ABM can work for your company

January 20, 2004

0 6 minutes read

Activity based management (ABM) is now seen as an integral part of the decision-making framework and more and more enterprises are using it to identify true end-to-end product, customer or channel profitability. So what is ABM and is it the answer to your problems?

ABM is the process of understanding, re-engineering, measuring and making decisions about activities to put an enterprise on the road to continuous improvement and excellence. It draws on the technique of activity based costing (ABC) to provide information to help make long-term strategic decisions about such things as product mix and supply source. If you understand how customers and products drive activities within the business and consume costs and resources, you can make informed decisions about improving margins and reducing costs.

The way we manage today can actually hinder performance improvement. Consider the following common current practices:

1 Budgeting by cost element
What's the problem? Well, work is not visible. All cost centre statements appear similar – only the numbers change. ABM gets over this by showing a cost summary where all work is visible.

2 Organising functionally
Imagine a case where one department works in relative isolation from another, for example, sales and manufacturing. One may be promising change to customer designs and functionality without consulting the other. A recipe for disaster. ABM allows all activities to be linked to business processes, helping managers to see the whole picture.

3 Incremental budgeting
The problem here is that wasteful activities are hidden. Building on past budgets does not force the issue of how useful the activities are in the first place. ABM reviews every activity and its link to strategy. Is an activity adding any value to getting the organisation to where it wants to go?

4 Hierarchical organisations
These divorce responsibility from authority. Staff do not feel empowered to make decisions and communication channels are long and complex. ABM encourages people to focus on the business processes and help break down complex management structures. Don't underestimate the changes that will occur in an organisation once ABC/M is under way. Implementing ABM represents a major change in the way you do business.

5 After the event reporting
Variances are not prevented and by the time they are reported it is often too late to take corrective action. ABM provides a performance-management system that provides “feedforward” as opposed to feedback. ABM is especially powerful if integrated with total quality.

6 Fixed and variable costs are separated
We can't change a fixed cost, so we shall ignore it. Take something like property costs that can be distributed evenly over all departments. Using ABM, we can identify how much space we need and highlight the rest as excess. It can help an enterprise identify under-performing assets and non-value added activities. In many industries it is perceived wisdom that the driving issue is the fixed cost and that filling unused capacity becomes priority, but labour and materials can be costly.

7 Improvement is the responsibility of the accountant
That means no one else signs up to the improvement initiative. ABM requires company-wide involvement. Many enterprises mistakenly believe that they can forego ABM and enhance shareholder value by downsizing. However, this can lead to some ill-informed, value-destroying decisions.

Perhaps one of the main reasons why managers undertake ABM projects is to cut costs, or more generally, to provide support for decision making at the strategic and operational level. Using activity based information, enterprises can make informed commercial decisions such as:

pricing their products and services more accurately;
identifying the most profitable groups of customers to be the focus of future CRM (customer relationship management) activities;
identifying how to price sales coming from e-commerce against regular business;
providing detailed costing information as the basis for negotiating discounts with key accounts.

The key stages of ABM can be broken down into several steps.

What activities are performed?
The initial data collection process involves the development of departmental lists (or dictionaries) of activities. There should be between 10 and 20 activities defined for a department. Any more and the analysis will be too detailed.

What resources do they consume?
Managers within the business then allocate resources against these activities, based on an assessment of where people spend their time, and the resources consumed.

What outputs are produced?
Almost all activities have an output. Some will be easily measurable, others harder to define. By capturing information on resources and outputs we can benchmark an activity.

What factors cause the activity to occur?
This means looking at “activity level drivers” and “cost input drivers”. Activity level drivers determine how often the activity takes place. Cost input drivers are factors that affect the cost of doing the activity, such as the type of technology used.

How can we improve things?
Some companies introducing ABM are disappointed with what they achieve. This can be because they attempt the exercise at an unsustainable level of detail, or do not focus on the final stage of generating improvements. Implementations often fail because the business does not take the time to identify what it is trying to achieve. For an enterprise to decide on the right approach to ABM there are a number of issues it must consider. Planning is vital and should include an implementation phase. Often companies lose many of the benefits of ABM by not committing enough resources to implementation.

Education and awareness are key to the success of ABM.
ABM is company-wide and all those involved need to be included in training. Training should be fun and preferably should include realistic simulation exercises that demonstrate its benefits.

Process/activity definition should be done “top down” and in a workshop environment.
The aim of this phase is to define a structure for your activity database.

Data collection should exploit technology.
A good activity analysis should be flexible enough to be used for ABM, BPR, benchmarking and total quality.

Value added analysis – activity classification should always include some kind of value added/non-value added analysis (VA/NVA). Activity classification is subjective and all staff involved in classifying activities should understand that NVA is anything that can be eliminated without detriment to the final product or service.

Planning the system – in terms of budgeting, costing, modelling, reporting and performance measurement. The vision of the final ABM system should be defined as early as possible and the information requirements should be specified by all potential users. Failure to involve users can lead to the construction of a “dinosaur”.

Implementation – this should be well planned and care should be taken to address change management issues. A sponsor and owner should be identified for each major change.

There are many factors affecting the success of ABM. For example, the amount of time necessary to reach a usable stage of the ABC/M process increases as the company grows. In a study by the Cost Management Group of the American IMA (CIMA Management Accounting April 1998 “ABC: why it is tried and how it succeeds”, by Kip Krumwiede) companies with sales less than $100 million reported an average time of 2.3 years, while for larger firms this rose to 3.6 years.

In the same study, several respondents said they were having trouble implementing ABC/M because of other priorities, such as entering new products or markets, implementing new information systems and restructuring or re-engineering projects. One respondent was stuck at the analysis stage of ABC because of major initiative overload: besides ABC/M, his company was implementing a division-wide information system, total quality management, lean manufacturing, just-in-time, balanced scorecard, and manufacturing resource planning.

Smaller companies need to be particularly creative to find reasonable activity cost drivers in their often more limited data. For example, one company in the study used cost material as a proxy for its weight. The message is to look for available drivers that have some correlation with how resources are spent.

The same study concluded that improvements to information technology often precede both ABC and ABM adoption. A high level of IT sophistication appears to be an important factor in success. Companies will have an easier time implementing ABM if their IT system has the following characteristics; good subsystem integration, user friendly query capability, available sales, cost and performance data going back 12 months, and real-time updates of all these.

Yet while the capabilities of an IT system are generally important to ABC/M success, it is possible to succeed in a relatively poor IT environment. For example, Krumwiede states that a vice president of cost management for First Tennessee Bank, which uses ABC extensively, applies the 80:20 rule. When starting out, his bank focused primarily on the core processes and gave up some precision for an understandable model of operations. In this example the ABC information is being used for strategic decisions because it is easily understood and “close enough” for current needs.

ABM is a fundamental shift in emphasis away from traditional costing towards performance measurement. Activities consume resources, so controlling activities allows you to control costs at their source. Understanding business activities allows us to eliminate those that are unnecessary and streamline costs. This is the real value and power of ABM; the information it brings.

The basic technique of activity analysis can be adapted to provide a range of benefits, such as re-engineering the annual budget process, major cost reductions (10-30 per cent), customer and channel profitability, continuous performance improvement and new forms of performance measurement, such as the balanced scorecard. The accumulated benefits of such a technique should lead to a competitive advantage. And if beating the competition is your problem, adopting ABM will certainly be to your advantage.