Activity Based Management Essay
Activity Based Management
Activity based management (ABM) is an approach to management that aims to maximize the value adding activities to the customers while minimizing or eliminating non-value adding activities. The objective of ABM is to improve the efficiency 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 managing activities to (1) reduce costs, (2) create performance measures, (3) improve cash flow and quality and, (4) produce enhanced value products in order to improve customer value (Business Dictionary.com). This ABM system’s top priority is in eliminating or improving those activities to increase profitability by seeking out areas where a business is losing money such as the factors which cause activities to be performed or activity cost to change.
Undeniably, in order to improve an organization’s work processes and activities to effectively and efficiently meet the rapidly changing environment in this globalisation world, management practices and methods have changed over the last decade and will continue to change in future. THE TRADITIONAL ABSORPTION COSTING is the first system implemented to keep track of the true cost of a product or service. It assigns indirect cost to cost object and uses unsophisticated methods to assign indirect costs. It allocates overheads to production and service departments and uses small number of 2nd stage cost drivers to allocate costs from cost centres or pools to productions or cost objects.
This system will only be appropriate when the (i)direct costs were the dominant costs, (ii)indirect costs were relatively small, (iii)information costs are high, (iv)there is a lack of intense global competition and (v)a limited range of products is produced, it might be difficult for every organization to use it. For instance, this system might not be appropriate for companies with complex processes and manufacturing practices. The large increase of indirect and overhead expenses will make the traditional costing method less efficient. Therefore, in 1980s, ACTIVITY-BASED COSTING (ABC) was introduced to overcome these problems.
ABC is a system for managing the organization better. It is a one-off exercise that measures the activities’ cost and performance, resources and the objects which consume them so as to generate more accurate and meaningful information for decision-making. It uses sophisticated or modern methods to assign the indirect costs. This ABC system allocates overheads to each major activity but not to departments and allocates costs to products or cost objects. However, it limits the company to have advantage of the ABC technique. It cannot be used for official record keeping as the IRS and stockholders require the use of traditional methods to create necessary reports for taxes.
In another words, companies need to use two different costing methods in order to get the benefit. The system is costly to build, complex to sustain and to modify. Therefore, the emphasis has shifted from ABC to ACTIVITY-BASED MANAGEMENT (ABM) which is also known as ACTIVITY-BASED COST MANAGEMENT (ABCM) later on. ABC is a subset of ABM as the application of ABC evolved from a manufacturing product costing orientation to a management philosophy of activity management applied in industries and organizations (Business Dictionary.com).
ABM has grown largely out of the work of the Texas-based Consortium for Advanced Manufacturing-International (CAM-I) (Investopedia). The CAM-I has initiated the development of a comprehensive glossary on ABCM terms by clarifying the significant confusion regarding the semantic and acronym associated with the activity based information (Investopedia). This ABM system makes the cost and operating information useful to improve decision making. Through the ABM analysis process, the management will gain a thorough understanding of its business processes and cost behaviour and management team in the company.
In addition, the results of an ABM analysis can help a company generate more accurate budgets and financial forecasts (Investopedia). It gives management insight into the cost structures for making and selling diverse products. In a simplified term, ABC is used to answer the question, “what do things cost?” and for ABM, a process view is taken to understand factors which cause the costs to occur. This system focuses on the ways to redirect and improve the use of resources, by using ABC data, to enhance the value created for customers and other stakeholders (Investopedia).
These two systems (ABC and ABM) have attracted high levels of interest from both academics and practitioners since its emergence in the late 1980’s. It is mainly due to the significant change in cost management systems they have brought. Due to the lack of pertinence and relevancy of traditional costing that leads to mutual subsidy between products and cost, ABC and ABM are used to enhance or replace the traditional cost calculation methods.
For example, ABM approach reports by activities while traditional analysis is by departments; ABM reporting is by sub-activities but traditional is by expense categories and ABM reporting can reports information on activities that are cross departmental boundaries whereas traditional is not allowed(Drury C, 2008). Thus, ABM is concluded to have more meaningful information as it gives more visibility to the cost of undertaking the activities that make up the organization and may raise the issues that are not highlighted in traditional analysis. Most forward-thinking companies have implemented them, or are in the process of doing so as it can be applied to different types of companies, including manufacturers, service providers, non-profits, schools and government agencies (Business Dictionary.com).
