Product Profitability in Pharma Industry – ABM/ABC

This article is based on logic that goes behind the product profitability using activity based management/costing in a manufacturing plant that makes medicines. R&D costs will not be shown since this company pays royalties to licencor to utilize the formula/licensed technology.

Step-1: Define/ identify line items on the ledgers

 Ten major ledger items have been selected.

Step-2: Trace/separate the direct costs andindirect costs of products (selected cost object) from the identified ledgers

 

Step-3: Identify activities in two categories- support activities and operating activities

By the operating activities we mean here the primary activities in the value chain (or similar to that activities) and the supporting activities are the activities that support these primary value chain activities.

In a pharmaceuticals manufacturing company the following major activities are classified into two categories:

Table 2

Sl.	Activity	Activity types	Comments
1.	In-bound logistics	Operating/ primary	Receiving and warehousing of materials, issue of materials to the manufacturing  etc.
2.	Machining	Operating/ primary	Machine set up, machine run for production
3.	Quality Control	Operating/ primary	Checking and ensuring quality of materials received before it issues to production, quality checking of finished goods before it is packed for warehousing
4.	Packaging	Operating/ primary	Packing of finished products for warehousing
5.	Out-bound logistics	Operating/ primary	Warehousing and distribution of finished products
6.	Plant administration and supervision	Supporting	To administer and supervise other activities at plant
7.	Selling & distribution	Operating/ primary
8.	Marketing	Operating/ Primary
9.	Accounting	Supporting
10.	IT Activities	Supporting
11.	Human Resource	Supporting

 

Step-4: Trace/allocate indirect costs (separated in step 2) to activity pools (identified in step 3)

In this stage we need to find out the resource drivers (also called first order cost drivers) based on which we can allocate identified indirect costs to identified activities (if a particular indirect cost is not traceable to a particular activity).

The following table (Table 3) will show the applicable resource drivers and quantity of resource drivers consumed by each activity for allocation of indirect costs to activities

Table 3

Activities	Resource drivers (first order cost drivers) in activity pools
	Lab chemicals and accessories	Salaries & allowances	Wages	Depreciation-M&E	Depreciation-building	Electricity & fuel expenses	Promotional & advt. expenses	Repairs & maintenance-M&E
	Assumed traceable from records	Assumed traceable from records	Labor hour	Cost of M&E used (‘000)	Area occupied (sft)	Kilo watt (kw) consumed	Assumed traceable from records	Cost of M&E  used (‘000)
In-bound logistics		2%	240	100	1,000	100		100
Machining		10%	720	140,000	5,000	50000		140,000
Quality Control	100%	5%	–	5,000	500	500		5,000
Packaging		–	1,200	150	500	50		150
Out-bound logistics		2%	240	100	1,500	100		100
Plant administration and supervision		20%	–	500	500	5000		500
Selling & distribution		31%	–	200	200	4000		200
Marketing		10%	–	100	100	3000	100%	100
Accounting & IT Activities		15%	–	500	300	8000		500
Human Resource		5%	–	50	75	1000		50
Total	100%	100%	2,400	146,700	9,675	71,750	100%	146,700

Tracing/ allocating indirect costs to activity pools in the following table (Table 4).

Activities	Indirect costs traced/ allocated to activities (on the basis of resource drivers of Table 3) (USD ‘000)
	Lab chemicals and accessory.	Salaries & Allowance.	Wages	Depreciation-M&E	Depreciation-building	Electricity & fuel	Promotional & advt.	Repairs & maintenance-M&E	Total
	Traced	Traced	Allocated	Allocated	Allocated	Allocated	Traced	Allocated
In-bound logistics		1,500	800	102	5,168	21		3	7,595
Machining		7,500	2400	143,149	25,840	10,453		4,772	194,114
Quality Control	15000	3,750		5,112	2,584	105		170	26,721
Packaging			4000	153	2,584	10		5	6,753
Out-bound logistics		1,500	800	102	7,752	21		3	10,179
Plant administration and supervision		15,000		511	2,584	1,045		17	19,158
Selling & distribution		23,250		204	1,034	836		7	25,331
Marketing		7,500		102	517	627	12,000	3	20,750
Accounting & IT activities		11,250		511	1,550	1,672		17	15,001
Human Resource		3,750		51	388	209		2	4,399
Total	15,000	75,000	8,000	150,000	50,000	15,000	12,000	5,000	330,000

 

In the next article we will look at allocation of costs to supporting activities.