Activity-based costingCould you please help me explain how the ABC is useful for pricing decisions? Thanks!
Activity based costing focuses on ascertaining cost of a product, based on determining the cost of various activities undertaken to manufacture and market the product. These activity based costs are then apportioned to each product based on the volumes of different activities undertaken in respect of each product. This results in more accurate determination of the real costs of different production and sales volumes.
This added accuracy of cost information enables managers to determine the more accurately the profit taking into consideration the the market price and sales volume relationship. Thus ABC costing enables managers to set price levels of product that are likely to maximize profit on each of the product marketed. The ABC system is particularly useful in service industry where the company is required to price separately different elements of service provided.
If your product is off-the-shelf type, then the cost of manufacturing that product is the same. But then depending upon the customer's behavior, the resources consumed by the customer is different. for example the # of changes in the schedule, special packing request, # of orders, payment schedule etc. This makes the profitability of the customer different if the price of the product is same.
Activity Based Costing helps the organization to understand the cost-to-serve the cutomer, based on their behavior and correspnding consumption of the resources. Based on this information the organization may decide a differential pricing strategy for differnt customers. Their could also be a 'menu-based-pricing' adopted by the organizaion.
For example a bank may say that if your average monthly balance is below 10000 then you can visit the branch only once in a month, trhice to ATM etc., for free. Any additional visit may be cahrged.
Pricing is in any case a decision taken by the organization, ABC helps the organization to understand the relevant and appropriate costs of the behavior of the people in the organization and of the customer. This in turn helps to understand the profitability of the products, customers etc.