From warehouses to distribution centers: Adopting activity-based costing and management in Uganda

Sub Title
New Insights Approaches: Article 2
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Date
September 19, 2022
Lead Paragraph/Summary

In the second article of this new series from GHSC-PSM, we examine how implementation of activity-based costing (ABC) and activity-based management in Uganda has enabled the assessment of actual cost drivers in warehousing and transportation services. Through four well-defined phases, ABC allows operational and management staff to adjust spending and address areas of concern. Moreover, ABC represents a fundamental shift in how an organization operates that leads to continual improvement and operational excellence, prescriptively addressing problems before they create bottlenecks, stockouts, and delays. Through the practice of ABC and activity-based management, warehouses can transform from simply being a place where goods are stored to a distribution center where they can and do become a competitive and lean operation.

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Determining the actual cost of warehousing and distribution operations
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Over the last decade, USAID has supported warehouses in Uganda to develop capacity for storage and transportation of health commodities. Joint Medical Stores (JMS) is a private-not-for-profit (PNFP) organization subcontracted by the USAID Global Health Supply Chain-Procurement and Supply Management (GHSC-PSM) project to provide warehousing and transportation services in the country. JMS provides storage and transportation for USAID-procured commodities accessed through over 800 PNFP service delivery points located in all regions of the country. 

While there had been some advances in infrastructure and upgrade of warehouse management systems, there was little information on the cost of different components of warehouse operations at JMS. Fees for warehousing and distribution were traditionally calculated as a percentage of value of commodities, which had no relationship with the actual cost of doing business. This approach meant the donor was not certain if JMS received adequate compensation for the services provided.

In 2018, GHSC-PSM started the process that would lead to implementation of activity-based costing (ABC) and activity-based management (ABM) to enable JMS management to understand cost drivers for the different functional areas of their operations. This article describes the ABC/ABM implementation process at JMS, its impact, challenges, and lessons learned.
 

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Implementing ABC
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ABC identifies costs of resource inputs associated with specific activities and considers allocation of indirect (overhead) and shared costs, thus identifying true costs of an activity.  In the case of JMS,  ABC worked as a systematic approach to understanding the true cost of warehousing, distribution, and total operational cost. ABC aims to answer several questions (Box I). 

Questions addressed by activity-based costing to understand the actual cost drivers of warehousing and trasportation services.

  • Does your distribution center know their actual cost?
  • Do they know the day-to-day, month-to-month, and year-to-year cost of operating their supply chains (distribution centers and transportation)?
  • Do they understand the cost drivers within operations that impact those costs?
  • Do they know how to adjust those drivers to become more efficient and productive, ultimately reducing operational cost?

For the case of JMS, ABC was implemented in four phases: Phase 1 was an exploratory phase that ended in September 2018; Phase 2 focused on customization of tools and training of JMS staff and was completed in July 2019; Phase 3 reviewed JMS implementation of labor reports and ended in November 2019, and Phase 4 introduced the Profit and Loss (P & L) analytical tool to enable monthly review of cost, and was completed in June 2021 (see Box 1I on ABC phases). The P & L tool provided a detailed breakdown of JMS' direct costs by item, giving visibility into the percentage of overall cost per item and changes and trends in spending, which allowed JMS' operational and management staff to adjust spending and address areas of concern.

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Activities conducted by GHSC-PSM in collaboration with JMS during the four phases of ABC implementation in Uganda
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Phase 1

  • Worked with JMS to identify all existing JMS and National Medical Stores cost activities associated with warehouse operations under their control, as well as data, financial records, or systems gaps that will preclude the application of ABC. 
  • Worked with JMS key staff to determine which sub-activities should be considered under the key activities. This aggregation was used in later phases of ABC exercises when assigning value for each activity. As an example, a key activity category like warehousing operations has the following cost subcategories: personnel, interwarehouse carriage, damage and losses, quality analysis, and equipment repairs. 

Phase 2

  • Trained JMS staff, implemented, and customized the Plan-Do-Check-Act (PDCA) cycle to improve supply chain operations efficiency at all levels.
  • Taught JMS how to conduct PDCA kick off and recap meetings and use the PDCA to manage daily business.
  • Customized the labor report template. 
  • Taught JMS how to populate the labor report with data from the PDCA daily planner.

Phase 3

  • Reviewed JMS implementation of labor report including allocation of direct and indirect costs, as well as transportation to include fuel, maintenance, depreciation, etc. per diem.
  • Supported labor allocations: conducted interviews to ascertain the percentage of support to a specific activity driver for all indirect labor costs (for example, customer service, order entry, procurement, etc.)

