Strategic objective costing: A new tool for improving resource allocation

Alasdair Macnab, FCMA, CGMA, director of corporate services for the Royal Botanic Garden Edinburgh, has adapted the Balanced Scorecard to create a new way of measuring the HR and financial costs of meeting strategic objectives.
Alasdair Macnab, FCMA, CGMA
Alasdair Macnab, FCMA, CGMA

The Balanced Scorecard (BSC) is arguably the most popular performance management and strategy formulation framework that provides a holistic picture of an organisation. A BSC typically achieves this by applying four or five perspectives – financial, internal process, customer, and employee learning and growth – with objectives and measures that can be integrated across the organisation’s functions and through its hierarchy.

If these components of the BSC are cascaded to sub-business units (and their cost centres), it should be straightforward to form a basis for budget requests. The structure of the cost centre usually mirrors the administrative structure of the organisation.

What may be interesting to senior management is where the real efforts of employees are focused. Activity-based costing (ABC) is a potential costing methodology for identifying activities and cost drivers in order to better understand overhead costs. ABC represents an improvement on traditional costing systems, but considerable work is required to set up the processes and obtain the data.

Knowing the costs of each strategic objective (as outlined in the BSC) may be more useful than attempting to allocate overheads against the output activities. In many public-sector organisations, structures do not necessarily follow strategy, and there can be a disconnect between the financial information provided and the achievement of strategic objectives that may be more effectively measured using nonfinancial key performance indicators (KPIs).

As employees often work in cross-divisional teams to achieve strategic objectives, the true costs of achieving these objectives cannot be collected by relying on the cost-centre structure. Rational allocation of resources can be difficult to achieve, posing difficulties for those responsible for allocating rational budgets.

A new approach to costing
As a result of these problems with existing management accounting techniques, a different model is required to capture the time that employees spend on the various activities and other costs that contribute to the execution of the corporate strategy. I have developed an approach, called “strategic objective costing”, in order to capture employees’ time and other financial expenditures and allocate those costs against defined strategic objectives.

Tailoring the BSC model
The Royal Botanic Garden Edinburgh (RBGE) case study involved novel managerial constructions that, significantly, adapted the BSC to fit the specific requirements of the organisation. This process included adding a fifth perspective to the BSC: the Scottish government, which is the RBGE’s principal external stakeholder. This adaptation of the BSC has provided a strategyformulation methodology at RBGE for six years. The model forms the basis of monthly performance reports on strategy execution to both the senior management team and the board of trustees.

Tracking staff time
RBGE uses Palladium Group’s Executive Strategy Manager (ESM) as its performance management system. This system is configured to report on every activity that supports the achievement of divisional and corporate goals.

Employees record how much time they spend on activities supporting objectives on a web-based time sheet (linked to our HR system). This time sheet is based on a drop-down menu and takes about five minutes a week for each employee to complete. Each activity has a unique code to support the objective coding system, allowing the organisation to track more than 100 activities.

Finance expenditure codes
The finance system was amended to require two codes: one for the traditional cost-centre systems necessary for producing financial accounts and another to allocate costs against a departmental activity. We decided to code expenditures against strategic objectives at the departmental level because the finance system could not provide a drop-down menu like the HR system – which meant that too many choices would be available to the user to code against, increasing the likelihood of errors. As a result, employees have around 30 codes to choose from, though most code against three or four objectives within their areas of responsibility. Future changes to codes can be made locally.

Data extraction
The HR and finance systems export the costs into monthly Excel spreadsheets. ESM can perform a query on these spreadsheet outputs and allocate both staff costs and nonsalary financial costs to the activities being tracked. These costs equate to the objective costs and appear as a measure in each objective. The component costs from the work sections contributing employees’ efforts to the achievement of objectives can be viewed through a drill-down mechanism within ESM.

Abstraction of costs from activities to strategic objectives
ESM is able to abstract the costing information up the scorecard system to provide objective costings at the corporate strategic level. However, staff costing information can be presented as an individual activity, divisional and strategic objective level, and is fed into all the separate activity measures by ESM. This provides visibility of costs/effort to operational managers at all levels in the organisational hierarchy. As a result, managers can decide whether the best use of scarce resources is being achieved.

This strategic objective costing system also allows managers to consider redeployment of skills/knowledge and assess the impact of such decisions. Managers can do this by reviewing the reporting process during the course of the year and noting the impact on the PIs and KPIs.

Strategic objective costing outputs
Strategic objective costing has no inherent value unless the resulting information is put to some use. It provides information to senior management on where staff effort is being deployed – either directed or self-managed – so that improved evidence-based decision making can take place. The detailed analysis of costs in Figure 1 shows which staff members have contributed what percentage of time to each objective. It also demonstrates that a detailed analysis of financial expenditure can also be provided.

By gaining a comprehensive understanding of how the costs are built up, rational decisions can be made about whether to change the variables by redirecting staff effort from one objective to another. With this improved knowledge, line managers can now give instructions to employees to change their work priorities accordingly in order to ensure that divisional goals that lead to strategic objectives are met.

Strategic objective budgeting
In January 2011, the senior management team indicated that sufficient data was available to produce a first strategic objective budget for the financial year 2011–12. Assessments were made of the likely income and attributed against the various strategic objectives.

This model provides the necessary information to show the input costs for each strategic objective, which can then be married up to the outputs (measures) that are linked to the achievement of the objectives (KPIs) and reconciled to the financial management accounts. This process allows strategic objective budgeting to occur.

The strategic objective budgeting process creates a useful lens on what activities are generating income and how best to allocate these resources to meet the corporate objectives by understanding the links between inputs (staff effort and costs) and outputs/outcomes (achievement of KPIs).

This new system of cost accounting will allow the board and/or executive management team to better exercise their governance responsibility by having improved information about organisational performance, including that of efficient use of resources.

Moreover, managers can shift employees’ efforts from one objective to another to ensure that the overall corporate goals are achieved by the judicious use of the scarce resources available.

Picture: Martin Hunter