When attempting to create value, manufacturing companies often jump into operational improvements or alternative sourcing arrangements to achieve cost savings. And in many cases, they don’t realize the expected outcome. Why? Decision-makers on the plant floor typically focus on what they understand best — things such as increasing throughput on a machine, adding more people, etc. — but lack an accurate cost baseline to support their decision. This can result in problems such as increasing throughput on a line only to create more capacity for which there was no demand. Or perhaps shifting production to a supplier or another country based on incorrect cost drivers, only to find costs actually increased because freight costs outweighed any labor synergies. There are countless examples of value creation initiatives that produce minimal results. More often than not, the failures are attributable to an improper allocation of costs in the production environment with decisions based on data that’s outdated or wasn’t valid to begin with.
Simplified costing methods are a major red flag
Relying on simplified costing methods in complex operating environments is a major red flag. For example, applying labor hours into machine‑intensive environments, or machine hours where material burden dominates, can create serious cost distortions. These inaccuracies often cause high‑volume, low‑complexity products to subsidize low‑volume, high‑complexity ones, masking true profitability and eroding EBITDA through poor pricing, product mix, and capital allocation decisions. In many cases, they simply waste operational improvement opportunities by focusing on the wrong process or SKU.
Ensure data accuracy with activity-based costing
When embarking on any value creation initiative, it’s critical to start with an accurate cost baseline. To achieve this, we recommend using an activity-based costing (ABC) approach. Unlike conventional costing, which relies on broad averages, ABC assigns costs based on actual activity drivers — labor and machine hours, square footage, utility consumption, etc. — creating a more accurate baseline. The resulting precision enables you to confidently prioritize operational improvements, optimize your supply chain, and target actions on high-volume, low-margin, or flagship products.
Even if you’re 100% confident in your current cost and margin data, validating the underlying assumptions is still a best practice. In situations of high confidence, a full costing review may not be necessary, but proving your data’s accuracy will ensure your operational improvements deliver maximum ROI. This best‑in‑class approach to value creation ensures decisions are driven by data that is both accurate and truly meaningful.
ABC replaces guesswork with a surgical approach to gathering data. Here are some key ways ABC can impact your operational improvements.
- Plant layout, material flow, and process flow: Inefficient layouts and flows lead to excess handling, wasted movement, and hidden costs. A layout change based on intuition can inadvertently increase handling costs, negating your expected savings. ABC reveals the true cost of each step, guiding redesigns that minimize waste and optimize flow. The result is streamlined operations, reduced costs, and improved throughput.
- Plant throughput and overall equipment effectiveness (OEE) improvement: Bottlenecks and downtime in manufacturing lines can significantly reduce output and profitability. Without proper costing you may opt for mitigation efforts that focus on low-impact areas, leaving major bottlenecks unresolved or even create new ones. Accurate costing data can properly quantify the financial impact of lost time and help prioritize fixes where they matter most. The result? Higher OEE, increased output, and better ROI on improvement initiatives.
- Automation investments: Automation investments are costly and must be precisely targeted for maximum benefit. Without proper costing, automation can be deployed where it’s least effective, wasting capital and missing bigger opportunities. ABC will properly identify high-cost manual processes, enable precise ROI calculations, and provide the needed data to prioritize your automation decisions, delivering real savings and productivity gains.
- Make vs. buy decisions: Deciding whether to produce in-house or outsource is complex and potentially risky. If you’re thinking about outsourcing work that’s a part of your core business, a good starting point is to ask how a competitor can perform it with their fixed costs and margin added and still be more competitive than you. Generally, they can’t, and the explanation lies in how you’re calculating your costs. Comprehensive ABC encompassing direct costs, indirect costs, quality, and logistics will enable true apples-to-apples comparisons, and may save you from outsourcing what’s actually cheaper to make internally. Conversely, it could save you from failing to outsource in areas where it makes sense and will improve your margins. There’s an operational sweet spot for every manufacturer. There may be some “outlier” products that perhaps you should consider outsourcing (or not doing at all), while focusing on your core group of “center of excellence” products. But without knowing what your true costing is for all of these items you have no idea where to start and stop in that core grouping.
Cost clarity as the foundation for value creation
As your products, processes, and supply chains grow more complex, relying on outdated or overly simplified costing introduces risk at every decision point. ABC supports the operational discipline needed to measure true performance, focus improvement efforts where they matter most, and adapt as the business evolves. Investing in this level of cost transparency will leave you better positioned to execute change effectively, scale profitably, and avoid the costly missteps that derail many transformation initiatives.