1. Features of ABM system
_A. STAGES OF IMPLEMENTATION_
In order to implement ABM system, the companies are required to carry out the three out of the four stages in ABC (Drury C, 2008). The steps are listed as below:
(i) Identify major activities that result in costs being incurred,
The activities are the aggregation of units of work or tasks such as machine set-up cost, purchasing cost and warehousing cost that use up resources. In order to identify all the activities within the company, activity analysis has to be carried out. The activities chosen must be at a reasonable level of aggregation based on the cost verses benefit criteria. In addition, the activities have to be either influenced by the total cost of activity centre or the ability of a single cost driver to provide a satisfactory determinant of the cost of the activity.
(ii) Assign cost centers to each activity, and
The companies should not use the arbitrary allocations in assigning the significant proportion of costs to activities as it will reduce the reliability of cost. They have to identify and assign the direct costs to specific activity and assign the indirect costs on cause-and-effect cost drivers. By doing so, the cost incurred on each activity can be determined.
(iii) Determine the cost driver for each major activity
In this stage, the drivers are called as activity cost drivers. In selecting the cost driver, there are two factors which the companies need to consider. Firstly, the cost driver should provide a good explanation of costs of each activity cost pool. Additionally, the cost driver should be measurable easily, and the data should be easily obtained and be identifiable with products. (The cost driver can be production or service oriented).
_B. TWO CATEGORIES OF ABM APPLICATION_
Based on the source adapted by Kaplan & Cooper (1998), this system accomplishes its objectives through two complemetary applications which are the operational ABM (“Doing things right”) and strategic ABM (“Doing the right things”).
Operational ABM enhances efficiency of operation and asset utilization and lowers costs. Its focus are mainly on doing things right and performing activities more efficiently. Management techniques such as activity management, business process reengineering, total quality management, and performance measurement are used in the ABM application.
As for strategic ABM, it attempts to change the activities demands and boost proﬁtability by improving activity efficiency. It focuses on choosing proper activities for the operation, eliminating non-essential activities and selecting the most proﬁtable customers. Strategic ABM applications use management techniques such as process design, customer proﬁtability analysis, and value chain analysis.
2. Comparison between Activity-based management system (ABM) and traditional system
ABM focuses on activity performed by business and hence, it views business as a set of linked activity that ultimately adding value to customers. Its goal is to satisfy customer needs while making fewer demands on organizational resources. Hence, ABM could have information of activities such as why activities to be performed, how to perform the activities and how well they are performed. In contrast, traditional system focuses on types of cost from departments. It gives less information to manager for the needs in decision making. ABM is better than traditional system as ABM could provide wider information and information could go deeply and more detailed as needed by the management in decision making.
Besides, the ABM system only seeks to use cause-and-effect cost driver which is different than the traditional system. It does not rely on arbitrary allocation bases. As we can see from table 1, the information provided by both systems is about customer order processing. However, these two systems take into account different information while preparing the customer order processing. ABM focuses on information that is relevant in the process of customer ordering while traditional analysis focuses on the types of cost incurred in the customer order processing.
ABM ANALYSIS RM
Preparing Quotations 100
Receiving Customer Order 280
TRADITIONAL ANALYSIS RM
Telephone bill 170
Depreciation of Asset 120
In addition, ABM is different from traditional system in terms of the report approach. ABM report is determined by activities while traditional system is determined by departments. It can include crossing departmental boundaries. For instance, material purchasing process might involve not only one department but it includes inventory control department, purchasing department and account payable department. The manager will be able to know how the amount spent (e.g: RM 2000) to be used in purchasing material under ABM system. It may show the relevant information such as inventory reviewing, sending purchase requisition and sending purchase order. The manager will be able to know how purchasing of material works on and what are the reasons of purchase delay as well as how to minimize the cost of purchase.
It focuses on information based on activity. As for traditional system, manager can get the information on material purchase which costs for RM2000 only. However, this RM2000 does not comply with the amount of goods order. By looking at one information itself, the reasons of non-compliance cannot be tracked as there is lack of information. Therefore, ABM system is better since it did not focus on information based on cost but it assigns cost of activities to products according to product’s demand for activities and relies on cost centres and cost drivers that cause activity resource consumption. Other than that, it assigns activity costs to cost objects on basis of cost driver usage and measures resources consumed by cost objects more accurately.
