What is Activity-based Management?
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 management is a cost accounting term where management uses past production activities and costs as a benchmark to adjust current activities as well as current company goals.
Activity-based management (ABM) is a system for determining the profitability of every aspect of a business so that its strengths can be enhanced and its weaknesses can either be improved or eliminated altogether.
Activity-based management (ABM), which was first developed in the 1980s, seeks to highlight the areas where a business is losing money so that those activities can be eliminated or improved to increase profitability. ABM analyzes the costs of employees, equipment, facilities, distribution, overhead, and other factors in business to determine and allocate activity costs.
Understanding Activity-Based Management (ABM)
Activity-based management can be applied to different types of companies, including manufacturers, service providers, non-profits, schools, and government agencies. ABM can provide cost information about any area of operations in a business.
In addition to improving profitability and the overall financial strength of a company, the results of an ABM analysis can help that company produce more accurate budgets and long-term financial forecasts.
Examples of Activity-Based Management (ABM)
ABM can be used, for example, to analyze the profitability of a new product a company is offering, by looking at marketing and production costs, sales, warranty claims, and any costs or repair time needed for returned or exchanged products. If a company is reliant on a research and development department, ABM can be used to look at the costs of operating the department, the costs of testing out new products and whether the products developed there turned out to be profitable.
Another example might be a company that has opened an office in a second location. ABM can help management assess the costs of the running that location, including the staff, facilities, and overhead, and then determine whether any subsequent profits are enough to make up for or justify those costs.
Importance of ABM
ABM focuses on accountability for activities rather than costs and emphasises the maximisation of system wide performance instead of individual performance. ABM control recognizes that maximizing the efficiency of individual subunits does not necessarily lead to maximum efficiency for the system as a whole.
The functional-based management control assigns costs to organisational units and then holds the organizational unit manager responsible for controlling the assigned costs. Performance is measured by comparing actual outcomes with standards or budgets. The emphasis is on financial measures of performance; non-financial measures are usually ignored.
The functional based management traces costs to individuals who are responsible for incurring costs. The reward system is used to motivate managers to manage costs by increasing the operating efficiency of their organisational units. This approach assumes that maximising the performance of overall organisation is achieved by maximising the performance of individual organisational subunits.
Activity Based Management – Implementation
Activity based management builds off of an activity-based costing system. Once a company has developed and implemented an activity-based costing system, implementing activity-based management involves the three following steps:
- Classify activities as either value-added or non-value-added
- Rank value-added activities in terms of added customer-perceived value
- Enhance value-added activities and eliminate or reduce non-value activities
If the benefits of doing so exceed the costs, then a company should implement ABM. Implementing ABC and ABM can be costly in terms of time and resources. Many recommend implementing ABM when a company is facing intense price competition. It is also recommended more for companies with many complex products and processes as opposed to companies with simple products and processes.
Application of ABM in Business
- Cost Reduction: Activity-based management facilitates the organization to identify the costs against activities to determine the ways to reduce costs and even eliminate the entire activity if it is not adding any value to the products.
- Activity-Based Budgeting: ABB supplies a framework for forecasting the input required as per the budgeted level of activity. A comparison is made between actual results and estimated results to outline the activities with a high level of variances from the budget for a probable reduction in the supply of inputs.
- Business Process Reengineering: It entails examining and redesigning the processes and workflows of the organisation for improving the performance and also gaining excellence in business operations. It involves making significant changes regarding the way in which organisation operates currently. ABM helps in improving the business process efficiency and effectiveness.
- Benchmarking: Benchmarking is the process of making a comparison of the products and services offered by the company with that of the other organisations. It aims at identifying the ways to improve products and services of the firm.
- Performance Measurement: Nowadays, most of the firms concentrate on activity performance by observing the efficiency and effectiveness of activities, so as to compete successfully in the market.
ABM is not just an approach but also a management philosophy, that is oriented towards planning, implementation and measurement of business activities. It helps in cost reduction and also provides a proper basis for management decision making.
- Activity-based management (ABM) is a means of analyzing a company’s profitability by looking at each aspect of its business to determine strengths and weaknesses.
- ABM is used to help management find out which areas of the business are losing money so that they can be improved or cut altogether.
- ABM often makes use of information gathered with activity-based costing (ABC), a means of identifying and reducing cost drivers by better use of resources.