Getting a handle on manufacturing costs, particularly in large corporations, can be a complex task. Traditional cost systems assume long production runs with static specifications, but this is not as relevant in many of today's dynamic environments where there are smaller lot sizes, a high broad mix and frequent changeovers. New approaches to costing are therefore gathering interest, particularly if they hold promise of improving plant performance.

One approach attracting attention is activity-based costing, or ABC. It segregates the expenses of indirect and support services, such as labor and machine-hour costs, and assigns these expenses based on the drivers of these activities. This provides managers with timely information about the costs of resources, but does it lead to direct improvements in plant performance?

Prior research suggests the evidence is mixed and often based on subjective factors such as managers' beliefs about the financial benefits of ABC. Tai-Yuan Chen of HKUST and his co-authors Rajiv D. Banker and Indranil R. Bardhan have taken a new look focusing on process-level performance measures rather than firm-level ones, and they show ABC can be beneficial - under certain circumstances.

"The adoption of ABC by itself may not provide much direct value, but it may facilitate the implementation of advanced manufacturing practices and other organizational capabilities which, in turn, may be associated with sustainable improvements in plant performance," they say.

"In our study, we focus on world-class manufacturing practices, such as just-in-time manufacturing, continuous process improvement, total quality management, competitive benchmarking and worker autonomy, which allow plant managers to adapt to the volatility and uncertainty associated with changes in customer demand and business cycles in agile manufacturing environments."

"ABC may provide the process infrastructure necessary to support managerial decision-making capabilities in these fast-paced circumstances by providing timely information about the costs of resources, especially when production runs are shorter or the production method changes."

The authors argue that ABC's beneficial impacts are completely mediated by world-class manufacturing and find support in tests they carry out on data from a 1999 survey of 1,250 U.S. plants, of which 248 had adopted ABC.

Comparing ABC and non-ABC plants in terms of the change in manufacturing costs, quality as measured by first-pass quality yield, and the manufacturing cycle and lead time, they show that world-class manufacturing on its own is associated with improved plant performance and that plants that implement ABC are more likely to adopt world-class manufacturing. However, there is no evidence to show ABC on its own makes a significant improvement in plant performance. While ABC can improve transparency and the accuracy of information, it is only associated with performance improvements in the presence of world-class manufacturing.

"Our findings emphasize the need for firms to strengthen their manufacturing capabilities when making an investment to implement ABC systems as ABC is unlikely to result in improved performance by itself. Plants may be able to reap significant benefits by combining ABC implementation with the deployment of advanced manufacturing practices," they say.