Research and Development investments in the pharmaceutical industry are continuously increasing, resulting in mounting pressure to improve efficiency in terms of output versus cost. Overall, traditional cost accounting methods do not improve effectiveness of pharmaceutical development activities. In drug discovery, cost control is often not based on any objectively measured data. This study describes the design and implementation of an activity-based costing (ABC) system related to drug discovery activities in a large pharmaceutical company. Both the theoretical model adapted to the specifics of drug discovery as well as the outcome of the data collection during one quarter are described. The methodological approach is based on a two-step allocation process: allocation of resource costs to the actual processes (activities) using these costs based on resource drivers, and allocation of activity costs to the cost objects (projects) based on activity drivers. Activity-based management (ABM) has been applied to the collected data. ABM refers to the entire set of actions and decisions that can be taken with activity-based cost information. Major and unexpected cost differences per project were observed. Causes for these cost differences are project stage, project type, activity type, complexity of the project, number of employees involved, and type of molecular target. The cause analysis on cost differences guides management decisions such as strategic project portfolio management based on project cost, benchmarking, identifying value-adding versus non-value-adding activities, outsourcing, and budgeting decisions. In conclusion, the ABC methodology secures cost and time reductions, guides project prioritization decisions, and improves cost effectiveness. Drug Dev. Res. 67:107–118, 2006. © 2006 Wiley-Liss, Inc.