Producing products or services is all about the activities, not just the resources.
That’s why looking at the activities your business runs, and not just your revenues, is key to building an accurate freight costing model, according to Kenneth M. Manning, president of Transportation Costing Group. Manning was a speaker at this summer’s Profitability Conference hosted by Motortruck Fleet Executive and Dan Goodwill & Associates.
Activity-based costing, or ABC, is a tool that addresses a lot of things in your business, said Manning. For example, shipment cross-subsidies can be very large. Activity-based costing is needed to avoid cross-subsidization.
It is a method of costing products or services based upon the activities required to produce the product or service. It’s also a flexible pricing tool, and an excellent way to create a simulation or a “what-if” analysis.
It’s also an invaluable repository of marketing, operating, and productivity data waiting to be mined with the right tools.
“You can’t just increase revenue and expect to increase your profit. Does your current system highlight opportunities for cost improvement?” asked Manning.
For example, do you understand the various activities performed in your company? Do you have the tools needed to estimate the profitability of prospective customers? Can you simulate the profitability of freight under forecast operating conditions?
The basic premise of ABC says that providing a service (freight transportation) consumes activities, which consume resources. The consumption of resources drives costs, and each activity has independently associated overhead costs.
“How is this useful? Trucking does not transport hundredweight. Trucking does not transport average shipments. Trucking does transport specific shipments with specific characteristics,” noted Manning.
Activity-based costing will look at various activities, adding labour and non-labour costs to each, then adding the cost of providing the service, plus an overhead to that cost, coming up with a more accurate model than traditional costing that just gives you a top line reading of profitability.
The cost of activities specific to a customer are to be borne by that customer.
Activities specific to a trip to be borne by all customers served on that trip, said Manning.
Why does this make a difference?
“You can accumulate the activities and costs accumulated per shipment this way. This makes a difference in terms of discovering opportunities for cost improvement, improving strategic decision-making, identifying money-makers and losers, and comparing different options (pricing adjustments, operating adjustments),” noted Manning.
The ABC system must be able to associate different handling characteristics in the cost of providing a service.
“It may not be practical to allocate all costs to activities. The allocation must be based upon the use of resources, not arbitrary assumptions,” said Manning.
Setting up activity-based costing means analyzing activities, gathering the costs of each, establishing output measures (cost per mile, minute, day, etc.) and linking the activities through their system.
“It’s not an accounting project -it has to be a top management project,” said Manning. “If you’re not making money on the round trips run to serve a customer, you’re not making money on that customer.”
Three essential ingredients -data, data, and data -are necessary for a good activity-based costing system, as well as completeness, consistency, and integrity.
“We’re providing a decision-making tool, not the actual decisions. Costing is science, pricing is art, and part of the art of pricing is, what do you want to do with that customer long-term?” said Manning.