Using Activity-Based Costing to Implement
Supply Chain Improvements
Terrance L. Pohlen
Lt Col, USAF, PhD
Overview
• Why transportation and logistics managers
require more accurate cost information
• How activity-based costing can provide
greater management insight
• Using ABC to support transportation and
logistics decision-makers
• Applying ABC to supply chain management
Transportation and logistics
managers need more
accurate cost information
•Critical link exists between corporate profitability and
logistics costs and performance
•Many logistics costs and effects of logistics decisions
buried in overhead costs
•Logistics particularly requires accurate costing
– Diversity in resource consumption
– Products and resource consumption not correlated with
unit based allocation measures
•Identifying and costing activities may reveal
opportunities to improve operating efficiencies
Problems typically encountered
in transportation and logistics
accounting systems
• Visibility frequently lost--included as part of
SG&A
• Allocated using cases shipped, miles, or
sales
• Costs not available by product, customer, or
supply channel
• Affect of logistics decisions/improvements
not readily apparent
• Output measures frequently not captured
“The imaginary profits--and losses--that arise from flawed
cost systems can lead to very expensive blunders. We may be
giving away the best business (high volume, but supposedly
low margin products) to foreign companies. Competitors
don’t want your cats and dogs--they want the volume
business. Once the high volume products are abandoned,
those that remain must carry a greater share of overhead, and
thus they too become less profitable.”
Fortune Magazine
12 October 1997
Traditional Cost Accounting
Overhead
Direct
Labor
Direct
Labor
Direct
Labor
Direct
Labor
Activity
Activity
Activity
Activity
DIRECT
MATERIALS
DIRECT
MATERIALS
DIRECT
MATERIALS
DIRECT
MATERIALS
OUTPUT $$
Problems with Traditional
Costing of Transportation & Logistics
• Unit based allocation suggests costs will vary with volume-cannot accurately determine how changes in customer
service effect total costs
• No reward for reducing indirect cost categories--benefits
diffused across all products
• Costs “reduced” by eliminating direct labor
• Overhead costs appear “fixed” and not affected by
management action
• Rewards based on cost center performance and not on total
product/customer/channel profitability
Are U.S. Manufacturers’ Accounting
Systems a Major Tool Used in
Management Decision-Making?
No
18%
Yes
82%
Source: National Center for Manufacturing Sciences, Focus, 1993
Warning Signals:
•
•
•
•
•
•
•
Division managers want to drop seemingly profitable lines
Product or customer profitability is hard to explain
Departments develop internal costing systems
The accounting department performs many special projects
Competitors’ prices appear unrealistically low
You have a high-margin niche all to yourself
Customers don’t mind price increases
Adapted from Cooper, Robin, “You Need a New Cost System When...,”
Harvard Business Review, January-February 1989, pp 77-79.
Activity-Based Costing
Supervision
Office
Support
Utilities
Supplies
Equipment
Resources
Receiving
Put-Away
Set-Ups
Packing &
Shipping
Activities
Product
Division A
Product
Division B
Product
Division C
Product
Division D
Cost
Objects
a technique to assign
more accurately direct
and indirect costs to
the activities,
customers or products
which consume an
organization’s
resources
Activity-Based Costing
IS:
An overhead
allocation
technique which
generates the
cost of activities
IS NOT:
A bookkeeping
system
A consolidation
system
ABC translates traditional costing
into actionable information for decision-makers
Cost data
translated
by ABC
General
Ledger
Data
(account
balances)
Activity-based
information
ABC
Model
Decision
Makers
How Does ABC Assign Costs?
