Activity-based management (ABM) is a framework for determining the profitability of every aspect of a business. The end goal is to maximize organizational strengths while minimizing or eliminating weaknesses. Activity-based management can be described in the following steps: identification and analysis, evaluation and identification of areas of improvement.
Aspect
Explanation
Definition
– Activity-Based Management (ABM) is a strategic management approach that focuses on optimizing an organization’s activities to improve efficiency, reduce costs, enhance quality, and increase overall performance. It is closely related to Activity-Based Costing (ABC) and is used to align an organization’s activities with its strategic objectives. ABM involves analyzing and managing individual activities or processes within the organization to achieve better outcomes.
Key Concepts
– Activity Analysis: ABM starts with a thorough analysis of activities and processes within the organization. Each activity is examined to understand its cost, resource consumption, and contribution to value creation. – Cost Drivers: ABM identifies the factors that drive the cost of specific activities. Understanding these cost drivers is crucial for cost reduction and resource allocation decisions. – Continuous Improvement: ABM emphasizes a culture of continuous improvement. It seeks to eliminate non-value-added activities, streamline processes, and enhance productivity. – Performance Metrics: ABM uses performance metrics to measure the effectiveness of activities. These metrics may include key performance indicators (KPIs) related to cost, quality, and time. – Resource Allocation: ABM helps organizations allocate resources more effectively by directing resources to activities that align with strategic goals.
Application
– ABM is widely used in various industries, including manufacturing, service, healthcare, and finance. It helps organizations improve cost management, product pricing, and resource allocation. – ABM can identify activities that consume excessive resources or contribute little to value creation. This information guides decision-making to optimize processes. – It assists in setting performance targets for activities, aligning them with overall organizational goals. – ABM supports budgeting and planning processes by providing a detailed understanding of resource needs.
Benefits
– Cost Reduction: ABM helps organizations identify and eliminate unnecessary costs by focusing on value-added activities. – Improved Decision-Making: It provides data-driven insights for better decision-making related to resource allocation, pricing, and process improvement. – Enhanced Quality: By optimizing activities, ABM can lead to higher product or service quality. – Competitive Advantage: ABM allows organizations to be more agile and responsive to market changes, giving them a competitive edge.
Challenges
– Data Requirements: Implementing ABM requires accurate data on activities and costs, which can be challenging to collect and maintain. – Cultural Change: Shifting to an ABM approach often requires a cultural change within the organization to embrace continuous improvement and data-driven decision-making. – Resource Intensive: Implementing ABM can be resource-intensive, particularly in the initial stages.
Strategic Questions
– Which activities are critical to achieving our strategic goals? – What are the cost drivers for these activities, and how can we reduce their costs? – How can we measure the performance of activities and set improvement targets? – Are there activities that can be eliminated or outsourced to enhance efficiency? – How can we create a culture of continuous improvement within the organization?
Key Takeaway
– Activity-Based Management is a strategic approach that focuses on optimizing organizational activities to improve efficiency, reduce costs, and align processes with strategic objectives. It involves a deep analysis of activities, identification of cost drivers, and a commitment to continuous improvement. ABM enables organizations to make informed decisions, enhance quality, and gain a competitive advantage.
During the 1980s, many organizations adopted activity-based costing (ABC) systems to accurately calculate the unit cost of a product or service. Soon after, it became apparent that the information produced in each costing could be applied to the thousands of different activities a business performs.
Activity-based management was then born, providing important cost analyses for employees, equipment, distribution, and facilities, among other areas. Cost is evaluated in terms of value chain analysis, where the cost of an activity is compared to the value it adds to operations or strategy. As a result, the ABM method improves profitability and also aids in the creation of more accurate budgets and financial forecasts.
How does activity-based management work?
Activity-based management can be described in the following steps:
1 – Identification and analysis
Most businesses perform hundreds or even thousands of activities daily. Therefore it is critical to identify the activities with the most impact on finances. Cost drivers also need to be identified, or the factors most likely to cause the cost of an activity to vary.
