The Waste of Activity-Based Costing (ABC) in the Service Sector

Monday, October 26, 2009 by Tripp Babbitt

During my lifetime I have witnessed two attempts at Activity-based Costing (ABC).  For those unfamiliar this is  an approach that flowcharts processes (activity) and then totals the costs of these activities.  Seems a reasonable approach to anyone trying to manage costs and productivity.

The method deployed is to interview workers involved with the process and find out how long each activity takes and what percentage of their time is attributable to each activity.  Each worker is allocated indirect costs (overhead) for things like lease expenses, information technology, human resources, etc.  The result is an activity cost.

The flaw of ABC is to assume that being active is being productive.  As managers like the idea that workers being active 100% of the time is to be efficient.  Such thinking brings the human robot to mind.

My personal experience has been attempts by accounting organizations coming in and doing organization-wide ABC.  The problem was at the end of the ABC exercise, I summed up the activity costs multiplied times the volume of actual activity and the costs did not come close to the organization’s total costs.  This was problematic, but by no means the end.

ABC treating all activity as work to be done ignores failure demand (demand from customers caused by failure to do something or do something right for a customer), duplication, errors, etc.  This is to manage costs instead of the causes of costs.

Where costs are high to deliver service, organizations still need to understand customer demand and the reasons for waste before making changes to the organization  Or they run the risk of making things worse.  To set targets for a piece or function of the process ignores the understanding of the end-to-end system and purpose.  

If a function or process is deemed too expensive it stands to be paid attention to by looking for cheaper outsourcing or shared services opportunities.  These also lead to increased costs as it disregards the end-to-end costs and waste that are not seen in the activity as already illustrated above.

My Vanguard partners in the UK found that the inventor of ABC Thomas Johnson changed his mind about the benefits of the technique after spending time at the Toyota plant in Georgetown.  He came to his senses regarding the foolishness of managing through costs.  My hope is that the US government and other private sector businesses will come to the same conclusion.  Millions are being wasted by conducting and taking action on the ABC approach.

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Tripp Babbitt is a speaker, blogger and consultant to service industry (private and public).  His organization helps executives find a better way to make the work work.  Download free from "Understanding Your Organization as a System" and gain knowledge of systems thinking or contact us about our intervention services at [email protected].  Reach him on Twitter at or LinkedIn at

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