episode A3.003 What is ABC (Activity Based Costing)?

Introduction
Here we are in the last week of July and the first month of the 3rd Quarter is ending - how much closer are you to success?

If you have been with us all month, you know we have been railing against the politicians and bureaucrats for acting arbitrarily in response to the pandemic; and any illusion they are making data-based decisions should have been dispelled by now. This is not about a specific political party or group, it is about the arbitrary use of power at the expense of the most important global community - you.

People like us, Living the Life, employ 57% of the planet's population and yet are treated as the source of its problems. Not here, we celebrate the contribution you make to a better society and our focus is to improve your chances of success. 

This week we continue the new programming structure. We use a Balanced Scorecard to format our weekday shows: Finance (Monday) = Operations (Tuesday) + Sales (Customers) + People (Employees) with Fridays dedicated to Owners. Look at the week this way - Monday through Thursday is working IN the Present, Friday is working ON the Future.

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Have a great business week.
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Show Objectives
Very seldom does all of this tedious but necessary process improvement work provide such a clear benefit. One of the most  important decisions you will make in Stage III is accurate pricing. You still have the dance of what price the market will allow but now you can work backwards to identify ways to decrease costs (time, non-value added steps, waste, etc.) and make a profit. Also you can look at the amount work required for each account and determine whom to replicate and whom to replace.

Key Issues - ​Owner Perspective:

1. Processes must be mapped to start - completing the "Processes Under Control" effort.
2. Which are our most profitable products & services - stop guessing.
3. Whom are our most profitable customers - necessary to Top Grade Accounts (EPISODE C5.002 AUDIT AND TOP GRADE ALL ACCOUNTS) and move into adjacent markets.
4. How well have we priced our offer - can we raise prices to improve profitability?

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What You Need to Know

1. Who are our most profitable customers?
2. What are our most profitable products (services)?
3. Are our products (services) correctly priced?

What You Need to Do
​One assumption we make when starting on this topic is the major or core processes related to production (or service delivery) have been mapped (see EPISODE A.021 THE OPERATIONS ELEMENT). If you have not broken your processes and made progress on updating, ABC is a waste of time.

1. Create a visual map of every major process - both internal and external.
2. Look for economies, improvements, reduction in steps in every process; we call it removing non-value - update the map.
3. Assign costs to each step - fixed costs (like power, rent, office staff etc) and variable costs (materials, labor, equipment maintenance).
4. Assign a margin to each step - start at 30% and if that makes the price too high, back off 1% at a time. If you have to go below 25%, go back and look for more economies in the process. Hint: the best companies are operating at 40+ margins.
5. Compute the total cost and gross margin (target price) for the specific product or service.

Shows

• Previous: EPISODE A3.002 WHAT STORY ARE YOUR FINANCIAL REPORTS TELLING ABOUT STAGE II?
• Next: EPISODE A3.004 What are the Results from Value Mapping fixed cost processes?