Supervision
Office
Support
Utilities
Supplies
Equipment
Resources
Packing &
Receiving
Put-Away
Set-Ups
Shipping
Activities
Product
Division A
Product
Division B
Product
Division C
Product
Division D
Cost
Objects
ABC uses a two-stage
process to assign costs
– Resource costs are
assigned to activities
based on use
– Activity costs are
assigned to the
products or customers
consuming the activity
Activity-based costing approach
Overhead Overhead Overhead Overhead
Direct
Direct
Direct
Direct
Labor
Labor
Labor
Labor
Activity
Activity
Activity
Activity
DIRECT
MATERIALS
DIRECT
MATERIALS
DIRECT
MATERIALS
DIRECT
MATERIALS
OUTPUT $$
Resources
Terminal
Insurance 13%
2%
Supervision Office Labor
3%
9%
Dock Labor
32%
Depreciation
4%
Maintenance
5%
Fuel
7%
License
1%
Pickup & Delivery
Drivers
18%
Utilities Yard Labor
5%
1%
• Resources are usually
derived from the general
ledger accounts
• Represent the resources
the organization has to
perform its mission
• Many ABC models use
budget information to
determine resources
Assigning Resource Costs
Terminal
13%
Supervision
3%
Office Labor
9%
Insurance
2%
Depreciation
4%
Maintenance
5%
Dock Labor
32%
Fuel
7%
License
1%
Pickup & Delivery
18%
Utilities
1%
Yard Labor
5%
Process Claims
4%
Maintain vehicles
10%
Marketing
5%
Billing
4%
Handling
10%
Pickup
6%
Unload
8%
Deliver LTL
17%
Load delivery
6%
Load line haul
6% Scheduling
3%
Line haul
8%
Accessorial Services
5%
Deliver TL
8%
• Resource drivers used to
assign costs to activities
• Interviews frequently
used for making the cost
assignments
• Activity costs are sum of
all resources needed to
perform the activity
Activity Cost
MHE
2% Supervision
Maintenance
4%
1%
Supplies
10%
Labor
47%
Facility
36%
LTL Shipping Activity
• An activity’s cost is the
sum of the resources
used in performing the
activity
• Consumption used to
trace resource costs to
the activities
Identification and Number
of Activities
Pallet picks
Pallet
sent picks
by RF
sent
by RF
to Fork
lifts
to Fork lifts
Pick lists
Placed in
Window
Warehouse
Signs for and
Takes Pick List
Property picked
and
Palletized
Pallet moved
to Shrink
Wrap Area
Warehouseman Orders Requiring
Annotates
CHEP Pallets
Work Log
Re-palletized
Pallet
Shrink-Wrapped
Pallet moved
to Staging
Area
• Activities identified by
implementation team
• Level of detail
determined by:
• Cost
• Diversity
• Management Focus
• Most DCs using 20-40
activities for costing
Receiving
Product
Storage
Transp Planning
Picking
Customer
Special Handling
Shipping
Administration
Brand
Cartage
Unload and inspect
Putaway
Bulk storage
Aerosol storage
Pre-shipment scheduling
Truckload planning
Post-shipment support
Transportation Administration
Manual picking
Mechanical picking
Stage pallet for order
Build pallet
Adjust pallet height
Clamp off/slip sheet
Spec Hdling/Warehouse office
Load pallet
Check full pallet
Check mixed pallet
Ship international order
Ship small package order
Returns
Rework
Administration
Assigning Activity Costs
Process Claims
4%
Maintain vehicles
10%
Marketing
5%
Billing
4%
Handling
10%
Pickup
6%
Unload
8%
Deliver LTL
17%
Load delivery
6%
Load line haul
6% Scheduling
3%
Customer E
8%
Line haul
8%
Accessorial Services
5%
Others
7%
Customer A
32%
Customer D
10%
Customer C
17%
Customer B
26%
Deliver TL
8%
• Activity costs assigned
using cost drivers
• Costs assigned on a per
activity basis (per case,
shipment, bill of lading)
• Desired behavior should
be considered when
selecting a cost driver
Assigning Distribution
Center Costs
We assign the
cost of this
activity
to
this
cost object:
using
this
activity driver
Manual picking
Rework
Unload & inspect
Truckload plng
Bulk storage
Administration
customer
brand
product
customer
product
brand
cartons mech picked
cartons reworked
pallets unloaded
pounds shipped
avg pallet on hand
no. of cartons shipped
Cost Objects
Customer E
8%
Others
7%
Customer A
32%
Customer D
10%
Customer C
17%
Customer B
26%
• The final output of the
organization
• Typically a customer,
product, service, or
distribution channel
• Provides total cost of
logistics support
Cost Object: Bill of Activities
Line Haul
55%
Delivery
6%
Billing
2%
Pickup
15%
Scheduling
3%
Breakout of
Customer A Costs
Dockhandling-Origin
10%
Processing Claims
Dockhandling- 1%
Destination
8%
Product Division D
13%
Product Division A
31%
Product Division C
16%
ABC
Results
Product Division B
40%
Product Division D
21%
Product Division A
29%
Traditional
Costing Results
Product Division C
20%
Product Division B
30%
Comparison of ABC and Traditional Costing
