Logistics is a source of competitive advantage. According to Porter, with cost leadership the business firm can gain competitive edge over its business rivals. Logistics has much scope for cost reduction and enhance the customer service simultaneously. Hence, logistics management must understand how the behaviour of one cost differs from the other.
The conventional method of cost accounting refers to the allocation of manufacturing overhead costs to the products manufactured. The conventional method assigns the factory’s indirect costs to the items manufactured on the basis of volume such as the number of units produced, the direct labour hours or the production machine hours. In the production process, the machine hours are used as the base for allocation of the manufacturing overheads to products.
Hence, it is implied that the machine hours are the underlying cause of factory overheads. The only cost driver in this case is machine hours. In case a manufacturer wants to know the true cost to produce specific products for specific customers, the traditional method of cost accounting is inadequate. In activity-based costing (ABC) many cost drivers are used to allocate a manufacturer’s indirect costs. A few of the cost drivers that would be used under ABC are machine hours, number of machine set-ups, the quantity of material purchased/used, the number of engineering change in the order and so on.
Source: Sople V.V (2013), Logistics Management, Pearson Education India; Third edition.
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