Technovation 25 (2005) 523–533

www.elsevier.com/locate/technovation

Performance measurement and costing system in new enterprise

A. Gunasekarana,*, H. James Williamsb, Ronald E. McGaugheyc
a
Department of Business Administration, University of Illinois at Springfield, One University Plaza, Springfield, IL 62703-5407, USA
b
School of Business, North Carolina Central University, Durham, NC 27707, USA
c
Department of Management Information Systems, The University of Central Arkansas, Conway, AR 72035-0001, USA

Abstract
In this paper, we describe a framework for measuring costs and performance in new forms of business organization that are evolving to meet the
competitive challenges of the 21st century. A literature review on cost management and performance measures in advanced manufacturing and
service organizations provides the basis for our framework. The framework emphasizes measurement of costs and performance in the virtual
enterprise and along the supply chain to enhance competitiveness in global markets. Investing in knowledge capital and information technology
plays an important role in improving organizational competitiveness in the 21st century, yet the measurement of performance in these important
areas is at best, imprecise. Managing and controlling costs and performance in new forms of organization poses challenges. We hope this article
will encourage research that will help practitioners meet the challenges of performance measurement in the 21st century.
q 2003 Elsevier Ltd. All rights reserved.
Keywords: Cost accounting system; Performance measures; Virtual enterprise; Supply chain; New enterprise

