Design and Implementation of Activity Based Costing

Background

NATO Maintenance and Supply Agency is the agency within NATO that looks after logistics for a large portion of NATO and many of its member nations. The organization specializes in procurement and provides additional professional services in support of NATO operations, ranging from contracting and managing infrastructure projects, supporting operations, demilitarization projects and so on.  The organization is supported by a staff of over 1200 people and has an annual turnover greater than 1.5 billion Euros.  Though the organization is designated as a public service, it operates in many respects like a private company, with the exception that it holds to the principle of no profit and no loss.

The Challenge

The Agency was faced with a very significant problem in pricing their services, and faced a great deal of criticism from its stakeholders over its pricing policy and the apparent lack of transparency thereof. The challenge was to be in a position to provide more transparent and reliable pricing models that would not need a cost adjustment either up or down to the final customer.  Adding to the challenge was the very complex way in which the administrative support costs were allocated, which though transparent, required a great deal of understanding of the inner workings of the agency in order to understand the allocation methodology.  Over a period covering 15 years, the Agency was grappling with how to better make the estimates which would result in zero profit and zero loss after the cost allocation exercise was carried out, which did not result in any significant change in the practices.

How We Helped

We carried out an in-depth analysis of the current pricing models in use within the agency, in order to identify the gaps in developing reliable pricing models that represented actual cost of services inclusive of the administrative burden required to support the operation.   Within the organization, there were a total of 21 divisions, of which 5 were seen as pure administrational units.  The biggest challenge was to determine the cost drivers that attracted and consumed administrative support.

The Solution

The solution that was developed and implemented used elements of activity based costing, combined with implementing an electronic time recording mechanism within each division using a work break down structure that represented each activity carried out in the division.  The operational divisions work break down structure closely matched the ISO recognized procedures, so there was a good correlation to the cost drivers.  In this way, we were able to identify the effort and therefore cost related to executing the deliverables or in their case the cost drivers.  The administrative units used a similar approach.  In order to overcome the change  management issues,  the divisions were brought into the recording systems one at a time, and a great deal of time was spent working with each to ensure that the lessons learned could be disseminated throughout the organization, while at the same time reduce the overall anxiety associated with the change.   The project had been tried several times in the past though the Agency was however, unable to implement until we carried out the project.