Activity-Based Costing - ABC

Fairness. That's what ABC tries to assess and allocate.

The activity of producing profits for the company is the key driver here. That's the goal. That's what shareholders want. So then to optimize those profits (and yes, these are long-term in thinking, not just profits next year), a company has to assess where its precious resources are being spent, and then what that spend is producing.

So, for example, a $50 million espresso-machine-making-robot named Suzy makes gorgeous $10,000-at-retail espresso machines. The company sells three of them a day at five grand in profit contribution each. But the company also has a $5 million machine that makes way cheaper, normal coffee machines that sell at retail for $500 each...but which sell 1,000 a day at $100 in contribution. Both machines are wearing out.

So the question: Does the relatively light activity in profit production garnered by the $50 million Suzy warrant re-upping for a new machine? Or would the money be better spent on the lower end machine?

If it's just up to the math, the lower machine wins by a mile, because it consumes way fewer resources and produces way more gross profits. But what ABC misses in its logic is the fact that Suzy is "the" brand...the top coffee maker in the world. And the reason that soooo many cheaper coffee machines are sold is that buyers aspire to be just a little like Suzy. So having that super-high-end machine out there, inspiring coffee makers around the world, carries untrackable-by-math-only value add.

The right answer? Yeah, it's hard to run a company. Go figure it out yourselves and then let us know, please. We worship coffee here at Shmoop.