1. Introduction particularly the automotive sector (Hicks et al., 2000).

In the 21st century, firms need not just operate in different
countries, they must develop global strategies to coordinate
their operations at all phases of the value-adding chain
(D’Amours et al., 1999). Coordination of the supply chain has
become strategically important as new forms of organization,
such as virtual enterprises, global manufacturing and logistics
networks, and other company-to-company alliances, evolve.
The Japanese are often praised for the way they use
information sharing to improve supply chain competitiveness.
Information exchange has become a key component in their
manufacturing strategies (Dyer and Ouchi, 1993).
Companies in all sectors are examining ways to reduce
costs, shorten product development times and manage risks.
The transactions between companies in supply chains are
characterized by adding value up through the chain and
incurring costs (and consequent payments) down the chain.
Supply chain management aims to reduce costs, risks and lead-
times associated with these transactions, thus releasing value.
There is limited research on supply chain management in the
low-volume Engineer to Order (ETO) sector. This is in stark
contrast to the extensive literature on high-volume sectors,
* Corresponding author. Tel.: þ 1-217-206-7927; fax: þ1-217-206-7543.
E-mail address: gunasekaran.angappa@uis.edu (A. Gunasekaran).
0166-4972/$ - see front matter q 2003 Elsevier Ltd. All rights reserved.
doi:10.1016/j.technovation.2003.09.010
Performance measurement is critical to the success of any
“for-profit” organization because it creates understanding,
molds behavior, and improves competitiveness. World-class
firms recognize the central role measurement plays in their
success and are often compulsive about their performance
measurement efforts (Fawcett and Cooper, 1998).
Manufacturers are looking to their suppliers, with increasing
frequency, for modules and systems, not just components. This
is particularly true in the automotive industry where the
industry’s procurement and engineering activities provide
lessons about selling modules and systems applicable to
virtually any other manufacturing industry (Henke, 2000).
Briers and Chua (2001) sought to illustrate how an organiza-
tion’s accounting system could be changed by a heterogeneous
actor-network of local and global actors and actants. Four types
of boundary objects were identified for this type of accounting
system: data repositories, visionary objects (conceptual objects
with high levels of legitimacy within a particular community),
coincident boundaries and standardized protocols.
Activity Based Costing (ABC) is a product costing
technique that has gained attention. Turney (1996) defined
ABC as a method of measuring the cost and performance of
activities and cost objects. It assigns costs to activities based on
their consumption of resources and then allocates costs to cost
objects based on their required activities. The focus of ABC is
524 A. Gunasekaran et al. / Technovation 25 (2005) 523–533
on accurate information about the true cost of products,
services, processes, activities, distribution channels, customer
segments, contracts and projects. ABC helps identify
problems and opportunities and formulate solutions to
problems or ways to take advantage of opportunities. It does
so by providing financial and non-financial information about
activities and cost objects. Numerous articles address the
design and implementation of ABC systems (Shank and
Govindarajan, 1993; Alan, 1995; David and Robert, 1995;
Booth, 1996). According to Innes and Mitchell (1990), ABC
provides process control information. A measure of the
volume of each activity (cost driver) is used to generate a cost
rate for estimating production cost, and as a performance
measure for the activity concerned. In practice, most
applications of ABC make arbitrary allocations of common
costs. The search for the activities which connect costs to
products and processes, and for the cost drivers which proxy
for them, involves compromise between accuracy and
manageability. The result is that some indirect costs are
excluded from the cost-pools associated with a practical set of
cost drivers (Armstrong, 2002).
Strategic performance measurement defines the focus and
scope of management accounting. Specifically the requirement
is that management accounting practice recognize and reflect
choices made in organizations for management accounting to
be relevant (Atkinson, 1998). For the purpose of strategic
performance measurement, the organization’s objective can be
entirely financial, social, or a mix of both financial and social
objectives. It is widely believed that the large-scale use of EDI
leads to improvements in the communication infrastructure
between organizations, and that this, in turn, strengthens the
economy of a nation and possibly a group of nations. It is also
widely recognized that EDI enables organizations to redesign
their processes significantly, because of its main capabilities:
high speed, reliability and ease of data capture (Sheombar and
Wagenaar, 1991). Hoogeweegen et al. (1998) describe a
comprehensive approach for evaluating the value of various
courses of action involved in implementing EDI. The first relies
on ABC and quantifies the costs and benefits that are to be
expected from the information processing when EDI is being
used. The second uses discrete-event computer simulation to
quantify the costs and benefits to be expected in the physical
logistic processes.
In advanced manufacturing/service environments, compa-
nies often operate in a physically distributed environment.
They rely more on business network partners (Partners in a
Virtual Enterprise) and suppliers for services and goods
required to make final products/provide services in a
networked economy. Traditional costing systems may not be
suitable for a virtual enterprise or integrated supply chain
management. Since most activities that add value, manufac-
turing and/or service activities, are outsourced to suppliers or
partners, the application of ABC seems inappropriate. In the
virtual enterprise, value adding activities may be less visible,
except for the activities of strategic alliance, information
sharing, and payment that takes place face-to-face, online, or
using other paperless means. Traditional costing and ABC are,
however, useful for external financial reporting purposes and
controlling the utilization of resources for producing goods
and services at the factory of suppliers and partners (Cousins,
1999; Croom et al., 2000; Green and Flentoy, 1991;
McCutcheon and Ian Stuart, 2000). In addressing performance
measurement within a virtual enterprise or supply chain, due
emphasis should be given to knowledge and information
technology management costs. Unfortunately, there is limited
research on this challenging problem area. Most organizations
do not have suitable performance measures, metrics and
costing systems for “new enterprise” models like the virtual
enterprise, fully integrated supply chain, and physically
distributed operations environment.
The organization of the paper is as follows: Section 2 deals
with the new operating environment and corresponding need
for new cost accounting systems and performance measure-
ments. Section 3 describes new approaches and new
enterprises for the 21st century. Section 4 describes the steps
involved in creating a Performance Based Costing system.
Section 5 presents a conceptual framework describing the
PBC system and the measures and metrics that can be used to
assess performance in the “new enterprises” of the 21st
century. Section 6 presents a brief summary and conclusions.
2. Need for a new costing system and performance
measurements
Global competition is leading companies towards a
renewed commitment to excellence in manufacturing. Atten-
tion to the quality of products and processes, inventory levels,
and workforce improvement has provided a competitive edge
for insightful companies striving to become world class. In the
advanced manufacturing/service environment, it is difficult to
see (monitor) some important activities because they are
mostly outsourced. In such cases, costing becomes more an
assessment of the cost of buying products/services. Infor-
mation sharing, communication, and trust play major roles in
improving the performance of virtual enterprises and
integrated supply chains. Most companies operating within
the context of these new business models still use the same
traditional costing and management control systems that were
developed decades ago for a dramatically different environ-
ment (Cooper and Kaplan, 1991). New systems and
approaches are needed and the reasons are as follows: (i)
traditional costing systems do not provide sufficient non-
financial information, (ii) existing product costing systems are
inaccurate, (iii) current costing systems do not encourage
improvements, and (iv) overhead costs are predominant. In the
virtual enterprise there is a need for new costing systems based
on performance. Such a system should identify critical success
factors (CSFs), develop measures and metrics that assess
performance in those key areas, and use those measures to plan
and control operations to improve organizational performance
and, thus, competitiveness.
 A. Gunasekaran et al. / Technovation 25 (2005) 523–533
Mouzas and Araujo (2000) discuss the implementation of
programmatic initiatives in manufacturer – retailer networks.
They define a programmatic initiative as a complex and
hybrid innovation problematizing a particular domain of
activity and supplying a set of ready-made solutions to tackle
those problems. They focus on one programmatic initiative,
“Efficient Consumer Response (ECR)”, a radical program of
change designed to achieve cost savings and speed up
business processes throughout manufacturer – retailer supply
chains. Information/transaction costs make it necessary to
decentralize some decision rights in organizations and in the
new economy. Decentralization, in turn, requires solving the
control problem that results when self-interested persons do
not behave as perfect agents. The following functions are
critical: (1) allocating decision rights among agents in the
organization, (2) measuring and evaluating performance, and
(3) rewarding and punishing individuals for their perform-
ance (Jones and Thompson, 2000).
Improvement should focus on the work that pertains to
value creating activities of the organization; however,
traditional costing does not report useful information about
those activities that have the most potential for improving
overall performance. Traditional costing provides information
about salaries and depreciation at the department level. Such
functional overhead reports do not provide information about
the effectiveness of the work done, nor do they capture and
describe the contribution of each worker. Traditional cost
systems are dominated by functional classification. This
