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When viewed as serving market segments, utilities differ little from manufacturing companies, where most costs are shared among products and processes.

Activity-based cost management has had a tremendous impact on manufacturing enterprises; and its use has spread to some service industries such as banking, insurance and health care. ABCM encompasses two well-known management concepts: activity-based costing and activity-based management. Now that electric utilities are gearing up for competition, it is time to ask if ABCM has any relevance in the public utility industry.

Automation, technology and computerization have shifted costs, making the typical manufacturing process less labor intensive and more capital intensive. This shift has changed the cost profile of many industries. No longer do direct materials and labor costs make up the major portion of total product cost. Instead, overhead, which is shared by many products and services, is the dominant cost. As a result, traditional approaches to overhead allocation that rely on direct labor as the allocation base have become highly unreliable. ABC was developed to improve that situation. It can be used to improve accuracy of cost information, allowing a company to develop a more competitive marketing strategy and better manage spending.

In a different era, it often was said that ABC would not prove applicable to a public utility because utilities sold only one product (em electricity, for example, or natural gas. If you wanted to know the kilowatt-hour cost of electricity, just divide the total costs of the power by the number of units produced. But utilities no longer enjoy the luxury of thinking in terms of a single product such as kilowatt-hours. With impending deregulation raising issues of impaired assets and stranded costs, the successful players in the electric utility industry will be those that develop marketing strategies based on reasonably accurate cost information. ABC serves that need, both in identifying activities, products and costs, and in forming the groundwork for a marketing strategy.

In short, ABC assigns costs to products by tracing overhead costs to "activities" (i.e., machining, production labor, quality control, order processing, etc.). Each product is charged based on the extent to which it used an activity. The result is a more accurate product cost, helping management decide which products to promote and which to de-emphasize. Some public utility customer segments, for example, demand more of the activities than do other segments. These characteristics are not accurately reflected in a customer segment costing approach that uses only kilowatt-hours or labor costs as the basis for allocating these shared costs.

The activity information necessary for ABC can also be used as a basis for process improvement often referred to as activity-based management. Instead of attributing the activity costs to cost objects such as customer segments, ABM breaks the activities into sub- activities and tasks and examines the interactions among and between the sub-activities and tasks. It also looks carefully at the nature of the tasks and the related cost, classifying them into value added and non-value added, which provides a basis for process improvement and performance measurement.

An Example:

Tracing Costs to Activities

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