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The background of this case study is discuss Colgate Palmolive uses ABC and ABM system to decrease product costs and provide a reliable selling price when it faces a competitive market. For this we should collect some of the theoretical information about cost leadership and product differentiation, compare ABC with Traditional Costing. Then asses the key areas for improvement through ABC system and determine the steps to be taken for each activities application to case. Lastly, discuss advantages of using ABC systems to calculate the product cost is necessary for this case study.
Colgate was founded in 1806. William Colgate registered a company by his own name. Formal use the name of the Colgate-Palmolive Company after merged with Palmolive Company in 1953. Today, after 200 years of ups and downs, its products have been sold to more than 200 countries and regions and become a leading global consumer products company in the world.
Activity Based Costing (ABC) and Activity Based Management (ABM) both of them have been around for more than 15 years and have brought about tremendous changes in the cost management systems. Now like Colgate Palmolive, most of forward-looking companies has begun to implement or preparing to implement them.
Activity Based Costing
Young, S./2003/Readings in management accounting: ABC has provided companies a new way to limit costs to the products and customers driving them. It already indicates that the cost accounting model would help improve profitability.
Design products and processes.
Set up molding machine.
Operate machines to manufacture lenses.
Maintain and clean the molds.
Set up batches of finished lenses for shipment.
Distribute lenses to customers.
Administer and manage all processes.
Activity Based Management
Young, S./2003/Readings in management accounting: ABM describes management decisions that use activity-based costing information to satisfy customers and improve profits.
Product pricing and mix decisions
Cost reduction and process improvement decisions
Drury. C/2007/Management and cost accounting: Cost Leadership generates economic value by having lower costs than competitors. Company should understand their strengths and shortcomings and select the appropriate corporate strategy to meet customer needs. Emphasized reducing the price of the unit cost and its goal is to become a low-cost manufacturer in its industry.
Drury, C/2007/Management and cost accounting: Product Differentiation generates economic value by offering a product that customers prefer over competitorsââ‚¬â„¢ product. Company can avoid price competition through their tooth brush and tooth paste cause a special impression to customers. And on the basis of non-price competition, not only customerââ‚¬â„¢s special impression but also focus on packaging and advertising to encourage customers to believe products are better than competing products.
The key areas for improvement
Firstly, considering the aspect of product analysis, board of directors thinks highly of product cost. So the Colgate Palmolive should focus on a low cost using ABC system to calculate cost instead of traditional methods. Cost basing on traditional methods, single allocation criteria, always appears to be higher in high yield but low direct cost products than low yield but high direct cost. Tooth brush and tooth paste are the former type which is overestimated, so that price of products might be higher than others. Which should not be ignored is production process and designation process takes up almost 90% to 95% of the cost. So to achieve a fairer and accurate price, reducing the cost on designation is the most potential method (Heidmann, M 2008).
Secondly, value chain analysis. To judge an activity is necessary or not, the activity from production process to sell process increases in value or not is the key criterion. About inside value chain, if an activity is zero value-added, it must be eliminated to avoid unnecessary waste of cost. Or if an activity is low value-added, managers can choose to eliminate or improve the activity. About the outside value chain, operators need to point to find the lowest price for factor from upstream industry and the highest price for products from downstream industry. At the same time, the value chain of competitors is also an important reference condition (Chapman, C. & Hopwood. A. Shield. M. 2007).
Thirdly, activity analysis. Managers should order all the activities by the cost and choose several top-cost activities to analyze in detail. Then give out reasons and methods to improve. Necessity and effectiveness also should take into consideration, through analyzing every single activity, managers should eliminate those activities which are of low efficiency or useless for management and consumers.
Last, resource analysis. The cost of the resources consumed is usually equal with or less than the cost of the resource offered. A bit of idle resources belongs to one activity but they are not come in handy. Managers has better to consider carefully how to deploy those resources (Drury, C. 2007).
The key areas for improvement are product cost, value chain, activity, resource. Improve designation process to achieve a low cost and adjust accounting method. Resources in an activity which is idle need to be remove to other activities that are short of resource or need additional resources to enhance production efficiency. There are three questions in activity analysis. If it is necessary? If it is in a normal level of cost? If it is efficient? As for value chain, managers should make decision adjusting industry structure considering inside and outside value chain.
The steps to be taken for each activity
First step, confirm and measure the cost of all resources. All kinds of human, material and financial resources which belong to tooth brush and tooth paste producing process should be counted.
Second step, distribute resources to activities and allocate cost in costing pool. Confirm all resources of each activity. In another word, sort factor of cost according to activities. And then find out the resource driver for those resources, sort resources by activities. According to the result of classification, count the amount of resource in each activity. Create a table contain all the resources of a activity, gather all kinds of cost factor, then calculate total cost of a activity into cost pool (Young, S. 2003).
Third step, choose activity driver to distribute cost in the cost pool to products. Count total amount of activity driver for each activity. According to statistics, compute the distribution rate of manufacturing cost which belongs to per unit activity driver of each activity. Count the amount of activity driver that each product spends on. Finally it can come to the manufacturing cost of each kind of product (Young, S. 2003).
