For a large majority of U.S. printing companies, profits are becoming increasingly difficult to earn. The annual ratio studies compiled by Printing Industries of America show that, from a financial performance standpoint, the U.S. printing industry is actually two industries – one composed of a relatively small number of firms that are performing fairly well, and one made up of a much larger number of printing companies that are producing little, if any, profits. In its ratio studies, PIA provides financial statistics for both the average company and for the average "profit leader." Profit leaders are the best performing 25% of companies, measured by net pre-tax profits as a percentage of value added. For the ten-year period from 1992 through 2001, the average profit leader earned annual profits of about 9.7% of sales. During that same time period, the average profit "lagger" – firms in the bottom 75% of profitability – earned annual profits of about 0.7% of sales. The average profit leader was, therefore, over ten times more profitable than the average profit lagger.

So, what distinguishes profit leaders from profit laggers? A careful examination of PIA’s ratio studies reveals that profit leaders exhibit certain characteristics that set them apart from average firms. One of the most significant financial performance characteristics of profit leaders is that, on average, they spend far fewer dollars on "support expenses" for each dollar of earnings generated than average printing companies. Support expenses are those operating expenses that relate to the performance of support activities, and support activities include all work activities that a printing company performs except direct production activities. PIA’s ratio studies clearly reveal the important role that support expenses play in determining the financial performance of printing companies. For example, according to the 2001 PIA Ratios, the average profit leading sheetfed printer with $15 million in annual sales spends about $447,000 less per year on support costs than an average firm of the same size. This pattern of support expense levels is not limited to sheetfed printers with sales of $15 million. An analysis of the full complement of PIA ratio studies indicates that this same basic pattern holds true for virtually all types and sizes of printing companies.

If reducing support expenses is vital to achieving superior financial performance, how do printing company managers gain control of those costs? The answer to this question begins with a fundamental principle. Any individual printing company incurs specific support expenses because that company is performing a particular set of support activities, at a particular quantity level, in a particular fashion. In order to reduce support expenses, therefore, a printing company must improve its efficiency in performing support activities. And in order to improve support activity efficiency, a printing company’s management team must be able to answer three questions: (a) What specific support activities is the company performing? (b) How, specifically, is the company performing those activities? and (c) How much does it cost the company to perform each of those activities?

Some printers may be able to answer the first two questions posed above. But, most printers probably cannot even begin to answer the last question, relating to the costs of support activities. In fact, the most significant barrier to improving the efficiency of support activities is the inability of printing company owners and managers to see the economic consequences of those activities. Unfortunately, the cost systems used by most U.S. printing companies provide little, if any, insight into the costs of specific support activities and processes.

For internal management purposes, printing companies operating in the market environment of the early twenty-first century need a cost system that can perform two basic functions:

1. It must provide printing company managers with necessary information for projecting the cost of business activities and business processes for the purpose of supporting process improvement and process reengineering efforts; and

2. It must provide printing company managers with necessary information for estimating the costs involved in producing individual print jobs, the costs involved in producing specific types of products, the costs involved in providing non-print services, and the costs involved in serving individual customers or defined customer groups.

The cost system currently used by most U.S. printing companies is based on the central concept of budgeted hourly cost rates, or BHR’s. Unfortunately, these BHR-based cost systems are incapable of fulfilling the fundamental functions of a cost system described above.

The first major flaw found in traditional BHR-based cost systems is that they make no attempt to identify or define support activities, nor do they trace or assign costs to support activities. The failure of BHR-based systems to provide information relating to support activities creates several problems. First, by ignoring support activities, BHR-based systems make it impossible for printing company managers to determine what activities and business processes are causing specific support expenses to exist. Second, without information about the cost of support activities and processes, printing company managers have no way of prioritizing process improvement and process reengineering projects based on potential economic benefits to the company and no way of measuring the progress of those projects once they are underway.

The second major defect in traditional BHR-based cost systems is that they "force" all support costs to be allocated to only one kind of cost object – the individual print job. This characteristic of traditional BHR-based systems distorts the underlying economics of printing companies for two distinct, but related reasons. First, every printing company incurs certain support costs that have no cause and effect relationship to the print jobs produced by that company. For example, the salary and benefits of a printing company’s CEO have no causal relationship to any specific job produced by that company. When this kind of cost is allocated to a print job (no matter what method of allocation is used), this process distorts the real economic costs of producing that job. Second, even with respect to support costs that should be assigned to print jobs, traditional BHR-based systems allocate such costs in an artificial and arbitrary way. By treating support expenses as a "burden" on production cost centers, traditional BHR-based systems implicitly assume that all print jobs will require and consume support activities in the same proportion that they require and consume direct production activities.

