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Summary
Activity-based costing (ABC) and similar cost-analysis techniques emerged more than 20 years ago as an alternative to the standard accounting-based costing. Savvy finance people recognized the need for an approach that more accurately enumerates true cost drivers. This is especially useful in organizations where a high percentage of indirect costs and shared production facilities hinder the accuracy of traditional costing techniques in measuring true economic costs. The need for techniques such as ABC is acute today as well. Ventana Research believes that getting a firmer grip on costs and managing them more effectively are important in challenging economic conditions, and they will continue to be so when business recovers.

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In a recession, companies are forced to find ways to cut costs. it's wise at the same time to find better ways of managing costs. But understanding the real economic costs in a business is an ongoing challenge. It's one that must be addressed if managers are to be able to make accurate decisions about sourcing, substitutions, pricing and logistics; standard cost accounting cannot always accurately measure the real costs of producing goods or delivering services. Activity-based costing can do this better, especially in more complex businesses environments where, for example, product lines share facilities or indirect costs are a high percentage of total costs.

ABC assigns costs based on the actual consumption of a company's resources, such as engineering, testing and machine setups. By exposing the true economic costs of business practices, ABC enables managers to make better-informed decisions that can improve profitability. When it first appeared in the 1990s, some potential users were disappointed because, in practice, the methods of ABC and the software used to support them were difficult to implement and laborious to maintain. Since then, practitioners have refined ABC and created similar, simpler  costing methodologies (such as time-driven activity-based costing) to support more pragmatic approaches. These advances, along with improvements in the software available to support them, make advanced activity-based costing methodologies substantially easier to implement and use. ABC also is the analytic technique behind activity-based management (ABM), which aims to reduce costs and improve customer value. The clearer picture of true economic costs that ABC delivers is the necessary first step in implementing this set of decision-making and operating processes.

Activity-based costing can deliver substantial business value. It can help companies achieve greater profit margins, since a better understanding of the real costs of delivering a product or service facilitates more appropriate pricing. Similarly, it can aid strategic planning and new product development choices because the real economic costs of decisions in these areas become clear. ABC can give a company a more accurate way to plan and budget, since an understanding of cost drivers leads to more accurate cost projections. ABC and ABM also can help improve effectiveness in IT spending. Today, most organizations allocate IT costs based on formulas that, although they appear reasonable on the surface, do not enable managers to make rational decisions about the IT services they actually consume. This disconnect often leads to spending too much on maintenance of marginal value and not enough on capabilities that would improve a company's performance. A word of caution here: While ABC and ABM can be used intensively across a corporation, we advise companies to take a step-by-step approach to make certain you get it right and gain internal acceptance before attempting a wider rollout.

Assessment
To survive (and maybe even thrive) in today's tough environment, businesses need to understand costs fully. Activity-based costing and activity-based management can enable many companies to handle their cost analytics and decision-making better. Ventana Research believes that by employing the right methodology, the right information and the right tools they should be able to improve their returns. Organizations with this capability will be equally valuable when business picks up.