In addition, ABM system provides both information from value and non value added activities. As for traditional system, it provides information on value added activity only. Value added activity is an activity that supports primary objective of producing outputs. For instance, activity like colouring adds value to a book. Under value added activity, traditional report will show the amount spent in colouring since it adds usefulness to customers. Customers would likely to buy books with some colouring or some pictures rather than books with only words as it might help them in memorizing and understanding the information stated in the book better. However, if the profit does not increase like what the company expected, manager will be able to trace back the cost incurred by looking at amount spent in colouring – non-value added activity.
Hence, non value added activity is important as it may affect the company’s profit. Non value added activity is an activity where an opportunity is available for cost reduction without decreasing product’s service potential to customer such as storing and moving raw materials. Under ABM system, manager will be able to draw attention on this issue and trace back the reasons such as waste in the production. Manager will be able to track the cost which has been wasted in the production by reducing material movement and improving production flow without reducing the value added to customer. In other words, customer can have same quality of products-same kind of books while management could reduce the cost of production.
3. Benefits and Limitations of ABM system
One of the benefits of the system is to help the management in decision making. It provides better decision making as the information provided by the ABM system is more useful and reliable. The management can make informed decision about product mix, lines of business, process, product design, services, capital investment and pricing. For instance, manager will able to make decision on how much capital to invest in new product and what kind of new product to be launched based on information that manager obtains in ABM system.
Furthermore, ABM is a system for continuous improvements. The system is not just an accounting tool but it also provides many tools that can enhance organizational performance management. In other words, ABM system provides other information as well (the product mix, customer services, line of business and capital investment) that would be able to help an organization in its future development and improvement. For instance, an organization knows how to serve customer better by looking into information provided in customer services activity.
ABM also provides a better understanding of cost driver. It is a factor that affects the costs associated with an activity. Managers apply activity- based management system to the operational activity in order to determine the cost to perform an activity and the cost associated with not performing the activity. Through this activity cost drivers, it seeks to provide an extensive view on the actual costs of an activity. For instances, we can see in the Mason & Cox. In Mason & Cox, they feel that it is expensive to implement the activity-based costing system because it is more complex and expensive to maintain. Nevertheless, ABM seems to be more helpful to them in term of improving the company profitability. For example, saving had been achieved by targeting non-value-added activities.
Their real cost driver had been identified so that manager may know what to eliminate. The drop in the price of the high-volume lines had met with customer approval. Furthermore, ABM enables company to monitor and improve quality and delivery customer value by tracking cost driver. The new approach provided timely information about factors that were important to customers and factors that employees could control. There was no doubt that ABM had helped Mason & Cox to improve both profitability and customer value. Besides that, in Blue Cross and Blue Shield of Florida (BCBSF) needs more sophisticated cost information to make better decision in order to compete in the nature of the health care insurance industry and the need to manage the cost of operation like ways to allocate administrative cost to the products and services. Hence, BCBSF decided to implement ABM system.
ABM helps manager to examine the analysis of value added cost and non-value added costs. A value added cost is the cost of an activity that cannot be eliminated without affecting a product’s value to the customer. Some value added costs are always necessary, as long as the activities that drive such cost are performed efficiently and effectively. For instances, we can truly understand this concept in the Carpenter Company. The senior vice president of sales and marketing said that pillow fall into two distinct segments, the “commodity” part of the business and value-added line. For the “commodity” part of the business- consists of polyester-filled pillows which are a normal pillow.
Besides that, the “value-added line”, which features technology-driven fibers and fabrics designed to enhance sleep. As we can see, Carpenter Company had produced variety function of pillow like muscle stress and pain relieve pillow as well as pillow which reduce unnatural awakenings. Today, consumers are better educated about the benefits of various sleep surfaces and they recognize that the role of pillow can play in quality sleep. Although the price for a pillow which features technology-driven fibers and fabrics designed will be expensive but it can help consumer to have a quality sleep. Thus, consumers will not mind to pay more to improve a quality sleep. As a result, we can see that the “value-added line” may help company to gain profit.
In contrast, a non-value added cost is the cost of an activity that cannot be eliminated without diminishing the value. Non-value added cost activities are assumed to be unnecessary as a result it always be minimized like storing and handling inventories; transportation of raw material or partly finished products. If this non-value added costs happened, company may reduce or eliminate it by careful redesign of the operational process. As we can see how Taipei Fubon Bank deals with those non-value added costs in this mature and complex market. Taipei Fubon Bank needs to accurately determine profit and loss data by customer and customer group so that it could help bank to reduce operating costs and increase profit while maintaining it quality of service. Hence, the bank had developed a customer profitability management (CPM) system that provide thorough information regarding cardholder spending pattern and profitability to build highly targeted marketing and retention program.
