Activity-Based Management (Encyclopedia of Business and Finance)
Activity-based management (ABM) is an approach to management in which process managers are given the responsibility and authority to continuously improve the planning and control of operations by focusing on key operational activities. ABM strategically incorporates activity analysis, activity-based costing (ABC), activity based budgeting, life-cycle and target costing, process value analysis, and value-chain analysis. Enhanced effectiveness and efficiencies are expected for both revenue generation and cost in currences. Since the focus is on activities, improved cost management is achieved through better managing those activities that consume resources and drive costs. The focus for control is shifted away from the financial measurement of resources to activities that cause costs to be incurred.
As an overall framework, ABM relies on ABC information. ABC deals with the analysis and assignment of costs. In order to complete cost analyses, activities need to be identified and classified. An activity dictionary can be developed, listing and describing all activities within an organization, including information on each activity's location, performance measure(s), and key value-added and non-value-added attributes. (See "ABC/ABM Dictionary," which was used to help construct many of the definitions used in this entry.) ABC information is extremely helpful in the strategic analysis of areas such as process and plant layout redesign, pricing, customer values, sourcing, evaluation of competitive position, and product strategy.
ACTIVITY AND ACTIVITY ANALYSIS
An activity is a business task, or an aggregation of closely related purposeful actions, with clear beginning and ending points, that consumes resources and produces outputs. An activity could be a single task or a simple process. Resources are inputs, such as materials, labor, equipment, and other economic elements consumed by an activity in the production of an output. Outputs are products, services, and accompanying information flowing from an activity. In seeking continuous business improvement, an overall examination of variations in performances of key organizational activities and their causes is referred to as activity analysis. Performance is measured by a financial or nonfinancial indicator that is causally related to the performance (adding value to a product or service) of an activity and can be used to manage and improve the performance of that activity.
The level of an activity within an organization depends on that level of operations supported by that activity. For instance, a unit-level activity is one that is performed directly on each unit of output of an organizational process. A batch-level activity is one performed on a small group, or batch, of output units at the same time. For example, the setup activity to run a batch job in a production process and the associated cost for completing such a setup is a batch-level activity. A customer-sustaining activity supports an individual or a particular grouping of customers, such as mailings or customer service. A product-sustaining activity supports an individual product or product line, such as product (re)design or (re)engineering. These last two types of activities are sometimes referred to as service-sustaining activities. Lastly, a facility-sustaining activity supports an entire facility, such as the actions of the manager of an entire plant, with an associated cost equal to the manager's compensation package. Not every activity within an organization is significant enough to isolate in an activity analysis.
A process is a set of logically related activities performed in order to achieve a particular objective, such as the production of a unit of product or service. Identification of all such processes within an organization along with a specification of the relationships among them provides a value chain. Value chains are often presented in terms of functional areas (a function provides the organization with a particular type of service or product, such as finance, distribution, or purchasing). Within each of these key processes, activities can be classified as primary activities, secondary activities, and other activities. Primary activities contribute directly to the providing of the final product or service. Secondary activities directly support primary activities. The "other activities" category is comprised of those actions too far removed from the intended output to be individually noted. They should be examined to determine if they are necessary and should be continued.
VALUE-ADDED AND NON-VALUE-ADDED
Each of the key (primary and secondary) activities noted from our analysis must be categorized as either value-added or non-value-added. This analysis is referred to as value analysis. An activity is value-added to the extent that its performance contributes to the completion of the product or service for consumers. While value-added activities are necessary, the efficiency with which they are performed often can be improved through best practice analysis and benchmarking. This process of improvement is referred to as business process redesign or reengineering.
Because many activities may not fit neatly into a value-added/non-value-added dichotomy, weightings may be assigned to indicate the extent to which an activity is value-added, such as a scale ranging from one to eight, with an eight representing total value-additivity and a zero, none. A non-value-added activity transforms a product or service in a way that adds no usefulness to the product or service. Non-value-added activities should be minimized or eliminated. An overall value-chain analysis would examine all the activities and associated processes in an attempt to provide greater value at the same cost, the same value at less cost, or both.
Because costs are initially assigned from resource cost pools to activity cost pools and from there to final cost objects, activity-based costing is viewed as a two-stage allocation process. Once activities have been identified, an activity-based costing analysis can be completed. Activity-based costing is a form of cost refinement, designed to obtain greater accuracy than traditional allocations in cost assignments for product costing and decision-making purposes. Costs are assigned to activities from resource cost pools. Costs are first accumulated according to the type of resource, such as materials or labor, with which they are associated. Then resource (cost) drivers, which measure the consumption of a resource by an activity, are identified and used to assign the costs of resource consumptions to each activity. The result of this assignment is an activity cost pool for each activity.
From the activity cost pool, the focus shifts to one or more activity drivers. An activity driver measures the frequency or intensity with which a cost object requires the use of an activity, thereby relating the performance of an activity's tasks to the needs of one or more cost objects. A cost object is why activities are performed; it is a unit of product or service, an operating segment of the organization, or even another activity for which management desires an assignment of costs for unit costing or decision making purposes. The activity cost pools are then reassigned to the final cost objects according to the intensity with which each cost object used the respective activity drivers.
A cost driver may be defined to be "any factor that has the effect of changing the level of total cost for a cost object." (Blocher et al., 1999, p. 8) In general, four types of cost drivers can be identified: volume-based, activity-based, structural, and executional (Blocher, et al., 1999, p. 61). Activity-based management focuses on activity-based cost drivers. In investigating and specifying cost drivers, many methods are used, such as cause-and-effect diagrams, cost simulations, and Pareto analysis.
Traditional cost assignment systems typically would assign directly to the cost objects the costs of those resource consumptions that can be economically traced directly to units of output requiring the resources. The remaining costs, referred to as indirect costs, would be accumulated into one or more cost pools, which would subsequently be allocated to the cost objects according to volume-related bases of allocation. When different products consume resources at rates that are not accurately reflected in their relative numbers (volumes), a traditional cost allocation approach will result in product cost cross-subsidization. That is, a high-volume, relatively simple product will end up overcosted and subsidizing a subsequently undercosted, low-volume, relatively complex product, resulting in inaccurate unit costing and suboptimal product-line pricing decisions and performance evaluations. Activity based costing tries to take the nonuniformity of resource consumption across products into account in the assignment of costs.
"ABC/ABM Dictionary." .
Blocher, Edward J., Chen, Jung H., and Lin, Thomas W. (1999). Cost Management: A Strategic Emphasis. New York: Irwin/McGraw-Hill.
Cooper, Robin, Kaplan, Robert S., Maisel, Lawrence S., Morrissey, Eileen, and Oehm, Ronald M. (1992). Implementing Activity-Based Cost Management: Moving from Analysis to Action. Montvale, NJ: Institute of Management Accountants.
Hilton, Ronald W., Maher, Michael W., and Selto, Frank H. (1999). Cost Management: Strategies for Business Decisions. New York: Irwin/McGraw-Hill.