Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
The purpose of this paper is to explain how the concept of "explicit cost dynamics" can be used to evaluate proposed projects. The idea is that every project should include a presentation of the value to be created for the company. The authors refer to this as a "value proposition".
Explicit Cost Dynamics
Explicit cost dynamics (ECD) is a concept or tool that excludes cost allocation or any attempt to determine product costs. The emphasis is on the dollars flowing into and out of the company. The authors point out that reducing costs can be obtained in only two ways, either by spending less on purchases, or purchasing less. Cost allocation confuses the issue by treating fixed costs as if they were variable and creating unit costs that are misleading and logically inaccurate.
ECD is based on two underlying concepts of capacity and two types of costs. Capacity includes static or input capacity, and dynamic or output capacity. Static capacity represents the ability to perform work. Dynamic capacity, on the other hand is represented by the work performed. In ECD these capacity concepts form the resource costs. A second type of costs in ECD is action costs. Action costs (not to be confused with ABC's activity costs) result when an action causes dollars to flow out of the company. According to Yu-Lee and Haun the concepts of static and dynamic capacity, and resource and action costs provide the basis for creating accurate value propositions.
Using ECD to Create Value Propositions
Improvement in performance requires improving the ratio of output to input. From the ECD perspective this means improving the ratio of dynamic capacity to static capacity. This measurement requires three steps:
1. Document the changes in static and dynamic capacity from the proposed project, both primary and secondary or direct and indirect. This involves creating capacity maps that represent the current state and the future state, including measures of static and dynamic capacity. Determine how the differences will be created.
2. Document the changes in explicit costs and revenues, both primary and secondary. These come from the capacity maps. Cost savings come from either reducing resource costs or action costs.
3. Document the steps required to realize the secondary benefits.
For more on Explicit Cost Dynamics see:
Yu-Lee, R. T. 2002. Target costing: What you see is not what you get. Journal of Cost Management (July/August): 23-28. (Summary).
Yu-Lee, R. T. 2003. Don't miss the bottom line with productivity increases. Industrial Management (January/February): 8-13. (Summary).
To Compare Explicit Cost Dynamics to The Theory of Constraints see:
Goldratt, E. M. 1990. What is this thing called Theory of Constraints. New York: North River Press. (Summary).
Goldratt, E. M. 1990. The Haystack Syndrome: Sifting Information Out of the Data Ocean. New York: North River Press. (Summary).
Goldratt, E. M. and J. Cox. 1986. The Goal: A Process of Ongoing Improvement. New York: North River Press. (Summary).