Allocate factory overhead where it is caused.
A plant-wide overhead rate is simple and wrong: it charges every product the same proportion of overhead regardless of the setups, changeovers and inspections it triggers. Activity-based allocation pools overhead by the work that drives it and charges each SKU for what it actually consumes, so the cost on the sheet matches the cost on the floor.
Cost and Profitability Consulting · 150+ models since 2010 · TDABC
One base cannot carry every driver.
A plant-wide rate spreads all overhead over a single base, usually labour or machine hours. That assumes overhead rises with that one measure, when in reality it is driven by many: the number of setups, the changeover time between products, the inspections a fiddly part needs, the handling and expediting a short run demands. A base that tracks none of those charges them to nobody in particular.
So the high-volume product, which absorbs a large share of the base, carries overhead it never caused, while the complex special, light on the base but heavy on setups and inspections, is charged far too little. The reported cost is precise and wrong, and every pricing and mix decision built on it inherits the error.
PLANT-WIDE RATE VS TRUE COST
Illustrative. Under a plant-wide rate both SKUs look profitable. Allocate overhead by its real drivers and the complex run carries its true burden, flipping into loss.
Pools, drivers, capacity, SKU.
Define the cost pools
Group overhead by the activity it pays for: setup, changeover, quality, material handling, scrap, expediting, plant support.
Pick the real driver
Each pool gets the driver that actually moves it, setups, changeover minutes, inspections, moves, not a single volume base.
Cost at practical capacity
TDABC sets a cost per minute of practical capacity, so unused capacity shows as its own line instead of inflating every product's rate.
Charge to the SKU
Each product carries the overhead its batch size, complexity and changeover frequency actually cause, traceable back to the driver.
The rate hides it. The drivers show it.
| Plant-wide rate | Activity-based | |
|---|---|---|
| Allocation basis | Labour hours | Setups, runs, scrap |
| Overhead / unit, SKU A (simple) | €0.84 | €0.51 |
| Overhead / unit, SKU B (complex) | €0.84 | €2.10 |
| SKU A reported margin | understated | correct |
| SKU B reported margin | overstated | correct |
The total overhead is identical; only its allocation changes. But that change moves SKU B from apparent winner to real loss-maker, and stops SKU A subsidising it in silence.
EVERY SKU, BY SIZE AND TRUE MARGIN
Illustrative. With overhead allocated by driver, the loss-makers a single rate kept hidden separate clearly from the SKUs that carry the plant.
Pricing and mix on real cost.
Allocate overhead by its drivers and the quote desk, the mix decision and the make-or-buy call all rest on a cost that reflects how each product is really made. The plant stops pushing complexity it loses money on and discounting the simple lines that quietly fund it.
The total cost does not change. Where it lands does, and that is the decision.
Frequently asked questions
- What is wrong with a plant-wide overhead rate?
- It charges overhead to products in proportion to a single base, usually labour or machine hours, regardless of the setups, changeovers, inspections and handling each product actually triggers. Simple high-volume products end up over-costed and complex low-volume ones under-costed.
- What drivers does activity-based allocation use?
- The drivers that actually cause overhead: number of setups, changeover time, inspection and quality checks, material movements, expediting and scrap. Each cost pool is charged to products by the driver it responds to, not by volume.
- Why cost at practical capacity?
- Costing each activity per minute of practical capacity keeps the cost of unused capacity visible as a separate line, instead of inflating the rate on everything you make when the plant runs below full.
See where your overhead really lands.
The Profit Check needs no data upload. It shows how much your plant-wide rate is likely distorting product cost, and what it is worth to allocate by driver.
- Duration
- 12 to 15 minutes
- You receive
- Score, 7 dimensions, sector benchmark
- Price
- Free, no email needed
Workshops20-21 Oct · Online, ZoomReserve a seat
Reviewed by
Miguel Guimarães
Founding Partner, Cost and Profitability Consulting
More than 150 Time-Driven ABC engagements across 11 sectors since 2010, working within the Kaplan and Anderson framework.
About the author →Published Updated
Who you would be talking to
Miguel Guimarães, Founding Partner
Cost and profitability practitioner for 25+ years. Lectured alongside Professor Robert S. Kaplan at the CFO conference in Amsterdam (2009).
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