Want FREE Templates on Strategy & Transformation? Download our FREE compilation of 50+ slides. This is an exclusive promotion being run on LinkedIn.


Jeff Bezos, CEO of Amazon, famously remarked, "Your margin is my opportunity." Basking in the truth of this statement, companies that desire to compete in the cut-throat corporate world must find ways to decrease costs while increasing value. One such method developed in recent years that has demonstrated its competency and efficacy is Activity-Based Costing (ABC).

Understanding Activity-Based Costing

Within the context of Strategic Management, Activity-Based Costing represents a costing technique that assigns indirect costs to activities, then links these costs to the entities causing the demand. Unlike traditional cost-accounting systems that broad-brush overhead costs, ABC attributes these costs to the very activities that incur them, offering greater accuracy and leadings towards more efficient cost management.

Unleashing the Power of Activity-Based Costing

A successful implementation of ABC can turn a company's financial ship around in multiple ways:

Implementing Activity-Based Costing

Despite the apparent benefits, the ABC methodology should not be implemented lightly. It involves a three-step strategy:

  1. Activity Identification: This step involves documenting all actions associated with the production of a good or service.
  2. Cost Assignment: Here, costs are allocated to each identified activity on a rational basis.
  3. Cost Analysis: Finally, costs attributed to each activity must be analyzed to note inefficiencies, draw insights, and formulate potential cost reduction strategies.

Taking a Step Further - Activity Based Management

What could potentially maximize the benefit of ABC, even more, is the introduction of Activity Based Management (ABM). ABM combines ABC data with strategic objectives to enhance Operational Excellence and Competitive Advantage. ABM uses ABC information to make strategic decisions about product mix, pricing, process improvement, and more.

The Digital Transformation of Activity-Based Costing

In the recent past, the advent of technologies like Cloud Computing and Big Data Analytics has transformed the landscape of Activity-Based Costing. Integration with Business Intelligence platforms and harnessing Machine Learning strategies have added accuracy and speed to ABC, allowing businesses to generate real-time insights and make more informed and rapid decisions.

The Drawbacks

Like any other management strategy, it's essential to understand that Activity-Based Costing is not a one-size-fits-all solution. Its limitations should be noted in terms of cost and complexity of implementation, employee resistance due to potential job redundancies, and potential utility only in certain sectors where overhead costs significantly influence final product prices.

Final Thoughts

While Activity-Based Costing is not new, its full potential is yet to be recognized and harnessed in many sectors. As markets become increasingly dynamic and competitive, ABC and ABM could emerge as potent tools in the corporate armory, provided that their limitations are earnestly considered and their execution tactfully handled. McKinsey's body of work suggests that the strategic planning and the digital transformation of ABC can influence Risk Management and Performance Management positively, proving beneficial in the long run.


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.

Browse our Business Toolkits
to quickly find the documents you need.
Each business toolkit is a collection of documents around a common management topic.


  Show all available toolkits.

Download our FREE Strategy & Transformation Framework Templates

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.