According to BalaBalachandran,we need to look

at knowledge in a newway. We need tobecome savvier.

Balachandran isthe J.J. Kellogg DistinguishedProfessor of Accounting,Information Systems andDecision Sciences atNorthwestern University’s presti-gious Kellogg Graduate Schoolof Management. And he hasinvented a new concept: what hecalls strategic activity-basedbusiness intelligence (SABBI).

Balachandran says this is thekind of knowledge that top man-agement needs in tomorrow’scompetitive environment.

HOW PRACTICAL IS THISADVICE?

That may sound trendy andsuperficial. But Balachandran isno ivory-tower academic. He’s apractical man who has both feeton the ground. For his master’sand Ph.D. degrees, he dealt withthe pragmatic world of engi-neering production—manufac-turing, production engineering,

and industrial engineering. Sohe has a very down-to-earthbackground.

“That’s why I can under-stand the problems of a factorymanager,” Balachandran toldme, “or even a production man-ager who has only a highschool education, but istremendously experienced inproduction. I know exactly howthat person feels, and so I wantto help out."

Fortunately, Balachandranalso has a talent for thinkingabout those practical matters inan innovative way. His Carnegie-Mellon Ph.D. thesis, on opera-tions research and industrialengineering, was awarded firstprize in a competition conductedby the Operations ResearchSociety of America.

But Balachandran wanted tolearn even more. So after hebecame a full professor at theKellogg School, he took twoyears out to study accounting,

working with ArthurAndersen. Then hetook and passed theCPA exam. “So I havethree or four hats thatI wear,” Balachandranexplained. “I wear the

hat of a production engineer. Inaddition, I wear the hat of a stat-istician, because I have a mas-ter’s degree in that, as well. AndI’m also a CPA.”

What’s more, Balachandranis now chairman of Kellogg’sDepartment of Accounting andInformation Systems and servesas the editor for ManagementScience in Accounting, arguablythe most prestigious journal inmanagement education andresearch. “So I have a variedbackground,” Balachandrannoted modestly. “This allows meto see companies from a cross-functional, horizontal perspec-tive, rather than looking at a ver-tical silo. For example, if you area finance person, you know onlyfinance—not production and notstrategy. If you are a marketingguy, you know only marketingand nothing else. But I know atleast four or five different areas.So I can look horizontally at thetotal picture of how things move

9© 2000 John Wiley & Sons, Inc.

According to one leading activity-based costingconsultant, we need to look at knowledge in anew way.

© 2000 John Wiley & Sons, Inc.

Edward J. Stone

How SABBI Can Make You Savvy

featu

reartic

le

in the business world."That kind of holistic

approach is rare in business.“Some people,” Balachandranrelated, “say, ‘I am a financeguy. I don’t care about marketingor manufacturing. Leave mealone.’ Or another may say, ‘I amin manufacturing, and I don’tcare to know about marketing.’But I look at the total picture ofthe business.”

UNDERSTANDING SABBI

From this broad perspective,Balachandran formulatedSABBI. But exactly what isit, and why is it important?

“Activity-based cost-ing was ’discovered’around 1987 or so,”Balachandran said.“Everybody saw it was abetter way of measuringcosts—especially the indi-rect costs and fixed costs. Butby 1991, they realized, ’Hey,this is a big deal! It is not sim-ply a cost system. It is not justan accounting system. It is amanagement system! So it cov-ers all kinds of things—notonly accounting, but also mar-keting, manufacturing, andeverything else.

"Suddenly,” he continued,“we were using this informationinfrastructure to look at not onlythe costs, but also the revenuesand other measures. Thatenabled the field and seniormanagement to strategicallyevaluate the relative positioningof their products and profitabili-ty. And it let us view what wecan do in the future. Once weused data from past and currentaccounting, to look at past andcurrent management practices.Now, we are looking at a radar

screen showing the future. We’reasking, “How do I positionmyself for the next year, or thenext 30 years, and beyond?”

Companies started to strate-gically examine what core com-petencies they had, from theperspective of costs and rev-enues. They thought more aboutpositioning themselves strategi-cally and what targets to pur-sue.

