Activity-Based Cost: Three Reasons To Avoid It

Activity-Based Cost or ABC has proven itself to be superior over traditional costing methods. Most traditional methods evolved during the early industrial age when life, while more complex than an agrarian culture, was simple. The introduction of computers and modern data processing triggered the rise of ABC giving people the power to manage data driven cost models.

However, there are still reasons to avoid implementing or using ABC:

  1. You manage a product line that is being subsidized by other product lines. Often your product has more capital or technology requirements but probably lower sales volume. It could be a newer product that does not have all the bugs worked out. Special processes or adaptations have been put in place for your product but they are all in the overhead allocation. So you know that the product is actually using more than its share of company resources but is not being charged for them. But you’re okay with this since your product is the future of the company. Let others take the heat; you’ll make it up with volume in a year or two.
  2. You manage a process. You’ve managed to make it look good to upper management but you suspect that really there is a lot of waste and inefficiency inside the process. But you don’t know where the waste is. As long as you can keep things looking good for another year until you’re promoted, you will not have to invest the time and effort to bring the process to an effective state. Making a change is risky and a lot of work. It would be worth it to the company, but not for you. Let your successor take the heat.
  3. You have a large portfolio of customers. You’ve heard repeatedly of those ABC studies that show that ten to twenty percent of customers lose maybe ten times your net profit; that about sixty percent of customers breakeven – just consuming capacity but not really contributing to profits; and that the remaining ten to twenty percent make all the money.  But your compensation is based on revenue – not profits. So, profit really does not matter as long as you make your revenue number. Besides, actually working with customers to improve how you serve them; adapting your processes, and maybe raising selected prices takes time and effort.  Yes, it would improve company profits but not your bonus.  So just wait it out.

So despite what you’re heard about the benefits of Activity-Based Cost, there are still reasons not to adopt this cost visibility methodology. You can keep using the old methods. Just say: “If they are good enough for external financial reporting, they must be good enough to manage with.”