately saw flaws in his charge. What resulted was: no program closures, only about 50 positions eliminated, expansion of student services programs intended to improve quality of life for students on the campus, investment in faculty and staff development, and a self-sustaining financial performance that ended that fiscal year with a positive $500K operating margin.

The philosophy, of course, is only one piece of the puzzle, but its continued practice has resulted in operating margins for the campus that have increased every year since. That campus finished FY16 with a positive operating margin of $13.8 million. This success would not have been possible without ABC at the foundation of our model. That approach has now spread to our main residential campus and our Worldwide Campus operations.

A Closer Look: Embry-Riddle Before ABC

Prior to the implementation of ABC principles, I’d have to say the single biggest frustration was the annual across-the-board cost-cutting exercise across all campuses. When the CFO’s staff would present their report at the end of the first quarter, projecting an institution-wide shortfall of margin at the end of the current fiscal year, the immediate restrictions on everything came out in memorandum. We all know how well that works.

Using ABC, we’ve been able to understand where challenges reside and address them on an individual basis, without penalizing operations that were already efficient. We have also been able to illustrate, finally, where real efficiencies are being gained in academic and administrative operations. It used to be impossible for us to determine what degree programs really were financial burdens on the campuses. In so many ways, it was like shooting arrows into the darkness hoping we would hit a target out there somewhere. ABC has moved us from what once was cost-cutting measures into a solid practice of expense management.

Even more importantly, we really didn’t understand how newly proposed degree programs would impact the cost structure of the campus. Many proposals were coming forward as ways of generating revenue, but the expense side of the equation was severely lacking in rigor. A faculty member proposing a new program would state in their proposal that their program would not cost the campus any additional money whatsoever, because they were qualified to teach the core material and no new faculty lines were necessary within their college. As programs were implemented, the robust margins that were proposed were not coming to fruition and nobody could determine why that was the case.

ABC enabled us to understand the incremental cost impacts each new student would have across other colleges on the campus that would provide support, such as general education or elective courses in other colleges. Plus. we were able to see the impact on administrative areas such as housing, food services, bursar, etc. Suddenly the epiphanies began to happen, as we began to see more clearly how each student carries an incremental cost with them that must be addressed in forecast models.

Without sound ABC practices, we also couldn’t determine that it was a better decision to re-engineer challenged programs and not simply close them. The first thing you realize is that your revenue stream dries up fast, but you simply redistribute your expenses across other programs because faculty don’t simply support one single program; they have to support multiple programs simultaneously.

Embry-Riddle After ABC

Our ABC analysis modeling has really enabled us to get our heads around what it takes to deliver our product to students. When I’m asked the question about what one thing stands out in my mind that would be considered the deal maker for an argument promoting ABC, I have to look at people and tell them there isn’t any one thing. It is everything! The use of ABC modeling really let us understand that in a service organization, everything works in a system. And ABC enables us to understand how everything plays a role in its contribution to our products we deliver: how adjustments in one area can, and often will, have an impact on other areas. We are able to understand the magnitude of what happens on a campus and how it impacts students through cost contributions.

Using ABC also enables us to make better informed planning decisions, as we are able to provide predictive analytics to support our planning efforts. We have been using these methods for many years on a variety of planning models with great success. It’s when the results of these models become arbitrarily compromised that things begin to go awry.

One additional big return we see is the ability to convey understanding about expense management to faculty. It provides us with the ability to understand and communicate why decisions about expenses are made, especially when someone has to say “no.” The faculty don’t always like what is being said, but they can understand the rationale rather than simply being delivered an edict from on high by administration. That is so important across all areas of an institution, as it also helps break down the barriers of distrust and provides greater transparency for everyone involved.

As we move into our future, we are utilizing ABC in our modeling that brings together qualitative measures for degree programs and student learning. This produces multi-dimensional results, providing us with systematic illustrations of our programs, as well as better understandings of our cost of delivery, break-even points, and the level of investment necessary to attain the balance between academic effectiveness and operating efficiency. This cannot be achieved without the implementation of ABC practices.