As we discussed in Modeling: A Decision Taking Asset, a process model should include an estimate of the execution cost, adding value to any business case. Focusing on the importance of measuring while modeling, this approach is an invitation to conduct a team review of any initial calculation model with the Stakeholders, before submitting it to the Executive Board.
Understanding the current state (click for explanations)
Managing change and planning change involves understanding the current state and defining the future state of a business process.
At an early stage of any process improvement initiative, it is the best time to provide a first calculation model of the current state.
If you are brave enough and visionary, and the process is straight forward, it is a good idea to provide at the same time some initial thinking about potential savings along the process.
Calculation model (click for explanation)
Let us review the variables used for this calculation and evaluate how it adds value to the modeling exercise.
We estimate the annual expenditure to transmit daily 45 Purchase Orders at $790,000. It does not assess yet if the process is effective, but provides us a first dimension of the current cost.
One could infer that a 10% efficiency improvement would represent an annual saving of nearly $80,000. However, is this enough to trigger a process improvement initiative? Can we achieve this improvement with a minimum expenditure, to ensure a return on that investment?
By establishing a first measurement, it is easier to engage in this discussion with stakeholders, much better than presenting a process diagram alone.
In a second iteration of the calculation model, we might examine the process in term of transaction volume; we can already communicate to the process owner a cost per unit. Using the calculation model, we learn that for 11 700 Purchase Orders over a year, this output of the process each costs $67.60 to the enterprise. It is almost evident that the process owner never had an opportunity to figure it by himself in most cases.
Consider the real costs (section 1)
How can we establish an hourly rate beyond $90, in our calculation?
Payroll and Availability
The average earnings of a resource might seem the best way to pursue the calculation of a business process cost. However, is it enough? One must equally consider the social and side benefits paid to employees, to achieve a fair real-time rate. In that case, it is best to refer to the Human Resources Manager to agree on a factor across all processes.
One must additionally consider the number of weeks available to work, when resources are engaged in the execution of process activities. One could even subtract from the current 37.5 hours a week the different breaks and factor in absences, which will establish a realistic hourly rate.
One can even establish a full-time equivalent (FTE) to estimate the number of busy resources executing the process. This equivalent is particularly important when evaluating any process improvement requiring a reorganization of tasks, roles and responsibilities.
Consider the indirect costs (section 1)
We often overlook at the overhead allocation. There is a basic rule of setting it to 150%, which generally represents the enterprise’s operation costs such as rental space, amenities like energy and telecommunications, supplies, taxes, insurance and equipment related to IT systems (see reference in the bottom of the article for more details). There is a cost to maintain facilities where real people are working, want it or not.
Why must we consider these indirect costs?
As a plain vanilla example, an enterprise employing 200 employees, each earning $50,000 a year, will spend around $13 millions a year for the resources, available 1800 hours over that time period. In fact, it would make up to 360K available hours to execute all operational, support or administrative business processes.
Applying the 150% standard across all processes would represent an annual expenditure of approximately $ 20 millions, to convert into an hourly rate to fit in the calculation model. This expenditure is also a part of process execution cost, we must insist. In that case, it is best to discuss with the Financial Controller, to agree on a standard rate across all processes.
After establishing this standard rate, use it in all your process models. It is unrealistic to believe that one can model all business processes; in principle, if that were the case in our example, we would have 36,000 hours available, excluding outsourcing.
Efforts by activity (section 2)
This section presents no particular problem; however, why would we calculate the volume of activities on an annual basis? This is to answer this very relevant question: « But how much it cost us?” Implicitly, Enterprise CXOs are very close of their annual planning – both for income and expenditure.
Impact on decision-making
What we all learn from this exercise is that Stakeholders and Executive Boards too often underestimate the real cost of most of their business processes. As an indirect consequence, they may be reluctant to promote improvement initiatives because they underestimate costs and cannot envision big savings.
Relying on a standard calculation model attached to each process diagram becomes an additional incentive to encourage change initiatives. In fact, this is one good reason to believe that process modeling is more than process diagrams. There is often confusion between these two levels, as we already discussed before.
This first exercise is a good starting point, but to engage in a thorough discussion and set targets for improvement, it is also important to provide accurate measurements, much more to benchmark against standards of excellence.
In the case of Purchase Orders, to use our example, how can we investigate a little more? Using the metrics proposed by APQC, in the next article, we will review and evaluate if our calculation model can be refined to answer more questions from CXOs or Executive Boards, if any.
The Power of Business Process Improvement – The Workbook, section Estimate Time and Cost, chapter 5, for a detailed review
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