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Tuesday, July 13, 2010

Steinway & Sons ABC Costing

(2)Activity based costing (ABC) is very advisable to be applied by Steinway&Sons (“the Company” or Steinway for brevity). The company, although it has at least fifteen activities to finish one item of piano, these activities are very well defined. Activity Based Costing would be very appropriate approach to determine the cost drivers and therefore, the cost of each piano, including both the direct and indirect costs.

As instructed, I have made a detailed examination upon my virtual tour of Steinway & Sons. I have learned that each of these fifteen very well defined procedures hat the Company carefully applies to its world renowned product, I have realized that using ABC would appropriately identify and quantify the cost of each activity, its cost driver and these data would in turn give a detailed information of the total cost of a piano model. For Steinway&Son’s management, it is very important to determine the “true” cost of each object, be it an activity, a product, a job, or each of the various piano models. It would be important for the Company to determine which part of the process or processes of each product are very costly and which activities are value added ones and which ones are not value added activities.

With a piano that sometimes cost fifteen million dollars ($15, 000) it is very important to identify cost drivers and properly allocate the overhead costs. ABC is better compared to any costing approaches because it traces costs back to specific activities (i.e., sanding, bracing, voicing, final inspection) rather than allocating them to cost objects, say the intuition approach or the peanut butter style of costing of a traditional costing method. With this approach, the ABC, the indirect costs are not “very indirect” anymore. With proper tracing, they are near to direct than to be indirect overhead cost. Say for example, with the activities I have learned in the Company’s website, each of the fifteen activities I have identified would consume resources of the Company, which in turn be the cost driver of that particular activity. With this understanding of how costs and activities or cost drivers are interrelated, total cost have greater possibility to be managed and controlled. With these knowledge available, pricing of each piano item or model would be better and if Steinway has stiff competitors, it can correctly price its products and will have a better profit.

The activities that I have identified are the following:
1. Rim Bending
2. Bridge Notching
3. Soundboard Formation
4. Veneer Cutting
6. Sanding
7. Iron Plate Fitting
8. Wire Stringing
9. Felt Hammer Making
10. Wood Heating
11. Damper Examination
12.Action Weigh-Off
13. Voicing Process
14. Tone Regulation
15. Final Inspection

With the above activities identified, they would be useful guides in determining the cost drivers. The pro-forma table may help on determining the exact cost of each model of Steinway pianos.

Activity Total Cost Piano Model 1 Cost
Piano Model 2 Cost Piano Model 3 Cost
Piano Model 4

1. Rim Bending $ xxx $ xxx $ xxx $ xxx $ xxx
2. Bridge Notching xxx xxx xxx xxx xxx

Indeed, ABC is the best method of costing, and this is also true for the case of Steinway&Sons. It avoids or minimizes product cost distortion caused by arbitrary and/or proportional allocations of indirect costs. The ABC system allows tie-up of cost per process and it gives a better provision of budget and resources for the company. Forecasts are also more reliable if based upon ABC than any other costing methods.

(3)However, there might be a possibility that Steinway&Sons is not using the ABC system. What can go wrong then? Since ABC system provides more accurate data when it comes to costing, pricing would be impaired if traditional costing method, or any other costing method is applied by the company rather than ABC. This is the number dysfunctional decision that Steinway can make. The Company, would not be able to price its product more accurately, when costs are spread arbitrarily. A true financial picture would not be visible if ABC is not used by the Company.

Steinway company managers would have difficulties when it comes to identifying value and non-value added activities and would not be able to accurately identify the activities that best accomplish piano-making. Operational management would be misled with cost information if ABC is not applied given the Steinway production setup. This would result to a poor service delivery and later, may cause customer dissatisfaction if customers find out the improper costing of the products, in this case, the pianos.

Moreover, when Steinway would be confronted with a strong competitor, it would have difficulties to benchmark the cost of each product to the cost of its competitor’s products. Why? Because as have been mentioned, if ABC is not applied, there is a big tendency that the costing of the product is not very appropriate and not very “true”.

The final inspection process may be given a better budget or assigned greater cost when in fact, if ABC is used, this process obviously does not add value to the product. Final inspection is a non-value added activity, which, for ABC system, deserves a lower cost.

Finally, Steinway can go wrong with its forecasts if it is not applying ABC system as its company costing policy.

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