James P. Womack, founder of Lean Enterprise Institute, famously remarked, “You’re either known for the problems you create or the problems you solve.” Product costing, a significant aspect of Strategic Planning and Performance Management, is undoubtedly one of the areas we need to solve to ensure operational success.
Understanding Product Costing
Product costing is an accounting process that assigns costs to individual products or services, providing visibility into each item's actual cost of production. In essence, it lays out exactly what you spend to make, sell, and maintain each product—giving you a clear picture of where you are allocating resources and, ultimately, informing your pricing strategy.
The Role of Product Costing in Strategic Management
Optimal Pricing Strategy is a fundamental pillar of effective Strategic Management. As such, a deep understanding of every cost associated with your product is key. Accurate product costing enables organizations to set prices correctly, maintain healthy profit margins, identify non-performing products, and make informed decisions about product development and growth strategies.
The Importance of Cost Allocation
At the heart of product costing lies the principle of cost allocation. This is the process of assigning costs that are indirect or hidden to the actual products or services. Some costs, like raw materials or direct labor, are easy to assign. Others, such as overhead or shared expenses, are more difficult, requiring a method of cost allocation to ensure accuracy.
Methods of Cost Allocation
Direct Allocation: This method assigns costs directly to each product based on a clear, identifiable relationship. For example, assigning the cost of raw materials directly to the products they create.
Step-Down Allocation: This process begins by allocating the costs of departments that directly support the production process; then, those departments' costs get allocated amongst other enterprise segments.
Reciprocal Allocation: This approach is the most comprehensive, as it considers mutual services provided between different departments. It is also the most complex, as it requires advanced calculations or iterative methods to ensure each cost gets adequately allocated to each product.
Choosing the Right Product Costing Method
Choosing the right Product Costing method can have a significant impact on your Profitability Analysis and Risk Management. It should align with your strategic goals, reflect the complexity of your operations, and take into account the product's lifecycle. The most commonly employed methods include:
Job Costing: Suitable for enterprises that produce custom, unique products or jobs.
Process Costing: Ideal for companies that mass-produce identical or similar products.
Activity-Based Costing (ABC): This method takes into account all activities associated with production and is beneficial for organizations where overhead costs represent a significant portion of total costs.
Achieving Operational Excellence with Digital Transformation
In recent years, advanced analytics, automation, and machine learning technologies have been driving Digital Transformation in product costing. These digital tools offer the potential for more accurate, real-time cost insights, enabling organizations to respond rapidly to market changes, reduce waste, improve decision-making, and deliver increased value to customers.
Pitfalls and Common Challenges in Product Costing
While effectively managing product costs can drive operational excellence, it is not without challenges. Some of the most common pitfalls include: failing to account for all costs, inaccurately allocating overhead costs, and ignoring the impact of external factors such as market volatility and supply chain disruptions. But with the right cost allocation method, clear strategic objectives, and leveraging the power of Digital Transformation, organizations can overcome these hurdles and reap the rewards of efficient product costing.
CUSTOMER TESTIMONIALS
"I have used FlevyPro for several business applications. It is a great complement to working with expensive consultants. The quality and effectiveness of the tools are of the highest standards."
– Moritz Bernhoerster, Global Sourcing Director at Fortune 500
"Flevy is now a part of my business routine. I visit Flevy at least 3 times each month.
Flevy has become my preferred learning source, because what it provides is practical, current, and useful in this era where the business world is being rewritten.
In today's environment where there are so many challenges and there is the need to make the right decisions in a short time, with so much scattered information, we are fortunate to have Flevy. Flevy investigates, selects, and puts at our disposal the best of the best to help us be successful in our work."
– Omar Hernán Montes Parra, CEO at Quantum SFE
"One of the great discoveries that I have made for my business is the Flevy library of training materials.
As a Lean Transformation Expert, I am always making presentations to clients on a variety of topics: Training, Transformation, Total Productive Maintenance, Culture, Coaching, Tools, Leadership Behavior, etc. Flevy usually has just what I need to make my point.
It is well worth the money to purchase these presentations. Sure, I have the knowledge and information to make my point. It is another thing to create a presentation that captures what I want to say. Flevy has saved me countless hours of preparation time that is much better spent with implementation that will actually save money for my clients."
– Ed Kemmerling, Senior Lean Transformation Expert at PMG
"FlevyPro provides business frameworks from many of the global giants in management consulting that allow you to provide best in class solutions for your clients."
– David Harris, Managing Director at Futures Strategy
"As a small business owner, the resource material available from FlevyPro has proven to be invaluable. The ability to search for material on demand based our project events and client requirements was great for me and proved very beneficial to my clients. Importantly, being able to easily edit and tailor the material for specific purposes helped us to make presentations, knowledge sharing, and toolkit development, which formed part of the overall program collateral. While FlevyPro contains resource material that any consultancy, project or delivery firm must have, it is an essential part of a small firm or independent consultant's toolbox."
– Michael Duff, Managing Director at Change Strategy (UK)
"As a consultant requiring up to date and professional material that will be of value and use to my clients, I find Flevy a very reliable resource.
The variety and quality of material available through Flevy offers a very useful and commanding source for information. Using Flevy saves me time, enhances my expertise and ends up being a good decision."
– Dennis Gershowitz, Principal at DG Associates
"I have found Flevy to be an amazing resource and library of useful presentations for lean sigma, change management and so many other topics. This has reduced the time I need to spend on preparing for my performance consultation. The library is easily accessible and updates are regularly provided. A wealth of great information."
– Cynthia Howard RN, PhD, Executive Coach at Ei Leadership
"As a niche strategic consulting firm, Flevy and FlevyPro frameworks and documents are an on-going reference to help us structure our findings and recommendations to our clients as well as improve their clarity, strength, and visual power. For us, it is an invaluable resource to increase our impact and value."
– David Coloma, Consulting Area Manager at Cynertia Consulting
SELECT CUSTOMERS
Since 2012, we have provided best practices to over 10,000 businesses and organizations of all sizes across the world—in over 130 countries.
Below is just a very small sample of our customer base.
Did you know?
The average daily rate of a McKinsey consultant is $6,625 (not including expenses). The average price of a Flevy document is $65.
Download our free compilation of 50+ Strategy & Transformation slides and templates. Frameworks include McKinsey 7-S Strategy Model, Balanced Scorecard, Disruptive Innovation, BCG Experience Curve, and many more.
Download our free compilation of 50+ Strategy & Transformation slides and templates. Frameworks include McKinsey 7-S Strategy Model, Balanced Scorecard, Disruptive Innovation, BCG Experience Curve, and many more.