ACTIVITY BASED MANAGEMENT

Changes in the business environment, triggered by global competition and

technological innovation, have led to innovations in the use of financial and nonfinancial
information in organizations. The new environment demands relevant information and data
about costs and performance within the organizations activities, processes, products,
services and customers. Usually, leading companies are using their cost systems to design
products and services that both meet customers expectations and can be produced and
delivered at a profit, guide product mix and investment decisions, assists employees in their
learning and continuous improvement activities, etc (Kaplan & Cooper, 1998:5).
Activity-based costing or management have attracted high levels of interest from both
academics and practitioners since its emergence in the late 1980s (Bjornenak & Falconer,
2002: 481). Activity-based management (ABM) is subsequently defined by CAM-I
(Consortium for Advanced Manufacturing-International) as a discipline that focuses on the
management of activities as the route to improving the value received by the customer and
the profit achieved by providing this value. ABM includes cost driver analysis, activity
analysis, and performance measurement, drawing on ABC as its major source of data. Using
ABC data, ABM focuses on how to redirect and improve the use of resources to increase the
value created for customers and other stakeholders.
To give an overview also, Activity-based costing (ABC) is defined as a methodology
that measures the cost and performance of activities, resources, and cost objects.
Specifically, resources are assigned to activities, then activities are assigned to cost objects
based on their use. ABC recognizes the causal relationships of cost drivers to activities
(Institute of Management Accountants, 1998). ABC was developed as an approach to
address problems associated with traditional cost management systems, which tend to have
the inability to accurately determine actual production and service costs, or provide useful
information for operating decisions. With these deficiencies managers can be exposed to
making decisions based on inaccurate data. The higher exposure is for companies with
multiple products or services.
It was therefore, ABM is a tool developed to support the process-based organisation
by providing information and data needed to plan, manage, control, and direct the activities
of a business to improve processes, products and services, to eliminate waste and to
executive business operations and strategies. This information takes the form of the outputs

of an ABM information system. ABM accomplishes its objectives through two complementary
applications which are the operational and strategic ABM. The diagram below shows the
summary of ABM complementary applications.

Based on the diagram above, the operational ABM is works to enhance efficiency,
lower costs and asset utilization. It can increase the capacity of resources by reducing
machine downtime, improving or eliminating entirely faulty activities and processes and
increasing the efficiency of the organizations resources. The benefits from operational ABM
can be measured by reduced costs, higher revenues through better resource utilization and
cost avoidance.
On the other hand, for strategic ABM, it somehow explores various ways a company
can create and sustain a competitive advantage in the marketplace. ABM attempts to alter
the demand for activities to increase profitability, encompasses decisions about product
design and development where the biggest opportunity for cost reduction exists, improves
relationships with suppliers and customers.
Some of the specific uses of ABM in organizations today include attribute analysis,
strategic decision making, benchmarking, operations analysis, profitability/pricing analysis,
and process improvement. ABC/ABM systems can use (IMA, 1998) many different attributes

or data tags for a specific cost. Data attributes allow a company to perform analysis on
many different dimensions of a management problem using the same basic store of data.
Organizations that are designing and implementing ABM will find there are five basic
information outputs which are:

relevant information about the cost of activities and business processes;

the cost of non-value-added activities in order to identify activities that do not

contribute to customer value or the organizations need and make improvement
efforts;

activity-based performance measures to provide scorecards, to report how well

improvement efforts are working;

accurate product/service cost (cost objects) information this is vital for selecting
the segmented markets where an organization competes;

cost drivers in order to identify factors that can cause changes in the cost of an
activity

The real life example of the implementation of activity based management was
described in Mason & Cox story. Mason & Cox was Australias largest independent foundry,
producing metal castings for a wide range of local industries and export customers. Their
conventional planning and control system are based on standard costing and budgeting. It
had been business for a long time, but by the 1990s its profits had declined. The cause of
the problem was not clear from the companys existing conventional management
accounting system. Olivia Shannon who was the accounting manager knew that an
improved product costing system would help with strategic decision making.

