Teaching The ABCs

our years ago, federal fire chief Steve Hauck bought $56,000 worth of new firefighting gear and rescue equipment for his crew at Fort Huachuca, Ariz. Not a dime of it came out of his budget.

Hauck did not use accounting gimmicks to find the extra money, nor did he hold a fund-raiser. Instead, the 52-year-old manager studied the post's fire department to find ways to improve performance and cut costs. Hauck soon realized he could save thousands if Fort Huachuca's police and fire departments combined their emergency dispatch centers into one office that took all 911 calls. This move saved $87,000 for Uncle Sam, most of which was returned to Hauck to buy new equipment.

Twenty miles from the U.S.-Mexican border, Hauck is a key player in one of the most ambitious management experiments the government has seen in years. Since 1997, managers at Fort Huachuca have tried to meet the base's goal of spending 3 percent less than they get in each year's budget. Their chief weapon is activity-based costing (ABC), a private sector accounting tool that has been fitfully applied by federal agencies over the last decade.

ABC targets a chronic weakness in federal financial systems: They are good at tracking how agencies spend their budgets, but do not show the full cost of activities and programs. ABC captures these costs by apportioning spending across an agency's programs. The method begins with an output-anything from providing day care to maintaining a firing range-and traces the cost of the activities that feed into that output. At Fort Huachuca's day-care center, for example, director Heidi Malarchik can tell you what it costs to care for a child, and then identify what portion of that cost reflects classes, teacher training and building maintenance.

ABC may sound basic, but its proponents see it as a magic bullet for solving federal management problems. Once an agency knows the full cost of its activities, the theory goes, it can adjust funding or staffing to produce better results. By showing the relationship between an agency's output and the factors that drive its costs, ABC can even be used to make personnel decisions. For example, if an agency has a surge in workload, ABC can be used to determine how many new employees to hire.

ABC can also help agencies meet President Bush's government reform goals. To get a top-rated "green light" for financial management on the Bush management scorecard, agencies must comply with all federal accounting standards. These include a 1998 mandate from the Federal Accounting Standards Advisory Board to develop full-cost accounting systems such as ABC. The board, made up of veteran federal financial managers, sets accounting standards for the government.

At the Interior Department, officials hope ABC can help them steer funding dollars to high-performing programs, another Bush management priority. By fiscal 2004, Interior will use ABC to discover the costs of such activities as fighting fires, selling wild horses and maintaining public lands. Cost information will be used to develop best practices and reward successful programs with more funds, says Lynn Scarlett, Interior's assistant secretary for policy, management and budget.

Interior's ABC plan has the endorsement of Mark Everson, controller at the Office of Management and Budget, who says OMB does not require agencies to use ABC or any particular full-costing method. Still, as OMB begins to fund programs based on performance, agencies need accurate cost information to justify their budget requests. "It will be very important to have a comprehensive method that establishes what the cost is of providing a service," says Everson. "It's the only fair way to evaluate what's working and what's not working."

ABC can be a godsend to agencies facing a budget crunch. At Fort Huachuca, ABC allowed managers to take control of their operations in a period of annual budget cuts, says retired Col. Ted Chopin, who served as base commander from 1997 to 1999. "There was no other way to get a handle on what was going on. If we were going to be cut every year, I said let's use ABC and target [the] reductions ourselves." ABC has enabled officials at Fort Huachuca to rethink how they do business. Malarchik and her staff have redesigned all sorts of activities at the day-care center. She used ABC data to come up with a less expensive way to train teachers-staff now squeeze in training during free moments of the day, such as nap time, instead of scheduling training sessions after work hours. ABC also helped Ernest Beil, who recently retired as manager of Fort Huachuca's firing ranges. He saved $20,000 by switching to cheaper mowing equipment. 'I'm changing the way I look at what I do and what my people do with ABC," says Beil.

But despite its potential, ABC has proved exceedingly difficult to implement. Ten years after the first ABC pilot tests sprang up in government, only a handful of agencies are using the approach. Even at Fort Huachuca, the jury is still out on how well ABC is working. Only once in four years has the base met its goal of reducing spending by 3 percent, and it's unclear how well the post's managers have taken to ABC. When asked how ABC has caught on, Beil doesn't mince words: "Not well. I really believe that most people consider it just another [hoop] that we have to jump through to satisfy somebody at a higher level."

