Int. J.

Production Economics 79 (2002) 75}82

Activity-based costing and process modeling for cost-conscious

product design: A case study in a manufacturing company
Katja Tornberg*, Miikka JaK msen, Jari Paranko
Industrial Management, Tampere University of Technology, P.O. Box 541, 33101 Tampere, Finland
Received 3 April 2000; accepted 27 November 2000

Abstract

The most e!ective way to control costs is to design them out of the products. However, cost data is rarely available for
product designers in a usable form. The aim of this study was to investigate the possibilities of activity-based costing and
the modeling of design, purchasing and manufacturing processes in providing useful cost information for product
designers. The hypothesis was that activity-based costing and process modeling might provide an e!ective tool for the
evaluation of di!erent design options. The study was conducted in a large Finnish manufacturing company. First, the
most costly items of one product's sub-assembly were studied in order to identify the activities needed to produce the
items and to calculate their activity-based costs. Second, the processes, in other words the activity chains, were modeled
with graphic #owcharts from product design, purchasing, and manufacturing departments. Finally, the applicability of
activity-based cost information and process models to product designing practices was tested. The results of the study
suggested that activity-based costing and process modeling provide a good starting point in heading toward more
cost-conscious design. This way the designers learn the relationships between the activities performed in the organization
and their associated costs. The development of a parametric cost estimation model based on activity-based costing and
process modeling provides a challenge for future research.  2002 Elsevier Science B.V. All rights reserved.

Keywords: Activity-based management; Cost management; Product design; Process modeling

1. Introduction During the study both accounting professionals

1.1. Product design and cost accounting
The important role of product development in
cost management is undeniable. However, the need
for cost information in product development has
not been su$ciently met. Problems include both
the content as well as the form of information.
Uusi-Rauva and Paranko [1] examined the pres-
ent state of cost accounting from a designer's point
of view in four Finnish manufacturing companies.
* Corresponding author.
(information producers) and managers of designers
(users of information) were interviewed. As a result
11 improvement opportunities were presented, of
which two are presented here.
First, cost information should be better com-
bined with product structure and business process
activities. Second, designers need reliable informa-
tion on a product's total costs. It is common for
designers to get information only on a product's
direct costs. However, the decisions made on prod-
uct design also a!ect indirect costs [2].
Cost accounting should help product develop-
ment to design products that carry the lowest

0925-5273/02/$ - see front matter  2002 Elsevier Science B.V. All rights reserved.
PII: S 0 9 2 5 - 5 2 7 3 ( 0 0 ) 0 0 1 7 9 - 1
76 K. Tornberg et al. / Int. J. Production Economics 79 (2002) 75}82
possible total costs while also taking into consid-
eration other important design criteria. Cooper and
Turney [3] have argued that activity-based costing
provides cost information on each of the company's
production processes so that the costs of di!erent
designs can be compared. According to them, activ-
ity-based costing (ABC) puts product costs `on the
backsa of the engineers [3]. Consequently, com-
panies develop ABC systems to provide more rel-
evant economic information for product designers
[4].
1.2. Dexnitions
A number of writers [5}9], have provided de"ni-
tions for a business process. According to Laakso
a business process is a structured, measured set of
activities and #ows that use necessary resources of
the organization to provide a speci"ed output for
a particular customer [10].
Smart et al. [11] o!er a general process classi-
"cation framework. The framework is helpful in
specifying the business processes as well as in deter-
mining the process boundaries. In this classi"ca-
tion, the main process classes are the operating,
support, and managing processes. The operating
processes are de"ned as the cross-functional and
value-adding chains having a direct customer inter-
face. The four main operating processes are product
development, sales and marketing, order ful"llment,
and customer service. Furthermore, parts of the
main operating processes can be divided into sub-
processes. For example, a production process can be
seen as a part of the order ful"llment process. In
addition to production, the order ful"llment process
includes several other activities, such as customer
Fig. 1. An example of a graphical process model.
inquiry, proposal, contract, assembly, delivery, in-
stallation and invoicing [10].
The objective of process modeling is to help
companies to improve their business process un-
derstanding. A qualitative model that provides
a graphical interpretation of the process captures
the structure of a business process. The objective of
qualitative process modeling is to visualize the pro-
cess and to achieve a commonly agreed view of the
process structure. Graphical process presentation
facilitates communication between people and
helps in developing a common conceptual model of
what goes on in the studied process [10].
The graphical process models (Fig. 1) are forma-
tted into horizontal bands to illustrate where an
activity is performed and by whom. This way the
involvement of various constituents of the overall
process can be isolated. The process goes simulta-
neously from left to right and from the top down.
The activities are presented with a rectangle and the
branches of the process are presented with a dia-
mond. A shadow under a rectangle indicates that an
activity consists of several sub-processes. In this way
the process model becomes a hierarchical entity.
A quantitative analysis of quality, cost or
time may be done after the process structure is
visualized. The quantitative process modeling is
a vital part of the in-depth process understanding.
It identi"es problem areas and helps to make im-
provement decisions based on more solid informa-
tion [10]. In fact, quantitative process modeling
may in our case be seen as equivalent to activity-
based costing. This results from the fact that the
activities of an ABC model and the process steps of
a qualitative process model may be de"ned as
identical. In summary, qualitative process
 K. Tornberg et al. / Int. J. Production Economics 79 (2002) 75}82
modeling is the visual presentation of the process,
while quantitative process modeling/ABC is the
analysis of quality, cost or time of that process.
It should be noticed that qualitative process
modeling is not a precondition for activity-based
costing. However, if this is done simultaneously
with activity-based costing, important information
about the procedures of the organization can be
obtained quite easily.
1.3. Aim of the study
The aim of this study was to investigate the
possibilities of activity-based costing and process
modeling in providing useful cost information for
product designers. The hypothesis was that activ-
ity-based costing and process modeling might pro-
vide an e!ective tool for the evaluation of di!erent
design options (Fig. 2).
The focus of the study is on cost accounting. The
purpose was to examine the changing role of cost
accounting in providing useful information for de-
cision making by product designers. Though many
of the current trends in product designing practices,
such as concurrent engineering and design for
manufacturing and assembly (DFMA), emphasize
the role of costs, these methods are not studied
here. Rather than searching directly for the im-
provement of product designing practices, the pur-
pose was to investigate the usefulness of activity-
based cost information and information about the
company's processes for product designers.
The customer of this study is product design. As
majority of the total product costs incurs from
decisions made in product design, product de-
signers should be seen as the key customers of cost
information. This is why the usefulness of activity-
based cost calculations and process models was
tested on product designers. However, even though
the causes for most of the product costs can be
traced back to the decisions made in product de-
Fig. 2. Research problem and thesis.
77
sign, the costs mainly emerge in other parts of the
organization. Consequently, in order to receive as
much information about the product's total costs
as possible, activity-based costing and process
modeling were carried out in addition to product
design also in the purchasing and manufacturing
functions of the company.
2. Methodology
The study was carried out in a large Finnish
manufacturing company. The company has a sig-
ni"cant global position within its industry.
An example product sub-assembly was chosen.
First, the most costly items of the sub-assembly
were studied in order to identify the activities
needed to produce the items and to calculate their
activity-based costs. Second, the processes were
modeled with graphic #owcharts from product de-
sign, purchasing, and manufacturing functions.
