Activity-based management

Strategic Management Accounting

What is Activity-based management (ABM)? Some companies had introducing this method to distinguish and appraise activities on their business performances by using the activity-based costing (ABC) to show a value chain analysis, to improve strategic change and decisions making in organization. ABC was establishing relationships between overhead cost and activities therefore overhead costs can be more precisely allocated to products, services, or customer segments. ABM was focused on managing activities on reducing costs and improve customer profitability.

ABM is a tool can do a cost analysis, target costing and management accounting among the organization and it able to manager or enhance profits through cost control and tracking practices.

Besides that, ABM is allowing costs to be controlled at source through the control of the resource-consuming activities pursued by employees. ABM involves several key stages, including planning, activity/process definition, the awareness and education of all those involved and activity analysis via data collection. Performance enhancement measures should include activity-based costing, performance measurement, activity classification and cost driver analysis. The advantages and purpose of ABM is examined.

The advent of business process re-engineering (BPR) has led to a resurgence of interest in performance-improvement techniques. Unfortunately, the marketplace is now cluttered and confused, with an abundance of TLAs (three-letter acronyms). This has in rum led to...

Activity-based management and activity-based costing (ABM/ABC) have brought about radical change in cost management systems.ABM has grown largely out of the work of the Texas-based Consortium for Advanced Manufacturing-International (CAM-I). No longer is ABM's applicability limited to manufacturing organizations. The principles and philosophies of activity-based thinking apply equally to service companies, government of activity-based thinking apple equally to service companies, government agencies and process industries. The acronym itself has evolved from ABC to ABCM (activity-based cost management) to ABM, and the application of ABC evolved from a manufacturing product costing orientation to a management philosophy of activity management applied in industries and organizations other than manufacturing.

Approach to management that aims to maximize the value adding activities while minimizing or eliminating non-value adding activities. The overall objective of ABM is to improve efficiencies and effectiveness of an organization in securing its markets. It draws on activity based-costing (ABC) as its major source of information and focuses on (1) reducing costs, (2) creating performance measures, (3) improving cash flow and quality and, (4) producing enhanced value products.

Example, Activity-based costing is extremely helpful on the strategic analysis, plant layout redesign, pricing, customer values, sourcing, evaluation of competition position, and product strategy.

Activity-based management (ABM) is a method of identifying and evaluating activities that a business performs using activity-based costing to carry out a value chain analysis or a re-engineering initiative to improve strategic and operational decisions in an organization. Activity-based costing establishes relationships between overhead costs and activities so that overhead costs can be more precisely allocated to products, services, or customer segments. Activity-based management focuses on managing activities to reduce costs and improve customer value.

Kaplan and Cooper (in Kaplan, R. S., & Cooper, R. (1998). Cost and effect: Using integrated cost systems to drive profitability and performance. Boston: Harvard Business School Press.) divide ABM into operational and strategic:

Operational ABM is about “doing things right”, using ABC information to improve efficiency. Those activities which add value to the product can be identified and improved. Activities that don't add value are the ones that need to be reduced to cut costs without reducing product value.

Strategic ABM is about “doing the right things”, using ABC information to decide which products to develop and which activities to use. This can also be used for customer profitability analysis, identifying which customers are the most profitable and focusing on them more.

A risk with ABM is that some activities have an implicit value, not necessarily reflected in a financial value added to any product. For instance a particularly pleasant workplace can help attract and retain the best staff, but may not be identified as adding value in operational ABM. A customer that represents a loss based on committed activities, but that opens up leads in a new market, may be identified as a low value customer by a strategic ABM process.

Managers should interpret these values and use ABM as a “common, yet neutral, ground … this provides the basis for negotiation” (Kennedy & Bull 2000). The great debate. Management Accounting, 78). ABM can give middle managers an understanding of costs to other teams to help them make decisions that benefit the whole organization, not just their activities' bottom line.

Some companies introducing AMB are disappointed with what they achieve. This can be because they attempt the exercise at unsustainable level of detail, or do not focus on the final stage of generating improvements. Implementations often fail because the business does not take the time to identify what it is trying to achieve. For an enterprise to decide on the right approach to ABM there are a number of issue it must consider.

Education and awareness are key to the success of ABM.

ABM is company-wide and all those involved need to be included in training. Training should be fun and preferably should include realistic simulation exercises that demonstrate its benefits.

Process/activity definition should be done "top down" and in a workshop environment.

The aim of this phase is to define a structure for your activity database.

Data collection should exploit technology.

A good activity analysis should be flexible enough to be used for ABM, BPR, benchmarking and total quality.

Value added analysis

- activity classification should always include some kind of value added/non-value added analysis (VA/NVA). Activity classification is subjective and all staff involved in classifying activities should understand that NVA is anything that can be eliminated without detriment to the final product or service.

Planning the system

- in terms of budgeting, costing, modelling, reporting and performance measurement. The vision of the final ABM system should be defined as early as possible and the information requirements should be specified by all potential users. Failure to involve users can lead to the construction of a "dinosaur".