If a business wants to replace its entire fleet of rental vehicles, then the cost driver is the size of the fleet. Why? Because the number of vehicles will determine the total cost of maintenance, insurance, and so forth.
2 – Evaluation
Using activity-based costing, management then needs to assign a cost to each activity based on the overhead expenses it incurs. The value of each activity compared to the costs incurred must also be evaluated using a value-chain analysis.
3 – Identification of areas for improvement
After the evaluation stage, the business understands its profitable and non-profitable activities.
Here, there are two choices:
Operational ABM – which involves enhancing value-generating activities while eliminating unnecessary costs and non-value-generating activities. Managers using operational ABM can identify cost anomalies and investigate accordingly. Activities that do not meet a threshold value can be scrapped, with resources redirected to higher-yield activities.
Strategic ABM – where the business uses activity-based costing to analyze the profitability of an activity. For this reason, it is used to determine the most profitable products or customers to pursue. Strategic ABM can also be used for strategic decision-making during product launches, advertising, and target audience formulation.
Limitations of ABM
Despite its obvious benefits to customer relations and profitability, there are a few drawbacks to activity-based management.
These include:
Limited scope – activity-based management only focuses on the quantifiable, financial aspects of an activity. This comes at the expense of intrinsic value, which is much more difficult to measure though no less important. For example, a distribution manager may need to travel frequently to secure supplier contracts. ABM may deem the travel unnecessary because of its high cost, but in reality, the travel is facilitating robust supplier relationships that will benefit the business long term.
Strategic interference – for the same reasons mentioned above, activity-based management can contradict short-term strategy if the benefits of the activity can only be realised over the long-term.
Activity-based costing – in some cases, businesses may find it difficult to perform ABC accurately. Source data is not always readily available, and activity-based costing does not always conform to accepted accounting principles. Furthermore, data produced by this method may conflict with a management team preferring to use traditional costing methods.
Activity-based management examples
Reducing non-value and improving product costing
In the first example, consider a financial services company with sales revenue of around $3 billion.
The company’s current position, which was placing immense pressure on its profit margins, was characterized by:
Increased competition from domestic players.
Lackluster industry sales.
The rising prevalence of customer in-sourcing.
Old, unprofitable business units, and
Collaboration with a top accounting firm where forward momentum had stalled.
ABM approach
After reaching out to an ABM provider, a seminar attended by 30 of the company’s most senior directors and managers was held.
The provider started with a pilot program that consisted of education, office, and treasury services, with a further 5 workshops conducted for each functional area.
Some of the primary measures included:
Defining activities and then associating expenses with these activities.
Developing a definition for non-value and action plans to eliminate it.
Creating or updating process maps, and
The definition or redefinition of performance standards.
Once the pilot program was deemed a success, it was expanded to other areas of the organization such as management information systems (MIS).
Employees from each of the seven regions where the company has a presence then traveled to a central location to attend the seminar.
Since the cohort chosen represented a diverse cross-section of talent, skills, and experience, it was hoped that this would improve process improvement buy-in across the entire company.
ABM results
To improve profit margins and become more competitive, the CEO of the financial services company established a directive to transfer resources spent on non-value activities to those that would grow the business.
A senior vice president was also tasked with reviewing the cost drivers, activity costs, action plans, and performance measures that were generated by the continuous improvement process.
Improving an outdated management reporting system
The second example also concerns a financial services company.
This time, imagine a company with $70 billion in assets and 26,000 employees whose management system is based on ineffective statutory reporting.
The company was also saddled with almost 6,500 cost centers which the CFO believed was far too many.
To make matters worse, senior executives also felt they did not have access to the information they needed to make sound decisions.
ABM approach
After securing the support of senior executives, an activity-based management provider created a pilot program with 500 employees with five workshops held for each cost center.
