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12/03/2018 10:52:39 PM

Activity-Based Costing in Service and Merchandising Companies

One of the best tools for refining a costing system is activity-based costing. Activity-based costing (ABC) refines a costing system by identifying individual activities as the fundamental cost objects. An activityis an event, task, or unit of work with a specified purpose—for example, designing products, setting up machines, operating machines, and distributing products. More informally, activities are verbs; they are things that a firm does. To help make strategic decisions, ABC systems identify activities in all functions of the value chain, calculate costs of individual activities, and assign costs to cost objects such as products and services on the basis of the mix of activities needed to produce each product or service.

Although many of the examples of ABC originated in manufacturing, ABC has many applications in service and merchandising companies. In addition to manufacturing activities, the Plastim example includes the application of ABC to a service activity—design—and to a merchandising activity—distribution. Companies such as the Cooperative Bank, Braintree Hospital, BCTel in the telecommunications industry, and Union Pacific in the railroad industry have implemented some form of ABC system to identify profitable product mixes, improve efficiency, and satisfy customers. Similarly, many retail and wholesale companies—for example, Supervalu, a retailer and distributor of grocery store products, and Owens and Minor, a medical supplies distributor—have used ABC systems. Finally, a large number of financial services companies (as well as other companies) employ variations of ABC systems to analyze and improve the profitability of their customer interactions.

The widespread use of ABC systems in service and merchandising companies reinforces the idea that ABC systems are used by managers for strategic decisions rather than for inventory valuation. (Inventory valuation is fairly straightforward in merchandising companies and not needed in service companies.) Service companies, in particular, find great value from ABC because a vast majority of their cost structure comprises indirect costs. After all, there are few direct costs when a bank makes a loan, or when a representative answers a phone call at a call center. As we have seen, a major benefit of ABC is its ability to assign indirect costs to cost objects by identifying activities and cost drivers. As a result, ABC systems provide greater insight than traditional systems into the management of these indirect costs. The general approach to ABC in service and merchandising companies is similar to the ABC approach in manufacturing.

The Cooperative Bank followed the approach described in this chapter when it implemented ABC in its retail banking operations. It calculated the costs of various activities, such as performing ATM transactions, opening and closing accounts, administering mortgages, and processing Visa transactions. It then used the activity cost rates to calculate costs of various products, such as checking accounts, mortgages, and Visa cards and the costs of supporting different customers. ABC information helped the Cooperative Bank to improve its processes and to identify profitable products and customer segments. The Concepts in Action feature on page 160 describes how Charles Schwab has similarly benefited from using ABC analysis.

Activity-based costing raises some interesting issues when it is applied to a public service institution such as the U.S. Postal Service. The costs of delivering mail to remote locations are far greater than the costs of delivering mail within urban areas. However, for fairness and community-building reasons, the Postal Service cannot charge higher prices to customers in remote areas. In this case, activity-based costing is valuable for understanding, managing, and reducing costs but not for pricing decisions.

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