| It's an unwritten rule respected by many in the business world that you generally treat your best customers the best. The problem is, do you really know who your best customers are, or do you think you know? The majority of business people have the false perception that the best customer is the one that accounts for the largest portion of your income every year. This is not always the case for the simple reason that the same customer may be responsible for the biggest part of your expenses also.
There is a solution to the problem and it is as simple as Activity Based Costing.
Activity Based Costing, or simply ABC as it is known in the business world, if correctly applied and utilised can rank your customers in terms of profitability.
What is ABC ?
Activity based costing is a costing method that provides managers with useful information they need regarding the contribution that each customer makes to overall profitability. Also, ABC allows managers to see how to maximise performance and implement sound profit-growth strategies.
ABC also makes it very clear that integrated costs associated with the services that the customer demands play a crucial role in determining each customer's contribution to net profit.
Studies have shown that 20% of all customers virtually provide all the profits of a company. Another 60% break even and the remaining 20% only reduce the bottom line. Wouldn't it be nice if you had the names of that 20% of headache-inducing customers that are literally more trouble than they're worth?
Who Goes on this List of Names?
To determine how much a customer is costing you, you must first identify the activities that relate to each customer and determine the total cost absorbed by those activities. These activities or "cost drivers" should be considered then to measure the level of activity absorbed by each customer. The ultimate purpose of implementing ABC is to separate these activities into individual cost drivers. Then, all you have to do is measure each customer's participation in the specific cost.
Cost Drivers
When choosing cost drivers, make sure they are relevant and easy to measure. Relevancy relates to the direct or indirect relationship it bears to the cost of doing business and ease of measurement means that you must be able to allocate to each customer the portion attributable to the activities consumed.
Cost drivers might include, but not be limited to, inside/outside sales, order processing, credit, delivery, telephone expenses, training, application expertise, after-hour service, design time, machining etc.
To describe how to determine the total cost of each of these cost drivers and how that cost should be allocated to each customer is beyond the scope of this article. But help is available. Contact OffTech Computing Pty Ltd and one of our consultants will be more than happy to assist you with any questions that you may have.
Take control of your business today and start saving immediately by implementing Activity Based Costing methods.
The following chart diagram will help you to see how Activity Based Costing works :
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Cost Assignment View
(ABC)
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What Things Cost
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Resources
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<-- Resource Drivers
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Resource Cost Assignment
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Process View
(ABC/M)
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Resources
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Activities
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Manage Activities
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Activity Cost Assignment
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V
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<-- Activity Drivers
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Cost Objects
(Outputs)
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Why Things Have Cost
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Better Decision Making
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Kaplan has defined ABC simply as, "Activity based costing says that something has to be allocated" (Kaplan, 1989)
Hicks has defined ABC as, "ABC is a concept around which it can construct an economic model of its business that will provide the accurate and relevant cost information necessary to support sound business decisions of all types" (Hicks, 1999).
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