Broadly speaking, the content of each workshop was as follows:
Workshop 1 – the ABM provider started by explaining the overarching goal and asked the employees to define their respective activities.
Workshop 2 – each activity was then defined and reviewed in terms of how much time it necessitated. In some instances, time studies were performed to obtain more accurate numbers.
Workshop 3 – where cost drivers and non-value were identified, and process maps were defined and created.
Workshop 4 – where action plans were devised to reduce instances of non-value.
Workshop 5 – lastly, performance measures for cost, time, and quality were defined, discussed, and redefined as required. Each team was asked to present its action plans and performance measures to superiors.
Another pilot program was developed to analyze $150 million in expenditure on MIS components such as middleware, security, disaster recovery, internet, distributed processing, and research.
The provider took more of an active role in this pilot since the product-based language of management information systems sometimes hinders activity identification.
Once both pilot programs were completed, the financial services company performed an activity analysis and asked the ABM provider to review the results.
ABM results
The company managed to identify approximately $1.6 million in cost reductions from the first pilot program.
Management selected a software product to replace the existing cost accounting system which enabled them to forecast costs more accurately.
The software also allowed them to automatically download information to serve as the basis for all activity costs.
Case studies
Manufacturing Company:
Activities: Product design, raw material procurement, manufacturing, quality control.
Cost Drivers: Machine hours, material usage, labor hours, inspection time.
Cost Drivers: Project hours, research expenses, client interactions.
E-commerce Business:
Activities: Website maintenance, order processing, customer support.
Cost Drivers: Website traffic, order volume, customer inquiries.
Nonprofit Organization:
Activities: Fundraising campaigns, program delivery, administrative tasks.
Cost Drivers: Fundraising expenses, program beneficiaries, administrative staff.
Government Agency:
Activities: Public services, regulatory activities, infrastructure maintenance.
Cost Drivers: Service utilization, regulatory workload, infrastructure projects.
Key takeaways:
Activity-based management is a strategy used by businesses to determine the profitability of every activity they perform. The strategy is an adaptation of activity-based costing which became prevalent in the 1980s.
Activity-based management is performed by identifying high-impact activities and assigning a cost to each. The business can then choose strategic or operational ABM based on its specific needs.
Activity-based management does not focus on the intrinsic value of an activity and may conflict with short-term strategy or traditional accounting methods.
Key Highlights of Activity-Based Management (ABM):
Profitability Focus: ABM is a framework aimed at determining the profitability of all aspects of a business, focusing on maximizing strengths and minimizing weaknesses.
Evolution from ABC: ABM evolved from Activity-Based Costing (ABC) systems, which were originally used to calculate the unit cost of products or services. ABM extends this to analyze various activities within an organization.
Cost Analysis: ABM provides cost analyses for activities such as employee tasks, equipment usage, distribution, and facility operations.
Value Chain Analysis: It evaluates costs in terms of value chain analysis, comparing the cost of an activity to the value it adds to the organization’s operations or strategic goals.
Steps in ABM: ABM involves three main steps:
Identification and Analysis: Identifying impactful activities and cost drivers.
Evaluation: Assigning costs to activities and assessing their value to the organization.
Areas for Improvement: Identifying and improving profitable and non-profitable activities.
Operational ABM: Focuses on enhancing value-generating activities and eliminating unnecessary costs and non-value-generating activities within the organization.
Strategic ABM: Utilizes activity-based costing to analyze the profitability of activities and make strategic decisions, such as product launches and target audience formulation.
Limitations: ABM has limitations, including its focus on quantifiable financial aspects, potential conflicts with short-term strategies, and challenges in performing accurate Activity-Based Costing.
Related Frameworks, Models, or Concepts
Description
When to Apply
Activity-Based Costing (ABC)
Activity-Based Costing (ABC) is a costing methodology that assigns costs to activities based on their consumption of resources and then allocates those costs to products, services, or customers based on the activities they consume. ABC provides more accurate cost information than traditional costing methods by recognizing the different cost drivers that influence overhead costs. By understanding the costs associated with each activity, organizations can make more informed decisions about pricing, product mix, and process improvement.
