Until recently, utilities have not identified cost management as a critical factor to future success. While cost management clearly contributes to the success of any business, regulated or unregulated, current economic forces driven by emerging regulatory changes have raised cost management in the electric power industry to a level of paramount importance.
Deregulation is forcing dramatic shifts in pricing-and in the information needs of managers. Now utility executives need to know not only the profiles of their customer segments, but also the underlying profits and costs that those segments generate. The experience of Central and South West Corp. (CSW) demonstrates how utilities can use activity-based management (ABM) to better understand profitability in a deregulated environment.
Unbundling has caused electric utilities to review their strategies and goals in order to remain profitable. Accurate cost information is key to knowing where to add and where to cut.
Case in point
CSW, which owns and operates four electric utilities in the United States, serves 1.7 million people located in an area covering more than 150,000 square miles. CSW`s United States electric business is supported by approximately 7,000 employees, and the utility had revenues in 1997 of about $3.3 billion.
Early in 1995, CSW`s management recognized the corporation needed something more from its management accounting. While a wealth of good financial accounting information was available, the information was not useful from a process or operational perspective.
Based on earlier recommendations a pilot project was initiated in June 1995 to determine if activity-based management would provide the information CSW needed. The utility`s controller sponsored this pilot project.
The initial implementation was linked to a market segmentation study by CSW`s market research group. This market segmentation study sought to learn more about different characteristics of the utility`s various customers. The activity-based management team`s goal was to understand the cost structure and profitability of different segments or markets, including residential, commercial, and industrial customers.
Next the project team designed a strategic model that would calculate relative profits generated by each segment. However, CSW`s shared-services organizations existed throughout the company and supported the generation, delivery and after-sales support of electricity as well as its unregulated businesses.
Therefore, the costs of shared services was assigned to all internal consumers of each service. Otherwise the cost assignments would be invalid.
CSW`s strategic activity-based management model was completed in June 1996. As shown in the figure, the model included 15 ABM cost pools, 2,100 departmental cost centers, 100 strategic activities, two products, two delivery channels and 22 customer market segments.
The activity-based management model calculated the profitability of these domestic segments assigning $2.4 billion of costs to activities and then assigning those activities to cost objects. These costs represented 90-95 percent of CSW`s domestic costs. The model included fuel and purchased power cost, operating and maintenance cost, depreciation and amortization, debt and preferred equity capital cost, and other miscellaneous costs.
The initial project took 12 months to complete. The length of the project took its toll on the ABM team, which shrank from 15 part-time members at the beginning to only two full-time members at completion. In retrospect, Bryan Kaiser, CSW`s senior coordinating consultant, recommends an enterprise-wide pilot be broken down into shorter, more manageable pieces.
During the pilot, it became apparent that management needed additional performance measurement information to make better decisions. To address this need, an ongoing “activity-based costing and performance measurement” team was formed. This seven-member team was responsible for preparing performance scorecards, including unit cost measures.
The team also provided cost and profitability analyses for products, channels and customers. It automated the activity output data collection to the greatest extent possible by using commercially available software products and other data extraction tools.
“We have done a proof-of-concept pilot using Oracle database tools, and we plan on using them more in the future to store extracted data,” Kaiser said. The team also created formatted templates for clients who needed to provide the utility with data that does not reside in mainframe or other major systems.
The team is now trying to place cost information on CSW`s intranet. Their goal is to use all available technology to put information into managers` hands. By integrating activity costing with performance scorecards, a natural link was created between activity-based management and process decision analysis.
The team works extensively with groups that have a strategic focus on cost efficiency. These business units (which include power generation, energy delivery, customer relations, the supply chain, information technology and telecommunications) have begun to use cost and performance information for internal benchmarking.
One of the most important contributions of the activity-based management model has been in shared-service cost transfers. CSW spends much time assigning shared service costs based on the volume of consumption of a particular service. The best output volume for a particular service is determined, then information is gathered to determine how much of the output each department consumes. Costs are assigned to internal consumers based on the cost per unit consumed multiplied by the units consumed. These cost assignments are based on information provided by the ABM model.
Another area where activity-based management produced important results is profitability analysis. CSW`s ABM models provide insight into where the company can gain profitable revenues from other competitors as well as which markets CSW should defend.
CSW plans to expand the use of ABM as a management tool, rather than simply a method for gathering costs. The objective is to enable managers to make operating decisions that maximize long-term economic value.