What is the purpose of brakes — good brakes — on a car? To slow the car down? To stop the car? It's a thought-provoking question that you may have heard before. Perhaps the best and most expensive car braking systems in the world are on Formula One racing cars. You can imagine why.
The reason why we invest in great braking systems on Formula One cars is the same reason why we should invest in great managerial costing systems. In short, a commitment to high-quality managerial costing (MC) can significantly improve the profitability of decision making in the organization. However, there is a business case that must be made. Organization leaders need to understand the return on investment before committing to improving MC systems. The challenge is that the benefits of high-quality MC are harder to measure and quantify in dollars and cents compared to the costs of investing in new systems and personnel support. That said, “harder to measure” doesn’t mean “impossible to measure.”
How might we quantify the value of decision making that is faster, more confident, and strategically on point? In How to Measure Anything, author Douglas Hubbard provides an approach to estimate the value we’re “leaving on the table” when dealing with low-quality cost information in key management decisions. Below is a modified set of five critical questions from Hubbard’s book that we can use to quantify the value of better MC information by zeroing in on specific operational and strategic decisions being made by management.
What is the decision currently being supported by the organization’s existing MC system?
What is the potential value (profit) of making the right decision?
How much do we know right now about the total expected cost involved in the decision?
How much risk is currently in the decision due to uncertain or unavailable cost information?
What would it be worth to have a better MC system that provided cost information for the current decision that is faster, more detailed, and with higher accuracy?
One way to answer the final question in terms of dollars and cents is to consider the potential out-of-pocket cost of making a bad decision or the potential opportunity cost of walking away from an uncertain decision. Bottom line, to what extent does the existing MC system hinder managers in making faster, more confident decisions that support good strategy? What would it be worth to have a high-quality MC system that resulted in better value creation and value capture in the market?
So, what is the purpose of brakes on a car? If you’ve heard this analogy before, you know that the answer to brakes on a car is so that the car can be driven faster, more aggressively, more confidently. Think about how you would drive if you’re uncertain about the quality of brakes on your car. Would you slow down sooner before coming to a turn? Would you avoid making a quick switch into a lane that is packed with other vehicles? Would you leave more distance between you and the car in front? Would you skip making a turn that suddenly presented itself? Would you leave earlier than normal to arrive at the event safely and on time?
What if managers have to wait too long for the cost information? What if managers don’t have high confidence in the cost information? What if the cost system can’t respond with the level of detail needed by managers? The result will be (and should be!) slow, cautious, timid decision making. Otherwise, managers are at risk of making disastrous decisions. A high-quality managerial costing system is critically to aggressively “driving” the organization to its profitability goals.
So, how are the brakes on your car?
Want to learn more about Formula One braking systems? (It’s fascinating.) Go HERE.
Want to learn more about high-quality managerial costing? (It’s also fascinating.) Come join the discussion at PACE.