Logistics and Supply Chain Management, 4th Edition

LOGISTIC S & SUPPLY CHAIN MANAGEMENT

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Cost drivers and activity-based costing

As we indicated earlier in this chapter there is a growing dissatisfaction with

conventional cost accounting, particularly as it relates to logistics management.

Essentially these problems can be summarised as follows:

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There is a general ignorance of the true costs of servicing different customer

types/channels/market segments.



Costs are captured at too high a level of aggregation.

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Full cost allocation still reigns supreme.



Conventional accounting systems are functional in their orientation rather

than output oriented.



Companies understand product costs but not customer costs.

The common theme that links these points is that we seem to suffer in business

from a lack of visibility of costs as they are incurred through the logistics pipeline.

Ideally what logistics management requires is a means of capturing costs as prod-

ucts and orders flow towards the customer.

To overcome this problem it is necessary to change radically the basis of cost

accounting away from the notion that all expenses must be allocated (often on

an arbitrary basis) to individual units (such as products) and, instead, to separate

the expenses and match them to the activities that consume the resources. One

approach that can help overcome this problem is ‘activity-based costing’.

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The key

to activity-based costing (ABC) is to seek out the ‘cost drivers’ along the logistics

pipeline that cause costs because they consume resources. Thus, for example, if

we are concerned to assign the costs of order picking to orders then in the past

this may have been achieved by calculating an average cost per order. In fact an

activity-based approach might suggest that it is the number of lines on an order

that consume the order picking resource and hence should instead be seen as the

cost driver.

The advantage of using activity-based costing is that it enables each customer’s

unique characteristics in terms of ordering behaviour and distribution requirements

to be separately accounted for. Once the cost attached to each level of activity is

identified (e.g. cost per line item picked, cost per delivery, etc.) then a clearer pic-

ture of the true cost-to-serve will emerge. Whilst ABC is still strictly a cost allocation

method it uses a more logical basis for that allocation than traditional methods.

There are certain parallels between activity-based costing and the idea of mis-

sion costing introduced earlier in this chapter. Essentially mission costing seeks

to identify the unique costs that are generated as a result of specific logistics/

customer service strategies aimed at targeted market segments. The aim is to

establish a better matching of the service needs of the various markets that the

company addresses with the inevitably limited resources of the company. There is

little point in committing incremental costs where the incremental benefits do not

justify the expenditure.

There are four stages in the implementation of an effective mission costing

process: