Activity Based Costing at Amazon

This paper is a discussion on Activity-based costing (ABC), one of the costing methodologies used in business. The methodology essentially entails assigning a cost to the various activities of an organization, which range from planning and production to quality control, logistics, and distribution (Kaplan & Anderson, 2007). It also entails determining the amount of time required to perform the activities (Kaplan & Anderson, 2004). The cost and time are then used as a basis for determining the price of the organization's products or services. If properly implemented, ABC can deliver significant benefits to an organization, especially with respect to business performance and competitive advantage (Cokins, 2001). Focusing on Amazon, this paper discusses the use of time-driven ABC in e-commerce activities. First, a brief background of the organization is provided. Next, attention is paid to how a time-driven ABC system can be implemented in the organization and the associated benefits on business performance. The paper then examines how the ABC system can create competitive advantage for the organization in the marketplace as well as the potential impact of the system on online services compared to services provided via traditional channels.

Organizational Background

Amazon, an American multinational e-commerce and cloud computing firm, is the largest online retailer worldwide in terms of revenue and market capitalization. Operating out of its corporate headquarters in Seattle, Washington, the company has operations in several parts of the world including Canada, the UK, Germany, Netherlands, France, Italy, Australia, India, China, Brazil, and Mexico. The company serves tens of millions of customers, providing a broad variety of online services, including an internet marketplace, advertising, audio entertainment, educational programming, social cataloguing, as well as cloud computing. The online marketplace is the organization's major revenue earner. The website provides an e-platform for buyers and sellers to meet. Amazon offers thousands of products that can be purchased from the website, ranging from books and audio content to consumer electronics, clothing, fashion accessories, furniture, toys, video games, and household items. Founded in 1994 as an online bookstore, Amazon has become the world's largest player in the online retailing space. The company has extensively revolutionized the world of e-commerce.

Implementing ABC and Associated Benefits

Though the ABC method is traditionally used in the manufacturing industry, it can as well be used in the service sector (Stefano & Filho, 2013). By adopting the ABC system, Amazon can reap significant benefits. Nonetheless, this can only be achieved with proper implementation. In many cases, adopting ABC ends up being a disaster largely due to poor implementation. The first step in implementing ABC is to have a comprehensive understanding of the management of the system and their role throughout the entire process (Cokins, 2001). Without management commitment and understanding of the system, is quite unlikely that the undertaking will be fruitful and sustainable in the long-term.

It is important to conduct a pilot-run first, prior to rolling out the system in full (Kaplan & Anderson, 2007). Indeed, a pilot-run is often more important for large organizations. Amazon is a large organization, which makes piloting appropriate. The pilot-run may involve one of the departments or business units, especially the least profitable one. Though targeting the least profitable department appears risky, it may provide an opportunity to improve the department through ABC-oriented management. For Amazon, the customer support department can be used to test the system, for instance. The department is involved in, among other activities, processing and responding to customer complaints. A pilot run enables the organization to gain a better understanding of the system before full implementation, especially with respect to its successes and failures. For instance, success of the system in the customer support department or unit would mean that the rest of the organization could benefit from the system as well.

To implement the system, the management can create a team to supervise, coordinate, and oversee all related processes (Cokins, 2001). Having a team would be of significant advantage in terms of ensuring accountability. At times, however, it may be more helpful to hire an independent, external consultant with extensive experience in the area. An important role of the team or the consultant would be to identify and assess the activities that require revision so as to optimize costs and profit margins (Kaplan & Anderson, 2007). This entails selecting activities that need activity-based costing, identifying aspects of the activities that involve unnecessarily huge costs, and determining the activities fixed and variable costs. More fundamentally, the unit times associated with each activity must be determined (Kaplan & Anderson, 2004). Activity identification and evaluation is a particularly important step, as some activities may not appear to be costly superficially.

For Amazon, typical activities may include order processing, shipping, customer support, and addressing complaints. These activities involve costs such as personnel, information technology, and telecommunication costs. In addition, each of the activities involves a certain amount of time. For instance, addressing complaints may take up 40% of the time, and customer support 20% of the time. With the help of an ABC application, calculations are then done to provide a basis for management decisions. The decisions may involve eliminating some activities or optimizing costs, for instance.