functional classification is accompanied by the use of cost
variance as a key performance measure. Traditional measures
and metrics often cause behaviour that improves functional
performance at the expense of overall performance of a
company (Miller, 1996). Functional classification appears to
be fading because of the integration of functional areas using
information technologies and the increasing prevalence of
networked partnering firms. In either case the integration of
partners with suitable information systems and knowledge
becomes critical. Knowledge management should be a key
concern. Knowledge management involves various activities
that add value. That being the case, like any other activities that
take place in an organization, knowledge management could
be evaluated with a performance based costing system.
Good information about activities helps to focus effort on
improving overall performance. It helps to set improvement
priorities and provide feedback about progress. Moreover, a
traditional cost system does not report the activity information
needed to gain insight into how to improve the performance.
The last decade brought forth increased development of cross-
company relationships, alliances, and more complex business
networks. Tomkins (2001) examines fundamental concepts that
relate to the need for information, including accounting
information, in these interactive structures. It considers,
initially, some consequences for accounting when planning
and control is to be exercised across organizational boundaries,
but the main thrust of the research is to focus on the fact that all
relationships depend on trust to some extent. Likewise, planning
525
and control depend on accurate, timely, useful information.
Activities that create, disseminate and apply information
add value. All such activities could be costed with a PBC
system.
The cost profile of manufacturing has changed over the
last thirty years (Marrow, 1992). Production overhead and
non-production overhead have increased in importance as
more resources have been committed to the organisation and
management of production and quality and to providing
value adding services to the customer. For example, the cost
and complexity of logistics and shipping have increased
rapidly in new enterprises, especially when those engaged in
e-commerce. This highlights the importance of developing
cost and performance measures and metric in logistics.
Inventory management is a major challenge in a networked
economy, wherein firms must meet market demand in a
timely fashion.
The nature of overhead costs has changed from predomi-
nantly labor cost influenced by output volume, to a
composition determined largely by complexity and diversity
of production (Kaplan, 1984). Increasingly, overhead costs
arise from the quest to exploit economies of scope as well as
economies of scale. Knowledge workers, particularly engin-
eers and software specialists, have displaced much of the
direct labour force in many plants. In some cases, overhead
outside the plant associated with engineering, marketing and
distribution has increased to the point where it exceeds direct
labor cost. The costing process has become very challenging,
especially in virtual enterprises where the cost of purchasing,
logistics and overhead now dominate total product cost.
Regarding performance measures and metrics in supply chains
and in Virtual Enterprises, one should recognize the
importance of knowledge and information technology man-
agement, the development of trust, and the establishment of
strategic alliances with suppliers or partners. All of these add
value to products, ultimately providing value to the customer.
Companies are making fundamental changes in the
organization of and technology employed in their
manufacturing operations, but they ignore their costing
systems. It seems clear from the literature that the
information available from a traditional costing system or
ABC is not sufficient for the continuous improvement
programs that are essential to competitiveness in rapidly
changing market environments. Neither a traditional
costing system, nor ABC provides accurate information
about the consumption of different resources and
activities. The ABC system is an information rich
costing system useful in companies that perform value
adding activities within, but not for the virtual enterprise
where value is added by partners. ABC could be suitable
for a manufacturing supplier. For a virtual enterprise or
supply chain, because of their distributed nature, a simple
costing system that uses purchasing/logistics cost plus
overhead costs could be more suitable. Now we will turn
our attention to new business models.
526 A. Gunasekaran et al. / Technovation 25 (2005) 523–533
3. New pressures, approaches and enterprises
for the 21st century
Supply Chain management (SCM) is now recognized as
one of the best means by which enterprises can make instant
improvements to their business strategies and operations
(Kaihara, 2001). During the last few years, the focus has
shifted from the factory level management of supply chains to
enterprise level management of supply chains. This change of
focus is due to the increasing global presence of companies.
The physical flow of products amongst the nodes of the supply
chain is studied intensively in effective SCM. Supply chains
consist of several layers of business units. Resource allocation
is a quite important operational criterion at the workshop level
of SCM, but as the number of potential business units in the
supply chain increases, the effective management of product
distribution plays a more important role—it is a more dynamic
environment (Kaihara, 2001). Markets are naturally distrib-
uted and agents make their own decisions about how to bid,
based on the prices and their own utilities of the goods.
Communication is limited to the exchange of bids and a
process involving agents and the market. Issues of concern
include the following:
† How much the agent’s work contributes to the principal’s
marginal profits;
† The extent that ‘noisy’ (incomplete) information, distorts
the principal’s ability to accurately monitor the agent’s
performance;
† Factors which reward or penalize behavior that is required
or not--there is a need to develop optimal costing models
based on agency theory and employment contracting;
† Assessment of the optimal value of the agent’s contribution
for the principal, having considered the extent that the agent
is averse to carrying risks (Cullen and Hickman, 2001).
Cullen and Hickman (2001) examine relationships developed
in the UK’s defense branch of the aerospace supply chain.
Comparisons are made between economic and formal contrac-
tual relationships. Major customers tend to develop complex and
legalistic contacts with their suppliers and use the threat of
enforcement when problems arise. This requires development of
guidelines for the establishment of contracts between suppliers
and customers in a virtual enterprise environment. A different
type of costing system seems warranted. Perhaps transfer-pricing
mechanisms could be used for costing products in a supply chain
or virtual enterprise environment.
Mabert et al. (2001) argue that most companies are
pleased with their enterprise Resource Planning (ERP)
systems. Although many expect the useful life of the system
to be in excess of ten years, routine upgrades are required
over time. Companies believe that ERP systems enable and
enhance e-commerce initiatives, primarily by providing
accurate, integrated, transaction processing capabilities for
a firm. The conduct of business in the e-commerce
environment demands accurate information and the ability
to measure impact instantaneously. ERP provides the digital
nerve system to allow the backbone in an organization to
respond swiftly to customers and suppliers. To meet the
ever-changing business environment, many ERP vendors
have upgraded their systems to operate on the Web.
Aptel and Pourjalali (2001) highlight the differences
between variables in hospital logistics, including the following:
(1) the extent of responsibility given to the logistics department
with respect to items like purchasing, physical supply,
receiving, inventory management, internal distribution to
medical departments, and management information systems;
(2) the manner of distribution of supplies (such as central
warehouse vs. direct vendor distribution); (3) the quantity of
medicine distributed; (4) the degree of partnership between the
hospitals and their vendors and other hospitals, and (5) the past
efforts of logistics departments in improving supply-chain
management and future plans for improving logistics functions.
The study by Aptel and Pourjalali describes an interesting
situation, wherein a new cost accounting system was developed
to improve the overall performance of medical services and,
hence, organizational competitiveness.
Adoption of electronic commerce (EC)-enabled inter-
organizational systems (IOS) has become increasingly
important for organizations to remain competitive in this era
of globalization. Many organizations have established partner-
ships to develop new strategies jointly (for example JIT, QRM,
ECR) based on EC and other enabling information technol-
ogies to improve the competitiveness of their supply chains
(Kurt Salmon Associates, 1995; Holland, 1995; Johnston and
Lee, 1997). Adoption of such systems, however, has proved to
be extremely difficult since they span organizational bound-
aries. Adoption of IOS involves simple and sometimes
complex interactions with external entities (such as trading
partners, regulators and third parties) that normally have
different and conflicting interests. The model developed by
Kurnia and Johnston (2000) for the “first-order” model of
Efficient Consumer Response (ECR) adoption in Australia
included factors found to be associated with ECR adoption.
Lamming (2000) describes a new order wherein Japanese
suppliers are developing highly competitive, technical, real-
time, market driven configurations of products, without the
need to hold stocks in their supply chains and distribution
channels. This suggests that companies will need to produce
goods/services based on customer requirements.
Burgess and Gules (1998) divide advanced manufacturing
technologies into two types: hard and soft. Hard technologies
are biased towards the use of hardware such as robotics while
soft technologies, e.g. TQM, rely more on organizational
procedures and management methods. It has been proven that
supplier collaboration is more closely linked to the level of soft
technology implementation than to that for hard technology.
This should be taken into account in developing performance
measures and costing systems in a supply chain/virtual
enterprise environment. The new costing system should
focus on purchasing, supplier development, knowledge
management, information technology and logistics.
 A. Gunasekaran et al. / Technovation 25 (2005) 523–533 527

