ABC Costing — The Pricing Problem Hidden in Your Standard Cost System

The Costing System That Hides Problems

Traditional standard costing allocates overhead as a percentage of direct labour or machine hours. The logic was defensible 40 years ago when overhead was a smaller fraction of total cost and product variety was limited. Neither condition holds for most manufacturers today. Overhead is often 50-60% of total cost, and product ranges of hundreds or thousands of SKUs mean that allocation by a single driver creates systematic distortion.

For a textile machinery manufacturer, this distortion was severe. Their costing system allocated overhead as a percentage of direct labour cost. High-complexity, low-volume products with significant engineering support and quality control overhead were being allocated the same overhead rate as simple, high-volume standard products. The result: their highest-complexity products were systematically undercosted, and their simplest products were systematically overcosted.

What We Found When We Rebuilt the Costing

When we ran the ABC analysis — mapping actual activities to actual cost drivers for each product — 30% of the product range was priced below its true cost. Not marginally below. Some products had true costs 18-25% above their selling price. These products looked profitable in the standard cost system because they were absorbing only their proportional share of overhead when their actual consumption of overhead activities was three to four times higher.

The company had been growing these product lines based on volume and apparent margin. Marketing was pushing products that the business was losing money on with every unit sold. The sales team was incentivised on revenue, not contribution margin. The finance team's cost system was confirming the distortion rather than challenging it.

The margin recovery was 300 basis points — achieved through repricing the undercosted products, discontinuing the worst offenders where market pricing wouldn't support the true cost, and shifting marketing investment toward the genuinely high-margin product lines. No revenue growth was required. The business simply stopped subsidising bad business with good business.

Why This Matters More in a Reshoring Environment

In a reshoring context — where manufacturers are bringing production back from low-cost geographies — cost accuracy becomes critical. A product that was profitable at Asian manufacturing cost may not be profitable at domestic cost. Standard costing systems that don't properly allocate the higher domestic overhead will continue to show the product as profitable while it eats margin.

The ABC rebuild is not a one-time exercise. Cost structures change as product mix changes, as automation changes the ratio of labour to overhead, and as volume changes the fixed cost absorption. Building ABC into the ongoing costing cadence — quarterly recalibration of activity rates — is what makes the investment durable.

The Mechanics of an ABC Build

Step one: identify all activities that consume resources — engineering support, quality inspection, production setup, procurement, customer service. Step two: calculate the actual cost of each activity pool. Step three: identify the cost driver for each activity (number of engineering hours, number of inspections, number of setups). Step four: calculate the activity rate per driver unit. Step five: assign costs to products based on actual driver consumption. The result is a cost per product that reflects actual resource consumption rather than a blended allocation.