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.
Table of Contents
Understanding activity-based management
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.
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.
Agile Business Analysis (AgileBA) is certification in the form of guidance and training for business analysts seeking to work in agile environments. To support this shift, AgileBA also helps the business analyst relate Agile projects to a wider organizational mission or strategy. To ensure that analysts have the necessary skills and expertise, AgileBA certification was developed.
Business valuations involve a formal analysis of the key operational aspects of a business. A business valuation is an analysis used to determine the economic value of a business or company unit. It’s important to note that valuations are one part science and one part art. Analysts use professional judgment to consider the financial performance of a business with respect to local, national, or global economic conditions. They will also consider the total value of assets and liabilities, in addition to patented or proprietary technology.
A paired comparison analysis is used to rate or rank options where evaluation criteria are subjective by nature. The analysis is particularly useful when there is a lack of clear priorities or objective data to base decisions on. A paired comparison analysis evaluates a range of options by comparing them against each other.
The Monte Carlo analysis is a quantitative risk management technique. The Monte Carlo analysis was developed by nuclear scientist Stanislaw Ulam in 1940 as work progressed on the atom bomb. The analysis first considers the impact of certain risks on project management such as time or budgetary constraints. Then, a computerized mathematical output gives businesses a range of possible outcomes and their probability of occurrence.
A cost-benefit analysis is a process a business can use to analyze decisions according to the costs associated with making that decision. For a cost analysis to be effective it’s important to articulate the project in the simplest terms possible, identify the costs, determine the benefits of project implementation, assess the alternatives.
The CATWOE analysis is a problem-solving strategy that asks businesses to look at an issue from six different perspectives. The CATWOE analysis is an in-depth and holistic approach to problem-solving because it enables businesses to consider all perspectives. This often forces management out of habitual ways of thinking that would otherwise hinder growth and profitability. Most importantly, the CATWOE analysis allows businesses to combine multiple perspectives into a single, unifying solution.
It’s possible to identify the key players that overlap with a company’s business model with a competitor analysis. This overlapping can be analyzed in terms of key customers, technologies, distribution, and financial models. When all those elements are analyzed, it is possible to map all the facets of competition for a tech business model to understand better where a business stands in the marketplace and its possible future developments.
The Pareto Analysis is a statistical analysis used in business decision making that identifies a certain number of input factors that have the greatest impact on income. It is based on the similarly named Pareto Principle, which states that 80% of the effect of something can be attributed to just 20% of the drivers.
A comparable company analysis is a process that enables the identification of similar organizations to be used as a comparison to understand the business and financial performance of the target company. To find comparables you can look at two key profiles: the business and financial profile. From the comparable company analysis it is possible to understand the competitive landscape of the target organization.
A SWOT Analysis is a framework used for evaluating the business’s Strengths, Weaknesses, Opportunities, and Threats. It can aid in identifying the problematic areas of your business so that you can maximize your opportunities. It will also alert you to the challenges your organization might face in the future.
The PESTEL analysis is a framework that can help marketers assess whether macro-economic factors are affecting an organization. This is a critical step that helps organizations identify potential threats and weaknesses that can be used in other frameworks such as SWOT or to gain a broader and better understanding of the overall marketing environment.
Business analysis is a research discipline that helps driving change within an organization by identifying the key elements and processes that drive value. Business analysis can also be used in Identifying new business opportunities or how to take advantage of existing business opportunities to grow your business in the marketplace.
In corporate finance, the financial structure is how corporations finance their assets (usually either through debt or equity). For the sake of reverse engineering businesses, we want to look at three critical elements to determine the model used to sustain its assets: cost structure, profitability, and cash flow generation.
Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.
Value investing is an investment philosophy that looks at companies’ fundamentals, to discover those companies whose intrinsic value is higher than what the market is currently pricing, in short value investing tries to evaluate a business by starting by its fundamentals.
The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.
Financial accounting is a subdiscipline within accounting that helps organizations provide reporting related to three critical areas of a business: its assets and liabilities (balance sheet), its revenues and expenses (income statement), and its cash flows (cash flow statement). Together those areas can be used for internal and external purposes.