Table 1
Differences between traditional and networked organizations

Areas Traditional organizations Networked organizations

Strategy formulation
Tactical decisions
Operational controls
Purchasing and logistics
Knowledge management
Information technology
Focused on narrow market, centralized operations,
Limited competitive performance objectives, Long-
life cycle of products, horizontal organizational
structure
Aggregate Production Planning, Accurate
Forecasting, Stable Master Production Scheduling,
and Make or buy decisions.
Make to stock, Pull/push scheduling, Quality
assurance control systems, Large lot production
Domestic market, Less intensive competition, Lack
of focus on logistics, Focus on cost and not
customer service, Lack of communication and IT
applications
Knowledge workers, Less IT skills, Lack of
Innovation, Less investment in knowledge
capital, Human resource management
CAD/CAM, Legacy systems, Functional integration,
Investment in IT is internally focused
Strategic alliances, Global market, Global outsourcing,
Multiple competitive performance objectives, E-
Commerce, Vertical Organizational Structure, Shorter
product life cycle
Purchasing of goods and services, Enterprise resource
planning, Selection of partners/suppliers, Partnership
formation, Information productivity
Agile Manufacturing/services, Scheduling of deliveries
with Partners, Distributed inventory control
Contract, Negotiations, Agility, e-Market, Timeliness is
important, Reverse logistics, Customer service, Supplier
development
Invest in knowledge capital, Encourage to innovate,
Training and educating employees to work in virtual
enterprise, Multi-skilled workers
Integration of supply chain, ERP, Extended enterprise
integration, Invest in IT. Select suitable IT system
matching Business models, Investment in IT has both
internal and external focus

Summarizing the characteristics of new enterprise, the
following are the key observations that should influence
efforts to develop new performance measurements, metrics
and cost accounting systems:
† Activities are difficult to trace because of the distributed
nature of the virtual enterprise or supply chain environment;
† Many indirect costs will become direct costs and many direct
costs will become indirect costs;
† Logistics costs are a major portion of the total cost;
† Many costs are hidden, and thus difficult to measure;
† Knowledge management and information technology costs
will be major costs in the virtual enterprise or supply chain
environment;
† A complex cost system will not likely work with the supply
chain/virtual enterprise—a cost system similar to backflush
costing may be suitable for new enterprise models.
Different approaches to conducting busin
ess have evolved in response to pressures created by a
rapidly changing business environment. Businesses must be
proactive if they expect to prosper, or at least reactive in
order to survive. Table 1 highlights some key differences
between traditional and networked organizations that can be
gleaned from the discussion above.
accurate cost information. The basic principle of PBC is to
identify the business areas that add value to an organisation and
to calculate direct materials, direct labour, overhead, etc., for the
purpose of accurately estimating product cost. The product cost
depends on the value added and costs incurred in those areas.
Fig. 1 presents the steps involved in establishing a PBC system.
The accuracy of product cost depends upon the costs of value
creation areas and corresponding drivers. Based on this
principle, the steps required to design a PBC system are
explained.
4.1. Step 1: Develop objectives for the performance based
costing system
A PBC system may be desirable for a number of reasons. A
company must carefully define the purpose of the system in
terms of system objectives. Basic objectives of a PBC system
include the following: (a) encourage proactive rather than
reactive responses to markets, customers, and partners, (b)
promote agility, and (c) create wealth (maximize profits). Other
objectives would of course be necessary and would reflect
organizational needs as well as the business environment.
4.2. Step 2: Develop PBC team

