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In what industries is activity-based costing most useful?

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Activity-based costing (ABC) is a method of allocating overhead costs to products or services based on the activities they consume. It can help managers identify the true profitability of each product or service, and make better decisions about pricing, production, and resource allocation. However, ABC is not equally applicable or beneficial for all industries. In this article, you will learn about some of the factors that make ABC more useful for certain industries, and some examples of industries that can benefit from using ABC.

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1 Factor 1: Complexity

One factor that affects the usefulness of ABC is the complexity of the production process and the product mix. If an industry has a simple and standardized production process, with few variations or customization, then ABC may not add much value. The overhead costs can be easily allocated based on a simple measure, such as output volume or direct labor hours. However, if an industry has a complex and diverse production process, with many different activities, resources, and outputs, then ABC can provide more accurate and detailed information. The overhead costs can be allocated based on the actual consumption of each activity by each product or service, reflecting the differences in complexity and resource intensity.

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Adi-Elena N.

Senior FP&A Manager & Strategic Projects | ACCA | Finance Business Partner | Co-Director BRG "Women in Finance" | Finance Transformation | Budgeting | Forecasting | Strategy
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ABC will always work in the manufacturing industry, as it has its direct costs associated with production. However it has to take into consideration the cost-benefit analysis - as it’s a timely process and also can be costly to implement. For example - traditional costing uses individual cost drivers such as labor or machine hours to allocate indirect costs to products, while A S uses multiple cost drivers such as setup cost, inspections or even orders.

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Hannah Fisher

Director of FP&A at Pacifica Beauty I I write about business, personal development & working parenthood|10 years in finance
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In my experience activity based costing is valuable in a more complex manufacturing environment that involves various steps in producing a finished good. Ultimately, it needs to be worth the time setting it up so if costs can easily be allocated it may not be worth it but for more complex operations it can be invaluable

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2 Factor 2: Competition

Another factor that affects the usefulness of ABC is the level and nature of competition in the industry. If an industry has low or moderate competition, then ABC may not be a priority. The profit margins may be high enough to absorb the inaccuracies or distortions of traditional costing methods. However, if an industry has high or intense competition, then ABC can be a strategic advantage. The profit margins may be low or sensitive to price changes, and the customers may have high expectations or preferences. ABC can help managers optimize their product mix, pricing, and cost reduction strategies, and enhance their customer value and satisfaction.

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3 Factor 3: Innovation

A third factor that affects the usefulness of ABC is the degree and pace of innovation in the industry. If an industry has low or slow innovation, then ABC may not be necessary. The products or services may be stable or mature, and the changes in technology or customer demand may be gradual or predictable. ABC may not capture the significant changes or improvements in the production process or the product mix. However, if an industry has high or fast innovation, then ABC can be essential. The products or services may be dynamic or evolving, and the changes in technology or customer demand may be frequent or disruptive. ABC can help managers adapt to the changing environment, and allocate their resources more efficiently and effectively.

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4 Examples of industries

Based on these factors, some industries that can benefit from using ABC include software development, health care, and manufacturing. Software development has a complex production process with many activities, intense competition, and rapid changes in technology and customer needs. ABC can help software developers allocate overhead costs accurately and identify the profitability and value of each project, feature, or customer segment. Similarly, health care providers have a complex production process with many activities, strict regulations, and new discoveries in medical science and technology. ABC can help them allocate overhead costs precisely and identify the profitability and value of each service, procedure, or patient group. Finally, manufacturers have a complex production process with many activities, global markets, and new materials and methods of production. ABC can help them allocate overhead costs rationally and identify the profitability and value of each product, line, or market.

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Morgan Cheruiyot

CPA and Finance Strategist | Transforming Numbers into Strategic Business Insights
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Financial Services: In banking ABC can be valuable for analyzing the costs associated with different financial products and services, such as loans, investment management, and insurance. By understanding the costs of each product or service, financial institutions can optimize their product mix, pricing strategies, and resource allocation to improve profitability. Telecommunications: Telecommunications companies often offer a range of services, including landline, mobile, internet, and television services, ABC can help telecom companies allocate overhead costs more accurately across different services and customer segments, enabling them to make more informed decisions about pricing, service offerings, and investments in infrastructure.

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5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Michael Kamau

Finance Controller/Project Manager/Project Accountant
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ABC is deployed in industries where diverse and complex activities drive costs. Some industries where ABC is commonly applied include: 1.Manufacturing 2.Healthcare 3.Transportation 4.Service 5.tele ommunication

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In what industries is activity-based costing most useful?

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1 Factor 1: Complexity

2 Factor 2: Competition

3 Factor 3: Innovation

4 Examples of industries

5 Here’s what else to consider

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