Adopting The PACE Profitability Analytics Framework: Champions and Heroes

What does it take to successfully and effectively implement the PACE Profitability Analytics Framework (PAF)?

First, let’s describe some examples of the of the methods in the PAF. They include:

·  Profitability reporting (using activity-based costing [ABC] );

·  Strategy maps and their balanced scorecards with KPIs

·  Revenue Management

·   Lean management with lean accounting;

·   Quality management with the cost of quality (COQ);

·   Driver-based budgeting and rolling financial forecasts;

·   Enterprise risk management (ERM);

·   Data science and analytics.

A problem is the slow adoption rate by organizations, especially the CFO and their complicit accountants, to implement these methods.

The Facts Are In

A good example of a slow adoption rate is the reluctance to implement activity-based costing (ABC). I am an instructor for several accounting training firms that provide courses for CPAs to earn their continuing profession education (CPE) hours to annually retain their CPA certification. In any course there are polling questions required to “pass” the course.  

In one of my courses, after I have described ABC, a survey polling question (i.e., no correct or wrong answer) asks them how does their organization calculate product or service line costs with four choices. Typically, 95% of the responses answer that they allocate the indirect expenses, commonly called overhead, like spreading butter across bread. They use cost allocation factors like the number of labor hours, units produces, services delivered, sales amounts, number of employees in a department, or square feet. None of these reflect the unique consumption that the diverse products or services incur of the end-to-end business processes, and the work activities that belong to the processes, that in turn draw on the resources’ expenses.

This broad-brushed averaging results in some of the products or services being over-costed, typically substantially, and therefore the others must be under-costed because it is a zero-sum error calculation. This means the CFO and their complicit accountants are providing flawed and misleading information to their line managers and employees needed to gain insights and make better decisions. Yes, of course, this bad math satisfies GAAP for external statutory compliance financial accounting with 100% reconciliation of the expenses into costs, but is wrong in the parts, Activity-based costing resolves this with internal management accounting. 

Each time that I see that polling question result I do not know if I should laugh or cry! Harvard Business School emeritus Professor Robert S. Kaplan co-authored his book in 1987 titled “Relevance Lost – The Rise and Fall of Management Accounting” that described ABC. It is now 2024 almost 40 years since that book was published and 95% of the accountants continue to use the old, traditional, and flawed costing method.

What is the Explanation?

What can explain this slow adoption of ABC and likely of the other PAF methods?  Are CFOs and accountants uninformed? Were they not taught ABC in their university accounting classes? Are they fearful of being embarrassed that they have been doing costing wrong for all the years? Are they stupid?

The explanation is deeper. It involves behavioral psychology. *

This trap has a formal name: “escalation of commitment to a losing course of action.” In the face of impending failure instead of rethinking to better ways managers often double down on their past decisions. It feels better to be a fighter than a quitter.

One of the tragedies of the human condition is we use our big brains not to make rational decisions but rather to rationalize the decisions we have already made. For example, we stick around too long in dead-end jobs. We continue to stay the course even after friends have counseled us to change direction.

This also happens with businesses. Blockbuster went bust because instead of buying Netflix, their leaders escalated their commitment to renting physical videos. Kodak doubled down on selling film instead of pivoting to digital cameras.

Escalation of commitment helps to explain why leaders are often reluctant to loosen their grip on power. What? I am a CFO, and I am going to use an accounting method proposed by the operations, marketing or sales team? No way. A change like that can bruise egos and wound pride. CFOs know they are on a long journey to improve their organization’s performance with what they may believe the end is in sight.  So, they have reasons to believe they can succeed continuing to go their way.

People close to a leader, like the accountants under the CFO, are susceptible to confirmation bias. They are too personally invested in the success of the CFO and likely to dismiss warning signs of imperil and danger. As an example a large sales and high demanding and consequently unprofitable customer is increasing its demands (e.g., special services, price discounts) and becoming even more unprofitable.    

Champions versus Heroes

What a CFO needs is not a support network but a challenge network. People who already have a track record for making good decisions and are impartial. They are not worried about an adverse impact to their career. They may worry that pressuring the CFO may backfire. That is a valid concern but a rick they take. Pressure can make leaders defensive.

In the past I used to appeal to “champions” who for example might perform an ABC pilot of proof of concept project for their own organization to demonstrate that ABC is the way to go. To get buy in and overcome resistance to change. Pilot projects are very engaging because the pilot is their own organization that everyone can relate to. But now I want to appeal to “heroes”. Unlike champions heroes have courage, empathy, humility, confidence, ingenuity, selflessness, perseverance, and honesty.

A better approach can start with heroes praising their leader (e.g., the CFO) for their skills and contributions. This can make the leader more willing to rethink current methods or poor decisions from the past. Ask the CFO the pros and cons of ABC. An effective way to influence change is to open a stubborn mind is not to argue or create guilt or shame. It is to listen. Ask the CFO what would shift their thinking? What information do you need to change your thinking?

What CFO wants to retire and have a legacy that they severely underserved their executives, line managers, and employee teams with inaccurate, flawed and misleading information? They may believe their financial reporting is the “truth” but a more vital question is if the CFO knows how to hear the truth. It is an oxymoron to have alternative facts. ABC is fact-based. Refusing to change is not always a heroic act of resilience. It is often stubborn rigidity.

Conclusion

Successfully and effectively implementing the methods in the PACE Profitability Analytics Framework (PAF) enables organizations to improve their operational and financial performance.

·  * Much text in this article extracted near verbatim from a July 6, 2024 New York Times article titled “The Reason It’s So Hard for Powerful People to Walk Away” by Adam Grant.