The second step in designing a PBC system is to develop

4. Design of a Performance Based Costing (PBC) system
A PBC system focuses on performance (in terms of financial
and non-financial) rather than activities themselves, which
avoids distorted product cost information produced by the
application of traditional costing systems in the virtual
enterprise/supply chain environment. PBC provides more
a team, which should include members from several
disciplines and perhaps from different organizations in a
virtual organization or supply chain environment. Team size
depends on the organization’s size, urgency of completion
of projects and the availability of staff. The team members
should have the full support of top management, which is
only possible if top management is convinced that a new
528 A. Gunasekaran et al. / Technovation 25 (2005) 523–533
Fig. 1. Steps in PBC systems.
cost system is better than the old system, they should be
dedicated to the success of the system, and they should have
the required knowledge and experience to make a significant
contribution to system success.
4.3. Step 3: Address issues of organization
A PBC system affects many aspects of an organization and
its partners. The potential impact of the new system, especially
in terms of its effect on people and organizational relation-
ships, should be considered. Many of these organizational
impacts of a PBC system are not directly quantifiable, but to
ignore them for that reason would be to ignore some of the
most important issues, costs, and benefits (Lyne and Friedman,
1996). The particular nature and circumstances of an
organisation are highly pertinent to an assessment of how
suitable would be the adoption of the PBC methodology.
4.4. Step 4: Identification of value-adding areas and CSFs
The Value Creation Area (VCA) is where a set of processes
or procedures add value to products and services (value from
standpoint of customers) and hence to an organisation. They
are aggregations of tasks (whether performed by people or
machines) to satisfy the needs of customers (whether they are
internal or external) (Miller, 1992). The identification of the
critical success factors (CSFs) for a PBC system is a basic step
because it sets the structure and scope of the system. CSF
identification forces the accountant to determine what is
actually happening in the relevant areas of a business and
ensure that the costing system is built on reality (Innes et al.,
1994). It is to be noted that an “Area” can be defined as a set of
activities that occur to create value to customers”.
The identification of VCAs and corresponding CSFs
involves finding out where in an organization the most value
is created for customers. The approach to this task must be
systematic to ensure that all relevant areas are considered.
The “relevant” areas may differ in type and location from
one company to another due to the technology, size and
company approach. For a small company, quality control is
an important value creating area, but for a big company
quality control involves many areas that have broad scopes.
Quality control responsibility in world class manufacturing
is the job of all employees.
The identification of micro and macro value creating areas
is important for a PBC system. The micro areas are focal points
of improvement efforts. The micro areas are used to cost the
macro areas, which are the aggregation of related micro
activities. The primary purpose of a Micro value area is to
facilitate reporting of accurate product cost (Turney and
Stratton, 1992). Visiting all the departments of a company,
interviewing staff members, and listing the work done in each
department can identify macro and micro areas. Business
process reengineering is a valuable methodology that can
assist in identifying macro and micro value areas.
Clearly, a decision is required on the number of areas,
including CSFs, to be used in the PBC system. The
decisions should be based on the degree of CSF relevance
(potential to impact CSFs) associated with each area, the
level of detail required to give acceptable cost visibility to
management, and the degree of accuracy required for
product cost planning and control. Common activities in
organizations include purchasing, customer order proces-
sing, quality control, material handling, production control,
inspection, distribution, and maintenance (Miller, 1996).
Most of these activities exist, and there are others that
should be the focus of VCA/SCE (Supply Chain Efficiency)
in the virtual enterprise/supply chain environment.
4.5. Step 5: Identification of CSF drivers in areas
A CSF driver is a factor that has a direct influence on cost
and performance pertaining to the CSF or VCA. It provides the
best explanation of why costs in a CSF cost pool change over
 A. Gunasekaran et al. / Technovation 25 (2005) 523–533
time (Kennedy, 1996). A CSF/VCA driver can be defined as
any factor that causes a change in the cost of a VCA. The
primary cost drivers are the link between resources and
activities. They relate cost from the general ledger to the
activities (Berliner and Brimson, 1988). The accuracy of a
product cost depends on CSF drivers. The cost of each area is
an aggregation of the costs of primary drivers, and “product
cost” is an aggregation of the costs of areas. These CSF drivers
actually indicate how many specific resources an area
consumes. Different types of resources are required to perform
in each area; therefore, every area should be analyzed in detail
to create a list of all the primary CSF drivers. The estimation of
cost for each driver should be very accurate.
4.6. Step 6: Critical success factors cost pools
A CSF cost pool is the total cost associated with a particular
CSF. Each type of CSF has drivers that become cost elements
in a CSF pool. If all the costs of a CSF are identified by cost
drivers, then the costs can be directly charged to the CSF cost
pool. If some resources are shared by several CSFs, then some
measure of apportionment will be necessary. The basis of
apportionment should reflect as closely as possible the extent
to which each activity consumes the shared resource. The best
estimation of the apportionment rate does not adversely affect
the accuracy (Keegan and Eiler, 1994).
There are two views of categories of costs that should be
included in a CSF cost pool. The first view is that all traceable
costs should be included to create a fully absorbed CSF cost pool.
This is attractive conceptually, in that all resource consumption is
taken into account in the area (CSF) cost, and so all the resources
are therefore managed at the area level. In practice, fully
absorbed CSF costs become very complex and create a hierarchy
of cross charging which distorts the understanding of cost
behaviour (Marrow, 1992). The second view is that the costs
included in a CSF cost pool should be those relevant to the
decision being made and provide decision relevant information.
A good rule is to strike a balance between excessive system
complexity and the approach that suits the circumstances,
information needs and requirements of an organisation. The area
cost pool is traced to the cost object via secondary cost drivers.
4.7. Step 7: Secondary cost drivers
A secondary cost driver is a measure of the frequency and
intensity of demands placed on activities by a cost object
(Miller, 1996). It is used for assigning the cost of a CSF to a cost
object. A cost driver is a variable used as the denominator in
rates used to apply CSF costs to product or cost objects (Innes
et al., 1994). The cost driver rate can be calculated as follows:
Cost driver rate
¼ CSF cost for period=cost driver volume for period:
Selecting appropriate cost drivers is a creative process in the
sense that it goes beyond traditional analyses in the search for
529
the underlying reasons for cost. In choosing the secondary cost
driver, the following criteria should be considered: (i) the cost
driver selected should have a strong correlation with cost level
in the CSF cost pool, (ii) the variable should be quantifiable and
homogeneous, (iii) minimize the number of unique drivers (cost
and complexity are directly correlated with the number of
drivers), (iv) select cost drivers that encourage improved
performance, and (v) select cost drivers that are already
