In the recent half century, plenty of organisational research has confirmed one crucial fact: it’s hard for an organisation to make money if doesn’t put in some money into raw materials, research, human resources, advertising, etc. For the same reason, it’s equally, if not more, important to invest in its business processes.
Of course, no firm wants to simply pour money into a process and have the funds disappear into a black hole. The money must help create an effective process that contributes to profitability. And to make this happen, it’s vital to first understand the business process cost.
Why Business Process cost measurement is process-agnostic
Profitability, an important goal of any company, is determined in part by processes that produce an income and have controllable costs. To increase profitability, companies must reduce business process costs and increase process income. To reduce costs, it’s vital to first measure and analyse them.
Several cost models are available to measure process cost. Interestingly, all of them are process-agnostic, which means they can be utilised to measure the cost of any process for any business in any industry.
Only the cost elements and drivers vary and ultimately determine process cost. There may also be some variations in how costs are assigned to the process. Further, the specific characteristics of a process impact its cost drivers.
Even so, all costs are discoverable, regardless of process characteristics, cost drivers, or allocation strategies, and it’s usually best to start with the available cost information. The costs may then be refined by performing a deeper analysis of each cost driver.
Types of Business Process costs
A business process is a series of repeated, interconnected, and/or inter-dependent activities that enable the company to achieve some desired outcome. Processes are part of every kind of business in every industry. No company can function without its processes. Moreover, no company can survive if it doesn’t know its business process costs.
For most processes, there are four types of costs:
These refer to the expenses incurred when buying the inputs for one or more processes. So, for a manufacturing organisation, raw materials are a type of input costs. For a process producing an intellectual or intangible output, technology expenses, such as the cost of a subscription to a SaaS-based software is a type of input cost.
Also known as execution costs or operating costs, conversion costs are incurred when a process transforms some inputs into a required output. Examples include labour, equipment, facilities, and any other operating expenses incurred to execute various process tasks.
Overhead costs incurred during process execution and in support of a broader business goal are all types of support costs.
Some examples include:
- IT operations
- Knowledge management
- Administration and facilities management
Management costs are also a type of support cost.
This type of business process cost refers to the cost of delivering the process output. Distribution cost is one of the most common types of output costs.
Formula to measure Business Process cost
The most reliable formula to measure business process cost is, unsurprisingly:
The sum of the number of times each process element is expected to be executed x cost of each element
All business process costs are usually associated with the process activities, which refer to the work performed in the process. The other part of the process is a deliverable, which represents the benefit or return of performing that activity. In any process, costs are always attached to activities, not to deliverables.
The most common methodology to measure a business process cost is called end-to-end process costing. The end-to-end cost of a process is the average cost of performing the process many times over. Here, the word “average” is crucial because:
- Sometimes processes have branch points, so on one execution, the branch will go one way but go another way during another execution
- In some circumstances, an exception process may be required
- There may be loopbacks where the same activity is executed multiple times
Any of these aspects can add to actual process cost, which is why the end-to-end process cost is not simply the total cost of each activity. Rather, it is the formula mentioned at the start of this section.
Let’s consider a simple business process: booking a hotel room.
Step 1: Customer creates a profile on the hotel’s booking page.
Step 2: They find a room for their date and location.
Step 3: They reserve the room.
Step 4: Hotel sends them a confirmation email.
Every time the process is executed, all four activities must be completed. Moreover, each activity is done only once with no branches or loopbacks.
Therefore, the end-to-end business process cost is simply the sum of the four activity costs.
Now let’s take a look at another process: money transfer.
Step 1: Customer creates a profile on the company’s website on Day X.
Step 2: On Day Y, they log into their account to initiate a money transfer.
Step 3: The site authenticates the customer based on their profile.
Step 4a: If authentication fails, the customer gets an error message and is directed to re-login.
Step 4b: If authentication succeeds, customer proceeds to complete the transfer.
Step 5: Once the transfer is completed, they get a confirmation message on-screen and an email with important details like transaction ID.
Unlike the previous process, this process includes a decision point and a loopback. This will involve some re-work which must be considered when calculating the process cost, as per the formula discussed earlier.
This article does a deep-dive into the importance of measuring business process costs. By measuring and analysing the cost of running your processes, you will be able to identify opportunities to lower overall business costs and increase business profitability.
Moreover, if you are considering automating one or more processes, knowing process cost will help you create a baseline against which to measure the success of the automation effort. Without this baseline, you won’t know what kind of improvements to aim for, much less ensure that automation will deliver those improvements.
- It’s important to measure business process costs to understand the company’s profitability and create a baseline to assess the success of an automation initiative
- Most process cost models are process-agnostic. Only the cost drivers vary and ultimately determine the process cost.
- The four main types of business process costs are input costs, conversion costs, support costs, and output costs
- The most reliable formula to measure business process cost is: the sum of the number of times each process element is expected to be executed x cost of each element