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these competitors to invest in both new technology and new thinking. By the 1970s, American
industry had lost dominance in key industries such as steel, automobiles, and electronics.
Johnson and Kaplan argued that one major reason for this decline in competitiveness was the lack
of relevant internal cost information needed to compete on this global stage. Poor management
accounting systems did, in fact, hinder U.S. firms‟ ability to compete. The authors then called for a
rebuilding of management accounting systems based on the work of the early pioneers such as Church
and Clark. In the ensuing years, many manuscripts were written detailing best practices in constructing
internal management information systems that traced costs to outputs on a more logical or causal
basis. This body of work became known as activity-based accounting (ABC), and this chapter
discusses both the positive and the negative aspects of this movement.
Basics of Activity-Based Systems
It is perhaps easiest to first review how an ABC system is built and then reflect on the process. A
relatively simple example is used here to illustrate.
Company Z was an entrepreneurial venture focused on Web merchandising. A number of
executives experienced in this area formed the company to provide back-room operations to aspiring
Web merchants. Processes such as credit verification, fulfillment, and delivery tracking were a
constant headache to those selling online, especially if they did not have scale to provide these
services in an efficient manner. By building a hosted network, the entrepreneurs reasoned that they
could attract many of these merchants and build a revenue stream by providing an on-demand product,
back-room transaction processing. They crafted the following customer value proposition:
Join our network and get all these services seamlessly provided with state-of-the-art applications
run by highly trained IT professionals. We will convert a difficult-to-manage fixed infrastructure
cost into a totally scalable variable one since you pay only on a per-transaction basis. With us as
your partner, you can spend your creative energies where your investors expect.
It was not surprising that, given the massive growth in Web commerce, first-round financing from
venture capitalists (VCs) focused on proving the value proposition was oversubscribed. In 12 months,
Company Z was back for second-round money to scale the business. In that time period the start-up
had signed 10 merchants to contracts, built a smaller-scale system, and had 8 of the 10 merchants up
and running on it. But what the new firm did not have was a concise explanation of the underlying
economic model. The VC community did understand how one invested in bricks-and-mortar
businesses but needed a clear understanding of the evolving Web commerce arena. Company Z was
told to build this economic model if it wanted more funding.
A consultant was brought in to aid the firm. By talking with all involved in the business it
established that Company Z had three high-level processes that led to value creation. First, it had to
capture customers, defined as attaining a signed contract for transaction processing. Then it had to
load these customers onto the network, enabling them to process all their back-room operations
through Company Z systems. Only then could Company Z make money on the final process,