If properly implemented, ABC can deliver significant benefits to the organization. ABC offers a different perspective of the costs an organization incurs in producing its products or services (Kaplan & Anderson, 2007). This can be a valuable way of optimizing profit margins. In an environment where business organizations are striving to work with tighter and leaner budgets, ABC can prove advantageous. The organization would do away with non-value adding and unnecessary activities, ultimately improving the bottom line. ABC also supports product/service and customer profitability analyses, continuous improvement, and other performance management processes (Kaplan & Anderson, 2004). It is, however, important to note that ABC is not a quick-fix. The organization must be more focused on the bigger picture as opposed to short-term gains if the intended outcomes are to be achieved (Kaplan & Anderson, 2007).

Competitive Advantage

ABC can be a crucial source of competitive advantage for Amazon. First, ABC pays attention to cost drivers, unlike conventional costing, which focuses on labor hours and other volume drivers (Kaplan & Anderson, 2007). This gives the organization a better understanding of its costs. With a better understanding of cost drivers, the organization can make more effective pricing decisions, thereby driving customer value. Amazon operates in a stiffly competitive environment. The company competes with equally powerful players like eBay, Apple, Netflix, and Google. Further competition comes from retailers such as Walmart, Best Buy, Sears, and Target. By adopting the ABC system, Amazon can counter competitive rivalry. The company would be better placed to offer better prices, thereby attracting and retaining customers. In an environment with multiple players, the importance of competitive pricing cannot be overemphasized. While still keen on quality and value for money, customers desire affordable prices. ABC provides a valuable way through which such a balance can be achieved.

Competitive pricing would in turn have a positive impact on business performance (Cokins, 2001). The organization would be better placed to not only attract and retain customers, but also expand market share, improve revenue performance, and increase profitability. These are crucial performance indicators for any business organization. With the immense competition Amazon faces, which may be even greater in the future, ABC may be important for enhancing the organization's position in the marketplace.

Impact on Online and Traditional Retailing

Time-driven ABC can significantly affect management decisions regarding channels for service delivery. Traditionally, services are delivered via brick and mortar locations. With technological advancements, however, services can now be delivered online (Kaplan & Anderson, 2007). Amazon has been a leader in this regard, offering an online marketplace where buyers can purchase products at the click of a button obviating the issues of time and location. This offers the clients a great deal of convenience and flexibility in shopping. It offers even greater advantages from a cost perspective. An online store minimizes the substantial costs of operating a physical store. In recent times, however, Amazon has been opening physical bookstores, with a view to disrupting the conventional retail experience. This could somewhat be seen as a retrogressive move at a time when online retailing has been termed as the future of retailing. Nonetheless, with knowledge of ABC, the company can set-up brick and mortar stores in a more cost-effective manner. The company can optimize the related activities more effectively and costs to deliver services at even more competitive price.

Conclusion

Overall, ABC is a valuable way through which an organization can improve business performance and competitive advantage in the marketplace. By optimizing costs and eliminating activities that do not add value to the customer, an organization can deliver more competitive prices. This has immense potential to expand customer base, enhance customer retention, increase profit margins, and improve the bottom line. Adopting the ABC system may, therefore, be beneficial for Amazon given the intense rivalry the company faces. With the system, the company can enhance its position in the marketplace by delivering more competitive prices. Nonetheless, discretion must be exercised in the implementation of the system, with due diligence on management commitment and gradual implementation.

References

Cokins, G. (2001). Activity-based cost management: an executive's guide. Hoboken: John Wiley & Sons.

Kaplan, R., & Anderson, S. (2004). Time-driven activity-based costing. Harvard Business Review, November Issue.

Kaplan, R., & Anderson, S. (2007). Time-driven activity-based costing: a simpler guide and more powerful guide to higher profits. Boston: Harvard Business School Publishing.

Stefano, N., & Filho, N. (2013). Activity-based costing in services: literature bibliometric review. Springer Plus, 2, 80.