available and/or have a low cost of collection.
In practice, it may be possible that a number of cost
drivers exist for the same cost pool, and in these
circumstances, the exercise of professional judgement
involving the application of the above criteria to a given
situation will be necessary. For example, purchasing
activity’s cost pool can have different cost drivers, such as
the number of orders, number of suppliers and number of
parts ordered. The objective is to pick the right number and
the right type of cost drivers. Enough of the right types are
needed to report accurate cost. Too many of them may be
costly and create a system that is too complex to understand.
These cost drivers differ greatly from the basis for overhead
cost allocation in conventional cost accounting systems.
They are the linkages between products and activities that
represent opportunities for improvement in product or
process design (Turney, 1996). It may not be possible to
identify all cost drivers at the same level—they may span
multiple organizational levels/units and even multiple
organizations. In the traditional costing system, cost drivers
are identified at the unit level and at the facility level.
4.8. Step 8: Cost object
A cost object can be any customer, product, service, contract,
project or other work unit for which a separate cost
measurement is desired. The cost object resides at the bottom
of the cost assignment view of the PBC system. Most companies
have two hierarchies of cost objects, one for products and
another for customers (Turney, 1996). The ideal cost object is
‘products’ that are sold to customers. Linking the cost of a CSF/
VCA directly to areas and activities that affect the cost of
products is the basis for a product cost under a PBC system. To
operate effectively selected cost drivers should be clearly
identified with specific products (Innes et al., 1994). If this does
not occur, then the cost driver is effectively joint to several
VCAs and may have to be split amongst them equally on based
on some proportional assignment. Now the question is how to
allocate overhead costs. Perhaps one could use the value added,
contribution to CSF and overall performance of an organization.
The allocation of such costs to products remains arbitrary even
under a PBC system (Maurice and Nibbelin, 1992).
4.9. Step 9: Implementation
The costing of a product with a PBC system should be
compared with that of the traditional costing systems (one already
in use). There is a risk of increasing the cost of a product due to an
530 A. Gunasekaran et al. / Technovation 25 (2005) 523–533
increase in the cost of measurement. If the system is very detailed,
then the accuracy of the system will increase, but at the same, the
time measurement cost will increase. The cost of implementing
and maintaining a complex system can become excessive. If the
product cost is higher using this new system than with the
traditional costing systems (due to measurement cost and
complexity of system), then PBC system should be reexamined,
starting with identification of value creating areas. A simple
solution for reducing system cost is a reduction in area details, but
this reduction should be made carefully as it will affect the
accuracy of product cost.
For the successful implementation of a PBC system,
management must be convinced of the need to change. A
PBC system will be quite different from the existing system.
When a PBC system becomes available, a group of
managers and engineers should assemble to analyse the
results. A well prepared PBC team can convince them of the
PBC system’s value by presenting results for at least one
major product for which they are responsible. PBC
measures differ significantly from those reported by a
company’s existing cost accounting system. The design and
function of the PBC system should be explained to
managers so they can understand how the new cost system
differs from the existing one (Cooper, 1991).
The users should be educated so that they understand the
information available from the PBC system and how that
information should be used in decision making. The primary
aim of the new system is not to create an elegant and
technically robust solution, but rather to provide a solution
that will change behavior, particularly decision making
behavior, thus allowing management to improve the
performance of the business (Marrow, 1992).
The design of a PBC system requires a detailed analysis of
the already available information and collection of infor-
mation that is not available from the present system. The
identification of CSFs, value creation areas, and value
creation activities and levels is critical to the design of a PBC
system, because the cost of the system and the accuracy of
product costs depend on it. The steps explained above can
be applied to any organisation (service industry or manu-
facturing industry). A simple, but focused emphasis on value
creating areas as the basis for allocating cost would improve
the utilization of resources in the production of quality goods
and services.
5. A framework for measuring performance in new
enterprise
In today’s information age, and with the development of
e-businesses, the technology is transforming industry after
industry, as well as creating new industries. Hidding (2001)
argues that Sustainability Analysis (SA) assesses strategic
advantage from the product perspective. It starts from the
premise that no advantage lasts forever; the question is how
quickly the advantage will erode. SA recognizes that
product advantages come and go with different speeds, in
different environments known as “ecologies”. Different
ecologies imply different strategy paradigms, regarding for
example critical resources and key metrics. This is the basis
for developing a new set of performance measures, metrics
and costing systems.
Alvarado and Kotzab (2001) suggest that there is need
for integration of logistics and marketing. SCM orches-
trates activities between firms. Efficiency requires stra-
tegic supplier partnerships and advancing relationships
through mutual interests. Implementing ECR principles
tend to be the greatest challenge for supply chain
partnerships. Nevertheless, as Jenkins (1994) has insisted,
it remains critical that managers be able to adopt and
employ ECR principles. Following are several reasons
why ECR is important for managers working in the
grocery industry:
† The push strategy does not work
† Both suppliers and distributors have to work towards
consumer satisfaction
† Trust and compromise are better than power plays
† The competitive environment does not allow growth
based on sales only (Alvarado and Kotzab, 2001).
Many of the activities and processes involved in ECR
cross-functional boundaries as well as organizational bounda-
ries. ABC and traditional cost accounting methodologies lack
the capability to capture the value of some of the value creating
activities involved in ECR. On the other hand, there is nothing
inherently rigid in the PBC system that would preclude
assignment of costs to activities or areas and ultimately to
products for value creation areas and activities that cross-
functional and organizational boundaries.
Table 2 provides examples of value creation areas, critical
success factors, performance measures and CSF drivers. It is
our framework for relating value creating areas to CSFs and
CSF drivers, and to performance measures. This framework
does not, and could not possibly contain all value creating
areas, CSFs, performance measures, or CSF drivers, because
they are likely to vary from firm to firm, and from business
model to business model. Organizations could develop their
own matrices for relating the elements of PBC-matrices based
on their unique needs. Interorganizational teams of Virtual
business partner employees or from supply chain partners
could use this methodology to develop PBCs for assessing
value system performance from end to end. Such a system
wide approach to PBC could provide a starting place for the
internal PBC of individual partners.
6. Conclusions
Holistic and proactive concepts, such as Lean Pro-
duction, Just-In-Time, Total Quality Management, Con-
current Engineering and Supply Chain Management have
become important for companies seeking lean processes
 A. Gunasekaran et al. / Technovation 25 (2005) 523–533 531

