Activity based Management Concept, Rational, issues, Limitations

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 follow this premise: products consume activities; activities consume resources. If managers want their products to be competitive, they must know both:

(i) The activities that go into making the goods or providing the services

(ii) The cost of those activities.

To reduce a product’s cost, managers will likely have to change the activities the product consumes.

Activity-based costing is defined as a methodology that measures the cost and performance of activities, resources and cost objects. Specially, resources are assigned to activities based upon consumption rates and activities are assigned to cost objects, again based on consumption. ABC recognizes the causal relationships of cost driver to activities.

Activity-based management is defined 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.

In simple terms, ABC is used to answer the question “what do things cost?” While ABM, using a process view, is concerned with what factors cause costs to occur? 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.

Model

• Cost Driver Analysis: For the purpose of managing the activity costs, the factors that result in the activities to take place are to be identified.
• Activity Analysis: Activity Analysis is all about finding out the activities of the organizations and its centres, that are ought to be utilized in the activity-based costing. Based on the costs and benefits of the alternatives, the activities are divided into the number of activity centres. Further, it ascertains value added and non-value added activities:
• Value Added Activities: The activities which are very essential for the completion of the process are categorized as value-added activities.
• Non-Value Added Activities: Those activities which are not having any worth for both external or internal customers are termed as Non-value added activities. Indeed these activities do not enhance the quality of the product rather they have a negative impact on the cost and prices of the product or services as they create wastes, delays, increase the overall value etc.
• Performance Analysis: It involves discovering a proper measure to analyse the performance of the activity centres.

Importance

• 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.
• 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.
• 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.
• 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.
• 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.

Issues, Limitations

The trouble with ABM is its underlying assumption that all of the benefits and costs of a cost object can be translated into monetary terms. For example, the outcome of an ABM analysis might lead management to the conclusion that the workplace should be downgraded to a lower-grade property in order to save money; in reality, a fancier office space is useful for attracting recruits to the company.

For the same reason, it can be difficult to apply ABM to strategic thinking. The problem in this area is that a new strategic direction may be quite expensive in the short-term, but has prospects for a long-term payoff that are difficult to quantify under an ABM analysis.

For the two indicated reasons, the information generated by an ABM analysis cannot be used to drive all management decisions; it is simply information that can then be inserted into the general context of how an organization should be operated. Thus, it is one of several decision tools that management can use.

Risks

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 who represents a loss based on committed activities, but who 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”. 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.