Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing.
With ABC, a company can soundly estimate the cost elements of entire products ACTIVITIES and services. That may help inform a company's decision to either: * Identify and eliminate those products and services that are unprofitable and lower the prices of those that are overpriced (product and service portfolio aim) * Or identify and eliminate production or service processes that are ineffective and allocate processing concepts that lead to the very same product at a better yield (process re-engineering aim).
In a business organization, the ABC methodology assigns an organization's resource costs through activities to the products and services provided to its customers. ABC is generally used as a tool for understanding product and customer cost and profitability based on the production or performing processes. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing, identification and measurement of process improvement initiatives.
Handling Product, Distribution, and Customer Variety
HISTORY AND BACKGROUND
Kemps, a leading U.S. dairy in the Upper Midwest and Gulf states, produces and distributes a full line of products, including milk, ice cream, sour cream, cottage cheese, and yogurt.' During the 1990s, Kemps, like most dairies, saw a major consolidation in its customer base. Small, independent retailers became absorbed or put out of business by giants such as Wal-Mart, SuperValu, Nash Finch, and Roundy's. The buying power from these large distributors and retailers put suppliers' margins under heavy pressure.
Kemps also had to respond to increased demands from its wholesale and retail customers for more specialized packaging, distribution, warehousing, and just-in-time replenishment services. Many large retailers were reducing their refrigerated and frozen warehousing and receiving capacity, pushing the responsibility for managing inventories onto suppliers, such as Kemps. SuperValu began charging its dairy suppliers for handling and storing products in its retail freezers. Target, another large customer, instituted consignment sales so that Kemps would earn revenues only when consumers paid for the product at Target's checkout counters.
To supply the multiple delivery options demanded by its large and diverse customer base, Kemps managed a complex transportation system. Its trucks delivered full loads to supermarkets and their distribution centers; made direct deliveries of less-than-truckload quantities to convenience stores, small retail stores, and homes; and shipped double-stacked frozen loads of ice cream to distribution centers across the United States.
Kemps plants, responding to customer and consumer demand for high product variety, were now operating complex production processes. Predictable, high-volume production runs produced standard products. Special recipes of ice cream, yogurt, and milk in customized packaging for retailers' private-label brands, however, required small, unpredictable production runs. Recently, Kemps installed a $2.5 million line just to produce a new product line, yogurt in a tube.
Historically, the company had focused on developing a long-term relationship with its retail and wholesale customers. Kemps would provide whatever services its customers requested, under its philosophy of delivering the right products to the customers in the right quantities at the right time. For example, Kemps might bid for a customer contract, assuming deliveries would be made twice a week. If the customer subsequently asked for daily deliveries, Kemps would meet this demand.