The impact of cost allocation errors on price and product-mix decisions

Homburg, Carsten; Nasev, Julia and Plank, Philipp (October 2017): The impact of cost allocation errors on price and product-mix decisions. In: Review of Quantitative Finance and Accounting: pp. 1-31

Abstract

We use simulations to examine the impact of cost allocation errors on pricing and product-mix decisions. We compare the imperfect cost allocation of cost systems based on heuristics to the ideal cost allocation of a benchmark model. First, we find that more complex cost systems are associated with substantially lower profit errors. Second, we decompose the profit error and find that production quantity errors are larger than product portfolio errors indicating that reducing product portfolio errors is less critical in designing cost systems. We also document that overproduction errors are larger than underproduction errors and errors from keeping unprofitable products are larger than errors from dropping profitable products suggesting that cost systems tend to underestimate full costs. Third, we find that profit errors increase for more complex cost systems as resource sharing levels rise, which is an interesting counter intuitive result.

• Item Type: Journal article
• Keywords: Cost systems; Simulation Pricing; Product mix; Product portfolio; Decision; Activity-based costing; Profit error; Cost heuristics; Cost allocation
• Faculties: Munich School of Management
• Subjects: 300 Social sciences > 330 Economics
• ISSN: 0924-865X; 1573-7179
• Language: English