Activity-based management (ABM)

3.1. Example of customer cost analysis

To better understand how customer cost analysis is done, let's look at the following example.

Friends Company, a manufacturer of valves, has the following customer costs and cost rates:

Activity	Cost Driver	Cost Rate
Order taking	Orders taken	$25 per order
Order processing	Processed orders	$18 per order
Order processing	Processed items	$1.25 per item
Delivery	Number of orders	$120 per order
Delivery	Miles	$ 1 per mile
Expedited delivery	Number of expedited orders	$600 per order
Customer visits	Number of visits	$160 per visit
Monthly billing	First statement	$6 per statement
Monthly billing	Subsequent reminders	$15 per reminder
Sales returns	Number of returns	$80 per return
Restocking	Number of items returned	$5 per item returned

Friends Company also incurred the following costs: $120,000 per month in sales personnel salaries and $60,000 per month in office expenses.

The abovementioned costs, as well as the costs in the table above, can be grouped as follows:

Customer Cost Category	Customer Cost
Customer unit-level costs	Order processing (per unit)
Customer unit-level costs	Restocking
Customer batch-level costs	Order taking
	Order processing (per order)
	Delivery (per order)
	Delivery (per mile)
	Expedited delivery
	Sales returns
Customer-sustaining costs	Sales visits
	Monthly billing (1^st statement)
	Monthly billing (subsequent reminders)
Sales-sustaining costs	Sales office salaries
Sales-sustaining costs	Sales office expenses

To perform a customer cost analysis, let's continue the Friends Company's example. Friends Company has the following three customers: AutoCo, Motor, Inc., and Fast Bike LLC. The following data pertains to the aforementioned clients:

	AutoCo	Motor, Inc.	Fast Bike LLC
Total sales	$ 100,000	$ 360,000	$ 450,000
Sales discounts	2,000	8,000	14,000
Sales returns and allowance	12,000	15,000	65,000
Cost of goods sold	56,000	260,000	302,000

Number of orders	7	16	44
Average items per order	500	380	150
Delivery miles	20	35	46
Number of expedited orders	0	1	6
Number of customer visits	1	2	4
Number of reminders	0	1	4
Sales returns	2	3	12
Average units per return	30	34	20

Let's look in greater detail at the calculation of the total customer cost of Motor, Inc.

Motor, Inc.
Activity	Cost ($)	Calculation
Order taking	400	= $25 per order x 16 orders
Order processing (per order)	288	= $18 per order x 16 orders
Order processing (per item)	7,600	= $1.25 per item x 16 orders x 380 items per order
Delivery (per order)	1,920	= $120 per order x 16 orders
Delivery (per mile)	560	= $1 per mile x 16 orders x 35 miles
Expedited delivery	600	= $600 per order x 1 order
Customer visits	320	= $160 per visit x 2 visits
Monthly billing (1^st statement)	6	= $6 per statement x 1 statement
Monthly billing (reminder(s))	15	= $15 per reminder x 1 reminder
Sales returns	240	= $80 per return x 3 returns
Restocking	510	= $5 per item x 3 returns x 34 items per return
Total	$ 12,459

Using the formulas presented in the table above, we can calculate the customer cost of AutoCo and Fast Bike LLC. The customer cost analysis of the Friends Company's three clients is as follows:

	AutoCo	Motor, Inc.	Fast Bike LLC
Order taking	$ 175	$ 400	$ 1,100
Order processing (per order)	126	288	792
Order processing (per item)	4,375	7,600	8,250
Delivery (per order)	840	1,920	5,280
Delivery (per mile)	140	560	2,024
Expedited delivery	0	600	3,600
Customer visits	160	320	640
Monthly billing (1^st statement)	6	6	6
Monthly billing (reminder(s))	0	15	60
Sales returns	160	240	960
Restocking	300	510	1,200
Total	$ 6,282	$ 12,459	$ 23,912

After we have determined the cost of each customer, now we can perform the customer profitability analysis.

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