San Francisco’s Millennium Tower, the tallest residential building in the city, was constructed in 2009 and won numerous engineering awards upon construction. It didn’t take long, however, before it was discovered that the 58-story luxury high-rise was both sinking and tilting. By 2018, the building had sunk 18 inches and had a lean of 14 inches. Then residents began to hear popping and creaking sounds. A window in one unit developed a crack in a pane of glass that was rated to withstand hurricane force winds. Many lawsuits followed. Finally, in 2020, a $100 million plan was approved to stop the sinking and eliminate half of the building’s tilt.
Millennium Tower’s problem was that it was built on a foundation of dense sand, not on bedrock like most downtown towers. The sand foundation was incapable of supporting the engineering wonder whose weight it was expected to bear. It reminded me of the old Harry Belafonte song “Hosanna” in which he declared, “House build on a weak foundation, will not stand, oh no!” and later offered the alternative, “House built on a rock foundation, it will stand, oh yes!”
It also reminded me of the scores of wonderfully designed EPR and accounting systems I’ve seen over the past decades that do an excellent job of providing managers with inaccurate, incomplete and irrelevant decision support information. These systems collect volumes of raw data and manipulate that data in an efficient, timely and often complex manner. But the models they use to manipulate the data – the foundation on which the systems are built – are seriously flawed.
Models are simplified versions of a more complex reality. Valid models include the key elements of that reality and reflect the cause-and-effect relationships (causality) among those elements. A company’s primary models are its revenue, cost and investment models. If those models are not valid – if they don’t include all key elements and their causality-based relationships – the information systems used to effectuate those models will generate flawed and misleading information for decision makers. The systems are built on a foundation of sand, not bedrock.
Management accountants should be concerned about the validity of all three primary models, but they are directly responsible for one of them – the company’s cost model. If the company’s information system in not based on a valid cost model of the organization, the cost information provided to decision makers will not support quality decisions. Instead, it will undermine the quality of decision making.
In almost all cases, the oversimplified cost accounting models that support financial accounting are not just inadequate for, but detrimental to, decision making. They fail to reflect the fundamental economics that underlie the operation of the business. A well-designed managerial costing model, on the other hand, does incorporate those fundamental economics. When a modern information system is built on a valid managerial costing model, not an oversimplified financial accounting cost accounting model, the system will generate high-quality, accurate, relevant and actionable cost information that will improve the quality of business decision and enhance the organization’s financial performance. The system will be built on bedrock, not on sand.
The Profitability Analytics Center of Excellence (PACE) is committed to helping organization’s improve their financial performance through the development of quality decision support information – information that is based on the bedrock of valid revenue, cost and investment models. Won’t you join us in that quest?