Besides that, she hoped that the new product costing system will help to reduce
costs and improve performance in other key area in order for them to survive. They start to
explore the ABM to improve the performance. ABM is differing from ABC in term of the
activities involved, the cost drivers and the performance. It is proven that ABM enabled them
to reduce costs and manage other important aspects. To reduce costs, Shannon worked
through four steps which are identifying the major opportunities for cost reduction,
determining the real causes of non-value added costs, developing a program for reducing
costs and introduce some new performance measures to monitor the effectiveness of cost
reduction efforts.
Shannon undertook a value analysis or also known as activity analysis in order for
her to identify opportunities to reduce costs. This is where she classified activities as valueadded or non-value added. Value-added activities provide essential value to the customer,
or are essential to the functioning of the business. For example, while managing the
business and preparing annual accounts. On the other hand, the non value-added do not
add value to a product from the customers perspective or for the business and, therefore,
can be eliminated without detriment to either. In many businesses, major sources of non
value-added activity include waiting, inspection, rework and the unnecessary movement and
storage of inventories.
To eliminate non value-added costs, Shannon began by building activities into
process. Then she analysed those processes to find the causes of the non-value added
activities. This is where she identify each activity, the one who will supply the input, the one
who consume the input, etc. When the link activities together, it will become a processes.
Once the processes had been identified, Shannon attempted to identify the root cause cost
drivers of the three major non value-added activities at Mason & Cox. Root cause cost
drivers are the basic factors that cause activities to be performed and their costs to be
incurred. She then used cost driver analysis to identify root cause cost drivers for the major
non value-added activities.
The next step for Shannon was to develop a program to eliminate the root causes of
the major non value-added activities. For example, she identified metal impurities as a
primary cause of defects in castings and, therefore as a major cause of the non value-added
activities. After that, she worked with the purchasing manager to improve the quality of the
metal used in castings. Next, the last step that Shannon is using by identified performance
measures that reflected both costs and cost drivers. She also introduced activity-based
performance measures to monitor quality and delivery. An activity-based performance

measure is used to monitor the effectiveness of cost reduction efforts, as well as other key
sources of customer value. Mason & Coxs management identified three aspects of
performance that it believed were critical to the achievement of strategies and, therefore, to
the success of the business which are the quality, delivery time and cost.
There are several benefits that a company can get by implementing it in their
business. Among the benefits of activity-based management that many firms have
experience were, firstly was the information gain is effective for decision making. It provides
more accurate measurements of activity-driving costs, and helping the managers to improve
product and process value by making better product design decisions, better customer
support decisions, and fostering value enhancement projects. Besides that, the company will
have information that will help them to continuously improve processes and reducing the
cost incurred. Moreover, the implementation of ABM will somehow improve the services and
products quality. Last but not least, the benefit through ABM is that it improves the
relationships with the suppliers as well as customers.
Although activity-based management provides better product or service costs than
activity-based costing systems, managers should be aware of its limitations or drawbacks.
One of it is that it hard to make an estimation of the plans or budgets. Moreover, it can be
costly in terms of time and resources required during the processes.
Therefore, we can conclude that the successful implementation of ABM is not the
same in every organization or follows the same path. Tailored to the unique strategy,
structure, capabilities, and needs of the firm, ABM is a universally useful concept and system
that can take on a multitude of shapes and uses. ABM data should meet the needs of the
companys decision makers and support their efforts to create value for all stakeholders.
Uses of ABM increase not only the value received by customers but also the rms prots.
Customer protability analysis traces costs to customers to allow management to determine
customer protability and to provide more attentive service to high-prot customers, acquire
new high-prot customers, and improve the protability of current customers. Numerous
factors play important roles in implementing ABM. To be successful, management
accountants need to cooperate with engineers and manufacturing and operating managers
to form a design team.

http://www.cimaglobal.com/Documents/ImportedDocuments/ABM_techrpt_0401.pdf
http://en.wikipedia.org/wiki/Activity-based_management