Table 2
A framework for measuring performance in new enterprise

Value creation areas Critical success factors Performance measures Drivers of CSF

Networking Experience, Education, Knowledge workers, Number of Investment in Skilled workers,

Conferences, New Initiatives, Joint conferences or meetings attended, Support for exhibitions and
Projects Number of joint projects, number Product promotions, New
of new products introduced products
Partnership formation Communication, Trust, Data mining, Data Warehousing, Investment in KM workers,
Infrastructure, Past performance, Number of partners/suppliers, Investment in IT, Training and
Selection of business strategy, B2B Training and Education Education in Virtual Enterprise
Knowledge management Information technologies (Internet, Number of IT trained Managers, Investment in training and
EDI, WWW), Training and The age of the website, Integration education, Strategic alliances
Education of B2C and B2B, ERP, BPR, with high tech companies,
E-Commerce Investment in knowledge capital
Information technology Selection of suitable IT, Number of Software, Number of Business strategy, agility
Integration of suppliers/partners, PCs, Budget for IT training and focused, E-commerce enabled
Eductaion, ERP system, and SCM, Global manufacturing,
Investment in IT Global outsourcing,
Global market
Trust creation Long-term relationship, Number of years in business, IT Strategic alliances, ERP,
Transparency, Good investment, Past performance, Constant meetings between
communication, Meetings and Repeat orders, Delivery partners, Long-term business
Contracts performance contracts, Technological support
Purchasing & logistics Inventory control, Warehousing, Selection of partners for logistics Warehousing operations strategy,
Shipping and Transportation service and suppliers for goods, Outsourcing of logistics service,
Time to deliver products, Logistics Number of partners/suppliers,
cost, Time to Process orders Number of products, IT in
purchasing and logistics
Customer Relationship Management (CRM) B2C, Customer service, Good IT Time to respond to customer Invest in IT and KM systems,
skills, Communication skills, enquiries, CRM system, Budget Training and Eductaion, Strategic
Knowledge of Products and for training and education, Number alliances to facilitate better CRM,
Services, Knowledge about of meetings, Workshops, Incentives Invest in communication
technical content of the product technologies, Incentives for good
job

