Activity Based Costing: A Competitive Costing Method

Activity Based Costing is a cost method which helps a company establish a competitive advantage.  This competitive advantage is obtained by the decisions and actions taken by management after interpreting the data which is created by ABC.  The data is used by organizations primarily to achieve accurate price setting, explore outsourcing options, and assess or plan strategic decisions on process improvements.

   The ABC method attempts to link the cost which the business incurs to its products or services provided to its customers.  Using this method an organization’s overhead is exponentially reduced due to the fact that most of its current indirect costs will change to direct costs as they are being assigned to a specific product or service. The fact that costs are being assigned to the products they contribute to allows for proper price setting which will provide an accurate level for break even price per product or service.  By knowing the break even price an organization can stay competitive by setting a certain price level while still achieving a specific profit margin per product or service.  This price setting ability can also be used to determine the future of a newly found failing product.  For example if a specific product’s contribution margin is too low or even negative management could use the ABC data to decide on possibly scrapping the production of the product in order to stay competitive.

1. Outsourcing is a viable solution to reduce high production costs and with the use of ABC some organizations are noticing that in-house production is too much of a cost burden and in some instances a giant obstacle towards remaining competitive.

As previously stated, the lifetime of an organization depends upon its ability to stay competitive in the market.  With ABC tracking the production costs of various products and services a manager has the ability to examine the current production practices.  If an internal process is found to be non-value added it could be possible for the organization to eliminate the process entirely which in effect would reduce its overall costs.  ABC also allows for management to experiment in improving the current practices of production by tracking the change in costs associated with adding new tweaks to the process or even implementing an entirely new practice.  This ability to view which changes reduce costs and increase production helps management to streamline an organization’s production process.  Efficiency is critical in remaining competitive, and with ABC allowing for process perfection costs are able to be reduced while production stays constant or even increases. 

The method of Activity Based Costing has allowed for organizations to become and remain competitive in their markets.  Its known that markets are constantly evolving and expanding and that these markets are no longer isolated or bounded by geography.  U.S. organizations are no longer subject to only home grown competitors, but global competition as well.  With this in mind every business will be looking for some edge to get a leg up on the competition, and with the abilities that ABC offers more and more will begin to implement this costing method. 

One other outcome from ABC is the possibility of outsourcing.  With all costs being tracked to the production of a specific product or service it is now simple to compare the costs of internal production to external production which aids management in deciding upon whether to outsource a certain sector of its production.  For example if an organization’s main product is watches, it is now easy to compare the costs of producing its own watch band versus purchasing an externally produced band.  If the externally produced component is cheaper the company might purchase rather then produce, or change production methods such as produce in a country with lower wage regulations.   Organizations today are under extreme pressure to remain competitive.  With companies failing left and right the urge to reduce costs and stay afloat is greater then ever before.  Outsourcing is a viable solution to reduce high production costs and with the use of ABC some organizations are noticing that in-house production is too much of a cost burden and in some instances a giant obstacle towards remaining competitive.

As previously stated, the lifetime of an organization depends upon its ability to stay competitive in the market.  With ABC tracking the production costs of various products and services a manager has the ability to examine the current production practices.  If an internal process is found to be non-value added it could be possible for the organization to eliminate the process entirely which in effect would reduce its overall costs.  ABC also allows for management to experiment in improving the current practices of production by tracking the change in costs associated with adding new tweaks to the process or even implementing an entirely new practice.  This ability to view which changes reduce costs and increase production helps management to streamline an organization’s production process.  Efficiency is critical in remaining competitive, and with ABC allowing for process perfection costs are able to be reduced while production stays constant or even increases. 

The method of Activity Based Costing has allowed for organizations to become and remain competitive in their markets.  Its known that markets are constantly evolving and expanding and that these markets are no longer isolated or bounded by geography.  U.S. organizations are no longer subject to only home grown competitors, but global competition as well.  With this in mind every business will be looking for some edge to get a leg up on the competition, and with the abilities that ABC offers more and more will begin to implement this costing method.