Today, all companies, even those that roll out multiple products to the market often, face dilemmas in formulating an effective costing strategy. The market is such. There is so much dynamism due to changing customer preferences and the growing competitive landscape.  That reflects not just on their pricing considerations but also on the cost of their inputs and the other activities that go into building these products.

The traditional way of costing

This approach is simple and might even be sufficient for companies that have very few products or that are looking for very preliminary information on the likely costing. But as the number of products increases and the scale grows to align with the pressures of the real world, this approach falls apart.

One of the biggest reasons behind the inadequacy of this traditional costing technique is   that some production-linked activities may incur more overheads for specific products while they may not for others.

In the long run, the overheads from those activities might push the overall costing model over the edge into inaccuracy. Also this approach does not hold much relevance when the need is to pinpoint where costing inefficiencies or problems exist. This gap will make it difficult for companies to develop strategies to cut costs in specific areas as they will not have clear visibility into what are all the resources and activities driving up costs

The solution – Activity Based Costing (ABC)

Any business with statistically significant overhead costs needs to find out where its money (and efforts) is being distributed during the production cycle. There might be hundreds or even thousands of activities that work in concert to create different products in a specific period. ABC is a costing approach that helps companies break down overhead and indirect costs by segmenting the production workflow into a list of activities and the cost incurred by each activity.

Every activity in the production workflow is assigned a unique identifier in the ABC approach. The unique identifier is associated with a cost and is recorded for further analysis on an ongoing basis. An example could be the inspection of a product by a 3^rd party quality analyst (his or her fee or salary) or the process of delivery of a particular raw material for use in production etc. Every granular activity is associated with a cost and is captured for use in the overall costing model of a product.

ABC provides a comprehensive and nuanced approach to costing. For companies in sectors such as pharmaceuticals and auto ancillaries, it offers valuable insights into production costs. It helps them in creating the most transparent costing structure for their products which ultimately reflects in their pricing models as well.

The key benefits of ABC

Activity Based Costing provides some major benefits to companies. It is extremely apt for companies engaged in the manufacturing of multiple products and that cater to different geographies with production units also experiencing diversity in terms of location and sourcing. Let us deep dive into the 3 major benefits that ABC can bring to the table for enterprises:

Expand cost pools

With ABC, enterprises must no longer consider a single organization-wide cost pool for managing overhead costs. Instead, overhead costs are segmented into different pools based on the activities that are responsible for creating them in the first place. This brings about efficiency in understanding the overall cost structure. It creates a well-connected framework that deals with every activity and not the product directly as a single entity when it comes to cost models.

Flexible overhead cost management

With ABC, it becomes easier for leaders to identify the real entities that drive cost escalations based on their activities. Such traceability provides enterprises with the ability to pinpoint, with greater accuracy, the source of inefficiencies in the value chain and thereby take up course corrective actions. A more stable and balanced price-setting exercise  would be the end-result of addressing such inefficiencies.

Optimize costing strategies

ABC provides decision-makers with clear visibility into all operational activities in the business and the budgets they consume. When cost optimization is necessary or budget cuts are to be made for optimal business performance, ABC helps identify overhead and indirect costs that can be reduced or removed without causing any major impact on business continuity.

For any business to remain competitive in very challenging markets, it is essential to have clear control over their spending and revenue. While revenue is tied to their selling abilities, expenditure is one area where many optimizations can help bring down the cost of creating their products in demanding market conditions. ABC is a major driver of this transformational change in costing models.

The real challenge for enterprises will be to enable the right ABC strategy coupled with the most tailored technology solutions that help empower costing with ABC. This is where a dedicated partner like Proactive Solutech can be a game changer. Get in touch with us to know more.