Abc and Traditional Methods

Consider the following scenario raised by John Shank, Professor of Accounting,

Dartmouth College: ―Suppose an airline has an empty seat on a flight leaving in one

hour. Isn‘t the contribution approach (i.e., covering variable costs and ‗contributing‘

something to fixed costs) appropriate for pricing that seat?‖

For decision makers, the question takes many forms:

―Shouldn‘t we bid on that direct sale at a 3% margin … most of it goes to the

bottom-line?‖

―Shouldn‘t we under-bid on the systems contract … the big gross profit dollars on

the contract contribute to ‗fixed‘ overhead?‖

―Shouldn‘t we price it at ‗X‘ dollars … that will cover our variable costs?‖

―Shouldn‘t we forgo the delivery charge…we‘re driving by their location

anyway?‖

―Shouldn‘t we pick up their new line … we‘re already carrying their other lines?‖

How do you answer these questions in your daily decision making? Professor Shank

answered his airline question this way:

I understand as well as you the sense in which that extra seat is free. What I have

said is that for my 25 years of experience, the mindset that will sell that seat for

$50 because it is free destroys companies. We have created the mindset that

profit at that level is real profit.

2

I suggest it could also destroy industries—possibly your industry. To continue the

story … ―the airline sells the seat for $50 and the ―smart‖ passenger sits next to you. Her

―discount price‖ of $50 comes up in the course of the conversation; you, the business

traveler, paid $300 for your seat. The next time you fly, you hold out for the ―discount

price‖ of $50 and sit next to another business traveler. You mention the $50 fare to your

seat mate—a full-fare business traveler. You notice your old seat mate is sitting across

the aisle talking to another business traveler. You overhear the word ‗$50.‘‖