Second-generation Cost Models
going beyond ABC, new product/service cost models improve accuracy and encourage entrepreneurship

Speech Abstract

There's a big difference between first- and second-generation cost models, both in financial accuracy and organizational impacts.

Cost models assign all a department's costs to its products and services. Product/service costing provides a basis for budgeting, demand management, chargebacks or allocations, and outsourcing benchmarking.

First-generation cost models, such as activity-based costing (ABC) and "cascade" approaches, treat internal support services as "cost pools" which are amortized to products and services sold outside the department.

Second-generation cost models treat every group within a department as an entrepreneurship, and internal support services as "sales" within the department. Indirect costs flow through a spider-web of internal relationships until they ultimately are applied to external products and services.

Recent research has measured significant distortions resulting from first-generation cost models, often exceeding 30 percent. Some products and services are severely over-priced, while others do not contribute their fair share to indirect costs.

Second-generation cost models are far more accurate.

Beyond that, there are other benefits of treating every group as a business within a business.

Cost-saving opportunities are discovered when managers take responsibility for what they "buy" from their peers, and when internal entrepreneurs suggest creative new ways they can serve the department.

Furthermore, when support groups become customer focused, the result is improved service and enhanced teamwork.

This presentation explains the difference between first- and second-generation cost models, the findings on distortion, and the benefits of the new second-generation cost models.

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Outline

• Why calculate internal product/service costs

• Components of cost

• First-generation models

• Resulting distortion

• Case studies

• Second-generation models

• Benefits of second-generation models