This system did helped bank to reduce cost by updating timely management report, thus speeding marketing strategy adjustment decision. However, they wanted more information regarding a detailed analysis such as the profitability by card type at the individual customer level. As a result, they entered into the new CPM system by performing an in-depth analysis at the transaction level. The new CPM system contributes to division-wide productivity through the delivery of as-needed reporting to the user custom portal. The reporting may include customer spending habits, customer ranking by demographic criteria or the profitability of co-branded card by service channel. After using this system, Taipei Fubon Bank has significantly improving division profitability and now they can make more faster and accurate decision.
In Dow Chemical Company (DCC) which produces chemicals and plastics implement ABM to identify the activities they perform, eliminate non-value-added activities, determine cost drivers, set activity price to charge users and benchmark these price to ensure that they are competitive. While ABM has brought benefits to DCC but also brought many challenges to them. For instances, DCC feels that it is difficult to capture cost driver information without creating additional work. As the activity analysis became more and more detailed, DCC had to justify the complexities in obtaining and processing activity information. Ultimately the company decided that should not break activities down to task level, otherwise the resultant activities were too small and numerous.
By comparing with the traditional system, ABM system is more costly. Implementation of ABM system requires many resources such as human resources and time consuming. Different activities require different resources. Data that concerns on major activities must be measured, collected and entered into system. As we can see that Scottish National Blood Transfusion Service (SNBTS) feels that ABM system is a timely and costly system. By using ABM system, they need to implement a thorough mapping of all processes, drill down and filtering of all “relevant” activities, the identification of cost driver and others are enormous challenges. Thus, this may cause the company to take up much time and resources because this company consists of over 1100 staffs. Furthermore, everyone may have different point of view and searching for different data therefore they need times to eliminate and collect the right data into the right activities. Incorrect data collection and allocation may result to setbacks during the implementation stages and may jeopardize the whole project.
Misinterpretation might also happen in ABM system. This is because most of the information is interrelated and ambiguous. For instance, cost assigned to material, products and customer may be relevant and cause the manager to overlook some information. This causes misinterpretation happen and link to the wrong decision making. Wrong decision making may cause some issues happen in the operation such as production delay, over-production and wrong shipping.
Reports by using ABM system are suitable for internal users only and cannot report to external users. This is because ABM system has limitations since it does not conform to generally accepted accounting principles (G.A.A.P). Stakeholder might not be able to understand the reports on ABM system and therefore, ABM system is only restricted for internal use.
Previously, company usually apply traditional accounting system to manage the company’s operational activity but this system does not provide more detailed information that needed in this competitive environment. Therefore, managers require better information by developing activity-based management. This approach allow everyone in the organization understand where costs are being incurred, why are they being incurred and how these activities contribute to a higher value added to customers. Moreover, ABC explores to identify activities that can be eliminated or improved. In additional to that, communications will improve and changes are easier to make if company conducts the activity-based approach.
In addition to the above purpose, we feel that ABM system may be useful for a company. This is because it not only focuses on the product of a company but also the services and customers of a company. Besides that, it also help company to find out the cause of a problem, action plan for future development as well as evaluation of managers’ or departments’ present performance. In addition to that, it also helps company utilize true cost data which generated through ABC for further improvement in business profitability in the long run.
ABM in best practice firm lies at the heart of the decision-support process. Integrating ABM within the total information and management control system of the organization can lead to quantum improvements. Therefore, an organization needs to understand and address the common pitfalls and barriers to success at every stage of implementation. Besides, the ABM system should include and draw on the insights of the people who use it no matter during planning, activity analysis or other so that the implementation will success when the people use the system. Organization should tailor to the unique strategy, structure, capabilities, and needs of the firm so that the implementation will be succeeded. This is because ABM will not look the same in every organization although it is a universally useful concept.
Finally, we have an in-depth understanding of ABM during the process of working out this assignment and we found out that activity-based approach has more advantages than disadvantages. We have learned many things like time management and how to get along with our group members. Although we spent much time for discussing the lessons and recommendations, we didn’t have any argument during our discussion and everything went on smoothly.
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