• Focus shifts from correlating unit level cost drivers (direct labor hours) to
correlating cost drivers at the unit, batch, and process levels
• Overhead assigned to activities based on consumption--costs assigned to
products based on the consumption of the activities performed
• “Fixed costs” viewed as long-term variable costs affected by short-term
management decisions
• Isolation of costs enables managers to trace cost reduction efforts to specific
products, customers, or supply channels--benefits no longer diffused
• Managers can trace the effect of decisions on product or customer
profitability--ABC captures the effects of diversity
• ABC provides significant amounts of non-financial information--useful for
integrating cost management with performance management
How ABC Can Assist
Logistics Decision-makers
• Can more accurately determine how changes in service
requirements will affect logistics costs
• Provides ability to trace indirect resources to logistics
activities and outputs
• Focus on high cost activities or processes
• Translate logistics performance into corporate
profitability
• Greater visibility over logistics costs--better trade-offs
within the firm
• Simulate changes and impact on logistics costs
Benefits Obtained From ABC
65%
Identify cost driver
59%
Improved cost info
47%
Better pricing
Performance measures
41%
Elim redundant work
41%
Cost control
23%
LaLonde and Pohlen, Journal of Business Logistics, 1994
Terminal
Insurance 13%
2%
Supervision Office Labor
3%
9%
ABC demonstrates
how logistics resources
and activities are consumed
Depreciation
4%
Maintenance
5%
Dock Labor
32%
Fuel
7%
License
1%
Pickup & Delivery
Drivers
18%
Marketing Billing
Process Claims 5%
4%
4%
Maintain vehicles
10%
Utilities Yard Labor
5%
1%
Handling
10%
Pickup
6%
Unload
8%
Load delivery
Deliver
LTL
17%
6%
Customer E
8%
Others
7%
Load
line haul
6%
Customer D
10%
Customer A
32%
Customer C
17%
Customer B
26%
Scheduling
Line haul
3%
8%
Accessorial
Services
5%
Deliver TL
8%
Problems frequently encountered
during ABC implementation
•
•
•
•
•
•
•
•
Management and employee buy-in
A new “system” and stand alone initiative
Accuracy versus precision
Delay in immediate pay-off
Multiple views on cost allocations and costs
Putting controller in charge
Too much detail--costing vs reengineering
Cost and effort required during implementation
Where ABC best practices
are being implemented
General Analysis:
Nabisco, Roundy’s, Food Lion,
Tops, Coca-Cola, Pepsi-Cola,
Dial Corp, Bozzotos, Kroger,
Shaw’s
Category Analysis:
Procter & Gamble, Super Valu,
Fleming, H.E. Butt
Menu Pricing:
Spartan, Fleming, Super Valu
Application of activity-based costing to
supply chain management
• ABC can evaluate alternative supply chains
• Activity analysis can achieve a sustainable
competitive advantage by lowering costs or
differentiating services
• Supply chain analysis enables firms to exploit
linkages and perform trade-offs across the
entire supply chain
• ABC/ABM provides means for assessing
individual firm as well as supply chain
performance
Supply Chain Costing
Vendor
(Upstream)
Total Cost of
Ownership
Perspective of
the Firm
DPP, ABC
Customer
(Downstream)
DPP, ABC
Marketplace
Landed Cost
Operations
Physical
Distribution
Inventory Carrying Costs
Materiels
Management
Physical flow costs
Supplier
Information costs
• Determine overall effectiveness of
the supply chain
• Identify opportunities for
improvement
• Measure performance
• Evaluate alternative supply chain
structures
• Select supply chain partners
• Support “make versus buy”
decisions
• Negotiate prices
• Evaluate effects of technology
improvements
• Reengineer the supply chain
Transaction costs
Why supply chain costing?
Customer
Supply Chain Costs
Why use supply chain costing?: customer
and channel profitability
• Type of customer and distribution
channel generally have greater
affect on costs than product type
• ABC can determine how customers/
channels drive indirect costs
• Customer/channel costing provides
technique for assessing profitability
• Joint action between supply chain
members can reduce costs
Using ABC to simulate cost changes
within the supply chain
Process
redesign
Target
Setting
Performance
measurement
& benchmarking
Activity
Analysis
Problem
solving
Activitybased
costing
Time
Quality
Cost
Flexibility
The Continuous Improvement Cycle, Paul Sharman,
CMA Magazine, Vol 66, No. 4
Distribution Center Application:
Activity Volume Change
• Determine how anticipated shifts in activity
volumes will affect distribution center costs.