This method is different from traditional method. It allocates cost for products using various kinds of distribution modes. It is better to create tables to attain calculation results for each step so that it is convenient for managers to acknowledge information about manufacturing cost clearly and make decision.
The role that ABC system plays in achieving an increased national market
Enterprises aim to maximize the interests so to achieve economies of scale and high market share. Specific goal for an enterprise is to enforce cost leadership and product differentiation. It is important to decrease the cost of per unit product to enlarge the production scale. Price of products gets lower because of low cost. Elasticity of supply of manufacturer becomes an advantage in game. Consumers as the recipients can just receive the price and fell no unsatisfied. Another important factor is to refresh products and create new ideas for designing products. New shape, new functions and new taste can irritate consumers to try products and satisfy the demands of consumers persistently (Atkinson, A., Banker, R., Kaplan, R. & Young, S. 2003). This factor decides the market share and discourse power in business. Colgate Palmolive to achieve these aims, higher management level and efficient management structure is necessary. The circumstance requires Colgate Palmolive to explore and make use of ABC system.
ABC system not only offers accurate information about cost but also offers information about non financial for management. The connections between the two aspects also are reflected clearly. And it promotes that the range of financial management of a company is in accord with operation management. ABC system can make a company find new important chances through analyzing product, value chain, activity and resource. And it also helps to choose the best chance to decrease cost by offering accurate costing message. ABC system regards company as multiple functions of the combination of the value chain and centers on multiple functions to take on management (Bhimani, A. 2006). These ideas of management can help Colgate Palmolive fit with keen competition in national market especially Malaysian market. It can also achieve the goal of different cost for different objectives. Company offers financial returns only including inventory cost but when it comes to obtain allowance, company can offer another financial returns including manufacturing cost. In a word, ABC system enhances the ability of company in adapting and increasing (N. V. 2012).
The advantages of using ABC systems to calculate the product cost
The superiority of using ABC systems is evident comparing with traditional methods. The reasons are as follows:
Firstly, ABC system not only offers accurate information about cost but also offers information about non financial for management. ABC system concerns on activity rather than product. It concerns on finding out the reasons that causing cost changing instead of collecting quantitative index about products. When managers adjust the management tactics, it not only decrease the cost from the side of result, but also improve the reason that causing high cost. Even more, ABC system can deal with the problems about high cost fundamentally, and the quality of products and the future of market will not be influenced negatively (Hrvoje, P. & Ivana,D [on-line] April 2008).
Secondly, ABC system forms systematic management system. Control of cost usually includes forecasting of cost, cost decision, cost reduction and benefit cost analysis. ABC system makes all these aspects systematic and organism combination. ABC system gives seasonable message about cost decision. ABC system offers scientific reference for cost reduction. ABC system offers useful information for benefit cost analysis. Through following process of activity to attain dynamic reflection, ABC system offers seasonable, scientific, useful information for managers (Ali, U. [on-line] November 2010). A company usually ignores what is going on inside of it and how to collect cost information then to order it. Managers always do not know clearly their own company. ABC system makes a thorough investigation and study about inside so that managers combine inner cost analysis and outer market institution along with competitorsââ‚¬â„¢ advantage and disadvantage to adjust the stratagem for the company to win the game. So the administrative decision can play a better role in promoting the management of the company (Just, A. & Mahlendorf, M. D. (2009)).
Thirdly, ABC system considers company as a functional value chain. From upstream to downstream, supplier and consumer are all integrated into value chain of company. ABC system considers company as a multiple function of the combination of the value chain and company centers on multiple functions to operate. From the position of life-cycle process, ABC system not only focuses on cost management after completion and commissioning but also points to cost management during designation process before completion and commissioning. This advantage explores a huge potential in decreasing cost (Shafer, W. E. (2002)).
Finally, in one hand facing with rapid change of requirement, ABC system can offer company the ability to shorten the life-cycle of update products. It helps to produce new products and service during a market cycle and a consuming cycle. That means the company create profit with lower cost and shorter cycle to occupy more market share and explore new market. In the other hand, the flow of funds becomes swift and smooth. The system strengthens the ability that the company responds to risk and accommodates funds. It is a kind of reflection of vitality and brighter future development (Obermaier, R. & MÃÂ¼ller, F. (2008)).
In conclusion, activity based costing is that although activity based costing is a scientific approach, the method of implementation is complex, time consuming, and costly. It is recommended that the process of data collection and data entry requires substantial resources, and remains costly to maintain. It is also recommended that the Colgate Palmolive should reduce collection of unnecessary data and also to improve the work efficiency. ABC also might identify one distribution channel as non-remunerative, or an inspection as non-value adding. Such channeling or processes might be non-profitable, but placed in the first place to achieve some other strategic objectives. It is recommended that Colgate should understand their main objectives in Malaysian market and clear priorities to achieve the strategic objectives.
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