Drive Growth with Customer Profitability Management How Time-Driven Activity Based Costing Delivers on the Promise of ABC

Activity-based costing was introduced in the mid-1980s through several Harvard Business School cases and articles. While the settings of these cases differed, they all had one characteristic in common. The resource expenses assigned to an activity were determined through interviews, time logs, and direct observation of the amount or percentage of time people spent on various activities. For example, the costs of warehousing goods would be driven to activities − such as Receiving, Inspection, Put-away, Picking, Packing, and Shipping − based on estimates by warehouse personnel of the percentage of their time they spent on each of the activities. The project team then calculated activity cost driver rates, used to assign activity costs to individual products or customers, by dividing these activity costs by the outputs of each activity − such as number of receipts, number of inspections, number of items picked, and number of shipments.

This procedure for estimating an ABC model, while feasible for initial pilot studies, has proved difficult and costly to extend to company-wide applications. Also, even after the initial model has been built, updating the model requires essentially re-estimating through a new round of interviews and surveys to reflect changes in a company’s operations. Consequently, ABC models are often not maintained and their cost estimates soon become obsolete. In this paper, we review the problems associated with traditional estimation of ABC models. We describe a new approach that is both simpler − for estimating and maintaining an ABC model − and also more accurate. The new, time-driven approach allows for more heterogeneity in activities, orders, and customer behavior without placing burdensome demands for calculating activity, product and customer costs.

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