Academic journal article Management Accounting Quarterly

Product Line and Customer ROI: The Next Generation of ABC

Academic journal article Management Accounting Quarterly

Product Line and Customer ROI: The Next Generation of ABC

Article excerpt

THE CONCEPTS OF ACTIVITY-BASED COSTING CAN BE EXTENDED TO ENCOMPASS ALLOCATION OF ASSETS TO ACTIVITIES. SUCH AN EXTENSION PERMITS MANAGEMENT TO EVALUATE PRODUCT AND CUSTOMER RETURN ON INVESTMENT IN A MANNER SIMILAR TO THE RETURN-ON-ASSETS METRIC TYPICALLY USED TO EVALUATE BUSINESS UNIT FINANCIAL PERFORMANCE.

Competition from both domestic and international sources has motivated firms to continually evaluate how they conduct business. This evaluation has resulted in increased attention on cost management, which has led to redesigning business processes and products; outsourcing of production, assembly, distribution, or backoffice functions; and the reduction of costs through increased automation.

To support both making and evaluating the impact of these decisions, managers have often relied on activitybased costing (ABC) to provide them with better information regarding the identification and reduction of nonvalue-added activities, to streamline processes, and to work with both customers and suppliers in a more cost-effective manner.1 In addition, ABC techniques have facilitated a firm's understanding of both customer and product profitability.2 The use of ABC has been shown to be beneficial for increasing overall profitability in a variety of organizations.3

As beneficial as ABC information has been in enhancing profitability in this competitive environment, we contend that it still has not been utilized to its full potential. Indeed, the increased focus on profitability and cost control alone has the same shortcomings today that were evident nearly 100 years ago when an executive of E.I. DuPont de Nemours & Co. wrote, "The true test of whether the profit is too great or too small is the rate of return on the money invested in the business and not the percent of profit on the cost."4 It was this thinking that led the DuPont company to develop the then innovative measure of return on investment (ROI). Since that time, little advancement with respect to return on investment has taken place. In addition, little has been done to develop this measure below the business-unit level in a way that will enhance managers' understanding of the relative contributions of individual product lines and customers. Further development of ROI has not been undertaken, in part because of difficulties associated with the identification of assets at the product and customer levels. With the acceptance and implementation of ABC, many of the difficulties associated with the implementation of ROI below the business-unit level have been alleviated. We propose here the extension of ABC principles such that assets also are assigned to activities. Assignment of assets to activities and ultimately to products and customers will allow managers to analyze customers and products with the same attention to return on investment that has been used for evaluating business units for nearly 100 years.

The extension of ABC to accommodate activitybased asset allocation is relatively easy to implement in organizations once an ABC system is in place. The development of these innovative return metrics is accomplished by extending the logic of ABC, which requires the identification of an organization's activities and cost drivers and then the tracing or assignment of resources (costs) to those activities. A direct extension of this logic also is to trace and assign the investment in assets associated with these activities. Once the level of assets associated with a given activity is determined, it is possible to assign assets to customers, products, or processes in the same fashion that ABC assigns costs. This allocation of assets is accomplished most efficiently by using most, if not all, of the same activities and drivers. It then becomes possible to determine customer return on investment (CROI) and product return on investment (PROI). The extension of ABC to the allocation of assets is most appropriate in those situations in which products or customers have significant differences in the utilization/consumption of company assets such as equipment and machinery, tooling, inventories, and receivables. …

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