Setting prices, determining hard and soft costs, and figuring out overhead expenses are a few of the basic tenets of business. Unfortunately, not all companies get it right. In fact, Tom Pryor has seen a lot of distributorships in the last few years who seem determined to live in the dark ages, working with pricing models that were developed decades ago and never updated.

To those distributors, Pryor suggests a switch to activity-based costing. "I work with a lot of different distributors in various industries," says Pryor, president of Arlington, Texas-based ICMS, Inc., a training and consulting firm that specializes in helping organizations improve financial results using ABC. "When I ask them how they came up with their pricing methods, the answer is usually ' "someone who worked here 15 years ago developed it, and he's no longer here.' "

The acronym "ABC" itself may be elementary, but the words that stand behind it can be somewhat intimidating for the average hose distributor. Put simply, ABC is a systematic, cause and effect method of assigning the cost of activities to products, services, customers or any cost object.

ABC systems trace costs using multiple allocation methods in a "bill of activity" format, frequently called "cost drivers." Pryor says numerous organizations across various industries today use ABC for product costing, target costing, service pricing, customer profitability analysis and product line profitability analysis.

Pryor says that while most hose distributors know the costs they're shelling out for products and labor, very few know the actual cost of a sales transaction. "They know the cost of the salesperson and the workers, but they don't know the cost of the work," Pryor explains. For distributors, Pryor says ABC makes sense because the total cost of implementation for a small outfit is about $5,000, but the payback is at least 4:1.

To get the process started, Pryor says distributors must ask themselves three questions: Which 20 percent of our customers provide 80 percent of our pre-tax profit? How much does it cost to process an order? How profitable can I be if we eliminate:

• non-value-added labor and overhead waste;
• unprofitable customers; and
• unprofitable suppliers?

From there, it's a matter of figuring out how to maximize the company resources and allocate them to tasks that actually make the enterprise money.

Tim Clarke, president of Netherland Rubber in Cincinnati, sees ABC as a valuable internal tool for hose distributors, but says extending the process out to the customer probably doesn't make sense unless that customer relationship is solid and healthy. Giving the customer too much information about specific costs and functions, he adds, could put the distributor in a precarious position when it comes to customer pricing.

Clarke has been using some form of ABC in his own company for 12 years, and says the concept allows Netherland Rubber to trace its monthly and yearly costs as they relate to sales. He can then access the information in a single, comprehensive report that shows labor costs, inventory costs, warehouse costs and other measures.

Bob Doig started using ABC at his distributorship in 2003, and says he's already reaping the benefits of the switch. CEO of The Doig Corp., in Cedarburg, Wis., Doig says he heard about ABC at a trade association gathering and decided it would make a good addition to his company's continued improvement quality process. He started by identifying the value-added and non-value-added segments of the business, and figuring out which functions were making money, and which were not.

"We were able to identify which tasks we were doing for no apparent reason, then simplified some of those tasks," says Doig, who implemented ABC throughout the whole company. Some of the tasks are mandatory — such as driving to a customer location to make a sales call — but the process got Doig and his team thinking about which customers could be served just as well by phone, thus saving both time and money for the sales reps and the company as a whole.

"We discovered a way to make ourselves a lower-cost producer by identifying which tasks added value, and which ones didn't," says Doig. "We also improved our quality by measuring primary jobs (the job that the specific employee was hired to handle) versus secondary jobs (other tasks that the employee handles), and were able to rearrange responsibilities."

Doig advises distributors to consider ABC in some shape or form, and says using a consultant, software program or other tool to assist in the changeover can be invaluable.

"You can save yourself a lot of time and aggravation," says Doig. "Because ABC can be such a culture change for some companies, it makes for an easier sale if you have an expert from the outside come in and run through the process with your staff."

Pryor says any distributor that is unhappy with their current performance and ready for a change should definitely consider ABC. Problem is, when it comes to ABC, distributors' biggest challenges are a lack of time, resistance to change and a herd mentality that convinces them to hold off on implementing ABC until others in the industry dive in.

The distributor that works through those hurdles, says Pryor, can ensure that implementation runs smoothly by "keeping it simple" (stick to less than 50 company activities, for example); enforcing repetition and creating a buy-in attitude amongst employees.

"ABC can provide one-time benefits, but it works best when it's used daily," says Pryor. "Create a 'want to' instead of a 'have to' attitude among employees, and reward those who use ABC and penalize those who don't."