“So I created a new term,”offered Balachandran. “It is nomore ‘activity-based’ something.It is no longer just cost manage-ment or accounting. There is an

intelligence aspect at the end,and a strategic aspect in thebeginning. And so I called itSABBI: strategic activity-basedbusiness intelligence. It is nolonger just cost management oraccounting.”

SABBI answers one of thetraditional criticisms of account-ing: that it looks only at histori-cal data; it is backward-looking,and not forward-looking.

“You don’t drive your car byonly using your rearview mir-ror,” Balachandran said sensi-bly. “You need the rearviewmirror, no question about it. But you are driving forward. So I have two goals. One is that I want to move out ofaccounting boundaries to lookat the total business. And I alsowant to grow beyond past andcurrent business to look atfuture business. Therefore, I

used the words ‘strategic’ and‘intelligence.’”

GAINING COMPETITIVEADVANTAGE

So how do you gain a com-petitive advantage using this newknowledge?

Balachandran has advisedcompanies to do several things.First, determine the strategicvalue of activities and optimizethe use of resources. Next, deter-mine the profitability of cus-tomers and target customers.

Third, determine the prod-uct pricing and promotionstrategy based on costs.And finally, companiesmust measure, monitor,manage and minimizecosts and activities.

But what are the pit-falls in performing each ofthe above steps?

Balachandran replied, “Youcannot simply manage anythingpurely on hype or purely on gutfeeling. Of course, as a busi-ness leader, you have some gutfeelings, and you know whatworks and what doesn’t. Butyou’ve got to make an informedgut-feeling-based decision.Therefore, I want you to have agood measure. And I think abetter way of measuring thingsis to look at cost, using thisactivity-based concept.

“But you cannot simplyworry about costs alone,” hecontinued. “This is what we’velearned as we moved from thedecade of the eighties to thedecade of the nineties. The pit-fall is if you only worry aboutcosts. But profit is more impor-tant. And profit is like a two-sided coin. One side is the rev-enue part, and the other side is

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© 2000 John Wiley & Sons, Inc.

Companies started to strategicallyexamine what core competencies theyhad, from the perspective of costsand revenues.

March/April 2000 11

the cost part. Unfortunately,activity-based management wasfocusing exclusively—at least upuntil the last year—only oncost.”

Balachandran gave an exam-ple. “Suppose I cut the cost inmy company,” he suggested,“and I create a corporateanorexia. What do I donext? I’ve got to sell. Andso why don’t we look atthe selling aspect of it?Therefore, I want to lookat things holistically.”

Balachandran said thatthree things are especiallyimportant for a company.The first is the top line,which is revenue. That dependson things like price, volume, andmarket share. The second is themiddle line, which is cost. Andthe result of the first two lines isthe bottom line: profit.

“I want you to look at thethird line,” Balachandran assert-ed, “and see the dynamicsbetween the two, rather thanonly one line. And that’s wherethe pitfall lies. I want to go fur-ther. Cost drivers aren’t the onlyimportant things. Revenue driv-ers are equally important. Andthey are even more importanttoday. That’s exactly why theInternet is catching on like wild-fire, for example.”

But which of his recom-mended steps are most difficultfor companies to do?

“You completely control thecost part,” Balachandrananswered. “So that is easy. That’swhy everybody attacked the cost.But the revenue part is involvedwith the future. So it’s not soeasy. Because the revenue isinfluenced by the entire sum ofmarket forces and by your com-petitive position, you have tothink it through a little more

carefully. So you have a betterhandle on costs and not as firm agrasp on revenue. But that does-n’t mean you can simply avoidit. You cannot duck it! If youdon’t know it, are you going tojust say, ‘I’m sorry, that’s it?’No! You’ve got to find out howyou can estimate it.”

WHAT ARE THE PROBLEMS?

But what are the specificobstacles, for example, in deter-mining the strategic value ofactivities and optimizing the useof resources? What are the prob-lems?

“The problems are the fol-lowing,” Balachandran instruct-ed. “You know you identify thevalue. Let’s assume the value iscustomer satisfaction, or thevalue is getting the product ontime, to the right customer,through the right channel of dis-tribution. So you did everythingat a top-level basis. But thedaily strategic decision is not anoperational, day-to-day deci-sion. It is a sort of a five-yearor ten-year decision, or some-thing like that. You got every-thing ready, and then suddenly,in the year 1994 or 1995, some-thing called e-commerce andthe Internet arrived.

