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International Journal of Physical Distribution & Logistics Management, Vol. 31 Issue: 10,pp. 702-713, doi:
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IJPDLM
31,10 Supply chain costing:
an activity-based perspective
Binshan Lin
702 Department of Management & Marketing,
College of Business Administration,
Louisiana State University in Shreveport, Shreveport, Louisiana, USA
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Introduction
As the business world changes, business functions must do the same. To
stay competitive in the emerging global market, businesses must change the
way they view their traditional business functions. Businesses must look
beyond what the function currently accomplishes and envision what the
function can accomplish. Logistics has recently become a focus of such
attention. Traditionally, logistics was viewed as an expensive, necessary
cost of business rather than as a possible source of competitive advantage.
Only recently have experts begun to see the awesome potential in logistics
management, more commonly known as part of a broader supply chain
management.
Supply chain management as its own discipline did not exist a few
decades ago. In the late 1970s, deregulation of the public transportation
industry brought about a closer analysis of traffic management in many
corporations and allowed more decision-making capabilities in selecting
modes of transportation. Then in the 1980s, the functions of warehousing
and inventory management became of more concern among corporate
officers due to increasingly high interest rates and a flux of corporate
International Journal of Physical
Distribution & Logistics
buyouts. Another factor affecting the recent evolution of supply chain
Management, Vol. 31 No. 10, 2001,
pp. 702-713. # MCB University
management was the highly successful use of just-in-time manufacturing in
Press, 0960-0035 many Japanese firms. The rapid succession of these events prompted
companies to focus increasingly on coordinating the inbound and outbound Supply
flow of goods and services in a more cost-effective manner, which, in chain
essence, embodies the general idea of logistics management (Prince, 1999). costing
Logistics management can be formally defined as that part of the supply
chain process that plans, implements, and controls the effective, efficient
flow and storage of goods, services, and related information from the point
of origin to the point of consumption in order to meet customer 703
requirements (Chopra and Meindl, 2001). Supply chain management has
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ABC
Customer service, the outcome of the logistics function, ``involves getting the
right product to the right customer at the right place, in the right condition and
at the right time, at the lowest total cost possible'' (Lambert et al., 1998). To
know the lowest total cost at a given level of customer service, a keen
understanding of the logistics activities and underlying costs of those activities
is paramount. ABC is the method by which this critical cost data can be
gathered for analysis and utilization either in a single firm or among the firms
in the supply chain.
Although ABC has been around since before the Second World War, it has
only emerged into the limelight of corporate decision-making strategies
(Harrison and Sullivan, 1995). ABC can be defined as a system of:
. . . calculat[ing] the costs of individual activities and assign[ing] [those] costs to cost objects
such as products and services on the basis of the activities undertaken to produce each
product or service (Horngren et al., 2000).
are less costly than those required for the big retailer. ABC helps reveal the
true cost of doing business with a particular customer, supplier, or
distributor by comparing the revenues earned to the cost incurred on each
particular party. Consequently, the company can then point to the cost of its
internal activities in determining how to continue to do business with its
customers on a more profitable basis.
One of the major influences on the increased awareness and use of ABC is
the change in the nature of costs. As corporate strategies change and
manufacturing operations become more diverse, overhead costs increase at an
alarming rate. Research indicates that overhead costs represent around
37 percent and 66 percent of total costs in manufacturing and service firms,
respectively (Develin, 1999).
Traditional cost accounting systems have become extremely inadequate
since they continue to allocate these escalating overhead costs on a volume-
driven basis such as labor hours or machine hours which no longer depict
the true consumption of resources in modern manufacturing and design.
Some proponents of ABC contend that overhead should not be allocated
at all but become directly traceable, variable costs of the individual product
or process (Morton, 1997a, b; Harrison and Sullivan, 1995). In any case,
modern manufacturing and logistics operations now consume resources in a
very different manner from their predecessors of just a few decades ago in
which operations were more focused, less automated, and more labor
intensive.
ABC does not replace traditional accounting systems and records; ABC
merely attempts to define further the data aggregated in traditional accounts
into a more advantageous decision-making form for managers. ABC traces the
consumption of resources back to the consuming activity and then traces those
activities to particular cost objects such as specific products, territories,
customers, or departments of the corporation (Brac, 2000).
705
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Figure 1.
Activity-based costing
within the supply chain
The implementation of ABC for supply chain management can be broken down
into seven distinct steps (Gooley, 1995; Henricks, 1999; Thomas, 1994):
(1) selecting the team;
(2) analyzing the supply chain functions;
(3) breaking processes down into activities;
(4) identifying the resources consumed in performing the activities;
(5) determining the costs of the activities;
(6) tracing the costs to the cost objects; and
(7) analyzing the final cost information from a total cost perspective.
differentiated by activities.
709
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Figure 2.
Flow of resources within
ABC
causes an increase or decrease in the time and effort they spend on the activity.
The cost driver should have a direct relationship with the amount of effort
required to perform the task. For example, in an order-picking situation, the
number of cases per order would be a better cost driver than the number of
orders if each case on an order has to be handled, because an order with more
cases requires more effort and time and thus more resources and costs to
perform (Gooley, 1995; Conley, 1999). Another way of finding the true cause-
effect relationship of a cost driver is to run correlation analysis on a spread
sheet software program. A driver whose level of activity is more highly
correlated with the amount of resources consumed is a more relevant cost
driver.
Managerial implications
The discourse on ABC would not be complete without the inclusion of
several managerial implications concerning the drawbacks of ABC. Several
significant factors concerning the drawbacks of ABC are the lack of perfect
cost data, loss of customer focus, and the potentially negative effect of
internal politics.
cost of the logistics function and the customer service level it attains (Harrison
and Sullivan, 1995; Develin, 1999).
Implementation techniques
Obviously, other drawbacks exist that apply to any major change in
information systems such as cost and time. However, these factors can often
be offset by the advantages obtained from the new system and helpful
implementation techniques. Several techniques to help counter the
disadvantages of the ABC system (Computerworld, 1999; Henricks, 1999;
Conley, 1999; Thomas, 1994) are listed below.
. Keep it simple. There is no end to the number of activities and cost
drivers within an organization. Do not get bogged down with petty
details that cannot be explained or do not provide any added benefit. Use
only the relevant cost information.
. Establish a balanced team. As mentioned in step one of the
implementation process, all facets of the corporation must
be represented, from line operator to CEO. For ABC to be
successful, it must consider the cost activities of every area of the
organization.
. Set a reasonable time frame. A reasonable, aggressive time frame is six
months to a year, depending on the scope of the project. If the time frame
is exceeded, the project will lose its momentum and support from many
of those involved.
IJPDLM . Induce management to change. Make sure that top management is
31,10 supportive of the project. ABC will require a fresh perspective and
outlook for all parties involved. If any lack of support is indicated, be
sure to reinstate the invaluable benefits ABC can provide and cite cases
of successful ABC projects.
. Start where it matters. ABC will not affect all areas of a company in the
712
same manner. Start with an area that will display obvious benefits. This
will be a proving ground that ABC works and an additional way to get
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Conclusion
ABC is a complex system of cost allocation that assists in making important
strategic business decisions. Every aspect of decision making in supply chain
management from relocating distribution centers to outsourcing the
transportation function to third-party logistics service providers requires cost
data.
This vital cost information will only increase in significance in the near
future, especially in the field of supply chain management, as the global
economy continues to become more competitive and focus on streamlining
logistics operations. The logistics function can be more than just an expensive,
necessary, unavoidable cost of business. With the strategic use of ABC, the
support of management, and a vision of success, logistics can become a source
of competitive advantage.
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