Activity-based costing (ABC) provides more realistic estimates of how support costs change with increments in sales volume. For example, traditional cost accounting systems use bases like direct labor and machine hours to allocate to products the expenses of support activities. Instead, ABC segregates support expenditures by activities, and then assigns those expenditures based on the drivers of the activities and how they are linked to product sales volume. Some applications of ABC have allowed firms to estimate not just manufacturing costs, but also costs to serve different customers. ABC enables managers to identify the characteristics or drivers that cause some customers to be more expensive or less expensive to serve. Robert Kaplan identified the following differences in characteristics of high cost-to-serve versus low cost-to-serve customers:
ABC extends incremental costing to cost categories that are neither fixed nor variable, but are semifixed costs. For example, these may be costs associated with order entry personnel, or shipping personnel, that are incurred in less frequent outlays or lumps, but nonetheless change with larger changes in volume. ABC allocates these semifixed costs according to activity drivers, usually related to transactions associated with the function — for example, the number of orders received by the order entry department, or the number of shipments shipped by the shipping department. ABC is especially valuable in refining the manager's estimate of the true cost-to-serve an incoming customer order.