Culture of Costs

ABC adherents use it mostly to help set user fees, not to aid management efforts. Setting user fees is not a trivial exercise-the Patent and Trademark Office, the first agency to deploy ABC agencywide, used it to persuade Congress to change patent and trademark fees in 1999. By showing the cost of achieving a unit of output given certain levels of labor inputs, ABC provides an empirical basis for raising or lowering fees. Congress lowered most patent fees and gave PTO administrator Q. Todd Dickinson authority to raise trademark fees.

PTO is now launching management pilots to expand the use of ABC to its business operations. Experts question why other agencies with robust ABC systems for setting fees, such as the Immigration and Naturalization Service, have not used their cost information to improve management. "What's most troubling to me is the fact that some agencies have created fairly good organization-wide ABC models, but they do it for a particular reason: fee setting," says C. Morgan Kinghorn, a consultant with PricewaterhouseCoopers who led the IRS' ABC program in the early 1990s. "Very few have taken it to the next step of management."

Other agencies develop ineffective ABC systems or are deterred from even trying the method because of cultural challenges. Showing the full cost of federal operations inevitably creates opportunities for outsourcing. Indeed, the accounting method has been used to justify outsourcing at Fort Huachuca and at the Army Forces Command, which adopted ABC in 1996. If ABC is merely used to outsource positions, federal employees have little incentive to support it, argues Bill Early, chief financial officer at GSA. "If you did ABC, you would find areas that were less effective and contract them out," he says. "Well, in many cases then, is that getting you a return on all the hard work of creating the [ABC] system in the first place?"

Some agencies go overboard trying to win the support of employees. They try to factor every employee's job into their ABC models, creating top-heavy systems that measure the costs of so many activities that they become difficult to use. "People have hard-coded the measurement process before really understanding how they're going to use it," says Dale Geiger, an expert on government managerial cost accounting systems at the George Washington University.

Efforts to implement ABC have been held up by the lack of a clear champion in federal management circles. One group of potential advocates, chief financial officers, has been preoccupied with obtaining clean audits, according to Early. "If you can't produce a set of financial statements that gives you a clean audit opinion, you'll get beaten up for not having that done," he says.

Even if an agency creates an ABC system, one rosy budget forecast can make managers lose interest, says Jim Freauff, director of Fort Huachuca's cost management office. Freauff notes other Army installations have put ABC aside when their funding has been increased. "The worst thing that can happen is for the Army to have lots of money, because if you get lots of money, you don't worry about using it wisely," he says.

But perhaps the biggest obstacle to managing with ABC is convincing managers to think about costs when the law and Congress restrict them to a set budget. While the Coast Guard and PTO have incorporated some ABC information into their budget requests, no agency has submitted a so-called activity-based budget, a request based entirely on the projected cost of their activities. And even if an agency did take this step, congressional appropriators might ignore it, meaning good cost management could easily go unrecognized. At PTO, managers' biggest concern as they begin ABC management pilots is how it will affect the budget process, according to Michelle Picard, director of PTO's office of finance. "Budget rules the universe," she says.

Managing by cost radically upends traditional financial management practices, which for years have been based on making sure that civil servants "aren't robbing the treasury," says former OMB Deputy Director Sean O'Keefe, who is now NASA administrator. "What you're doing with ABC is saying, 'Don't worry about what has been the mantra of the financial management community for 80 years.' Instead, [you're saying] 'Let's focus on identifying the outcome you want and then back into the means of delivering it, by looking at how you do it right now, that identifies what the costs are.' That's a big culture change."

Wooing Converts

Chopin is an ABC evangelist whose enthusiasm sits well with his audience. At Fort Huachuca, his nonstop advocacy of ABC became the hallmark of his command and helped win over at least some managers to the idea of managing by cost. But while Chopin's tactics may be unique, he and other ABC adherents throughout government share the same task: creating an agency culture in which managers embrace ABC as a management tool.

Some agencies are designing new positions to make ABC stick. The Customs Service wants to turn budget officers at its 20 regional management centers into "budget counselors" who would use ABC data to help center directors allocate inspectors and other field agents to meet shifting needs. "I want [budget counselors] to be able to go in and say, here are the areas where you're not producing results; now, here are some areas we can invest in," says Rich Ballaban, who directs program management staff in the field operations office at Customs headquarters.