Post-mortem analyses review projects from start to finish to determine process improvements and ensure that inefficiencies are not repeated in the future. In the Project Management Book of Knowledge (PMBOK), this process is referred to as “lessons learned”.
Retrospective analyses are held after a project to determine what worked well and what did not. They are also conducted at the end of an iteration in Agile project management. Agile practitioners call these meetings retrospectives or retros. They are an effective way to check the pulse of a project team, reflect on the work performed to date, and reach a consensus on how to tackle the next sprint cycle.
In essence, a root cause analysis involves the identification of problem root causes to devise the most effective solutions. Note that the root cause is an underlying factor that sets the problem in motion or causes a particular situation such as non-conformance.
A break-even analysis is commonly used to determine the point at which a new product or service will become profitable. The analysis is a financial calculation that tells the business how many products it must sell to cover its production costs. A break-even analysis is a small business accounting process that tells the business what it needs to do to break even or recoup its initial investment.
Stanford University Professor Ronald A. Howard first defined decision analysis as a profession in 1964. Over the ensuing decades, Howard has supervised many doctoral theses on the subject across topics including nuclear waste disposal, investment planning, hurricane seeding, and research strategy. Decision analysis (DA) is a systematic, visual, and quantitative decision-making approach where all aspects of a decision are evaluated before making an optimal choice.
A DESTEP analysis is a framework used by businesses to understand their external environment and the issues which may impact them. The DESTEP analysis is an extension of the popular PEST analysis created by Harvard Business School professor Francis J. Aguilar. The DESTEP analysis groups external factors into six categories: demographic, economic, socio-cultural, technological, ecological, and political.
The STEEP analysis is a tool used to map the external factors that impact an organization. STEEP stands for the five key areas on which the analysis focuses: socio-cultural, technological, economic, environmental/ecological, and political. Usually, the STEEP analysis is complementary or alternative to other methods such as SWOT or PESTEL analyses.
The STEEPLE analysis is a variation of the STEEP analysis. Where the step analysis comprises socio-cultural, technological, economic, environmental/ecological, and political factors as the base of the analysis. The STEEPLE analysis adds other two factors such as Legal and Ethical.
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.
PMESII-PT is a tool that helps users organize large amounts of operations information. PMESII-PT is an environmental scanning and monitoring technique, like the SWOT, PESTLE, and QUEST analysis. Developed by the United States Army, used as a way to execute a more complex strategy in foreign countries with a complex and uncertain context to map.
The SPACE (Strategic Position and Action Evaluation) analysis was developed by strategy academics Alan Rowe, Richard Mason, Karl Dickel, Richard Mann, and Robert Mockler. The particular focus of this framework is strategy formation as it relates to the competitive position of an organization. The SPACE analysis is a technique used in strategic management and planning.
A lotus diagram is a creative tool for ideation and brainstorming. The diagram identifies the key concepts from a broad topic for simple analysis or prioritization.
Functional decomposition is an analysis method where complex processes are examined by dividing them into their constituent parts. According to the Business Analysis Body of Knowledge (BABOK), functional decomposition “helps manage complexity and reduce uncertainty by breaking down processes, systems, functional areas, or deliverables into their simpler constituent parts and allowing each part to be analyzed independently.”
The multi-criteria analysis provides a systematic approach for ranking adaptation options against multiple decision criteria. These criteria are weighted to reflect their importance relative to other criteria. A multi-criteria analysis (MCA) is a decision-making framework suited to solving problems with many alternative courses of action.
A stakeholder analysis is a process where the participation, interest, and influence level of key project stakeholders is identified. A stakeholder analysis is used to leverage the support of key personnel and purposefully align project teams with wider organizational goals. The analysis can also be used to resolve potential sources of conflict before project commencement.
Strategic analysis is a process to understand the organization’s environment and competitive landscape to formulate informed business decisions, to plan for the organizational structure and long-term direction. Strategic planning is also useful to experiment with business model design and assess the fit with the long-term vision of the business.
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.
