Environmental Considerations in Product Mix Decisions Using ActivityBased Costing and the Theory of

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Environmental Considerations in Product Mix
Decisions Using Activity-Based Costing and the
Theory of Constraints

• Julie Lockhart, Professor
• Julie.Lockhart_at_wwu.edu
• Audrey Taylor, Assistant Professor
• Audrey.Taylor_at_wwu.edu
• Western Washington University
• Bellingham, Washington

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The Problem with Environmentalism

• It is too costly to businesses.
• Companies are faced with pressures from
  government, stockholders, and the public to
  improve their environmental record.
• Corporate management must achieve profitability
  goals to keep Wall Street happy.

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The Problem Defined and the Underlying Assumptions

• Because
• Being a good corporate citizen requires
  additional environmental investments
• Current Environmental investments are not
  sufficient to meet the requirements of investors
  and society.

Because Going beyond regulatory compliance can
create value for customers and shareholders alike
Improve their environmental record
Invest in Environmental Improvements
Increase Long-Term Profit
Achieve profitability goals
Do Not Invest in Environmental Improvements

• Because
• Additional investment in environmental capacity
  does not yield sufficient benefits to outweigh
  the cost of the investment..
• There is no way to decrease toxic emissions
  without increased investment.
• Current utilization of our environmental capital
  is effective and efficient.

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A Proposed Solution
Improve the environmental record
Use our current Environmental investment wisely
to improve our record with no or minimal
additional investment.
Increase Long-Term Profit
Achieve profitability goals
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One possible solution

• Use of activity-based costing (ABC) in
  conjunction with life-cycle costing1 for
  allocating environmental costs to products, and
  thus getting a handle on what those costs are.
• However, ABC does not automatically consider
  constraints in the production process, and thus
  the product mix decisions made from ABC
  information may not facilitate profit
  maximization goals. 1Life-cycle costing tracks
  costs over the entire product life cycle from
  cradle to grave.

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ABC, TOC, and Differing Assumptions
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ABC, TOC, and Differing Assumptions
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Environmental Costs and Resources

• All businesses have an impact on the natural
  environment.
• Federal and state governments regulate hazardous
  material inputs and waste.
• Perhaps the most onerous of these are the
  Superfund regulations created to clean up toxic
  waste sites, and the Resource Conservation and
  Recovery Act (RCRA) for facilities that treat,
  store, and/or dispose of hazardous waste.

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Environmental Costs and Resources

• Many companies have chosen to adopt
  eco-efficient policies internally that have the
  dual result of saving the companies money as well
  as improving their reputation with certain
  stakeholders.
• Internal environmental costs when regulations are
  imposed may include record-keeping, reporting,
  labeling, emissions and effluent management,
  waste management, compliance, training, research
  and development, certification and permitting.

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Environmental Costs and Resources

• Costs may be different depending on whether a
  company is a generator/user, transporter, or
  disposal facility for hazardous materials.

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An Example Comparing ABC and TOC

• Clean Products Inc. manufactures four products,
  R, S, T, and U.
• Four categories of environmental costs are
  included in the array of manufacturing costs in
  the company.
• Hazardous chemicals are used in the manufacture
  of R, S, T, and U, with a hazardous waste
  disposal fee per pound, which is variable.
• Clean Products invested in a scrubber to clean
  emissions at the end of the process.
• The company incurs environmental reporting (by
  product) and regulatory costs (by facility).

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An Example Comparing ABC and TOC
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An Example Comparing ABC and TOC
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An Example Comparing ABC and TOC
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An Example Comparing ABC and TOC
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An Example Comparing ABC and TOC
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An Example Comparing ABC and TOC -Batch and
Product Level Costs
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An Example Comparing ABC and TOC - Facilities
Level Costs
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Utilization of each resource
The environmental scrubber is the constrained
resource in this example.
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Utilization of each resource
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Product Prioritization Using ABC
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Product Prioritization Using ABC
Note that ABC does not rank products based on
the constraint caused by the Scrubber.
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Profit when ABC is used to determine product mix
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Example of Product Ranking with TOC
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Example of Product Ranking with TOC
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Profit when TOC is used to determine product mix
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Product Rankings and Profit Changes Using ABC and
TOC
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TOC is always the best choice given the following
conditions

• Products use shared resources.
• Demand for all of the products sharing those
  resources is greater than the capacity of at
  least one resource.
• There is a commitment to maintain capacity at the
  current level for the immediate future.
• There is a desire to maximize profit over the
  current level of resources.

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TOC is always the best choice given the following
conditions

• When capacity increases are made the constrained
  resource is the first resource purchased.
• The market dictates the price of the competing
  products and those prices or price and volume
  choices are known prior to production plans being
  solidified.
• The creation of certain toxins are of concern to
  the company and there is a desire to determine
  the least toxic generating product mix.

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Possible Ramifications for Green Companies

• By using the TOC to identify the constraint and
  to use it so that the Environmental Scrubber was
  used most profitably, the company simultaneously
  
• Chose products that used the least amount of
  scrubber time per unit.
• Fostered the selection of a product mix that was
  cleaner than the previous mix since it emitted
  fewer toxins requiring scrubber time.
• Improved company profitability.
• If companies can reduce emissions while they are
  increasing profit, resistance to making
  environmental improvements should evaporate.

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Conclusions

• Investments in environmental assets can be very
  expensive. However, given the current regulatory
  environment regarding toxic substances, concern
  over the environment is obligatory.
• Regardless of the motivation, companies find they
  must be proactive about reducing the
  environmental impact from the products they
  produce.
• By adopting the TOC methodology, companies can
  maximize their profits given environmental
  investments while they are producing earth
  friendly products.