2. Activity Based Costing (ABC) used in Logistics & Supply Chain Management as Cost
Optimization & its benefits
Main focus of any business revolves around maximizing profits. There are two ways to maximize
profitability including increased revenue & decreased cost. Later one is more appropriate as it prevents
from excessive working as well as it makes sure brand loyalty by making costumers more satisfied(as it
delivers products with same quality but in lower price) thus builds a brand image.
Cost reduction requires a thorough understanding of all drivers & procedures causing to incur cost in order
to know that which most important driver is causing cost and which driver is just causing to increase cost.
Those drivers must eliminate to reduce cost which ultimately increases cost.
Types of costing and their difference.
Generally speaking, costing can be done through two ways including traditional costing and activity based
costing. Traditional costing is the allocation of factory overhead to products based on the volume of
production resources consumed. Under this method, overhead is usually applied based on either the amount
of direct labor hours consumed or machine hours used whereas later costing method determines all activities
included in the production of product or service. Cost is assigned to all activities in order to assign cost to
final product. Activity-based costing is used to get a better grasp on costs, allowing companies to form a
more appropriate pricing strategy. The important concept includes in ABC is the concept of driver includes
in every activity which is basically the main factor behind cost. Cost drivers enables the decision makers to
eliminate the activities or drivers which are not participating in efficient working in order to reduce cost.
Logistic activities occurring in any company are playing a vital role in company’s process. They are taking
part in achieving desired outcomes. Cost reduction in any organization involves the analysis and cost
reduction of logistics activities too. An efficient analytic system is required for the analysis of these
activities along with ABC.
Talking about ABC in logistics aspects. Following phases involves in the process including
Identification & classification of logistics process
Activities breakdown
Resource identification
Identification of cost driver
Cost determination finally the cost assigning
These phases can be applied to all processes involved in logistics including planning, procurement,
inventory management etc.
During the activity breakdown, it is important to fully understand the process along with the understanding
of cost driver. For the understanding of cost driver, it is better to analyze all the activities keenly as one
activity can be based on multiple drivers but, for cost reduction, it is better to choose most appropriate
driver. The cost of one product consists of the accumulated cost of drivers of all activities involved in the
production of that activity or services.
3. Activity based costing is an effective tool for decision makers but, along with this, integration of all logistic
activities/units is also necessary for a guaranteed success. It is very important to design an integrated
logistics system along with cost analysis system. For any organization, it is important that all the functional
units involved must be integrated in such a way that the cost reduction of one unit must not increase the
cost of other department to this level which is more harmful for organization than beneficial. So, to
eliminate this factor, it is important for the functional units to understand the trade-offs among units of
whole system. It is important to understand that what is the effect of cost reduction of one unit on other
departments cost as the purpose is to reduce cost as a whole instead of a single unit. This trade-off can be
understood by measuring different factor including:
Identification & thorough understanding of cost drivers which will be helpful in knowing cause and effects
of those drivers. Moreover, how, different drivers are working and interacting is also important in order to
decide which driver is important, which can be eliminated etc. The most important asset of any company is
its customers so, it is very important to retain the customers for sustained success as well as, to increase
revenue, increase in number of customers is also required which is only possible by satisfying customers
and creating brand loyalty. Both of these are possible by carefully measuring the customers’ needs and the
cost of services which can be provided to customers. This is also an important factor to measure while
analyzing trade-offs. Finally the evaluation of all these factors in order to decide the effective cost reduction
method.
Integrated logistics management system provides information which is useful for planning logistics
activities especially in case of inventory management, selection of suppliers, warehousing etc.
Disadvantages of ABC:
There are certain advantages & disadvantages of ABC. Many of the advantages are already discussed above
so moving towards disadvantages which includes:
It is not necessary that ABC is always effective due to some wrong considerations and wrong data. Not
everyone is willing to share the correct data. Even within organization, all functional units’ shows biased
behavior. Sometimes, they like to work in silos which hinders an effective costing. ABC requires immense
working and time to see & understand all drivers and other factors included.
The main focus of any organization while opting costing system is to ensure the collaboration of all
companies involved in supply chain. Every company or unit must share its cost structure with other units
in order to understand the concept of trade-offs for cost optimization.
