Essay about IWP field study

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The Impact of Activity Based Costing on Managerial
Decisions at Insteel Industries- A Field Study*

V.G. Narayanan
Ratna G. Sarkar
Harvard Business School

August 16, 1999
Contact Address

Harvard Business School
Boston, MA 02163
617-495-6359
vnarayanan@hbs.edu rsarkar@hbs.edu *

A previous version of this paper was titled, “ABC at Insteel Industries”. We would like to thank the Insteel
Industries management for generously providing us with their time and complete access, and Dave Conrad for the data. We also thank Stan Abraham, Sarah Eriksen, and Gregg Friedman of the Harvard Business School for their research assistance, the Seminar Participants at the April 1999 NBER conference on Organizational Change and
Performance Improvement, Santa Rosa, California, and Ed Lazear the discussant at the conference, for their comments. 1. Introduction

In this paper, we seek to provide empirical documentation of the effect of Activity-Based
Costing (ABC) information on product and customer-related decisions made by managers in a company. Proponents of ABC argue that when an entity implements ABC, it reaps at least two important benefits. First, its entire operation is scrutinized in great detail and its performance and efficiency analyzed and benchmarked against best practices. Employees are encouraged to be critical of the status quo and to suggest improvements. This can result in process improvements that promote more efficient use of resources and hence reduce costs. Second, ABC generally yields a set of overhead cost numbers that, relative to traditional volume-based methods of costing, better represent the consumption of shared resources by the firm’s products, customers and service offerings. Evaluated in light of these new activity-based costs, particular products and customers may show up as ‘loss-making.' This information may enable a firm to change the mix of products produced and customers served allowing it to focus on making profitable products and serving profitable customers.
While there are a number of teaching cases and other such anecdotal evidence about implementation of ABC and decisions impacted by ABC numbers, there has been no systematic, statistical investigation of whether ABC really influences managerial decisions. An ABC analysis may not have any impact on a firm for two reasons. (1) It may not reveal any new information to the managers who intuitively know already what an ABC system formally captures. (2) It is conceivable that outside consultants are hired to do an ABC analysis but decision makers in the firm do not accept the ABC numbers, which often differ significantly from traditional cost numbers. Effective follow-up to the ABC analysis may require managerial decisions and actions significantly different from the status quo, resulting in organizational change and upheaval, to which managers may display resistance.
In this study, we conduct a statistical analysis of firm-level data in order to shed light on whether ABC provides new information to managers and whether Activity Based Management
(ABM) significantly impacts product and customer-related decisions. We supplement this analysis with interviews with top managers in the company on whether and to what extent the
ABC analysis influenced managerial decision making.

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We find evidence that product prices reflect the cost of raw materials and freight costs, but do not fully impound conversion costs (labor and production overhead costs). Hence there is not much support for the hypothesis that product prices reflect all costs even when a company does not have ABC information. We find that after the ABC analysis, Insteel displayed a higher propensity to:
1. Discontinue products that were found unprofitable in the ABC study compared to products found profitable in the ABC study.
2. Increase price of products that were found unprofitable in the ABC study compared to products found…