SOE managers did not previously have sufficient knowledge of how to manage sales activities, because until the 1980s SOEs used to produce goods based on the central government’s production quota.

China’s move to a market economy has seen the demise of some SOEs, while the remainder underwent a series of reforms. The surviving SOEs are now looking into better ways of managing sales activities. With this CIMA-funded project we adopted an activity-based approach to analyse the sales activities of Xu Ji Electric, a Chinese SOE-turned-plc in the manufacturing sector.

Company background
Xu Ji was the production arm of a former SOE (the Xu Ji Group, or XJG) in northern China, manufacturing relay and electricity grid equipment since the late 1970s. As part of the reform, XJG floated Xu Ji onto China’s Shenzhen stock exchange in the mid 1990s.

However, its sales were still handled by another subsidiary of XJG, the Sales Company. In 2006, XJG decided to realign the sales function with product lines, resulting in a large proportion of the sales force being merged into Xu Ji.

It was a challenging time for Xu Ji’s management because their expertise was primarily in product development and manufacturing, not in sales.

For example, Xu Ji’s CFO commented: “I want to know what the industry norm is in terms of selling expenses over sales revenue… It gets more complicated when you need to spend or invest now to build relationships in order to get future business or contracts. What is the balance?”

Xu Ji implemented an activity-based costing (ABC) system into its premier production unit in 2002 (Liu and Pan 1997) and saw the benefits of ABC in achieving lean operation and process standardisation in its production units.

Sales units
Before the realignment, both Xu Ji and the Sales Company were respective production and sales functions of XJG.

Xu Ji transferred its finished products to the Sales Company, based on internal selling prices set by XJG. The realignment of sales functions led to the revelation of a relatively high proportion of sales expenses over sales revenue (see Table 1 ).

In addition, there was long-standing friction between production and sales over the method of calculating selling prices. Production adopted a “cost-plus” approach, while sales used a so-called “market-led pricing” system (which was determined by a bidding price with some consideration of direct costs and profit margin).

Further investigation revealed some underlying issues.

1. Product cost information was based on material costs, plus a percentage for direct labour and overheads. This information was used as a reference point. However, evidence suggested that salespeople tended to ignore this in order to win sales contracts at all costs.

2. Xu Ji did not have overall control over the sales units’ operations and expenses. The finance department did not hold detailed sales expenses accounts. Sales recorded the sales expenses and reported a total sum at month end to the finance department. The finance department’s attempt to control expenses resulted in a monthly spending target being set for each sales unit, which was calculated using forecasted contractual sales, repayment to debt receivable  and gross profit margin. While the objective of this formula was to stimulate sales and debt recovery, the formula did not prevent a loss being made on some contracts.

3. The salaries and bonuses of salespeople were based on a certain percentage of signed contractual value and repayment of receivables, but not on profit margins.

Activity-based sales analysis
Before undertaking detailed activity analysis, we started by mapping Xu Ji’s existing sales process with responsibility centres, as shown in Figure 1. We then understood that each sales unit produced detailed sales plans at various levels.

The plan comprised sales targets, repayment targets and detailed activities that were important to achieve the end results. Most interestingly, the activities outlined in the sales plan were less on the number of sales visits or phone calls, but more on identifying ways to build customer networks. This approach is common in Chinese organisations.

Figure 1 Sales process flow and responsibility centres involved

Based on the above sales process flows, we then identified causal links between sales expenses with contracts and proposed cost drivers (see Table 2).

We took a few large contracts of Electric Grid to demonstrate a contract profitability analysis (see Exhibit 1).

This enabled management to clearly see contract profitability. However, there was fierce resistance from sales managers because they saw this ABC exercise as a “threat to their autonomous status”. In addition, some non-standardised practices that existed in sales activities meant that some traceable costs were unattainable.

For example, commissions were highly commercially sensitive, and therefore only implicitly disclosed in its internal accounting system. There was a non-causal link between sales activities (expenses) and winning contracts (sales).

For example, some salespeople invested time and money (travelling and entertainment costs) on clients, but did not necessarily win the contract. However, this cultivated relationships that may have led to a future contract without incurring any expenses.

Conclusions
This activity-based sales analysis is a retrospective analysis and is done by tracing sales expenses directly or indirectly to contracts (output). It is unconventional to some reported ABC sales analysis, which normally includes the number of sales visits.

The main benefits of this exercise are that first, it enabled Xu Ji’s management to have a better understanding of sales processes and activities; second, it helped to impose informed controls (e.g. enforcing standardised procedures) over sales units, and finally it highlighted the need to balance the pursuit of high sales revenues with obtaining contract profitability.

Chinese management styles rely more on managing people and relationships (Chinese management ethos) than on technological systems and management tools. The level of office and accounting computerisation and IT-enabled business solutions is not as advanced as those in the West.

Xu Ji started from a very basic level, building financial accounting systems and office computerisation before implementing the ABC costing system that captured direct costs and variable manufacturing overheads before processing.

The main achievements of Xu Ji’s 10-year ABC endeavour are that ABC radically changed the SOE-turned-plc’s traditional costing systems and introduced standardisation into their working practices and processes.

ABC also acted as a catalyst to Xu Ji’s IT developments (first accounting and office computerisation, and later the ERP implementation). One distinctive feature of Xu Ji’s ABC experience is the “top-down” instigation and zealousness of trying out innovative ideas and inducing corporate-wide learning. While a “top-down” approach is not so popular in the West, it is fairly common amongst SOEs, particularly in the northern part of China.

This approach has therefore worked well in Xu Ji, allowing it to move quickly from imitating Western ideas to developing its own (independently developed ABC system) and making informed decisions using sales activity analysis.

Authors
Lana Yan Jun Liu* Newcastle University, UK; Fei Pan Shanghai University of Finance and Economics, China; Lin Zhou Henan University of Economics and Law, China; Baozhou Ma Xu Ji Electric Co. Ltd. China.

* Corresponding Author Contact Details: Dr Lana Y J Liu Lecturer in Accounting and Finance Newcastle University Business School Newcastle University Newcastle upon Tyne NE1 7RU E-mail: lana.liu@newcastle.ac.uk

The authors gratefully acknowledge the support of CIMA in the undertaking of the research on which this project is based and express their gratitude to all participants of Xu Ji Electrics Co. Ltd. and Xu Ji Group Company for their zealous efforts and contribution that made this project possible.

Related reading on Xu Ji’s ABC experience
Liu, L.Y.J. & Pan, F., 2007. The implementation of Activity-Based Costing in China: An innovation action research approach. British Accounting Review, 39(3), pp. 249-264.