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Activity-Based Costing (ABC)

In recent years, ABC has lost ground in the metric wars. But it may be set for a resurgence.
David M. Katz, CFO.com | US
December 31, 2002

In the late 1980s, it was hard to imagine that the din over activity-based costing would ever die down. Just a few years earlier, Harvard Professor Robert Kaplan, along with others, had published their first papers on the new metric, touching off a rush of excitement in corporate conference rooms.

Kaplan's idea was downright revolutionary. In its broadest terms, ABC involves identifying cost drivers and assigning them to specific activities —rather than attributing overhead, for instance, to the entire organization. Kaplan and fellow ABC-backers asserted that many corporations didn't have a clue as to the true profitability of their products, or the best mix of products. Why? Because, managers at these companies didn't really know what resources (activities) went into producing their goods.

A lightning bolt. But by the mid-1990s, ABC started losing ground to flashier metrics, things like economic value added (EVA) and the balanced scorecard (another Kaplan creation). Even Kaplan admitted ABC had lost its luster. "ABC has stagnated over the last five to seven years," he said in 1998.

Activity-based costing did get a bit of a bump-up during the new economy. At the time, many corporate managers found themselves knee-deep in expensive customer relationship management (CRM) initiatives such as overnight delivery and 360-degree customer service. The problem: These managers were having a real tough time telling if those expensive projects were actually doing anything. To be sure, the rollouts tended to increase customer satisfaction, and with it, customer loyalty.

But often those boosts were accompanied by "declining profits, especially when the increased services are not accompanied by increases in prices or order volumes," wrote Kaplan and his Harvard colleague V.G. Narayanan, in a May 2001 white paper.

ABC offered executives therapy for those uncontrollable customer-delighting urges. By using a costing system based on precise activities, companies could customize their prices to account for service sweeteners, Kaplan and Narayanan argued.

What's more, ABC fit neatly into the marketing plans of software vendors and consultants looking to make the costing method part of grander, enterprise-wide installations. But such ambitions quickly lost traction as the economy foundered.

When the Age of the Customer morphed into the Age of the Accounting Scandal, complex internal data gathering and reporting suddenly seemed less appealing. These days, it's hard to convince an accountant to keep two sets of books for an entire organization, says Michael Paris, president of Paris Consulting, a company that advises manufacturers on their operations. "I think the idea of overlaying a second set of costing systems has gone away."

This is not to say that ABC has completely vanished. Lots of consultancies still offer activity-based costing and activity based management services. In addition, scores of application vendors -- particularly makers of ERP systems -- now offer ABC tools and modules as part of their software offerings.

Moreover, Uncle Sam seems to like ABC -- the U.S. Marine Corps. is an advocate of ABC. In the private sector, ABC is still found in business-intelligence software applications and in assorted one-off projects that tend to fall well short of 24-hour, total systems.

In fact, some observers contend that ABC will come back in vogue -- if the recession continues. During an economic downturn, they note, companies tend to focus their resources on existing customers, rather than seeking out new ones. ABC is excellent at helping separate profitable customers from money-losers. In addition, ABC can help companies figure out ways to raise profits without raising prices -- crucial in a period of low-inflation.




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