• Use cost per activity and activity volume to assess
effect
• Example:
Customers order more frequently but in smaller
quantities
Activity volume example
Activity
Cost per Activity
Load Whse Transfer
$150/truck
Load Pool Shipment
210/truck
Load LTL/UPS
Storage
16/shipment
18/order
Process Returns
75/return
$40/shipment
Ship Routine
$25/shipment
36/order
Receive Whse
Transfer
-10
+300
-2,100
+300
+5,400
+300
$10,800
4,800
4/pallet
Ship Priority
Pick/Build Orders
Change
125/pallet/year
Process Orders
Pull/Put Full Pallets
Activity Volume
95/WT
Net change to the DC: +$18,900
Using ECR scorecards to determine
supply chain capabilities and costs
INDICATOR
LEVEL 0
LEVEL 1
LEVEL 2
LEVEL 3
LEVEL 4
Receiving
Optimization
Non-staged or unitized
shipments manually
received with drivers
often expected to unload;
information processed at
time of delivery with no
advanced preparation
and poor document and
load integrity
Pallets staged to reduce
hand unloading and
improve unloading
efficiency; information
processed at time of
delivery with no advanced
preparation and limited
document and load
integrity
Pallets staged and loaded
to minimize in-transit
damage; manufacturer
electronically transmits
information (ASNs and
EDI) prior to delivery to
update files, increase
document integrity and
allow retailer receipt
preparation; some
delivery exceptions
Cross
Dock—
Custom
Cubes
Cross docking at retailer
DC not supported by
manufacturer
Cross docking supported
only for promotional
items for largest stores
and with extended order
lead time
Cross docking done for
promotional items for
most stores and with
above normal lead times;
beginning to support turn
items
Joint assessment for
each order and shipment
to reduce receiving time
and space, using freight
configuration, “tie and
high” capability, and DC
receiving area utilization
(drop and hook used
where applicable)
supported by EDI and
ASN transmissions that
support pre-delivery
activities; rare delivery
exceptions
Manufacturer supports
cross docking of storeready pallets; minimal
lead times; deliveries
accompanied by ASNs
Pallet and
Case
Labels
(Barcoding)
No labels supplied or
supported
Testing UCC/EAN-128
pallet labeling with
retailer; UPC (SCC-14)
bar codes available on
most outgoing cases
Supports UPC (SCC-14)
and UCC/EAN-128 (SSC18) on outgoing cases
and pallets; included on
ASNs, but not used to
receive via scanning;
considering compliance
issues
Manufacturer has
established cost effective
freight configuration
guidelines to optimize
space and unload time for
different load types,
supports drop and hook,
uses EDI and ASN
transmissions; allows
retailer receipt
preparation (matching,
label printing, etc);
minimal delivery
exceptions
Manufacturer supports
systemic cross docking
for both promotional and
turn items, primarily for
single SKU pallets;
normal lead times;
deliveries accompanied
by ASNs/Pallet UCC 128
Pallet and case labeling
is integrated fully with
ASNs to automate
receiving via scanning;
consistent compliance
with industry standards
Joint implementation of
pallet and case labeling
with retailer based on a
complete analysis of all
costs including the cost of
applying labels;
consistent compliance
with industry standards
Activity-Based Management
• Use non-financial data provided by ABC to drive
continuous improvement and reengineering
• Link performance measurement system to changes in
process costs or profitability
• ABC can trace effect of management decisions to
changes in total process cost
or profitability
The Two-Dimensional ABC Model
Cost Assignment View
Resources
Process View
Cost Drivers
Activities
Performance
Measures
Cost Objects
Peter B. B. Turney, Common Cents
Cost Assignment View
Cost Assignment View
Resources
Focus of early ABC efforts
Activities
Cost Objects
Objective - more accurate product
costs for product mix, sourcing and
product design decisions
Process View
Focus of newer ABC implementations
Objective - improving operational processes
by identifying (and eliminating)
non-value-added activities
Process View
Cost Drivers
Activities
Performance
Measures
Balanced scorecard approach
Financial Perspective
Goals
Measures
How do customers see us?
What must we excel at?
Internal
Business Perspective
Goals
Measures
Customer Perspective
Goals
How do we look
to shareholders?
Measures
Innovation and
Learning Perspective
Goals
Measures
Can we continue to
improve and create value?
Kaplan, Robert S., and David P. Norton, “The Balanced Scorecard - Measures
That Drive Performance,” Harvard Business Review, January-February 1992, pp. 71-79.
Vendor/Carrier Evaluation
Use ABC to assess current carriers and vendors:
• Vendor selection affects the costs of ordering,
expediting, receiving, inspection, production, and
distribution
• ABC provides a means of more accurately tracing
how vendor decisions affect total costs
• Purchasing managers can use “total cost of
ownership” in vendor selection and evaluation
• Activity analysis opens potential for exploiting
vendor-buyer linkages to reduce costs and
differentiate service
Key References
• Turney, Peter B. B., Common Cents: The ABC Performance
Breakthrough, Portland, OR: Cost Technology, 1993.
• Player, Steve and David Keys, Activity-Based Management: Arthur
Andersen’s Lessons from the ABM Battlefield, New York:
Mastermedia Ltd., 1995
• Journal of Cost Management published by Warren, Gorham & Lamont
• Brinker, Barry, editor, Emerging Practices in Cost Management: 1996
Edition, Warren, Gorham & Lamont, 31 St. James Avenue, Boston,
MA 02116, (800) 950-1213
• Cokins, Gary, Activity-Based Cost Management: Making It Work,
Chicago, IL: Irwing Professional Publishing, 1996