- this should be well planned and care should be taken to address change management issues. A sponsor and owner should be identified for each major change.

There are many factors affecting the success of ABM. For example, the amount of time necessary to reach a usable stage of the ABC/M process increases as the company grows. In a study by the Cost Management Group of the American IMA (CIMA Management Accounting April 1998 "ABC: why it is tried and how it succeeds", by Kip Krumwiede) companies with sales less than $100 million reported an average time of 2.3 years, while for larger firms this rose to 3.6 years.

In the same study, several respondents said they were having trouble implementing ABC/M because of other priorities, such as entering new products or markets, implementing new information systems and restructuring or re-engineering projects. One respondent was stuck at the analysis stage of ABC because of major initiative overload: besides ABC/M, his company was implementing a division-wide information system, total quality management, lean manufacturing, just-in-time, balanced scorecard, and manufacturing resource planning.

Smaller companies need to be particularly creative to find reasonable activity cost drivers in their often more limited data. For example, one company in the study used cost material as a proxy for its weight. The message is to look for available drivers that have some correlation with how resources are spent.

The same study concluded that improvements to information technology often precede both ABC and ABM adoption. A high level of IT sophistication appears to be an important factor in success. Companies will have an easier time implementing ABM if their IT system has the following characteristics; good subsystem integration, user friendly query capability, available sales, cost and performance data going back 12 months, and real-time updates of all these.

Yet while the capabilities of an IT system are generally important to ABC/M success, it is possible to succeed in a relatively poor IT environment. For example, Krumwiede states that a vice president of cost management for First Tennessee Bank, which uses ABC extensively, applies the 80:20 rule. When starting out, his bank focused primarily on the core processes and gave up some precision for an understandable model of operations. In this example the ABC information is being used for strategic decisions because it is easily understood and "close enough" for current needs.

ABM is a fundamental shift in emphasis away from traditional costing towards performance measurement. Activities consume resources, so controlling activities allows you to control costs at their source. Understanding business activities allows us to eliminate those that are unnecessary and streamline costs. This is the real value and power of ABM; the information it brings.

The basic technique of activity analysis can be adapted to provide a range of benefits, such as re-engineering the annual budget process, major cost reductions (10-30 per cent), customer and channel profitability, continuous performance improvement and new forms of performance measurement, such as the balanced scorecard. The accumulated benefits of such a technique should lead to a competitive advantage. And if beating the competition is your problem, adopting ABM will certainly be to your advantage.

ABC/M applications are now common in most industries. This section illustrates some example applications in the manufacturing and service industries and within government.

ABC/M Application in Manufacturing: Industrial Air Conditioner Units

AIRCO is a manufacturer of industrial air conditioning units. The units range in size and power from 5 to 20 tons. 1 Each unit has more than 200 parts, including holding tanks, electronic controllers, metal sheets, cooling coils, wires, and insulation material. Almost 90% of manufacturing workers are hourly workers, and the company operates two shifts. The organization of the manufacturing process is conventional, with separate departments for purchasing, engineering, job scheduling, materials handling, shipping, accounting, and human resources. AIRCO developed an ABC system to assist in the analysis of product profitability. Its first step was to identify the resource cost pools that make up total overhead of $4,458,605 at the plant (Exhibit 5.12 ). The resource costs (indirect labor, computer and software, etc.) are from the fi rm's accounting system, which collects resources costs in these 11 categories. The next step is to identify production activities and to use resource consumption cost drivers to assign the resource costs to the activity cost pools. The activity cost pools are machines; data record maintenance; material handling; product changeover (setup); scheduling and production preparation; materials receiving and handling; product shipment; and customer service ( Exhibit 5.13 , column 1). The assignment of resources to activities typically uses resource consumption cost drivers. Instead of using cost drivers, AIRCO determined the estimated contribution of each resource to each activity based on managers' and employees' experience.

For example, the resource, maintenance costs, $60,000, was assigned entirely to the activity, machines. To illustrate, the cost of the machine activity was determined from the resources as follows (other activities were obtained in a similar way):

A successful ABC/M implementation requires close cooperation among management accountants, engineers, and manufacturing and operating managers. They need to act as a team in identifying activities, cost drivers, and requisite information, both fi nancial and nonfinancial. Understanding the production process and identifying cost drivers require careful efforts. Efforts to redesign cost systems usually are rewarded when organizations have high product diversity, various cost drivers, multiple distribution channels, and heterogeneous batch sizes.

Heather Nachtmann, and Mohammad Hani Al-Rifai, “An Application of Activity-Based Costing in the Air Conditioner Manufacturing Industry,” The Engineering Economist, 2004, 49, pp 221–236.

Please be aware that the free essay that you were just reading was not written by us. This essay, and all of the others available to view on the website, were provided to us by students in exchange for services that we offer. This relationship helps our students to get an even better deal while also contributing to the biggest free essay resource in the UK!