Activity-Based Cost: More Than Numbers

Activity-Based Cost or ABC has gained wide acceptance as a modern cost methodology incorporating cause and effect and cost visibility. ABC provides relevant information for management decision making. However, some have criticized ABC for a singular focus on cost and profits. This criticism is misguided. While Activity-Based Cost does have a strong cost base, it is more than simply numbers.

First, cost does not exist in a vacuum; cost is a reflection of underlying operations and operating realities. When viewed in this light, cost is a symptom. Where cost is higher than the value added, there is a problem that must be investigated and resolved. Cost cannot be adjusted by itself. Only by resolving the underlying causes can cost be changed. Sometimes, we must allow cost to increase in one area to save cost in other areas.

Much like a doctor responding to a patient complaining of pain, the doctor must poke and prod the pain area, and often perform additional tests to isolate the real cause and eliminate other possibilities. Sometimes, the doctor must inflict short term surgical pain to gain long term relief.

Second, the ABC methodology includes qualitative relationships. Qualitative relationships cannot be evaluated numerically. These are the softer or fuzzy things. For example, Cost Drivers are the reason why an activity is performed; factors that cause poor quality; factors that cause long cycle time; and things that cause excess cost.

On one project, I was called in to assist a production control function analyze their activities. In addition to identifying their activities and the cost of activities, each team spent a little more time to identify cost drivers. Each team had no problem identifying many causes for poor quality, excess cost, long cycle time, and even why they did non value-adding activities. None of these cost drivers had a cost directly associated with it. However, each was associated with an activity with a known cost. Management was shocked to see the extent and value provided by this exercise.

Third, when ABC is coupled with other management initiatives, it provides a sound methodology to measure cost and measure impacts of proposed changes. Because ABC can measure cost, process improvement teams can prioritize their focus to areas that will yield the greatest impact on profits.

When I was a controller and we introduced ABC to our operations, we coupled it with our quality initiative and our self directed team efforts. Each of these otherwise separate methodologies benefited from the combined efforts.

Those who criticize ABC for being exclusively a cost exercise are miss-guided or uninformed. We must spend money, measured by cost, in order to make money, measured by profits. A company must have profits to grow and thrive. Activity-Based Cost provides an effective methodology to measure cost and to identify operating relationships. When viewed this way, ABC also empowers other disciplines that otherwise lack cost and profit tools.

One Response to “Activity-Based Cost: More Than Numbers”

  1. [...] One of the criticisms that ABC encounters is that it focuses only on cost and profit which is not true. While Activity-based Costing helps in effectively measuring cost and establishing operating relationships, it also empowers other disciplines that otherwise lack cost and profit tools (Source: Cost Matters) [...]

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