How can companies use activity-based costing to reduce costs?

Activity-based costing (ABC) is a more sophisticated alternative to traditional costing methods like job costing and process costing. It aims to assign overhead costs to products or services more accurately by considering the activities involved in their production, rather than simply using factors like direct labor hours or machine hours.

ABC analyzes costs related to each activity. Resources are allocated based on these activities to different products, services, channels, markets, etc., providing a clear view of the company’s costs. In this way the company gains a more precise understanding of how each activity impacts operating costs, enabling better cost and profitability management.

Describing the specificities and costs of each process enables a multidimensional analysis of expenses in each activity, from a global perspective to detailed visualization of each activity’s cost and its impact on profitability. This identification allows adjustments to reduce unnecessary expenses and revise planning to align with actual costs. Achieving an increasing cost reduction, then, becomes only a matter of time, as each manager will have access to more accurate information to analyze these processes. Additionally, it’s essential to note that the methodology’s effectiveness in controlling expenses makes it efficient for both small and large companies, regardless of their area of operation.

Here as some steps to implement ABC: - Determine the objectives of the ABC project - Make a smart mapping of activities - Make a good definition of Resources - Establish the various allocations and choose correct cost drivers - Define the ABC software tool for the project - Integrate the corporate data on a repeatable way with the ABC software - Calculate the model and extract reports and analyses

ABC systems are more complex and more costly to implement than others costing systems (like traditional method). It is important to consider the leap from traditional costing to activity based costing is difficult. I would not recommended to start this process before an analysis cost/benefits.

Is it really necessary? The quest for ABC started when variety was introduced (ie. no more one black T Ford only) and spreading costs became more complex. Marketing thought that variety made sense, well theoretically. There is something like the law of the Whale Curve whereby 20% of your customers/ products are highly profitable, 60% are only marginal and 20% loss making. So why introduce unnecessary variety? Focus on a small range and you do not need complex MA calculations and make more profit (I guess this is the goal of a company).

Focus on collaboration and communication, involving stakeholders throughout the ABC process fosters buy-in and ensures the model aligns with real-world needs. Regular communication prevents confusion and resistance. Actually I don't think, applying ABC rigidly can be counterproductive. Instead, emphasize its flexibility and adaptivity. Use it as a tool to guide decision-making, not a rulebook to constrain it. As example a company implemented ABC successfully by simplifying the model for specific departments, focusing on key activities with high cost impact. This ensured clarity and minimized resistance from employees.

Activity based costing?gives accurate production costs. This can help businesses analyze costs and make informed decisions on which products to produce or help them find cheaper and efficient methods of production, achieving maximum productivity with minimum wasted effort or expense.