Data for activity-based costing and process
modeling were gathered from personal interviews.
The company pointed out "ve product designers
with whom to investigate the gathered and ana-
lyzed cost information. The designers were chosen
for their extensive experience in their "eld. Their
current tasks included e.g. product development,
modi"cation design, and modular design.
Activity-based cost calculations and process
models of two example items were presented to
the designers. Detailed examples of this material
are shown in the appendices. The designers had
four days to explore the given material. At this
point, a questionnaire with structured questions
was administered. The questionnaire had two ob-
jectives: "rst to de"ne the needs of the company's
product designers regarding cost information and
second to determine their opinions about the use-
fulness of activity-based cost calculations and pro-
cess models.
78 K. Tornberg et al. / Int. J. Production Economics 79 (2002) 75}82
In order to obtain a better understanding of the
matter, the questionnaires were supplemented with
personal interviews. Interviews were conducted
with all "ve product designers. However, under the
time constraint, answers to the questionnaire were
received from only three product designers. In the
personal interviews, special emphasis was given to
the role of activity-based cost calculations and pro-
cess models.
In the activity-based cost calculations, the activ-
ity-based costs are divided into three main groups:
the costs of life-cycle activities, the costs of batch
activities, and the costs of volume activities (see
Appendix B). Life-cycle activities are performed by
product type. The costs of life-cycle activities can be
allocated only to the product for which the activities
are performed. Examples include programming the
machines, drawing the item, and making the annual
supplier contract. Batch activities are used by batches
of products or any other cost objects. Costs of batch
activities are allocated evenly to all the cost objects
produced in the batch in question. Examples include
setting up the machines, transferring the production
lot, and checking the invoice. The costs of volume
activities can be allocated directly to cost objects.
The total costs of volume activities depend directly
on the quantity of the cost object. Examples include
machining and inspection of the goods received.
A simpli"ed example of an activity-based cost
calculation is shown in Fig. 3.
The life-cycle of the example product is estimated
to be "ve years and the annual production volume is
100 units, which makes a total of 500 units in 5 years.
In batch activities the batch size varies according to
the activity in question: for example, the set-ups are
done for a lot size of 2 units, while checking the
invoice is done for a lot size of 8 units. Volume
activities are consumed by every unit produced.
The activity cost is the cost of performing the
activity once. The activity cost per unit is calculated
by dividing the activity cost by units. For instance,
the cost of programming the machines per unit is
Fig. 3. A simpli"ed example of an activity-based cost calculation.
calculated by the following formula:
1000 EUR (activity cost)/500 (units)
"2 EUR (cost per unit).
The numbers in the cost calculations are "ctitious.
Also, when comparing the amount of activity costs
versus material costs, it should be noticed that in this
study sales and marketing and administration func-
tions, which typically make up most of the over-
heads, were ruled out. If these were also taken into
account, the proportional amount of activity costs
as compared with total costs would be much higher.
3. Results
3.1. Product designers' needs
The "rst part of the questionnaire focused on
determining the product designers' needs regarding
cost information. The answers showed that the
product designers' cost accounting knowledge
varied considerably. For example, when the
procurement costs of an item were discussed, the
only cost that was mentioned was the price paid for
the item. However, this is only part of the total
procurement cost of an item.
Product designers make their daily designing
decisions based primarily on a product's technical
features. From the designer's point of view the most
important criteria for products are top quality,
durability, performance, and correspondence with
the customer's speci"cations. Only one interviewee
mentioned the "nal costs of the product as a cri-
terion for the designing decision. On the other
hand, the designers thought that their supervisors
evaluate them on the basis of timely delivery of the
design and potential warranty costs.
The questionnaire, however, indicated that prod-
uct designers generally think cost information is
important for them. On the other hand, the
 K. Tornberg et al. / Int. J. Production Economics 79 (2002) 75}82
designers were doubtful about whether their deci-
sions could have any impact on indirect costs. Con-
sequently, they felt the cost information of
manufacturing and product development functions
to be most important, while the costs of purchasing,
sales and marketing, and administration functions
were seen as less signi"cant or too di$cult to esti-
mate and include in their decision processes.
The cost information currently available was
seen to have many de"ciencies. The problems and
needs found in this study were very similar to
those presented by Uusi-Rauva and Paranko [2].
The only problems identi"ed in their study that
did not come out during the interviews were sup-
port in make or buy decisions and support in the
search for raw materials or suppliers. On the other
hand, this study revealed something that did not
appear in their study: the need for feature-based
cost information. Product designers were keen to
know how the costs of a product were a!ected
when, for example, tolerance was altered. The cost
comparison between di!erent production methods
such as welding and machining was also seen as
important.
3.2. The role of process models and activity-based
cost calculations
The latter part of the questionnaire was aimed at
"nding out the product designers' opinions about
the usefulness of the process models and activity-
based cost calculations. As one of the major bene-
"ts of the cost calculations the interviewees rated
the fact that cost information was presented by
