Robert Kugel's Analyst Perspectives

Activity Based Costing (ABC) is one several popular techniques to apply marginal cost analysis to arrive at a more accurate measure of a product’s true economic cost. It became popular in the United States starting in the 1980s (earlier in Germany) as it became clear to many that traditional cost accounting techniques do not reflect the true, economic cost of production in complex, multi-product environments. Consequently, companies might price items higher than they should and lose market share, or consider them unattractive from a profitability standpoint and possibly under invest in them from a sales/marketing standpoint. Or, the company’s profitability might be impaired because standard cost accounting measures do not enable them to determine the decisions that will maximize their profitability. Sales people might be given the wrong set of incentives, heavily promote less profitable products while ignoring high margin ones. ABC attracted a great deal of attention in the English-speaking world in the 1980s and early 1990s because proponents presented compelling arguments for its adoption. Unfortunately, it quickly fell out of favor because the time and cost of doing the type of “boil the ocean” comprehensive analyses associated with it at that point did not provide commensurate benefits. This was especially true because marginal cost analyses must be performed periodically to keep them up to date.