“Suddenly, your whole ideaof a supply chain must change!Before the Internet, you knewthat you are here, the customer isthere, and in between there werechannels of distribution. Here

are the suppliers; there are thechannels of distribution. But ifyou look at things that way, as asupply chain, suddenly—withthe Internet—now you are goingdirectly to the end consumer! By1996, perhaps you no longer hada traditional channel of distribu-tion. As a matter of fact, the con-

sumer now tells me whatprice he is going to giveme—take a look at price-line.com, for example!”

In today’s world, thingscan quickly turn upsidedown, without warning.

“Strategically,”Balachandran recounted,“you had positioned

yourself for the year 2000and beyond. Suddenly, you see anew technology coming, whichcompletely torpedoes all yourplanning and thinking! And itbecame a revolution, not an evo-lution. That is why I think thereis a big problem. Okay, you doyour strategic planning. But arethe assumptions used in thestrategic planning questionedtwo years from now?”

YOU ARE THE PILOT

So in order to be dynamic,you need a constant feedbacksystem.

“Absolutely,” Balachandranagreed. “I think this is why Icalled this business intelligence.In other words, I want everyCEO to sit in a kind of airplanecockpit. And that cockpit is to besupported by a radar screen.What is the purpose of the radarscreen? It tells you what are thechanging business conditions.What is the purpose of the cock-pit? It provides you with allkinds of controls. You have acost control, you have a profit

© 2000 John Wiley & Sons, Inc.

But what are the specific obstacles,for example, in determining thestrategic value of activities and opti-mizing the use of resources?

control, you have a marketshare control, you have a con-trol to select customers, and youhave a control that lets youselect a supplier. You have allkinds of controls and gadgets,figuratively. So you constantlysee how things move, and howthe technology moves. Andthen, you position yourself dif-ferently. But you have to maketremendous midcourse correc-tions—and fast!”

Using feedback, the corpo-ration has to constantly adjustto a rapidly changing environ-ment. It’s a kind of cyberneticmodel.

“That’s right,”Balachandran stated.“That’s why I like theword SABBI, rather thansomething else. You’ve gotto strategically changedirection, not operationallychange.”

But most companies doa cost management analysis andthen say, “Okay, we’ve done it.We don’t have to look at itagain.”

“Yes, they do that,”Balachandran said. “That’swhere there is a mistake. Youdid the thing, then you had apizza party and champagne.Nothing doing! You’ve got to berunning every second. Youknow, in Alice in Wonderland,one of the characters said,‘Alice! Why are you runninglike crazy?’ And Aliceanswered, ’I’m running just tostay where I am!’ Just to staywhere I am! So to keep yourrelative market position, youmust be sprinting—not onlyrunning, but sprinting. That isunfortunately the fact of life inthe last four years. It’s becauseof the technology.”

BYE-BYE, EDI?

Balachandran cited anotherexample to show how quicklythings are changing.

“Let me tell you, we thoughtElectronic Data Interchange(EDI) was the biggest break-through, just three years ago!”he exclaimed. “So for example,Proctor and Gamble and Wal-Mart made the connection. Theysaid, ‘At the moment, I knoweverything else. That’s why I canoptimize my inventory and pro-duction schedule.’ That was thejust-in-time (JIT) inventory tech-

nique. And that’s all becomeobsolete right now! It all becameobsolete! And honestly, threeyears ago, I thought it was agreat breakthrough.”

How did it become obsolete? “Because of the Internet,”

Balachandran answered, “theInternet and e-commerce. Now,suddenly, there is no longer amarket. It became a forum. Youtell me, as a consumer, what youwant to do! I tell you, as a seller,what I want to give. And we aredoing some auctioning, barter-ing, and then creating every-thing. For example, today’s WallStreet Journal reports that thepurchasing of $500 billion worthof supplies at Ford and GeneralMotors (GM) is going to bedone over the Internet. Instead ofassembly, we’ve moved to whatis called ‘e-ssembly.’ The article

explains how GM and Ford thinkthe Web can change the factoryfloor. By forcing the playersonline, car makers may ignite anew Internet sales boom.