Apply Activity-Based Costing to accurately allocate costs to activities and understand the cost drivers influencing organizational operations. Use it to identify opportunities for cost reduction, process improvement, and resource optimization by focusing on activities that add the most value to the organization. Implement ABC as a framework for strategic cost management, pricing decisions, and performance measurement to enhance profitability and competitiveness.
Activity-Based Budgeting (ABB)
Activity-Based Budgeting (ABB) is a budgeting approach that links the organization’s budget to its activities and operational plans. ABB focuses on allocating resources based on the activities required to achieve organizational objectives, rather than using historical budgeting methods or arbitrary cost allocations. By aligning the budget with the organization’s strategic priorities and operational activities, ABB helps improve resource allocation, prioritize spending, and drive performance improvement.
Apply Activity-Based Budgeting to align the organization’s budget with its strategic objectives and operational activities. Use it to prioritize resource allocation, identify cost-saving opportunities, and ensure that budget allocations support the organization’s goals and priorities effectively. Implement ABB as a framework for strategic financial management, performance planning, and resource optimization to enhance financial sustainability and organizational effectiveness.
Activity-Based Cost Management (ABCM)
Activity-Based Cost Management (ABCM) is a management approach that focuses on managing and improving activities to reduce costs, enhance efficiency, and create value for customers. ABCM combines activity-based costing with performance management techniques to identify and prioritize activities that drive costs and value creation. By managing activities effectively, organizations can optimize resource utilization, streamline processes, and improve overall performance and competitiveness.
Apply Activity-Based Cost Management to identify and manage activities that drive costs and value creation in the organization. Use it to streamline processes, reduce waste, and improve efficiency by focusing on activities that add the most value to customers. Implement ABCM as a framework for continuous improvement, cost reduction, and performance optimization to enhance organizational competitiveness and sustainability.
Value-Based Management (VBM)
Value-Based Management (VBM) is a management approach that focuses on maximizing shareholder value by aligning strategic decisions and actions with value creation opportunities. VBM emphasizes measuring and managing performance based on economic value added (EVA) or other value-based metrics, rather than traditional financial measures. By linking performance to value creation, VBM helps organizations prioritize investments, allocate resources efficiently, and enhance long-term shareholder wealth.
Apply Value-Based Management to align strategic decisions and actions with value creation opportunities in the organization. Use it to measure and manage performance based on value-added metrics, such as economic value added (EVA), and prioritize investments and initiatives that maximize shareholder value. Implement VBM as a framework for strategic planning, performance measurement, and capital allocation to drive long-term value creation and sustainable growth.
Lean Management
Lean Management is a management philosophy that focuses on maximizing customer value while minimizing waste and inefficiency in operations. Lean principles, such as continuous improvement, just-in-time production, and employee empowerment, aim to create a culture of efficiency, flexibility, and responsiveness to customer needs. By eliminating non-value-added activities and streamlining processes, Lean Management helps organizations improve quality, reduce lead times, and enhance overall performance and competitiveness.
Apply Lean Management principles to identify and eliminate waste and inefficiency in organizational processes. Use it to streamline operations, improve productivity, and enhance customer value by focusing on activities that contribute directly to organizational goals and customer satisfaction. Implement Lean Management as a framework for continuous improvement, operational excellence, and value creation to drive organizational performance and competitiveness.
Six Sigma
Six Sigma is a data-driven methodology for process improvement and quality management that aims to reduce defects and variation in products, services, and processes. Six Sigma uses statistical tools and techniques to identify and eliminate root causes of defects and performance issues, thereby improving process capability and customer satisfaction. By focusing on data-driven decision-making and continuous improvement, Six Sigma helps organizations achieve operational excellence, enhance quality, and drive customer loyalty and profitability.