with short throughput time and zero defects. In most plants,
the physical equipment is susceptible to failure through
breakdown, deterioration in performance through age and
use, and to obsolescence due to improvements in techno-
logy. The rising importance of “Streamlining” the processes
and achieving process control and flexibility has raised the
cost of disturbance, and, thus, increased the need for reliable
and consistent equipment without quality problems (Jons-
son, 2000). Likewise, there is a need for reliable and
consistent performance measurement methodologies to
meet the needs of businesses operating in our ever changing
and increasingly competitive global business environment.
In this paper, we described pressures and approaches that
characterize the 21st century global business environment.
We described some characteristics of new enterprise models
like the virtual enterprise. From those descriptions we
speculated about the nature of appropriate performance
measurements, metrics and costing systems that will be
required to improve the competitiveness of new enterprises
in the 21st century. A performance based costing system
was discussed, highlighting its capability to measure
performance in such areas as knowledge management and
information systems, as well as performance across
functions and organizations. The steps for setting up that
PBC system were described. Finally, a framework describ-
ing the relationship among PBC system components was
presented in the hope that it would provoke more thought on
and development of the concept.
Management practices and methods have changed and
organizations are moving from managing vertically to
managing horizontally. PBC and Performance Based
Management (PBM) provide cost and operating information
that mirrors the horizontal view. We believe that the PBC
system can provide accurate cost information and Activity
Based Management can use this information to initiate
performance improvements. We, like many other research-
ers and practitioners, recognize the limitations of traditional
costing methods when applied to business models that have
evolved over the last decade of the 20th century and the
early years of the 21st century. ABC helped to bridge the
gap (address measurement problems) when businesses,
particularly manufacturers were undergoing fairly dramatic
changes in the 80s and 90s. It appears now that limitations
inherent in ABC, as well more traditional costing systems,
make them less than perfect measurement approaches for
evolving business models. PBC systems may or may not be
the solution to performance measurement challenges faced
by organizations in the 21st century, but the time has come
532 A. Gunasekaran et al. / Technovation 25 (2005) 523–533
to examine new approaches. This is precisely why we have
presented our ideas on the PBC system. We believe more
research is needed on performance measurement tools for
21st century business models. Specifically, we believe
future research directions should include: (1) development
of a more precise framework based on the ideas presented
for developing a PBC or similar system and (2) empirical
testing of the performance measures and metrics that would
comprise a PBC or similar system. Action research and
longitudinal case studies would seem appropriate methods
for studying the implementation of PBC systems as well as
their effectiveness over time. Whatever the method, we
hope to see more research on this important area in the near
future.
Acknowledgements
The authors are most grateful to the Editor, Dr. George
Hayward for his constructive and helpful comments on the
paper.
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Dr. H. James Williams is Dean of the
School of Business, at North Carolina
Central University, located in Durham,
North Carolina. He earned the following
degrees: B.S. Degree in Accounting, at
North Carolina Central University (1977);
a M.B.A. Degree in Accounting at the
University of Wisconsin (Madison)
(1979); a Ph.D. Degree in Accounting, at
the University of Georgia (Athens) (1982);
and J.D. and LL.M. (Taxation) Degrees, at
Georgetown University Law Center (1988
and 1990, respectively). Dean Williams is also a Certified Public
Accountant and a Certified Management Accountant, with a wealth of
practical experiences, having worked in the public accounting
profession and in the legal profession (as a corporate and tax lawyer).
Currently, in addition to his responsibilities as Dean, Dr. Williams is
very active in the community, serving on a number of corporate and
community boards.

Dr. Angappa Gunasekaran is a Professor

of Business Administration in the College
of Business and Management at the
University of Illinois-Springfield. Prior to
joining the UIS, Dr. Gunasekaran was on
the faculty of the Charlton College of Dr. Ronald E. McCaughey (Ph.D.,
Business, University of Massachusetts Auburn University) is an Associate Pro-
(Dartmouth) since 1998. He has held fessor of Information Systems at the
academic positions at Brunel University
University of Central Arkansas. His
(UK), Monash University (Australia), the
research appears in the Journal of Systems
University of Vassa (Finland), the Univer-
Management, Information and Manage-
sity of Madras (India), and the University
ment, International Journal of Production
of Toronto, Laval University, and Concordia University (Canada). Dr.
Economics, International Journal of Com-
Gunasekaran has a PhD in Industrial Engineering and Operations
Research from the Indian Institute of Technology (Bombay). He has puter Integrated Manufacturing, the Jour-
over 150 articles published in 40 different peer-reviewed journals. He nal of Information Technology
has presented and published about 50 papers in conferences and given a Management and in other journals and
number of invited talks in more than 20 countries. Dr. Gunasekaran is conference proceedings. He is the Internet
on the Editorial Board of 20 refereed journals. He is involved with Editor for the Benchmarking: an International Journal and serves on
several national and international collaborative projects that are funded the editorial board of other journals. He has practical experience in
by private and government agencies. Dr. Gunasekaran has organized industry. His current research interests include manufacturing strategy,
several international conferences in the emerging areas of operations Benchmarking, E-Commerce, and the use of computers by the elderly.
management and information systems. He has edited books that
include, “Agile Manufacturing: The 21st Century Competitive Strategy”
and “Knowledge and Information Technology Management: Human
and Social Perspectives”. Dr. Gunasekaran is the Editor of Bench-
marking: An International Journal, Associate Editor of the Integrated
Manufacturing Systems: The international Journal of Manufacturing
Technology Management and the Regional Editor of the Supply Chain
Management: An International Journal. Dr. Gunasekaran has received
Thomas J. Higginson Award for Excellence in Teaching within the
Charlton College of Business. He has edited several special issues for
well known journals. Dr. Gunasekaran is currently interested in
researching benchmarking, e-commerce, performance measures, logis-
tics and supply chain management. He has been serving on over 25
committees at the department, college and university level committees
that include the university curriculum committee, general education
committee, and faculty evaluation committee. Recently, Dr. Gunase-
karan has received an outstanding paper award from Managerial
Auditing Journal for the year 2002.