The third major problem with traditional BHR-based cost systems relates to capacity costs. By using estimated utilization rates in the calculation of hourly cost rates, traditional BHR systems not only fail to measure the cost of unused capacity, they actually conceal such costs from printing company managers. Most industry participants will agree that the printing industry suffers from chronic overcapacity. In this situation, managing capacity and making capacity related decisions are critical tasks for printing company managers. Without information about how much unused or excess capacity exists and how much that excess capacity is costing the company, managers cannot make those decisions on an economically rational basis.

In summary, today’s printing company manager needs a cost system that accurately describes the "real world" economics of his company’s operations. The typical BHR-based system does not fulfill that basic need for several reasons. But, a cost system does exist that can enable printing company managers to make sound, profit-enhancing business decisions.

In the mid-1980’s, Robert S. Kaplan and Robin Cooper, among others, introduced the concept of activity based costing (ABC). ABC systems enabled support expenses to be traced, first to activities and processes, and then to products, services, customers, and other cost objects. Since its introduction, activity based costing systems have been implemented by an extraordinarily wide variety of organizations, both large and small. ABC systems provide business managers with a clear picture of the economics of their companies’ operations, and it is time for printing company managers to receive the benefits provided by well-designed ABC systems.

A properly constructed ABC cost system solves each of the major problems associated with traditional BHR-based cost systems. First, an ABC system provides accurate information regarding the costs of a company’s major business activities and business processes, both direct production processes and support activities. That information can be used both to prioritize process improvement and process reengineering efforts and to measure and track the progress of those efforts.

Second, unlike traditional BHR-based systems, which drive all costs to print "jobs," ABC systems can trace costs to a variety of cost objects. For printing companies, one of the most important cost objects available in an ABC system is the customer. Most printing company managers know intuitively that some customers are more difficult to serve than others. ABC systems can be used to trace the real costs incurred in serving individual customers or customer groups. This information enables printing company managers to estimate customer profitability, and measuring customer profitability accurately can provide dramatic insight into the dynamics of a printing company’s profits.

Third, ABC systems can provide extremely valuable information to printing company managers about the cost of unused or excess capacity. To illustrate how an ABC system deals with resource capacity costs, we can use a simple example. Suppose that a printing company has a major activity called, "operate four color press." This company runs an eight-hour, one-shift operation, five days per week, and it has one employee who is qualified to perform this activity. The company observes eight holidays per year, and the press operator receives two weeks of vacation per year. Based on budgeted expenses, the company estimates that it will spend $200,000 in the coming year to supply resources for this activity. Since print jobs will vary significantly in the amount of time they spend on the press, the ABC system designer decides that "number of press hours" is the most appropriate activity cost driver for this activity. In order for an ABC system to properly measure the cost of both used and unused capacity, the activity cost driver rates used in the system must be calculated based on the practical capacity of each activity. Given these hypothetical facts, the practical capacity of this activity would be 1,936 hours (total annual hours for one shift less holiday and vacation hours).

The cost driver rate for this activity would be calculated by dividing the annual activity cost ($200,000) by the practical capacity of the activity (1,936 hours). The resulting rate ($103.31/hr) would be the hourly cost rate that is used to assign the cost of this activity to individual print jobs. Now suppose that, when the operating year is completed, the printing company determines that this activity actually operated at 80% of practical capacity, or 1,549 hours, during the year. In this case, the cost of this resource that was actually used during the year would be approximately $160,000 (1,549 hours x $103.31/hr) and the cost of unused capacity for this resource would be approximately $40,000 for the year ($200,000 - $160,000).

Capacity cost information at the level shown above is both revealing and important. But, an ABC system can be refined even further to reveal why the unused or excess capacity exists. For example, our hypothetical press could be idle because it is undergoing scheduled maintenance or unscheduled repairs, or because it is "waiting for work" from upstream production activities. Alternatively, the press could be idle because the company has no work for the press. This information is important for assigning responsibility for unused capacity. If our press is idle because of maintenance or repairs, or because of upstream production "bottlenecks," the production department "owns" that unused capacity and should strive to reduce it whenever possible. If the press is idle because the company has no work for it, then that unused capacity is "owned" by the sales department, and the "cure" is more sales. Looking at resource capacity in this manner enables printing company managers to focus on the real issues surrounding unused capacity, and it points them toward the right kinds of solutions, rather than suggesting, as BHR-based systems do, that capacity issues can be solved by pricing.

Activity-based costing provides printing company owners and managers with a powerful tool for improving profits. Implementing an activity-based costing system is not all that is required to produce long-term success, but it is an important step toward that goal.