Apply Six Sigma methodology to identify and eliminate defects and variation in organizational processes. Use it to improve process capability, enhance quality, and drive customer satisfaction by reducing errors, defects, and waste. Implement Six Sigma as a framework for continuous improvement, problem-solving, and performance optimization to achieve operational excellence and deliver value to customers and stakeholders.
Theory of Constraints (TOC)
Theory of Constraints (TOC) is a management philosophy and methodology that focuses on identifying and managing constraints or bottlenecks that limit organizational performance and throughput. TOC emphasizes the importance of optimizing the flow of work through the organization by identifying and resolving constraints systematically. By addressing constraints effectively, organizations can improve overall throughput, reduce lead times, and enhance operational efficiency and effectiveness.
Apply Theory of Constraints to identify and manage constraints that limit organizational performance. Use it to optimize the flow of work through the organization, reduce bottlenecks, and improve throughput by focusing on activities that impact system performance the most. Implement TOC as a framework for continuous improvement, constraint management, and performance optimization to achieve operational excellence and maximize organizational effectiveness.
Balanced Scorecard (BSC)
Balanced Scorecard (BSC) is a strategic performance management tool that provides a comprehensive framework for translating organizational strategy into actionable objectives and measures across four perspectives: financial, customer, internal processes, and learning and growth. The BSC helps organizations align their activities and measures with strategic priorities, monitor performance against strategic goals, and drive continuous improvement and innovation.
Apply Balanced Scorecard methodology to align organizational activities and measures with strategic objectives. Use it to define and track key performance indicators (KPIs) across financial, customer, internal process, and learning and growth perspectives, and drive performance improvement and innovation in line with strategic priorities. Implement BSC as a framework for strategic planning, performance measurement, and continuous improvement to achieve organizational goals and enhance long-term competitiveness and sustainability.
Total Quality Management (TQM)
Total Quality Management (TQM) is a management approach that emphasizes continuous improvement, customer focus, and employee involvement in achieving organizational excellence. TQM principles, such as customer satisfaction, employee empowerment, and process improvement, aim to create a culture of quality, innovation, and responsiveness to customer needs. By focusing on customer requirements and continuous improvement, TQM helps organizations enhance quality, reduce waste, and achieve operational excellence.
Apply Total Quality Management principles to foster a culture of quality, innovation, and continuous improvement in the organization. Use it to engage employees, empower them to contribute to quality improvement initiatives, and align processes with customer requirements and expectations. Implement TQM as a framework for achieving organizational excellence, enhancing customer satisfaction, and driving continuous improvement and innovation to sustain long-term success.
Kaizen
Kaizen is a Japanese term that means “continuous improvement” and refers to a philosophy and methodology for making incremental, ongoing improvements to processes, products, or services. Kaizen emphasizes the involvement of all employees in identifying and implementing improvements, fostering a culture of continuous learning and innovation. By encouraging small, incremental changes over time, Kaizen helps organizations achieve significant improvements in efficiency, quality, and customer satisfaction.
Apply Kaizen methodology to promote a culture of continuous improvement and innovation in the organization. Use it to engage employees at all levels in identifying and implementing small, incremental changes to processes, products, or services that lead to significant improvements in quality, efficiency, and customer satisfaction. Implement Kaizen as a framework for continuous learning, problem-solving, and performance improvement to drive organizational excellence and competitiveness.
A failure mode and effects analysis (FMEA) is a structured approach to identifying design failures in a product or process. Developed in the 1950s, the failure mode and effects analysis is one the earliest methodologies of its kind. It enables organizations to anticipate a range of potential failures during the design stage.
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Activity-based management (ABM) is a framework for determining the profitability of every aspect of a business. The end goal is to maximize organizational strengths while minimizing or eliminating weaknesses. Activity-based management can be described in the following steps: identification and analysis, evaluation and identification of areas of improvement.
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Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