At the Marine Corps, which has implemented ABC at all 16 of its installations, ABC is creating a new civilian career track: business management. Marine Corps leaders believe civilians lend continuity to ABC and other business reform initiatives and free up Marines to be, well, Marines. The service is investing in training for its civilians and plans to establish "business management officer" positions at its installations to help managers use ABC. The new positions "give us a career target as a civilian Marine," says Stefanie Kenny, a reengineering business consultant who is guiding ABC efforts at the Yuma, Ariz. Marine base.

The Marine Corps has made taking care of its people the centerpiece of its ABC program. Corps leaders believe they can achieve $33 million in savings from ABC-powered reengineering in the next few years, enough to allow them to shift 2,800 Marines off bases and into the field, a move leaders think will encourage troops to re-enlist. And twisting the notion that ABC spurs outsourcing, the service ordered a rapid deployment of ABC in 2000, in part to help installations prepare for public-private job competitions mandated by the Defense Department. Uncovering full costs would give installations a roadmap for redesigning their operations and ultimately makes for better competitions, according to Dave Clifton, head of the installation reform office at Marine Corps headquarters. In the future, Clifton believes ABC could make operations so efficient that private firms will shy away from competing against them.

"Pretty soon people will say about our civilian Marines the same thing they say about our Marines when they go and deploy. They're going to say . . . these guys are the incumbents, they know their costs, and maybe they are bulletproof in terms of competition," he says. Other agencies are using a carrot-and-stick approach to convince their managers to try ABC. At Fort Huachuca, Chopin sometimes let managers keep savings generated by reengineering initiatives to pour back into their operations. Other base commanders offer cash awards to managers who think up new ways to save. Base commanders use quarterly evaluations to check how well managers are controlling costs and to forecast costs for the next quarter.

At the Education Department's Office of Student Financial Assistance, ABC is now part of a manager's bottom line. In a pilot test, SFA has made managing with ABC a performance measure in the evaluations of managers on 28 agency teams. These managers must keep their programs within cost targets set with ABC data or risk a poor evaluation and no performance bonus. The cost targets are often less, and never more, than a manager's actual budget allocation, so managers will have to come in under their budgets to meet the targets. If they do well, SFA will expand the test.

"The idea is not just to focus on budget cuts, but to encourage all managers to do better and to actively beat their current unit cost," says an SFA official involved in the pilot. The agency is also developing cost targets for its three main operating divisions and the overall organization.

SFA has left the bells and whistles off its ABC system to make it simple to use. Agency programmers still use sophisticated software to create ABC cost models, but then convert data into easy-to-read Microsoft Excel spreadsheets that managers can access at their convenience. PTO has eased its managers into ABC over the past few years by using it to measure the cost of several activities at a time. Now, as the agency begins managing with ABC in eight offices, officials think its gradual approach has helped employees accept the system. "I don't think anybody looks at this as something that we'll have to weather," says John Hassett, who supervises 60 employees in PTO's Office of Administrative Services, which started managing with ABC in October.

Divine Inspiration

"I knew we were up to something when I heard that challenge," he says. "I became absolutely convinced, beyond the point of anybody being able to undo my resolve, that we were really on to something here."

Proponents of ABC are firm in their belief that it can solve any number of ills. But they also agree it is fragile-ABC seems to work best, when it works at all, when managers dive into it on their own. "You can't have a compliance mindset and do a good job with this. It's impossible," says Steve Pellegrino, who works in the Marine Corps ABC office under Clifton. So how do you mandate a management tool that depends so much on initiative?

The Customs Service, Marine Corps and certain Army installations plan to benchmark ABC systems within their organizations to share best practices and encourage innovation among offices and bases. But experts warn that forcing everyone to use the same ABC model would turn ABC into another system for external reporting, diminishing its ability to solve management problems unique to a given installation or office.

Marine Corps installations will keep modifying their ABC systems even as headquarters starts to set certain cost targets that every installation will be expected to meet. This, leaders believe, will allow installations to keep ownership of ABC and keep it from becoming an external reporting tool.

If it does, it won't be long before managers lose interest, warn ABC veterans at Fort Huachuca. Beil has been to many of the same ABC meetings as Chopin. Afterwards, some managers are less than enthusiastic. "After the meetings, I've stood around talking to other folks, and I've heard, 'Oh God. Here's another thing that's going to take time from my job. Another thing to justify somebody's position,' " Beil says.

Fort Huachuca officials say Beil, who retired in February at 62, was a great cost manager. "I just hope the person who comes in to take my place is as hooked on [ABC] as I am. It will make his or her job a whole lot easier," says Beil.