Phase 4

  • Profit and Loss (P & L) analysis: using JMS financial records, GHSC-PSM created a revised P & L template that helped identify key cost drivers for each reporting period and compare them to other periods to analyze trends and establish priority targets. 
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The impact of ABC in Uganda: A team owns its performance
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JMS adoption of ABC enabled the operations and management team to review costs monthly to understand the cost drivers and design mitigation actions to manage the costs and increase profitability. JMS used the P & L tool, which incorporates labor reports and all direct and indirect cost elements and allocates this to all the functional areas. Using these tools, JMS could sort expenses into appropriate categories such as warehouse, administrative, information technology, sales, procurement, building, and transportation. JMS managers could then monitor labor utilization in various operational areas–such as receiving, put away, selection and dispatch–and gain efficiency by deploying staff according to projected output. While implementing the labor report and reviewing throughput (number of units processed per hour) daily in Phase 2, JMS achieved an upward trend in throughput. It became clear that, once an activity is measured, the responsible team becomes owners of their performance.  

JMS throughput: As JMS started implementing the labor report in Phase 2, the operation staff set targets in terms of units to be handled in each operational area, and they reconciled this with actual daily numbers. The graph shows that total throughput increased from August 2019 to April 2020, except for November and December (a holiday period including a close- down to assess and record the amount of stock).

As JMS started implementing the labor report in Phase 2, the operation staff set targets in terms of units to be handled in each operational area, and they reconciled this with actual daily numbers. The graph shows that total throughput increased from August 2019 to April 2020, except for November and December (a holiday period including a close- down to assess and record the amount of stock).

Using the P & L tool, JMS and GHSC-PSM came to a common understanding and agreed on the actual cost of warehousing and distribution of program commodities procured by different funders/donors, including USAID. In October 2021, a new contract was signed between Chemonics and JMS using a percentage fee applied for all types of commodities that is based on actual cost of storage and distribution. JMS took on the implementation and will continue applying ABC/ABM once GHSC-PSM technical support ends.

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Addressing challenges
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Despite the successful implementation, some challenges arose. The main issue was that data required to monitor and analyze key performance indicators —for instance, information on the exact volume of commodities and distances traveled during delivery—were incomplete at the start of the ABC process. The system must be developed to capture the data and provide reports that facilitate analysis in the later phases of the activity and report trends.

Also, as JMS continued to monitor units of products processed daily and monthly using the labor report, it became clear that immediate action was required to improve performance. For example, JMS improved the receiving process by eliminating break-case (purchasing in cartons  instead of smaller units). Another key area of improvement was in picking and packing, a labor-intensive part of warehouse operations in which staff prepare orders for delivery.  JMS created additional pick slots, used flow racking (high-density racking system), and streamlined pick patterns, resulting in faster picking and packing and improved throughput.

"Using the labor report has helped us understand and be able to predict the amount of labor we need for a projected output. We are now able to adjust the number of temporary staff with accuracy based on previous labor reports. In addition, we can now predict the types of trucks and tonnage required for planned deliveries.” - Paul Senyonga, Manager Customer Services, JMS

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Lessons learned and scalability of ABC
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The main lessons learned from the implementation of ABC in Uganda are:

1. Implementing a major change in like ABC requires the participation of all key players and epxplaining to them the potentital benefits of the new system and the importance of compliance.

2. The process to capture any missing data required for ABC should be initiated in phase 1 of the activity for the successful implementation of the following phases.

3. By showing some early impact of the activity, for instance in Phase 2 while COVID-19 restrictions occurred, JMS was able to review and understand how changes in order processing patterns due to COVID-19 restrictions affected the throughput. Changes in movement due to the COVID-19 restrictions included reduction of transferred freight from satellite warehouses, elimination of part-time staff, and processing larger orders with lower item count.

4. Regular monitoring of costs using the monthly P & L tool enabled JMS to keep track of the cost trends under different areas of their operation and identify the cost drivers. The benefits of this regular review included; understanding real costs of activities in a transparent way, developing and implementing continuous improvement plans, understanding the cost of goods to help and inform pricing and purchasing policy, revealing unnecessary costs to eliminate and improve operational efficiency.

ABC is designed to provide managers with cost information for strategic decisions that potentially affect capacity, resources, and costs. ABC is not just a costing methodology, but a true shift in how an organization operates, leading to continual improvement and operational excellence. Implementation of ABC ideally enables warehouse operators to transition to ABM in a way that ensures that they are more efficient in the use of their supply chain resources, prescriptively addressing problems before they create bottlenecks, stockouts, and delays. In other words, ABM means operationalizing the efficiencies introduced through ABC into day-to-day management.

Through the practice of ABC/ABM, warehouses can transform from simply being a place where goods are stored to a distribution center, where they can and do become a competitive and lean operation.