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ABCSeven Steps
1) 2) 3) 4) 5) Define activity cost poolsthe value chain steps Assign costs to the pools Determine the driver(s) for each pool Measure aggregate activity units for the driver(s) Divide costs (step 2) by driver units (step 4) to get cost per driver unit 6) Measure driver units for a customer (or product) for each cost pool 7) Activity-based cost for the customer equals: cost driver units (step 6) x cost per driver unit (step 5), summed across all cost pools


Steps 1 and 2 The Basic Cost Matrix (Step 2)

Line Items
Storage... Salaries Fringe Benefits Rent Depreciation TOTAL STEP 1 STEP 2

Value Chain Stages (Step 1)

Stock Selection... Data Entry... TOTAL




Define the Cost Pools (The Value Chain Stages) Assign Costs to the Cost Pools


Steps 1 through 5
(1) (2) (3) (4) (5) Value-Added Total FY92 Cost Cost Driver Activities Expense per Driver Units Service Defined as: Activity (000) Defined FY92 Plan Costs Storage $1,550 Cartons in Inv. 350,000 $4.44 Requisition Handling $1,801 Requisitions 310,000 $5.81 Warehouse Activity $761 Req. Lines 775,000 $0.98 Pick Packing $734 (PP) Lines 700,000 $1.05 Data Entry $612 Req. Lines 775,000 $0.79 Per Time ~8,500 $30.00 Desk Top Delivery $250 $5,708 Freight Charge Actual Cost Inventory Finance Inventory Value Capital Charge*


Step 6A Saga of Two Customers p g

Annual Revenue Requisitions q Requisition Lines (all pick pack) Average Inventory at the Centers Cartons $ Per carton Cost Average Revenue* Shipments Number Desk Top Freight. $ Freight/Shipment F i ht/Shi t Customer A $79,320 364 910 350 $15,000 $43. $68. 52 0 $2,250. $43. $43 Customer B $79,320 790 2,500 700 $50,000 $71. $113. 156 26 $7,500 $48

*Cartons shipped = $50,000 $43 = 1,163 cartons. Revenue of $79,320 1,163 = $68. (A) = $50 000 $71 = 704 cartons Revenue of $79 320 704 = $113 (B) $50,000 cartons. $79,320 $113.


Step 7
Storage Customer A 350 Cartons x $4.44/carton $1,554 364 requisitions x $5.81/requisition $2,115 910 lines x $.98/line $892 Customer B 700 Cartons x $4.44/carton $3,108 790 requisitions x $5.81/requisition $4,590 2500 lines x $.98/line $2,450 $2 450

Requisition Handling

Warehouse Activity

Additional "Pick Pack" Charge910 pick-pack lines 2500 pick-pack lines x $1.05/line x $1.05/line $956 $2,625 $2 625 Data Entry 910 lines x $.79/line $719 $ 19 2500 lines x $.79/line $1,975 $1 9


Step 7 C S 7Continued i d
Desk Top Delivery Customer A 0 times x $30/time $0 $2,250 Customer B 26 times x $30/time $780 $7,500

Freight Out (Actual)

Inventory Financing $15,000 inventory $50,000 inventory (Estimated WACC of 13 5%) 13.5%) x 13 5% 13.5% x 13 5% 13.5% $2,025 $6,750 Inactive Inventory Surcharge $0 inventory (A proxy f obsolete inventory for b l t i t x 1 5% 1.5% cost borne by TFC) x 3 months $0 Total Service ChargesABC Basis $10,510 $7,000 inventory x 1 5% 1.5% x 3 months $315 $30,093


Allied TFCCustomer Profitability TFC Customer Analysis

Old Method Sales Product Cost Service Fees (32.2% of
product cost)

Customer A $79,320 (50,000) (16,100) $13,220 17%

Customer B $79,320 (50,000) (16,100) $13,220 17% Customer B $79,320 (50,000) (30,093) (773) Negative

Gross Profit Gross Profit % G P fit

Activity-Based Analysis Customer A Sales $79,320 Product Cost (50,000) Service Fees (per ABC) (10,510) Gross Profit $18,810 Gross Profit % 24%

Which is the better customer?


Customer A now appears much more profitable than before and dramatically more profitable than Customer B. But, Customer A is much more vulnerable to a p g competitor who would charge use-based prices. And, Customer A does not fit the businessTFC cannot build a business around customers who d t use it d t h dont its services!


Customer B now shows losses. But, they are a heavy user of the servicesthey like what services they TFC offers. Of course, they may only like it g y y as long as they dont have to pay for it! So Customer B really uses the services TFC , y p y offers, but they dont pay for them. Customer A is very profitable for TFC, but they dont use much of the service which is the basis for TFCs business.

AOP 10

Moving From Analysis to Action

Marketing Strategy Decisions Customer Selection Pricing "Value-Engineer" The Cost Structure

AOP 11

Marketing Strategy Decisions

Pi i Pricing
SBP Pricing (Services Based Prices) Implementation Issues
Raise Prices for Bs? Lower Prices for As?

Customer Selection
Do we want more As or Bs? Wh t kind of new customers to seek? What ki d f t t k? What to do with the current customers?

The Value Proposition

Vending versus Value Selling

AOP 12

1. 1 Yes for menu pricing pricing.

a. L i ll th h Logically, the heavy users should pay h ld more than light users. b. b Pricing should allow the customer to decide which services to use, based on a cost-benefit trade-off. c. Right now, B is getting a free ride and A is being overcharged.

AOP 13

2. No for menu pricing.

a. Lowering prices to the As will not make them happy. b. Why drop a price when A i h b Wh d i h is happy now at th hi h price? t the higher i ? c. Raising prices to the Bs will encourage them to change suppliers. This will drive our unit costs even higher. d. What is the justification for a price increase? Blaming it on a new accounting system wont impress most customers.

AOP 14

3 3. Maybe for menu pricing. aybe o e up c g a. The real issue is value to the customer. Cost is C t i not di t directly relevant f tl l t for th the user; value is. b. What do we know about customer p perceptions of value here? Not much! p c. SBP is a variation on old-fashioned cost based pricing pricing. It may or may not represent good value to customers.