On the Profit Performance of Tidy Cost Systems: A Numerical Experiment

Organizations routinely use reported product costs to select their product portfolio. However, these data contain errors because observed cost systems are based on limited information and rely on ad hoc design rules. We employ a numerical experiment to examine the effect of these errors on the quality of the product mix decision and the resulting profit. As decisions change total costs, we consider systems that have a tidy allocation: total resource costs must equal total product costs so that decisions are consistent with available information. We examine how tidy systems evolve and the role of variations in tolerance for tidiness. With the full information based profit as the benchmark, we investigate cross-sectional variation in the profit efficiency caused by differences in output markets and cost system design choices. In particular, we focus on the effects of cost system design on improving low profit efficiency.