“Previously,” he added, “theway we thought about cost pro-duction was, “If I do ten units ina minute, let me now do 12 unitsa minute.’ That was the kind ofthinking—linear thinking. Now,that whole style of thinking isgone. You do things completelydifferently. All the logic and allthe assumptions that we assumedwould create our business modelare questionable and thrown out.

Doing the same thing youused to do is not an option.You will die.”

So JIT won’t work anymore?

“No, I didn’t say that,”Balachandran objected.“JIT inventory will be asubsystem. It will still be agood idea. And that philos-

ophy—a philosophy rather thana system—will never disappear,no matter what technologicaldevelopments occur.”

Will the time between inven-tory surveys shrink to compen-sate for the increased pace?

“The time will be adapted tothe new conditions,”Balachandran advised. “So youwon’t throw anything out. I don’tthink you’ll throw any of thosegood things away. But the onlything is, the good things wereassuming a system of technolo-gy. For example, take AmericanAirlines. I used to buy a ticketthrough my travel agent, and hewas supposed to be pretty good.Now, I don’t do that. If I godirectly to American Airlines onthe Web, I get 5 percent off!

“Now that was not widelypredicted even one year ago!

12 The Journal of Corporate Accounting & Finance

© 2000 John Wiley & Sons, Inc.

“That’s why I like the word SABBI,rather than something else. You’vegot to strategically change direction,not operationally change."

One year ago, we never thoughtit would happen. Now what hap-pens to all these travel agents?But is JIT going to go away? No.Is activity-based calculationgoing disappear? No. Actually,activity-based calculation isgoing to show you how to copeby showing you that these arethe activities that you do. Buthow you do it is going to be dif-ferent.”

So perhaps you will reducecosts not by making linearimprovements but by radicallychanging the way you do busi-ness.

LEARNING FROM SOMESUCCESS STORIES

What are some examples ofcompanies that have been espe-cially successful in implement-ing activity based costing andmanagement?

“In my opinion, Chryslerhas,” Balachandran said. “It hasbecome fantastically activity-based throughout the world.They do much better than everbefore. They understand costs.They understand where the driv-ers of costs are. So they are able

to attack those non-value-addedactivities and have significantlysaved costs close to 30 and 40percent of the time! And IBMhas done it, Motorola has doneit—all the semiconductor com-panies have.

"The semiconductor indus-try has embraced this extremelywell,” he continued, “and theautomobile industry has alsodone well. Now, even a serviceindustry can improve. Let’s lookat health care. For example, yougo to your physician, they do aseries of tests, and they chargeyou a fee for services. Now sud-denly, the government says tothe doctor, ‘For these kinds oftests, I’m only going to give you$3,250.’ Done! So therefore, thedoctor now has some decisionsto make, given that the revenueis a maximum of $3,250. Hethinks, ‘What kind of activi-ties—which are important butnot absolutely necessary—can Ieliminate?’

“In the old days, we hadcost-based pricing. You knowthe cost, and add some margin,add profit, and that’s where theprice comes from. Now it isprice-based costing. If this is theprice I can have, you tell me

what you can do. What kinds ofactivities are crucial andabsolutely essential? What kindsof things are not so essential?And what kinds of activities areabsolutely stupid to do—whichwe are doing without reallyknowing why we are doingthem?”

So activity-based costing hassparked a kind of revolution.

“All these things came uponly because of activity-basedcosting,” Balachandran offered.“It is happening in the insuranceindustry and in the serviceindustry. For example, I did a lotof consulting work with the FAA[Federal AviationAdministration]. You know, theFAA deals with very trickyissues. It is not only cost control.There is also the question ofvalue.

“What is the value?” heasked. “The value is that I don’twant the plane to ever crash! Sotherefore, there are certain thingsfor which I cannot worry aboutcost. However, I may do certainother things that are not neces-sary. So let me eliminate them.Or perhaps there is something Ican reconfigure, to get bettervalue with the same cost.”

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© 2000 John Wiley & Sons, Inc.

Edward J. Stone is the editor of The Journal of Corporate Accounting and Finance.