product structure and by activities performed,
which is usually not the case with traditional cost
accounting. With the help of process models and
cost calculations it was possible to estimate the
e!ects of di!erent design options on product costs.
In addition to these cost-related advantages,
there was still one which concerned speci"cally the
process models: their role was seen as getting the
whole picture of what goes on in the company. The
models re#ect the actual phases that the product
goes through in the organization as it is being
designed and produced. This led to an increased
understanding of the activities needed to deliver the
sub-assembly in question.
79
The designers also pointed out the limitations of
the process models and activity-based cost calcu-
lations. First, the information gathered was focused
only on one sub-assembly and a limited amount of
activities (product design, purchasing, and manu-
facturing). Thus, the scope of the study was quite
narrow and did not provide a su$cient basis for
evaluating the cost of other product components or
sub-assemblies.
Second, at present the cost calculations include
too many activities. This makes the calculations
too complicated and too slow to use. However, it
was considered extremely important to get more
detailed information about the activities when
needed. Third, the problem of the right level of
information was seen to apply also to process mod-
els: the "rst picture should be quite simple, but it
should also be possible to get more detailed in-
formation about design, purchasing, and manufac-
turing processes when needed.
The designers provided suggestions on how to
deal with these problems. Regarding the narrowness
of the scope of the study, the solution suggested
was to present the cost information by product
parameters. With respect to the slowness and com-
plexity of the cost calculations and the process mod-
els, the designers had two improvement suggestions:
"rst, it would make sense to categorize the activities
into larger groups. For example, all the life-cycle
activities used by an item could be presented as only
three activities: the life-cycle activities in manufac-
turing, the life-cycle activities in product design, and
the life-cycle activities in purchasing. Second, it
could be useful to combine the information on the
cost calculations with the process models. An activ-
ity may be easy or more di$cult to perform due to
certain circumstances. Therefore, it would make
sense that each step of the process model be given
three di!erent activity options: easy, ordinary, or
di$cult, each one with its own cost. Also the rea-
sons which cause the same activity to be easy or
more di$cult should be attached to the process
model.
In summary, the cost estimation model for prod-
uct designers' use should be simple at "rst sight, but
it should also enable more detailed information to
be obtained when needed. The model should be
easy to use and provide information on-line.
80 K. Tornberg et al. / Int. J. Production Economics 79 (2002) 75}82
4. Conclusions
The results of this study lend support to the results
of Uusi-Rauva and Paranko [2] regarding the need
in product development for cost information. The
di!erences which emerged between these two studies
concerning needs result mainly from the di!erent
interviewee groups: the previous study concentrated
on the needs of managers of designers (and ac-
counting professionals), while in this study the focus
was on the needs of product designers themselves.
Consequently, the needs found in this study accen-
tuated the daily work of the designer, that is, for
example, cost information by product structure, by
activities and also by product parameters.
On the basis of this study, it can be argued that
process modeling and activity-based costing can
provide useful cost information for product de-
signers. This derives basically from the following
facts. First, the cost information is presented by
product structure, which is the form in which de-
signers normally receive other important informa-
tion in their daily work. Second, the process models
and cost calculations reveal the e!ects of di!erent
design options on the whole order-to-delivery pro-
cess, i.e. the total product costs.
The calculations and process models created
so far, however, are too complicated and too
slow for daily use. The categorization of activities
into larger groups and the attachment of cost in-
formation to the graphic process models provide
a basis for solving this problem. Furthermore, on
the basis of this information it is possible to esti-
mate only the costs of a particular sub-assembly.
Thus, feature-based costing, parametric cost es-
timation, etc., provide a challenge for future re-
search.
The critical role of product design in cost
management is being recognized. Product design
should be considered as one of the clients for
a company's cost accounting; perhaps as one of
the most important clients of this function.
This demands a new perspective toward cost in-
formation: the content and form should vary ac-
cording to who is the target of the information.
Activity-based costing and process modeling pro-
vide one possible solution for providing product
designers with the kind of cost information they
desire and need.
Appendix A. Process model
 K. Tornberg et al. / Int. J. Production Economics 79 (2002) 75}82 81

Appendix B. Calculation of activity-based costs

Example item Units Activity cost Cost per unit % of total

costs

Life-cycle activities
Checking the drawing 500 1000 2
Designing the fastener 500 2500 5
Designing the tools 500 500 1
Drawing the item 500 3500 7
Making the annual supplier contract 500 2500 5
Production routing 500 500 1
Programming the machines 500 1000 2
Reviewing the annual supplier contract 500 1000 2
Selecting the suppliers 500 1500 3
Testing the program 500 500 1

29 2.5
Batch activities
Checking the invoice 8 2 0.25
Closing the work order 2 2 1
Loading #exible manufacturing system 2 11 5.5
Material handling 2 30 15
Ordering the materials 8 23 2.875
Receiving the materials 2 12 6
Setting up the machine 2 29 14.5

45.125 3.9
Volume activities
Inspection of delivery 67 67
Machining with a lathe 252 252
319 27.5

Materials 767 66.1

Activity costs 393.125 33.9

Total costs 1160.125 100

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