What is Activity based management? How does it work?

Activity-based management (ABM) is a procedure used by companies to assess the profitability of each segment of their business, allowing them to recognize problem areas and areas of particular strength. Its goal is to highlight the areas where a company is losing money so that certain activities can be reduced or changed in order to boost profits.

What is Activity based management?

The term Activity based management (ABM) is used to refer to the cost management application of Activity-based costing (ABC). The application and use of ABC as a costing technique to control/manage costs at the activity level is known as Activity-based management.

ABM is a discipline that focuses on efficient and effective management of activities as a means of continually improving consumer value and satisfaction. It makes use of the cost information gathered through ABC analysis. ABC aids in the mapping of costs/resources to activities or business processes and then allocates such activity costs to different products/services. This information, in turn, serves as a valuable input for ABM analysis.

Keynote:

“ABC supplies the information, and ABM uses this information in various analyses designed to yield continuous improvement”.

What is its scope?

Manufacturers, service providers, non-profit entities, colleges, and government agencies are all examples of organizations that may benefit from Activity-based management. ABM may provide cost information on any aspect of a company’s operations.

Further, ABM takes into consideration all costs, including equipment costs, operating costs, staff costs, facility costs, and delivery or distribution costs.

For example, if a company has opened an office in a new location, ABM might be helpful to the management in assessing the costs of operating that particular site, such as personnel, equipment, and overheads, and then determining whether any resulting earnings are sufficient enough to cover up or justify those costs.

What objectives does it serve?

There are three main objectives served by Activity based management:

1. To identify and enhance value-added activities

2. To identify and reduce non-value-added activities

3. To re-design processes to improve efficiency and profitability

Objectives of activity based management

Various types of analysis in Activity based Management

Activity-based Management plays an important role in making a number of different analyses, some of which are:

  • Cost Driver Analysis

In order to manage activity costs, the factors that trigger activities to be performed must be known. Such causal factors are identified by cost driver analysis.

  • Activity Analysis

ABM can assist managers in identifying value-added and non-value added activities.

Value-Added Activities (VA): The value-added activities are those activities that are indispensable for a process to get completed. Customers are generally willing to pay (in some way or the other) for these services. For instance, polishing furniture by a manufacturer dealing in furniture is a value-added activity.

Non-Value-Added Activities (NVA): The non-value added activities represent tasks that are not accorded any value by the external or internal customer. Such activities do not enhance the quality or function of a product or service; in fact, they can have an adverse impact on costs and prices. Moving materials between places (or from one department to another) and machine set up for a production run could be some examples of NVA activities.

None of these activities add any value to the customer. For example, inspecting is an activity in which time and resources are spent ensuring that the product meets specifications. But inspecting would not be necessary at all if the product is produced correctly the first time itself.

  • Performance Analysis: Performance analysis involves the identification of effective metrics to report the performance of activity centres or other organizational units, consistent with each unit’s goals and objectives.

Using Activity-based management as a tool for business analysis

ABM may be used in the following ways:

1. Cost Reduction: People must first recognize the activities that a product consumes before they can make substantial cost savings. They must then find out how to rework those activities in order to increase production efficiency.

ABM assists an organization in identifying costs associated with activities and identifying opportunities to streamline, reduce or remove the activity altogether, especially if there is no value-added.

2. Business Process Re-engineering: Examining business processes and making substantial improvements to how an organization currently operates is what business process re-engineering entails. ABM is a valuable tool for assessing business performance, calculating the cost of business output, and finding opportunities to increase process efficiency and effectiveness.

For example, procurement of materials is considered as a business process comprising activities such as receiving a purchase request from the production department, finding suppliers, making purchase orders, mailing purchase orders, and performing follow-up. One way in which this process could be re-engineered is by sending the production schedule directly to the suppliers and by entering into a contractual agreement to deliver materials as per the schedule. With this, there could be a significant elimination of some activities like raising a purchase request every time materials are needed, finding potential suppliers each time, and waiting for their bid; all of which may cause a delay in the production process, thereby, hampering an organization’s goals.

3. Benchmarking: Benchmarking involves a process of comparing ABC-derived activity costs of one segment of a company with those of other segments. It necessitates uniformity in the definition of activities and measurement of their costs.

4. Performance Measurement: Many businesses are now focusing on activity performance as a means to compete with their competitors and to manage costs by tracking the efficiency and effectiveness of activities. A few examples of performance measures used to monitor activities may be:

AreaMeasure
Quality of purchased componentZero defects
Quality of output% yield
Customer awarenessOrders; the number of complaints

How can one implement ABM?

ABC system forms the very basis for implementing ABM. Once an organization has built and implemented an Activity-based costing system and once activity-wise cost data is available, implementing ABM involves the below mentioned three steps:

1. Classify activities as either value-added or non-value-added

2. Rank value-added activities in terms of added customer-perceived value

3. Enhance value-added activities and eliminate or reduce non-value activities

Takeaway

Activity-Based Management (ABM) is a means of analyzing and evaluating a company’s business activities through Activity-based costing. Activity-based costing serves as a major source of information in ABM.

To read more about how to develop an activity-based costing system in your business, please refer to our blog linked below:

What is activity-based costing? – Meaning and suitability

Ruchi Gandhi

The author enjoys to write informational content in the domain of company law and allied laws. She takes interest in doing thorough and analytical research on legal topics. She is a CA along with MBA (Fin) and M. Com.

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